Rue Belliard 35, B-1040 Brussels, tel: +32 2 286 18 11, www.eftasurv.int

Brussels, 26 March 2021 Case No: 86598 Document No: 1200352 Decision No 023/21/COL

[Non-confidential version]

[The information in square brackets is covered by the obligation of professional secrecy]

Ministry of Finance and Economic Affairs Arnarhvoli 101 Reykjavík Iceland

Subject:

Aid to Farice ehf. for investment in a third submarine cable

1 Summary

(1) The EFTA Surveillance Authority (“ESA”) wishes to inform Iceland that, having assessed the aid to Farice ehf. for investment in a third submarine cable (“the measure”), it considers that the measure constitutes state aid within the meaning of Article 61(1) of the EEA Agreement and decides not to raise objections1 to the measure, as it is compatible with the functioning of the EEA Agreement, pursuant to its Article 61(3)(c). ESA has based its decision on the following considerations.

2 Procedure

(2) The Icelandic authorities notified the measure on 23 March 2021.2

3 Description of the measure

3.1 Factual background

(3) Iceland is among the world’s most digitalised countries and reliance on international telecommunications connectivity is a critical component for most sectors of Icelandic society.

(4) Farice ehf. (“Farice”) currently operates the two submarine cables running from Iceland to Europe, FARICE-1 and DANICE. FARICE-1 runs from Seyðisfjörður, on the east coast of Iceland, and lands in Scotland, with a branch unit into the Faroe Islands. DANICE runs from Landeyjarsandur, on the south coast of Iceland, and lands in Denmark. The routes of FARICE-1 and DANICE, the only submarine cables running from Iceland to Europe, intersect in the Atlantic Ocean. A third submarine cable, Greenland Connect, runs from Iceland to Canada (see Section 3.2.2).

(5) FARICE-1 was laid in 2003 and put into commercial operation in 2004. The Icelandic Government participated in the financing of the project by: (a) granting a state guarantee in the amount of EUR 9.4 million; and (b) providing a capital injection in the amount of EUR 13 million. In July 2006, ESA concluded that these measures constituted compatible state aid.3

1 Reference is made to Article 4(3) of the Part II of Protocol 3 to the Agreement between the EFTA

States on the Establishment of a Surveillance Authority and a Court of Justice. 2 Documents No 1189996, 1190000 and 1190159, and attachments, Documents No 1189980,

1189982, 1189986, 1189988, 1189990, 1189992, 1189994, 1190002, 1190004 and 1190006. 3 See ESA’s Decision No 227/06/COL State aid in favour of Farice hf.

Page 2

(6) Preparations for the second cable, DANICE, commenced in 2007. At the time, Farice was jointly owned by Icelandic telecommunications operators and the

Icelandic Government. The construction of DANICE was funded on market terms.4

DANICE was put into commercial operation in 2009.

(7) Farice entered into severe financial difficulties in 2008 as a result of the financial crisis and the devaluation of the Icelandic currency. From 2010 to 2012, the Icelandic authorities initiated measures for the restructuring of Farice. These measures included a capital increase, debt conversion and a state guarantee. In addition, Farice and the Icelandic authorities entered into a public service contract whereby the Icelandic authorities provided Farice with funding to support the operations of the company. On 19 July 2013, ESA issued a comfort letter to Iceland regarding the public service contract.5

(8) On 23 February 2021, ESA received a complaint from Sýn ehf. (“Vodafone Iceland”) regarding Farice.6 In its complaint, Vodafone Iceland alleges that Farice has received public service compensation from the Icelandic authorities in violation of SGEI rules,7 including compensation for costs related to surveys conducted in preparation for a possible third submarine cable. At the date of this decision, the complaint case remains open.

3.2 Policy background and current vulnerabilities of international connections

3.2.1 Iceland’s Telecommunications Policy

(9) On 3 June 2019, the Icelandic Parliament adopted a parliamentary resolution approving the Government’s telecommunications policy for the years 2019–2033 (“the Telecommunications Policy”).8

(10) The objectives of the Telecommunications Policy are, inter alia, to promote accessible and effective communications and to guarantee the security of telecommunication infrastructures.

(11) To achieve those objectives, the Telecommunications Policy emphasises that three active submarine telecommunications cables shall connect Iceland with Europe from different landing sites. As a geographically remote country, effective international connections are a prerequisite for the development of Iceland as a modern technology-based society. A substantial part of IT systems in use in Iceland today are hosted in data centres outside of Iceland. A serious disruption in international connectivity would cause major damage to the Icelandic economy and society as a whole.

(12) According to a risk assessment produced by Farice, the main vulnerabilities of the current international connections network relate to human error, malfunctions, accidents, natural disasters and other unforeseen events.9 Furthermore, the lengths of the submarine cables increase the probability of incidents compared to shorter cables going from Scandinavia and the UK to mainland Europe. Moreover,

4 See ESA‘s Decision No 787/08/COL regarding the DANICE project.

5 See, ESA comfort letter of 19 July 2013.

6 Document No 1182556.

7 “SGEI” stands for “Services of General Economic Interest”.

8 https://www.althingi.is/altext/pdf/149/s/1688.pdf.

9 See Document No 1190004.

Page 3 other countries in the EEA are connected to major international network connection points via a diversified network of multiple land and/or submarine cables while Iceland is dependent on only two submarine cables.

3.2.2 Greenland Connect submarine cable

(13) A third submarine cable, Greenland Connect, owned and operated by Tele Greenland, terminates in Iceland and its traffic is directed through Danice and FARICE-1 on the way to Europe. It is possible to buy services to mainland Canada, and from there to New York, from Tele Greenland. However, the Icelandic authorities consider that Greenland Connect does not meet the requirements for serving as a backup for Iceland.10

(14) In this context, for a cable to provide additional security it needs to have a separate risk profile from existing cables. As Greenland Connect shares a landing station and the route out from Iceland with DANICE, it does not meet the required criteria of a backup cable. In addition, the marine route of the cable has proven to be faulty with long periods of outage. In December 2018, Greenland Connect experienced a fault that lasted until August 2019. Also prior to that, Greenland Connect had experienced multiple faults.

(15) Moreover, one of the more serious risk factors that needs to be mitigated with a backup cable is the need for the network to withstand flooding from a large volcanic eruption of the Katla volcano that is situated close to the landing site of DANICE and Greenland Connect. A severe flooding that would cause harm to the landing station or cables close to the mountain would cause fault in both DANICE and Greenland Connect at the same time. For these reasons, the Icelandic authorities do not consider Greenland Connect to meet the requirements needed to secure international connections to Iceland.

3.2.3 Current vulnerabilities of international connections

(16) According to the Icelandic authorities, the current risks relating to possible malfunctions to international connections have been analysed in a statistical model taking into account the probability of a total outage, meaning an outage of both paths simultaneously during a 10-year period, and the proportional projected availability. Simultaneous interruptions of the submarine cables would be the worst case scenario and the single most critical risk factor. The expected11

theoretical availability of both cables as one system is 99.96% and therefore the probability of one outage during a 10-year period is 12%.12 A simultaneous outage of both cables has an expected duration of about 10 days, meaning no international service would be provided by Farice to Iceland during that period. The calculations above only model pure submarine failures. Other threats on-land increase the outage probability.

(17) Furthermore, there are permanent risk factors that could disrupt the international connection network. The most realistic risk factors are disruptions caused by

10

The requirements for increased security in international connectivity by a third cable are based on the objectives of the Icelandic authorities in its Telecommunications Policy. 11

Based on international statistics of submarine cable where Mean Time Between Failures (MTBF) is 3 years and assumed repair time (MTTR) of 3 weeks per cable. 12

Based on exponential distribution: p(failure during a period T) = 1 - P(no failure) = 1- e-(T/MTBF)

, where T = 10 years, e=2.71 and MTBF is the Mean Time Between Failures for the system in years.

Page 4 human error, e.g. mistakes and disruptions caused by fishing vessels or other man-made objects in the ocean. Should a fishing vessel cause a submarine cable to break, the repair time will be counted in weeks, or months should the break occur during wintertime, as the repair vessels require favourable weather conditions to operate. During such a period, Iceland would only be connected to Europe via a single submarine cable, where a simple land connection failure will cause a full network outage.

(18) Moreover, there are several natural events that could jeopardise the security of FARICE-1 and related terrestrial routes. Mainly, there is a possibility of flooding in the Skeiðará river in south Iceland which could rupture the southern path of the terrestrial cables of FARICE-1 causing outage for weeks. This would result in the disconnection of a large part of FARICE-1 as traffic cannot be re-routed to the northern path within a short timeframe.

(19) According to the Icelandic authorities, carriers (service providers) try to distribute the waves on the south and north route as much as possible. For smaller carriers that is challenging. A failure in the south route can potentially take 25%–50% of the available bandwidth from a service provider, which would result in worse service and possible damage to end users.

(20) The main risk factors concerning DANICE are, as previously mentioned, related to a volcanic eruption in Katla, which could lead to a flood in the Markarfljót river. Such a flood could be capable of inflicting severe damage on the DANICE cable and the installations and equipment on its landing site in Landeyjasandur. A volcanic eruption in Katla can furthermore create turbidity currents on the seabed that can cause disruption of submarine cables even if the landing station would not be damaged by the flooding. This can affect cables up to hundreds of kilometres off the coast.

(21) The Icelandic authorities note that the significance of the described vulnerabilities must be assessed in light of the extreme weather conditions and the prevalence of natural disasters in Iceland and the heightened risk of such disasters due to climate change. As these events are unforeseeable and extremely hard to fully prepare for, the only realistic cause of action to reduce the likelihood of network disruption is to increase the redundancy of submarine cables and landing sites by laying a third submarine cable from Iceland to Europe.13

(22) The addition of a third submarine cable would make a single route cut less impactful, due to an increased diversity of routes. Moreover, by adding a third cable to the system the security of international connectivity increases circa tenfold. The projected uptime increases to 99.9993% and the probability of a total outage in a 10-year period is reduced to 0.2–1.5%.

(23) Consequently, and in relation to the Icelandic authorities’ work on the Telecommunications Policy, Farice signed an agreement with the

13 The Icelandic authorities note that satellite connections are not a viable security backup in the

event that both submarine cables fail. The possible bandwidth that a satellite can offer is 0.1–1% of the needs of Iceland, as satellites are not designed to carry big trunk capacities. The satellites could only carry the most critical services, for example for the finance and airline industries. Cloud computing that most enterprises rely on requires much more bandwidth than is possible with satellites. Satellites also have higher latency. Satellites as a backup in Iceland were last used in 2003.

Page 5 Telecommunications Fund (Fjarskiptasjóður) in December 2018, engaging Farice to start preparations for the possible construction of a new submarine cable between Iceland and Europe, i.e. the IRIS cable project, described in detail in Section 3.7. The Icelandic authorities note that the agreement did not entail any obligation on or pledge by either party as regards the funding, investments or realisation of the possible laying of the new cable, and that the project was at that stage only a possibility.

3.2.4 Previous plans to build and operate a third submarine cable between Iceland and Europe

(24) According to the Icelandic authorities, few stakeholders have in the last decade signalled interest in investing in international data connectivity services between Iceland and Europe or America, i.e. a submarine cable. According to the Icelandic authorities, these projects have not materialised primarily due to problems with constructing a sound business case for such an investment (see also Section 3.8.2).

(25) The Icelandic authorities assert that three main issues have adversely affected the feasibility of the projects to the point where none of them have materialised: laying a single cable to Iceland without having secured redundancy is problematic; the small size of the Icelandic market is a natural hindrance; and the income from international data centre operators is uncertain.

(26) As for previous plans to build and operate submarine cables, in 2010–2016, interest was shown by the undertakings Emerald and Nordic Networks, as described in a Government report from 2018.14 Their plans entailed tapping into the AEC-1 cable which runs between America and Ireland. Those plans envisaged substantial state support and did not materialise.

3.2.4.1 Proposals by Vodafone Iceland to invest in a third submarine cable

(27) Most recently, in 2018–2020, the Icelandic Ministry of Transport and Local Government, as well as the Ministry of Finance and Economic Affairs, received proposals from the Icelandic media and communications provider Sýn hf. (“Vodafone Iceland”), both as an independent project and in collaboration with the Norwegian undertaking Celtic Norse AS. These proposals did not entail financing in full by the private investors, but required cooperation with the Icelandic State and/or Farice. Following discussions with Farice and the Icelandic telecommunications fund (Fjarskiptasjóður) the project did not materialise, as described in more detail in the following.

(28) By way of background, the Icelandic authorities state that first discussions between Farice and Vodafone Iceland, regarding any potential co-operation concerning a new submarine cable, took place […].

(29) Farice responded to Vodafone Iceland’s proposal […].

(30) On […], the board of the Telecommunications Fund met with Vodafone Iceland, where the company presented […].

14

https://www.stjornarradid.is/lisalib/getfile.aspx?itemid=b83cf908-1e33-11e8-9425-005056bc4d74.

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(31) The board of the Telecommunications Fund informed the Icelandic authorities about these developments. The board recognised that any action or decision relating to this proposal from Vodafone Iceland would go beyond its purview. However, it was agreed to hire an independent consultant to compare the two projects, i.e. the proposed plans of Vodafone Iceland and Farice’s IRIS project.

(32) According to the Icelandic authorities, the specialist hired for the task was instructed not to make recommendations. However, the final report included recommendations and relied on available, but unverified, data from Farice and Vodafone Iceland.

(33) In April 2020, the board of Farice received a letter from the Ministry of Transport and the board of the Telecommunication Fund, in which Farice was informed that the conclusion of the specialist report was […].

(34) Farice then continued discussions with Vodafone Iceland […].

(35) In a meeting between Farice and Vodafone Iceland, held in May 2020, Vodafone Iceland stated that […].

3.2.5 Summary

(36) Against this background, the Icelandic authorities consider that there exists a need to construct a third submarine cable from Iceland to Europe. They have selected Farice to own, operate and oversee the construction of that submarine cable (“the IRIS cable”).

3.3 Objective

(37) The primary objective of the measure is to enhance security and reduce the vulnerability of international connectivity to and from Iceland by building a third submarine cable from Iceland to Europe.

(38) The secondary objective is to shorten the digital distance between Iceland and Europe, by reducing data latency, allowing Icelandic people and businesses to make better use of international digital services available in Europe.

3.4 National legal basis

(39) The measure is based on parliamentary resolution No 31/149, approving the Government’s Telecommunications Policy, and parliamentary approval of the State budget to finance the project with public funds.15

3.5 Granting authority

(40) The granting authority is the Ministry of Finance and Economic Affairs (“the granting authority”).

3.6 Beneficiary

(41) Farice is a private limited liability company established in Iceland in accordance with Act No 138/1994 on Private Limited Liability Companies (lög um einkahlutafélög). Farice was neither established nor does it operate under special legislation.

15 See Article 5.15 of the State Budget for 2021 (5.14 Að auka við hlutafé í Farice ehf. með það að

markmiði að standa undir fjármögnun á lagningu á nýjum sæstreng).

Page 7

(42) The purpose of Farice, according to its articles of association, is the wholesale of international data transfer between countries through a fibre optic cable, the operations of fibre optic cable systems and the sale of services in relation to such activities.

(43) As previously mentioned, Farice operates the FARICE-1 and the DANICE submarine cables between Iceland and Europe. Farice uses the submarine cables to provide international telecommunication services to its customers between designated service points in Iceland and Europe. The products offered to customers are 100G/10G waves primarily sold to telecommunication carriers from Iceland, the Faroe Island and Greenland, and the largest customers of Icelandic data centres that provide services to international customers.

(44) Farice also offers connectivity via IP transit service and circuit connections (Ethernet or SDH) between connection points in Iceland and Europe to carriers and data centre customers. Farice does not provide any other telecommunication services in the Icelandic market, but buys access to telecommunication infrastructure as needed to provide services between designated service points. For example, to be able to provide connectivity services from a main network hub in Iceland to an internet exchange in London, Farice buys telecommunication services from Míla in Iceland connecting the Icelandic network hub with the FARICE-1 landing site in Seyðisfjörður.

(45) The company has no subsidiaries. The company owns a landing station in the UK for the landing of FARICE-1 and a landing station in Iceland for landing of the DANICE cable. Facilities for landing in Denmark for DANICE and Seyðisfjörður and in the Faroes for FARICE-1 are leased.

(46) The company is fully owned by the Icelandic State and all long-term borrowing comes from the Treasury. The State acquired the company in full in March 2019 following the classification of international submarine cables as infrastructure by the Icelandic Government.16

(47) Farice is currently operated on commercial terms without financial support from the State.17

(48) The objectives of the economic model of Farice are twofold, reflecting the two markets that Farice operates on:

16 According to the Icelandic authorities, the Prime Ministry is currently working on a legal

framework for the legal classification on which segments of infrastructure should be considered as critical infrastructures from a national security perspective. This is further described in a recent report from the Prime Minister to the Icelandic Parliament on infrastructure and national security. The report states that international connectivity is viewed as a cohesive system, including both submarine cables and terrestrial broadband connections. This cohesive system is considered a critical infrastructure from a national security perspective as stated in the report. The Department of Civil Protection and Emergency Management (Almannavarnir) has further classified submarine cables as critical infrastructure in its policy documents and has included scenarios involving connectivity failures of submarine cable in its risk assessments. 17

In 2013–2018, Farice received public service compensation from the Telecommunications Fund for offering electronic communications connectivity between Iceland and Europe through FARICE-1 and DANICE. The last payment on this basis was made on 4 October 2018. Farice further received public service compensation from the telecommunications Fund for seabed survey from 2020–2021. The last payment on this basis was made on 15 January 2021 for invoices issued in December 2020.

Page 8

(i) That Farice’s revenue stream supports the renewal and reasonable yield of its investments which are comprised of two telecommunications cables to Europe (“Telco market”).

(ii) That Farice offers internationally competitive prices to customers of Icelandic data centres (“DC market”).

(49) In order to achieve the first objective, Farice sells international connectivity services to Icelandic, Faroese and Greenlandic telecommunications companies where the prices reflect the cost base of Farice, including depreciation and the return on equity required by its shareholder. The second objective is achieved by offering internationally competitive prices to customers of Icelandic data centres reflecting the market environment at each time. The latter objective therefore supports the former as the increase in revenues and contribution margin from customers of data centres reduces the dependence on revenues from telecommunications companies.18

(50) Farice’s pricing policy to telecommunications operators is based on a unit 10G reference price published on Farice’s website.19 The reference price is revised annually to reflect Farice’s development in relation to its economic model. According to the Icelandic authorities, this provides for transparent and non-discriminatory pricing on market terms. The Icelandic authorities also note that access to international connectivity services is granted by Farice in an open and non-discriminatory manner.

(51) In this regard, the Icelandic authorities note that Farice’s operations fall under the scope of the Electronic Communications Act No 81/2003 and under the supervision of the Post and Telecom Administration of Iceland (“Póst- og fjarskiptastofnun”). The Electronic Communications Act implements relevant EEA legal instruments relating to the electronic communications sector. Farice is a licensed telecommunications operator and has a general license to operate electronic communications networks and provide electronic communications services.

(52) The supervisory role of the Post and Telecom Administration entails ensuring that the integrity and security of public communications networks are maintained. Such rules follow mainly from administrative regulations such as rules relating to the functionality of public communications networks and the protection of information in public communications networks.20

(53) The Post and Telecom Administration has authority to impose certain obligations on Farice under the Electronic Communications Act regarding operators with significant market power. Firstly, Article 28 of the Act gives the Administration authority to require operators to provide open access to third parties to, and use of, specific network facilities. Article 28 corresponds to Article 12 of Directive

18

See Document No 1190006. 19

http://is.farice.is/thjonusta/verdskra/ 20

Regulation No 1222/2007 on functionality of public communications networks and No 1221 on protection of information in public communications networks. See a complete breakdown of relevant laws and regulations applicable to telecommunications operators in Iceland on the website of the Post and Telecom Administration – https://www.pfs.is/log-reglur-og-urlausnir/log-og-reglur-um-fjarskipti/.

Page 9 2002/19/EC (“the Access Directive”).21 Secondly, Article 30 of the Act gives the Administration authority to impose obligations of non-discrimination in relation to interconnection and/or access, in particular to provide equivalent services under the same conditions. This obligation extends inter alia to prices in contracts with customers. Article 30 corresponds to Article 10 of the Access Directive. Articles 29 and 32 of the Act further grant the Administration powers with regard to transparency and supervision of price indexes.

(54) The Icelandic authorities stress that the Post and Telecom Administration has not imposed restrictions on Farice, relating to prices on the Telco market, but is nevertheless competent to step in should a problem arise.

(55) Farice’s non-discriminatory and equal pricing obligations also stem from competition law. The Icelandic authorities have stated that Farice thus grants non-discriminatory and open access to telecommunications operators in line with Article 11 of the Competition Act No 44/2005, as Farice is in a dominant position for international connectivity services to and from Iceland and is therefore obliged to provide equal terms to its counterparties.

(56) According to information provided by the Icelandic Authorities, Farice mainly sells services to internet services providers and general telecom services providers. The service providers are all treated equally whether they are Icelandic or foreign providers seeking international connectivity to Iceland. Farice does not in general sell to the enterprise market with the exception of the export data centre market. The nature of data services is such that larger bandwidths can be divided into smaller bandwidths and resold again into the same wholesale market. As a result, a service provider buying from Farice can also operate in the wholesale market for international connectivity. A small service provider may therefore engage larger service providers to sell them international connectivity. According to the Icelandic authorities, Farice does not view other service providers as competitors for international connectivity services.

(57) Today, the two existing submarine cables generate enough revenue to support the operations, loan payments and financing costs of Farice. Moreover, the two current cables are not at full capacity, meaning that any investment in a third cable does not address capacity needs.

(58) According to the Icelandic authorities, the current economic model of Farice does not support the financial burden of a third cable. The company has, since the construction of DANICE, never returned a profit and is expected to continue to operate at a loss until 2025, when FARICE-1 will have been depreciated in full. The engineering lifetime of submarine cables is 25 years and Farice’s economic model therefore needs to assume renewal of FARICE-1 by 2028 and DANICE by 2034.

3.7 The IRIS cable project

3.7.1 Background

(59) As previously mentioned, in relation to the Icelandic authorities’ work on the Telecommunications Policy, Farice signed an agreement with the

21

Directive 2002/19/EC of the European Parliament and of the Council of 7 March 2002 on access to, and interconnection of, electronic communications networks and associated facilities (OJ L 108, 24.4.2002, p. 7).

Page 10 Telecommunications Fund in December 2018, engaging Farice to start preparations for the possible construction of a new submarine cable between Iceland and Europe, the IRIS cable.

(60) Since then, Farice has engaged in researching and analysing the most suitable route and structure of the proposed new submarine cable along with preliminary designs for the connection of the submarine cable with telecommunications networks in Iceland, in cooperation with, and for the benefit of, the Telecommunications Fund.

(61) According to the Icelandic authorities, they are not required to tender out a project concerning the construction of a third submarine cable to Europe, as it concerns the provision of a public communications network (see also Section 3.7.3). Accordingly, the Icelandic authorities decided to choose Farice, which is fully owned by the Icelandic state, to own and operate the new submarine cable and oversee its construction.

(62) According to the Icelandic authorities, Farice was chosen because it is the only entity that; (i) currently operates submarine cables from Iceland to Europe, (ii) has extensive experience in such operations, and (iii) is able to work fast in seeing the project through within the desired timeframe.

3.7.2 The IRIS Cable

(63) The new submarine cable will run from Iceland to Ireland. The current cables run from Iceland to the United Kingdom and Denmark. Connecting the cable with Ireland will ensure a low-risk path that does not intersect other submarine cables, diversification in landing sites, and cost-effectiveness as a result of Ireland’s geographical proximity to Iceland.

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Image 1: The paths of FARICE-1 and DANICE, and the proposed path of IRIS.

(64) The Icelandic authorities note that as this cable is supposed to increase security of connectivity for Iceland there are certain restrictions on where the cable can land in Iceland. As previously stated, there are natural hazards almost everywhere in Iceland, which calls for diversification of risk. For that purpose, it is important that the landing stations for the cables are situated in different risk areas which makes them less likely to fail at the same time. Further, it is optimal that the new cable does not intersect with the other two cables to prevent the risk of a single point of failure event. These constraints entail that the optimal landing site of the cable is in the area west of the DANICE landing site (Landeyjasandur).

(65) […]

(66) The Icelandic authorities note that access to Farice’s network is granted in designated points of presence (POP) that are large data centres or telecommunication hubs where all the major telecommunication carriers have network connections. The IRIS cable will follow the same logic, with access provided in POP’s, not at the landing site of the cable.

(67) The new submarine cable is in principle expected to complement the existing submarine cable infrastructure. The interconnection to the new cable will be technologically neutral, provided that instructions and recommendations are followed.22

22

The new IRIS cable will be based on an open cable architecture which means that customers can be given an access to the infrastructure by using their own terminal equipment. Access to

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(68) Moreover, Farice as the operator of the new cable will grant effective wholesale access to the system on an open and non-discriminatory basis. According to the Icelandic authorities, the access obligations will be enforced irrespective of any change in ownership, management or operation of the infrastructure.

3.7.3 Selection of cable manufacturer and installer

(69) Public procurement rules in Iceland are governed by Act No 120/2016 on public procurement (“the Procurement Act”). The Procurement Act implements Directive 2014/24/EU on public procurement (“the Procurement Directive”).

(70) According to the Icelandic authorities, the project is exempt from the Procurement Act with reference to Article 10 of the Act, see Article 8 of the Procurement Directive, as the Act and the Directive do not apply to contracts for the principal purpose of permitting the contracting authorities to provide or exploit public communications networks, or to provide to the public one or more electronic communications services.

(71) However, according to the Icelandic authorities, Farice has opted to engage possible suppliers in the spirit of the public procurement rules by receiving offers from interested parties and selecting the most economically efficient offer, having taken into account all relevant considerations.

(72) There is a limited number of suppliers that can build and lay submarine cables. Furthermore, the rapid growth of the worldwide digital economy has fuelled demand for new cables causing limited availability of specialised cable laying vessels and manufacturing plants. Farice was in direct contact with three suppliers in the first round of supplier selection and received budgetary offers from those suppliers by the end of 2019 for connection between reference landing sites in Iceland and Ireland. The suppliers were Subcom, Alcatel Submarine Network (“ASN”) and Huawei Marine. Updated firm offers where received from ASN and Subcom in June 2020, as the landing site in Ireland had been selected by then.

(73) Having reviewed the previous offers presented, Farice asked the two companies to present final offers in August 2020. The offers contained detailed information with regard to the execution of the project, work schedules and time schedules with regard to the construction and laying of the cable.

(74) ASN’s offer amounted to EUR […], and the proposal entailed that financing and signing of contracts would be concluded […], with the company then being able to roll out the cable […]. Subcom’s offer amounted to EUR […], and the proposal entailed that financing and signing of contracts had to be concluded by end of […]. The offer further proposed that the cable would be laid […].

[…] Figure 1: Cable manufacturer/installer offer comparison.23

(75) After considering the offers, Farice decided to engage Subcom, which had the lowest offer at EUR […], for exclusive negotiations, taking into account also […].

infrastructure can be granted by own fibre pair or fractional fibre pair (spectrum). Furthermore, the technology to use the submarine cable is standardised and based on Ethernet, which is the technology commonly used. A more advanced interface in the form of OTU2, OTU3 and OTU4 is also offered. 23

Document No 1189990.

Page 13

(76) In preparation for the IRIS cable project, Farice has worked with Subcom24 along with McMahon Design and Management Ltd.25 and EGS Survey,26 which have worked on seabed research on the coast of Ireland.

3.8 The measure

3.8.1 Aid instrument, intensity and budget

(77) The aid instrument will be in the form of an estimated EUR 50 million share capital increase for the benefit of the recipient, Farice. The aid amount is estimated and subject to reduction should the eligible costs prove lower than the estimate.

(78) The eligible costs are the investment costs related to the new cable, costs relating to survey of the seabed and the optimal path of the cable,27 construction of landing sites and project management. The costs are considered investment costs, including project management costs which are directly related to the investment project. Costs already incurred by Farice relating to the investment in the IRIS cable are not considered eligible costs.

(79) The Icelandic authorities have estimated the cost of the project at approximately EUR 50 million divided in the following segments:

[…] Figure 2: Estimated cost of the IRIS cable project.

(80) The maximum aid intensity is 100% of the eligible costs. The board of directors of Farice will authorise the capital increase in intervals during the construction period of the new cable. The financing needs of the recipient will be assessed at each interval and only established costs will be granted through the capital increase. The granting authority will review any expenses of the recipient and will control overcompensation retroactively by a capital decrease, dividend payments or other available means.

(81) Therefore, the share capital increase will be solely applied to the construction of the new cable. […]

(82) As for possible alternative financial instruments that the measure could have included, the Icelandic authorities note that due to various factors related to investing in the IRIS cable project, detailed in Section 3.8.2 below, a loan or guarantee would not be feasible. In particular, the Icelandic authorities note that a loan would necessitate a price increase to Farice’s customers, which its customers would find unacceptable. This is because a realistic case of sales over IRIS returns a negative EBITDA throughout the lifetime of the cable, which in turn means that the IRIS project cannot sustain any form of interest payments without increasing revenues elsewhere, i.e. though a price increase. A capital increase from the market is also impossible since market investors would require a rate of

24

https://www.subcom.com/. 25

http://www.mdmeng.ie/. 26

http://www.egssurvey.com/Home.html. 27

The costliest part of the seabed survey is the detailed mapping of the seabed on the projected route of the cable. This type of research is done by specialised research ships with high-tech equipment. This specialised seabed survey, i.e. survey of the seabed on the path of the new cable in the Atlantic Ocean and the further surveys at the shore if Iceland have not yet been done and will be funded by the aid measure.

Page 14 return on equity which Farice would not be able to deliver.28 The Icelandic authorities have therefore opted to fund the project with a direct capital increase.

(83) Farice’s auditors have concluded that the capital increase would be in accordance with Icelandic accounting law although the value of IRIS on Farice’s accounts might have to be reduced through an annual impairment test of the asset. In the consolidated accounts of the Icelandic State, the value of IRIS might however be maintained as it will be part of the national infrastructure of Iceland and as such have value for the Icelandic State throughout the designated lifetime of the cable. The auditors of Farice have further concluded that the IRIS project should be kept separate from Farice’s commercial activities in the accounts of Farice following the completion of the project.

(84) Finally, according to the Icelandic authorities, it is not feasible for market operators to undertake investments in the project in the absence of aid. This is due to the long investment period, highly uncertain customer volume and other factors, which make the profitability of the IRIS project very uncertain (see further Section 3.8.2). The Icelandic State therefore acts as an investor in the project, but the investment is not made on market terms for the reasons mentioned above and detailed in the next section.

3.8.2 The investment case for the IRIS Cable project

(85) As already noted, Farice has since the DANICE cable was constructed never returned a profit, and has received compensation from the Icelandic authorities for many years through a public services contract.

(86) According to the Icelandic authorities, the current income of Farice from its customers is budgeted to be EUR […] million in 2021, leading to a budgeted net income loss of EUR […] million.

(87) Farice management has constructed a long-term operating model to capture the balance of long-term operations with investments needs. Currently, the business is operated at a breakeven point. As FARICE-1 will have reached its end of design life in 2028 and DANICE in 2034, it is important for Farice to aggressively repay debt over the coming 8 years as an investment in the replacement of FARICE-1 must be assumed. The combined investment need for new cables will be […].

(88) The Icelandic authorities assert that the room for growth in domestic markets in Iceland, the Faroe Islands and Greenland is very limited, as carriers continue to pressure for lower cost with lower unit prices counterbalancing income for higher sold capacity. The only realistic room for growth is from the Icelandic data centre market, which has so far not lived up to growth expectations. The data centre market currently provides Farice with a revenue of EUR […] million compared with EUR […] million from operators in Iceland, the Faroe Islands and Greenland.

(89) Farice’s operating model shows that with a target equity ratio of 30% the business can service its debts, maintain investment of two cables and operate the business

28

Documents No 1189992 and 1189994.

Page 15 in a responsible manner, but the financials leave very limited room for any shareholder value or new investments, such as the IRIS cable.29

(90) […]

(91) […]

(92) […]

(93) According to the Icelandic authorities, the calculations above highlight the highly unlikely scenario of achieving acceptable return on the investment in the IRIS cable project. Any forecast for income from international data customers is purely speculative and not based on market research, customer letters of intent or other factors that could form a basis for a realistic business case. As such any forecast for the investment would not qualify against reasonable due diligence questions that private investors would require in evaluating the investment case.

(94) According to the Icelandic authorities, the analysis shows the fundamental market failure in the market for international connections to Iceland as a private investor will have to have secured sales higher than the total sales sold to international data centre customers in Iceland today over a single submarine cable, just to break even on its investment over 25 years.

(95) Finally, the Icelandic authorities note that even though market participants could in theory be willing to finance the construction of a new cable without State involvement, there is no assurance that access would be granted to market participants in an open and non-discriminatory manner, which is necessary so that the new cable can fulfil the Icelandic authorities’ objectives regarding the security of international connectivity.

4 Presence of state aid

4.1 Introduction

(96) Article 61(1) of the EEA Agreement reads as follows: “Save as otherwise provided in this Agreement, any aid granted by EC Member States, EFTA States or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Contracting Parties, be incompatible with the functioning of this Agreement.”

(97) The qualification of a measure as aid within the meaning of this provision requires the following cumulative conditions to be met: (i) the measure must be granted by the State or through State resources; (ii) it must confer an advantage on an undertaking; (iii) favour certain undertakings (selectivity); and (iv) threaten to distort competition and affect trade.

4.2 Presence of State resources

(98) The measure is in the form of a share capital increase in Farice, whose sole owner is the Icelandic State. Therefore, the measure is financed by public funds constituting State resources and is imputable to the State.

29

Document No 1190006.

Page 16 4.3 Confers an advantage on an undertaking

(99) The state aid rules only apply if the beneficiaries of the measure are undertakings. Undertakings are entities engaged in economic activities, offering goods or services on a market. The construction of a broadband network infrastructure with a view to its future commercial exploitation constitutes an economic activity.30 Since Farice will utilise the IRIS cable commercially, it is engaged in economic activities, and is therefore an undertaking.

(100) An advantage, within the meaning of Article 61(1) of the EEA Agreement, is any economic benefit, which an undertaking could not have obtained under normal market conditions, that is to say in the absence of State intervention. The measure entails a capital increase in Farice by the State as sole shareholder, in order to finance an investment in a submarine cable. While the investment could in theory be profitable, any potential profitability is contingent on rather unrealistic metrics, such as customer growth. Therefore, no market investor would enter into such an investment on terms similar to the ones present in this case. Consequently, the measure confers an advantage on Farice that it would be unable to obtain under normal market conditions.

4.4 Selectivity

(101) An advantage must be selective, in that it favours “certain undertakings or the production of certain goods”.

(102) State measures supporting the deployment of submarine cables are selective in that they exclusively target undertakings operating in certain segments of the overall electronic communications services market, namely those providing international connectivity services.

(103) Moreover, the measure is directly selective, since the envisaged capital increase benefits Farice exclusively. As for any potential indirect beneficiaries, the economic advantages entailed for them are not selective.

4.5 Effect on trade and distortion of competition

(104) The fact that a measure strengthens the position of an undertaking compared to other undertakings competing in intra-EEA trade is sufficient in order to conclude that the measure is liable to affect EEA trade.

(105) The markets for electronic communications services are open to competition between operators and service providers that generally engage in activities that are subject to trade between the EEA States. By favouring Farice, the notified measure is liable to distort competition and affect EEA trade.

4.6 Conclusion

(106) In light of the above assessment, ESA concludes that the notified measure constitutes state aid within the meaning of Article 61(1) of the EEA Agreement.

30

ESA’s Guidelines on the notion of State aid as referred to in Article 61(1) of the EEA Agreement (“NoA”) (OJ L 342, 21.12.2017, p. 35 and EEA Supplement No 82, 21.12.2017, p. 1), paragraphs 202 and 216, and ESA’s Guidelines on the application of the state aid rules in relation to rapid deployment of broadband networks (“Broadband Guidelines”) (OJ L 135, 8.5.2014, p. 49 and EEA Supplement No 27, 8.5.2014, p. 1), paragraph 7.

Page 17

5 Procedural requirements

(107) Pursuant to Article 1(3) of Part I of Protocol 3 to the Agreement between the EFTA States on the Establishment of a Surveillance Authority and a Court of Justice (“Protocol 3”): “The EFTA Surveillance Authority shall be informed, in sufficient time to enable it to submit its comments, of any plans to grant or alter aid. … The State concerned shall not put its proposed measures into effect until the procedure has resulted in a final decision.”

(108) The Icelandic authorities have notified the measure and have yet to let it enter into force. They have therefore complied with the obligations under Article 1(3) of Part I of Protocol 3.

(109) As previously mentioned, on 23 February 2021, ESA received a complaint from Vodafone Iceland regarding Farice. Vodafone Iceland alleges that Farice has received public service compensation from the Icelandic authorities in violation of SGEI rules. Part of the complaint alleges that Farice has received payments from the Icelandic authorities for seabed research related to the IRIS cable project, in violation of state aid rules. ESA considers that the scope of the complaint does not encompass the measure under assessment in this decision, since the complaint concerns payments already made that do not form the eligible costs of the measure under assessment. With regard to the alleged aid for the seabed research, this can be distinguished from investment costs for surveys, which form part of the eligible costs of the measure, as described in Section 3.8.1. Consequently, the notified measure is severable from the alleged state aid measures in the complaint.

6 Compatibility of the aid

6.1 Introduction

(110) In derogation from the general prohibition of state aid laid down in Article 61(1) of the EEA Agreement, aid may be declared compatible if it can benefit from one of the derogations enumerated in the Agreement. The Icelandic authorities invoke Article 61(3)(c) of the EEA Agreement as the basis for the assessment of the compatibility of the aid measure.

(111) The compatibility of aid for the rollout of broadband networks, for the purposes of securing coverage, access or connectivity, is normally assessed under the Broadband Guidelines.

(112) The Broadband Guidelines’ primary objective is ensuring widespread availability of broadband services to end users or access to higher speed internet. The problem targeted by the measure at hand is different, as it concerns redundancy and the level of security and robustness of the international connectivity services that are already available to the end customers at high speeds. Exposure to this type of vulnerability is to a great extent geographically determined and is probably relevant only for a small number of the Contracting Parties. The fact that Iceland is a very remote and small market has undoubtedly contributed towards the channelling of most international traffic through two submarine cables.

(113) The Broadband Guidelines do not specifically lay down compatibility conditions for measures targeting the specific security issues raised by the lack of geographical diversity and robustness of international connectivity services, which characterise the Icelandic market. The particularities of the measure and investment at hand

Page 18 demonstrate that the Guidelines target different types of measures than the one under assessment. The need for intervention is also different as the Guidelines target situations where the market does not provide sufficient broadband coverage or the access conditions are not adequate.31

(114) ESA considers that the Baltic Sea Cable infrastructure, assessed by the Commission directly under the Broadband Guidelines,32 was more suited for direct application of the Broadband Guidelines, as it specifically targeted the expected dramatic increase of traffic that could not be supported by the existing infrastructure (capacity concerns). Hence, the Baltic Sea Cable targeted (long-term) broadband availability specifically, although also bringing a number of security benefits comparable to the ones present in the case at hand.

(115) As the measure specifically targets the security issues raised by a lack of geographic diversity (redundancy), it falls outside the scope of the Broadband Guidelines.33 Nevertheless, the Broadband Guidelines are the most detailed guidance available for assessing the compatibility with the EEA Agreement of state aid to broadband infrastructure projects. ESA will therefore apply the principles of the Broadband Guidelines by analogy to the extent that they are relevant when assessing the measure directly under the Agreement.

(116) Article 61(3)(c) of the EEA Agreement provides that ESA may declare compatible “aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common interest”. Therefore, in order to declare the aid compatible, first, the aid must be intended to facilitate the development of certain economic activities or of certain economic areas and, second, the aid must not adversely affect trading conditions to an extent contrary to the common interest.34

(117) Under the first condition, ESA examines how the aid facilitates the development of certain economic activities or areas. Under the second condition, ESA weighs up the positive effects of the aid for the development of said activities or areas and the negative effects of the aid in terms of distortions of competition and adverse effects on trade.

6.2 Facilitation of development of certain economic activities or areas

6.2.1 Economic activities or areas supported

(118) Under Article 61(3)(c) of the EEA Agreement, in order to be considered compatible, a measure must contribute to the development of certain economic activities or areas.

(119) The primary objective of the measure is to enhance security and reduce the vulnerability of international connectivity to and from Iceland by building a third submarine cable from Iceland to Europe. The secondary objective is to shorten

31

The Broadband Guidelines, paragraphs 34–35. See also the pre-requisites for defining a service as an SGEI in paragraph 16. 32

Commission Decision SA.36918 (Finland), Baltic Sea Backbone Cable, OJ C 422, 8.12.2017, p.1. 33

See also Decision No 065/2019/COL Alternative pathway for electronic communications traffic, C 419 12.12.2019 p. 12. 34

Judgment of 22 September 2020, Austria v Commission (Hinkley Point C), C-594/18 P, EU:C:2020:742, paragraphs 18–20.

Page 19 the digital distance between Iceland and Europe allowing Icelandic people and businesses to make better use of international digital services available in Europe.

(120) As previously explained, the construction of a broadband network infrastructure with a view to its future commercial exploitation constitutes an economic activity.35 Furthermore, the telecommunications market in general constitutes an economic activity. The measure facilitates development in the market for international data transfer services specifically and the markets for electronic communications services in general.

(121) In view of the above, ESA considers that the measure constitutes aid to facilitate the development of certain economic activities, as required by Article 61(3)(c) of the EEA Agreement.

6.2.2 Incentive effect

(122) State aid is only compatible with the functioning of the EEA Agreement if it has an incentive effect and so effectively facilitates the development of certain economic activities. To establish whether the measure has an incentive effect, it must be demonstrated that it changes the behaviour of the undertaking concerned in such a way that it engages in an activity which it would not carry out without the aid or which it would carry out in a restricted or different manner.

(123) As mentioned in Section 3.1, Farice is the only owner and operator of submarine cables going from Iceland to Europe and has not generated a profit since the construction of the second submarine cable (DANICE). Therefore, the operation of submarine cables in this region can be considered not generally profitable. Moreover, while the revenues from the two existing cables are currently sufficient to support the operations and renewal of the two cables, the current revenue streams would not be sufficient to cover the investment in and operations of a third cable to Europe. Securing financing on market terms would necessitate a price increase to Farice’s current customers, which they would not be ready to take on (see paragraph (82)), and a capital increase from the market would require a rate of return on equity which Farice would not be able to deliver.

(124) In this context, as stated in Section 3.8.2, the investment that is financed by the measure, the IRIS cable, is unlikely to turn a profit, even with the aid. For Farice to achieve an acceptable IRR, several compounding factors would have to materialise, which ESA considers unlikely.

(125) Specifically, the only income increase that can be assumed from the IRIS cable is due to sale of bandwidth to international customers in Icelandic data centres, but the level of income is highly uncertain. […] These figures strongly indicate that the IRIS cable project is most likely unprofitable with aid and therefore even more unprofitable absent aid.

(126) Moreover, as mentioned in paragraph (37), the objective of the measure is primarily the security of international connections to Europe from Iceland. This security concern is an externality that would most likely not be taken into account

35

ESA’s Guidelines on the notion of State aid as referred to in Article 61(1) of the EEA Agreement (“NoA”) (OJ L 342, 21.12.2017, p. 35 and EEA Supplement No 82, 21.12.2017, p. 1), paragraphs 202 and 216, and ESA’s Guidelines on the application of the state aid rules in relation to rapid deployment of broadband networks (“Broadband Guidelines”) (OJ L 135, 8.5.2014, p. 49 and EEA Supplement No 27, 8.5.2014, p. 1), paragraph 7.

Page 20 if Farice was considering an investment opportunity on a purely commercial basis. While the third submarine cable will increase the data capacity of Farice’s submarine cable network, ESA notes that Farice is neither experiencing acute lack of capacity, nor can they realistically expect an imminent need that exceeds the capacity of the current two cable network. When these factors are taken together, ESA finds it clear that Farice would not make an investment in a third submarine cable in the absence of aid, since a market operator would not enter into an expensive long-term investment with uncertain returns to address an externality of a public interest (security) on a market that already has sufficient connectivity capacity.

(127) Finally, over the past decade, few stakeholders have signalled interest in investing in international data connectivity services between Iceland and Europe or America. Potential projects have not materialised, primarily due to problems with constructing a sound business case for such an investment. In any case, the projects would have been dependent on financial participation by the State (see Sections 3.2.4 and 3.2.4.1). This further demonstrates that a market-based investment in a third submarine cable is generally unattractive to market participants, including Farice.

(128) Taken together, these factors demonstrate that the measure facilitates an investment that Farice would not undertake in the absence of aid. Therefore, the aid measure has an incentive effect.

6.2.3 Compliance with relevant EEA law

(129) As explained in paragraphs (61), (62) and (70), the Icelandic authorities consider that the selection of Farice as owner and operator of the IRIS cable, as well as the selection of cable manufacturer and installer, is exempt from the Procurement Act with reference to Article 10 of the Procurement Act (see Article 8 of the Procurement Directive).

(130) Specifically, Article 8 of the Procurement Directive states: “This Directive shall not apply to public contracts and design contests for the principal purpose of permitting the contracting authorities to provide or exploit public communications networks or to provide to the public one or more electronic communications services. For the purposes of this Article, ‘public communications network’ and ‘electronic communications service’ shall have the same meaning as in Directive 2002/21/EC of the European Parliament and of the Council.” Furthermore, ESA notes that in accordance with Article 2(m) of Directive 2002/12/EC, ‘provision of an electronic communications network’ means the establishment, operation, control or making available such network.

(131) The primary objective of the measure in question is to increase security of international connectivity in Iceland by building a third submarine cable, which in turn will provide the public with more electronic communication services. Therefore, the investment in the submarine cable will permit Farice to “provide or exploit public communications networks”, as defined in Article 2(a) of Directive 2002/21/EC. Consequently, ESA considers that the measure in question falls under the exception provided for in Article 8 of the Procurement Directive.

(132) Farice has however opted to engage possible suppliers in the spirit of the public procurement rules (see Section 3.7.3), by receiving offers from interested parties

Page 21 and selecting the most economically efficient offer, having taken into account all relevant considerations.

(133) The measure’s conformity with other relevant EEA law is also ensured, since access to operators on the telecommunications market will continue to be granted on equal terms in an open and non-discriminatory manner, in conformity with requirements of competition law.

(134) In that context, ESA notes that Farice publishes its reference prices online (see paragraph (50)). Moreover, Farice is obliged to comply with all relevant laws and regulations relating to its role as a licensed telecommunications operator (see paragraphs (51) to (53)). Farice will therefore observe all relevant principles of the telecommunications legal regime, including the open access and equal treatment between categories of providers and the principle of technological neutrality. The measure does not change this fact and therefore does not in and of itself cause issues with conformity to relevant EEA law.

(135) Consequently, the measure does not raise issues as regards conformity with relevant EEA law.

6.3 Whether the aid adversely affects trading conditions to an extent contrary to the common interest

6.3.1 Introduction

(136) ESA has not only identified positive effects of the planned aid for the development of the abovementioned economic activities, but also possible negative effects that it may have in terms of distortions of competition and adverse effects on trade. These positive and negative effects must then be weighed against each other.

6.3.2 Markets affected by the aid

(137) The measure mainly has an effect on the wholesale market for international connectivity and the telecommunication market, both national and international. Additionally, the measure may have an effect on the market for data centres.

6.3.3 Positive effects of the aid

(138) The measure contributes to the development of a submarine cable between Iceland and Europe, thereby enhancing both redundancy and the security of the submarine cable network that Iceland relies on to participate in the global economy, see Sections 3.2.1 and 3.2.3. This is in line with the Government’s telecommunications policy for 2019–2033, whose objective is, inter alia, to promote accessible and effective communications and to guarantee the security of telecommunications infrastructures.

(139) To achieve those objectives, the Icelandic authorities have emphasised that three active submarine telecommunications cables will connect Iceland with Europe from different landing sites. As a geographically remote country, effective international connections are a prerequisite for the development of Iceland as a modern technologically based society. A serious disruption in international connectivity would cause major damage to the Icelandic economy and society as a whole.

(140) According to the Icelandic authorities, the main vulnerabilities of the current international connections relate to human error, malfunctions, accidents, natural

Page 22 disasters and other unforeseen events. The Icelandic authorities have provided a detailed description of the various and multiple disruptions that have happened in the past and disrupted the functionality of the two existing submarine cables (see Section 3.2.3). ESA considers these vulnerabilities both realistic and probable.

(141) Furthermore, the absolute lengths of the submarine cables from Iceland to Europe increase the probability of incidents compared to shorter cables going from Scandinavia and the UK to mainland Europe. Moreover, the Icelandic authorities note that other countries in the EEA are connected to major international network connection points via diversified networks of multiple land and/or submarine cables while Iceland is wholly dependent on only two submarine cables.

(142) By implementing the measure and adding a third submarine cable to the network, the Icelandic authorities expect the security of international connectivity increases circa tenfold (see paragraph (22)). In particular, a third submarine cable will; (i) increase the projected uptime to 99.9993%, (ii) reduce the probability of a total outage in a 10-year period to 0.2–1.5%, and (iii) diversify the land routes in Iceland, decreasing risks associated with a single route failure.

(143) In addition to enhanced security, the Icelandic authorities contend that the addition of a third submarine cable will also improve the competitiveness of Iceland as whole as the Icelandic digital market will become “closer” to major network hubs in Europe. Data latency in communications between Iceland and Europe will be reduced as a result of shorted cable length and simpler network structure than is available through the current system connecting Reykjavík with Europe. ESA considers this factor positive, as it contributes to the development of the Icelandic economy as a whole.

6.3.4 Limited negative effects of the aid

6.3.4.1 Introduction

(144) Article 61(3)(c) of the EEA Agreement requires an assessment of any negative effects on competition and on trade. The aid must not adversely affect trading conditions to an extent contrary to the common interest.

6.3.4.2 Necessity of the aid

(145) A state aid measure is necessary if it is targeted towards situations where aid can bring about a material improvement that the market cannot deliver itself.

(146) In order to assess whether state aid is effective to achieve its objective, it is necessary to first identify the problem that needs to be addressed. State aid should be targeted towards situations where aid can bring a material improvement that the market alone cannot deliver, for example by remedying a well-defined market failure.

(147) As explained by the Icelandic authorities, Iceland is currently only connected to Europe through two submarine cables, which does not fulfil the requirements of the Icelandic authorities in terms of security of international connectivity. Greenland Connect sells connectivity through its cable but due to risks inherent with that connection it does not provide sufficiently secure connectivity to Iceland.

(148) Over the past decade, few stakeholders have signalled interest in investing in international data connectivity services between Iceland and Europe or America.

Page 23 These projects have not materialised primarily due to problems with constructing a sound business case for such an investment. Furthermore, these planned and aborted projects by market actors would have been dependent on financial participation by the State (see Sections 3.2.4 and 3.2.4.1).

(149) It seems that three main issues have adversely affected the feasibility of submarine cable projects by market actors, to the extent that none of them have materialised: laying a single cable to Iceland without having secured redundancy is risky; the small size of the Icelandic market is a natural hindrance; and the income from international data centre operators is uncertain (see paragraph (25)). ESA considers these issues permanent features in the sense that they are not likely to change in the foreseeable future.

(150) As mentioned in Section 3.2.4.1, Vodafone Iceland entered into cooperation discussions with both Farice and the Icelandic authorities regarding the third submarine cable. In particular, Vodafone Iceland offered to build a submarine cable for the Icelandic authorities for remuneration, as well as a guarantee that Farice would change its operating model. ESA notes that Vodafone Iceland’s offer was to only build the submarine cable and then hand it over to the Icelandic State to operate. Consequently, that offer cannot be considered equivalent to the measure at hand, which entails that Farice builds and then operates the third submarine cable for its entire lifetime. Therefore, the fact that Vodafone Iceland signalled interest in participating in the construction of the third submarine cable does not alter the reality of a market failure.

(151) ESA considers that the repeat failed attempts by market participants to invest in a submarine cable between Iceland and Europe, and the inability to do so without State support, as well as the fact that no other submarine cables to Europe, other than those of Farice, have been built by market participants, demonstrates that there exists a market failure when it comes to the wholesale market for international connectivity in Iceland and the building of submarine cables to Europe. This is further demonstrated by the fact that both FARICE-1 and DANICE were constructed or operated with some form of State support.

(152) Moreover, when it comes specifically to the IRIS cable project it is evident, as described in Section 3.8.2, that the market realities make an investment in a third submarine cable from Iceland to Europe financially risky and most likely unprofitable. This fact further demonstrates the market failure, as it demonstrates the general unprofitability and risk associated with the market at hand.

(153) It is therefore clear that the market has not, and cannot, deliver the objective of the Icelandic authorities, i.e. an enhancement of security when it comes to international connections to Europe.

(154) Against this background, ESA takes the view that a market failure exists which necessitates State involvement.

6.3.4.3 Appropriateness of the aid

(155) EEA EFTA States can make different choices with regard to policy instruments and state aid control does not impose a single way to intervene in the economy. However, state aid under Article 61(1) of the EEA Agreement can only be justified by the appropriateness of a particular instrument to contribute to the development of the targeted economic activities or areas.

Page 24

(156) ESA normally considers that a measure is an appropriate instrument where the EEA EFTA State can demonstrate that alternative policy options would not be equally suited to contribute to the development of economic activities or areas and where it can demonstrate that alternative, less distortive, aid instruments would not deliver equally efficient outcomes.

(157) As for the situation on the market, i.e. the unprofitability of submarine cable infrastructure investments and projects from Iceland to Europe, ESA finds that an alternative policy instrument, such as regulations, would neither trigger investment in the IRIS submarine cable project, nor other similar investment projects.

(158) As regards the chosen aid instrument, a capital injection, ESA notes that due to various factors related to the IRIS cable project a loan or guarantee would necessitate price increases that Farice is unwilling to implement (see paragraph (82)). Moreover, the capital increase is directly tied to the actual investment cost incurred, and the granting authority will only grant a capital increase in intervals to meet those costs. Should cost be lower, the amount of aid will be lower. This gives the granting authority greater control over the amount and timing of aid, as opposed to a guarantee or loan that would additionally lead to price distortions.

(159) Consequently, ESA considers that alternative aid instruments, such as a loan or a guarantee, would not be a more appropriate instrument and that state aid in the form of a capital increase is the appropriate instrument to facilitate the development of the economic activities that the measure concerns.

6.3.4.4 Proportionality of the aid

(160) State aid is proportionate if the aid amount per beneficiary is limited to the minimum needed to incentivise the additional investment or activity in the area concerned.

(161) With reference to Section 3.8.1, the measure constitutes a capital increase in Farice. The board of directors of Farice will be authorised to increase the capital in intervals during the construction period of the new cable. The financing needs of the recipient will be assessed at each interval and only established costs will be granted through the capital increase. The granting authority will review any expenses of the recipient and will control overcompensation retroactively by a capital decrease, dividend payments or other available means, should investment costs prove lower than expected. This aid granting method and claw-back mechanism contributes to the proportionality of the aid.

(162) Moreover, as described in Section 3.7.3, while the contract for the construction and laying down of the submarine cable was not tendered out, Farice did engage in a competitive selection procedure whereby it selected a contractor who will manufacture and lay the IRIS cable. The selection procedure resulted in Farice opting to contract with the lowest bid, which further contributes to the proportionality of the measure. The selection process was conducted in line with the spirit and principles of the Procurement Directive, ensuring equal and non-discriminatory treatment of parties. The selection procedure was based on objective evaluation criteria, as described in paragraphs (71) to (76).

(163) Taken together, the amount of aid granted through the measure is limited to what is necessary to achieve the objective of the measure. Consequently, the measure is proportionate.

Page 25 6.3.4.5 Limited negative effect on intra-EEA trade

(164) As stated in Section 4.5, the measure has an effect on intra-EEA trade. However, in order to be compatible, a measure should limit those effects.

(165) As stated previously, the primary objective of the measure is to enhance the security of international connections in Iceland, and while a third submarine cable will increase capacity, ESA notes that the capacity of the current network is not fully utilised; the new infrastructure is principally expected to complement the other connections currently in operation. Therefore, the addition of a third cable does not materially alter the structure of the market, but rather enhances the security of the infrastructure already present.

(166) Moreover, even though a third cable will allow Iceland to be better connected to Europe, it will not change the fact that Iceland remains an island approximately 1 200 km from the nearest European country and 2 000 km from the European continent. The improved communication to Iceland will not bridge the natural data latency gap that exists between communication on the European continent compared with communication from the continent to Iceland. Therefore, ESA finds it hard to see how the IRIS submarine cable will have a material impact on the competitiveness of other EEA markets compared to Iceland. Therefore, the third cable, in and of itself, should not materially alter the dynamics of intra EEA-trade on the relevant market.

(167) To that end, ESA notes that there are no other companies, established in the EEA, that currently operate, or have shown concrete plans to operate without State support, a submarine cable similar to the IRIS cable. Therefore, market participants have not demonstrated any concrete will to invest in a submarine cable between Iceland and Europe prior to the implementation of the measure. However, the measure does not prevent any potential future market actors from investing in a similar submarine cable.

(168) Moreover, as regards the measure’s potential effect on data centres, ESA notes that the data centre market is not a single market of universal services since the digital needs of businesses are highly dependent on the applications hosted and operated in data centres. For the largest users of data centres, the closeness to major markets is key. Therefore, large users have located data centres close to international network hubs and within close proximity of densely populated areas. The construction of the IRIS cable will not change those facts.

(169) Other data centre operators focus on different and often niche applications. One such area is the field of high-performance computing where data processing applications require a great amount of electricity and cost-effective cooling options. Typical applications are crypto currency mining and different types of data simulations where raw data is sent to be processed in an economic manner. Data centres in Iceland have over the past 10 years attracted those types of applications as they can offer cost effective electricity and cooling to customers. ESA finds it unlikely that the measure itself will materially change these market dynamics.

(170) Consequently, while data centres might in theory be more inclined to invest in projects in Iceland, due to extended capacity and security of the international connection network, following the construction of a third submarine cable, ESA notes that it would only be one of multiple factors that would influence such a

Page 26 decision. Other factors, like electricity prices, start-up costs and regulatory environment also influence such decisions. Those factors are not altered by the measure.

(171) Finally, as regards potential effect on competition, ESA notes that according to the Icelandic authorities, Farice operates on two markets: (i) the wholesale market for international connectivity, and (ii) the market for data centres. As customers of Farice, data centres have historically enjoyed lower prices than telecommunication companies. However, the data centres and telecommunication companies do not operate on the same services market, which justifies differentiation in prices to the two customer groups.36 Therefore, the fact that these different customers may be treated differently does not raise competition concerns. Moreover, nothing in the design of the measure leads to discrimination between customers, nor does it incentivise or make inevitable such discrimination.

(172) With reference to the foregoing, ESA concludes that the effects of the measure on intra EEA-trade are, while present, limited to a minimum.

6.3.4.6 Conclusion on limited negative effects

(173) In light of the above arguments, ESA concludes that any negative effects of the aid on competition and on trade are limited.

6.3.5 Balancing positive and negative effects of the aid

(174) For the aid to be compatible with the functioning of the EEA Agreement, the limited negative effects of the aid measure in terms of distortion of competition and adverse impact on trade between Contracting Parties must be outweighed by positive effects, in terms of contribution to the facilitation of the development of economic activities or areas. It must be verified that the aid does not adversely affect trading conditions to an extent contrary to the common interest.

(175) The Icelandic authorities have demonstrated that the socio-economic benefits of the measure outweigh any potential adverse effect on competition or trade between EEA States, given the safeguards in place to minimise the latter.

(176) ESA considers that the measure under assessment will enable the construction of a third submarine cable, which, as explained above, will generate an important enhancement of the security of international connections in Iceland. Moreover, it will contribute to general economic development in Iceland.

(177) Taking into account the safeguards put in place by the Icelandic authorities, in order to mitigate the advantages that Farice may have from the completion of the IRIS cable project, the distortion of competition induced by the measure can be considered as mitigated accordingly.

(178) ESA concludes that the positive effects of the measure outweigh possible distortions of competition and adverse impact on trade. Therefore, the aid does not unduly affect trading conditions to an extent contrary to the common interest.

6.4 Cumulation

(179) The Icelandic authorities have confirmed that Farice will not receive payments under the measure, as well as compensation from the Telecommunications Fund,

36

See the Icelandic Competition Authority´s Decision No 2/2016.

Page 27 for the same eligible costs, such as costs already incurred related to the surveying of the seabed.

(180) The Icelandic authorities further commit that any state aid will not, and cannot, be cumulated with aid under the measure for the same eligible costs.

6.5 Transparency

(181) The Icelandic authorities will publish the full text of the aid measure and make all necessary disclosures on the website of the granting authority, along with all relevant information. The information will be available to the public for at least 10 years, without restriction. The Icelandic authorities have confirmed that the aid award will be published in the transparency register.

(182) Therefore, the measure fulfils the transparency requirements.

7 Conclusion

(183) On the basis of the foregoing assessment, ESA considers that the measure constitutes state aid with the meaning of Article 61(1) of the EEA Agreement. Since ESA has no doubts that this aid is compatible with the functioning of the EEA Agreement, pursuant to its Article 61(3)(c), it has no objections to the implementation of the measure.

(184) If this letter contains confidential information which should not be disclosed to third parties, please inform ESA by 23 April 2021, identifying the confidential elements and the reasons why the information is considered to be confidential. In doing so, please consult ESA’s Guidelines on Professional Secrecy in State Aid Decisions.37 If ESA 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 on ESA’s website: http://www.eftasurv.int/state-aid/state-aid-register/.

For the EFTA Surveillance Authority,

Yours faithfully, Bente Angell-Hansen President Responsible College Member

Frank J. Büchel College Member

Högni Kristjánsson College Member

For Carsten Zatschler Countersigning as Director, Legal and Executive Affairs

[Status]

(37)

OJ L 154, 8.6.2006, p. 27 and EEA Supplement No 29, 8.6.2006, p. 1.