Will the impending UEFA Financial Fair Play rule doom Chelsea?

Beginning with the 2013/2014 season, European clubs will have to have their books analyzed by UEFA prior to being granted a license to play in any UEFA tournament, with the goal of this being to eliminate excessive spending which is doing irreparable harm to the future financial health of the club. This came about largely after the financial trouble began coming out at Portsmouth and protests over ownership began heavily at clubs like Liverpool and Manchester United. With ownership groups like the Glazers and Hicks/Gillette borrowing so heavily at extreme interest rates just to purchase the club, there was very little chance that the clubs would be able to maintain a healthy financial situation going forward. UEFA stepped in and proposed a plan (found here) which was aimed at forcing teams to act in a financially responsible manor if they intended to compete on the largest stages in the sport.

Many pundits in England and Europe have heard of the rule, and have assumed that it means clubs like Manchester City and Chelsea who have benefited from rich owners willing to invest in the club are going to be banned from the competition. City have seemed oblivious to the rule, increasing spending every year since 2007 and showing no signs of slowing down. Chelsea, on the other hand, have been cutting costs for the last several summers. Players on huge wages have been allowed to leave, while there has generally been less money spent on replacements in each successive window. Coaching costs have also been dramatically reduced, leading one to believe that we may actually be worried about compliance with the rule. After the jump, we're going to break down how exactly the new regulations can be expected to force things to change at Stamford Bridge.

For the purposes of this discussion, we're only going to look at individual items of the rule that are specifically relevant to Chelsea and possibly changing the way they've operated in regards to wages and transfer fees. Most of the early portion of the regulations focus on club infrastructure, so we can pretty much disregard the first 26 pages of the regulation in regards to this discussion as they are about the same as they have been in the past. The regulations then get into overdue payments (to both other clubs and employees), which we can reasonably assume is not a problem with Abramovich at the helm. Once again, we'll simply pass over this particular section of the rule for this discussion. This is where the information relative to our particular situation truly begins. The first real item that should concern us can be found in Article 53:

The Club Financial Control Panel will at all times bear in mind the overall objectives of these regulations, in particular to defeat any attempt to circumvent these objectives.

This little nugget would prevent Chelsea or other clubs from deliberately making their books misleading by, say, paying John Terry a minimal salary with the club while employing him in a token job at one of Abramovich's other ventures for an obscene salary. Since there would likely be an infinite amount of possible loopholes like this, UEFA just gave themselves blanket coverage to eliminate them as need be. So I guess we can't simply skirt the rules by charging Abramovich 30 million pounds per year for a seat at the Bridge.

Now comes the section which has caused the media to fear for Chelsea's Champions League future. Article 58 begins the process of explaining the break-even requirement of the new regulations. I'm going to block quote the entire break-even requirement, but any emphasis added will be done by myself:

I. BREAK-EVEN REQUIREMENT

Article 58 – Notion of relevant income and expenses

1 - Relevant income is defined as revenue from gate receipts, broadcasting rights, sponsorship and advertising, commercial activities and other operating income, plus either profit on disposal of player registrations or income from disposal of player registrations, excess proceeds on disposal of tangible fixed assets and finance income. It does not include any non-monetary items or certain income from non-football operations.

2 - Relevant expenses is defined as cost of sales, employee benefits expenses and other operating expenses, plus either amortisation or costs of acquiring player registrations, finance costs and dividends. It does not include depreciation/impairment of tangible fixed assets, amortisation/impairment of intangible fixed assets (other than player registrations), expenditure on youth 34 development activities, expenditure on community development activities, any other non-monetary items, finance costs directly attributable to the construction of tangible fixed assets, tax expenses or certain expenses from non-football operations.

3 - Relevant income and expenses must be calculated and reconciled by the licensee to the annual financial statements and/or underlying accounting records, i.e. historic, current or future financial information as appropriate.

4 - Relevant income and expenses from related parties must be adjusted to reflect the fair value of any such transactions.

5 - Relevant income and expenses are further defined in Annex X.

I've highlighted one little gem at the end here, and while I won't get into it at this particular moment please note that it's there for slightly later in the discussion. At the end, this may in fact be one of the most important items in regards to Chelsea in the entire 85+ pages of text. Basically what this article is doing is defining what incomes and expenses are. You'll note (and the media has) that nowhere in this definition is a gift from the owner included. Slightly later, the break even result is defined very simply for us:

The difference between relevant income and relevant expenses is the breakeven result, which must be calculated in accordance with Annex X for each reporting period.

There it is again folks...Annex X again poking it's head into the discussion. I hope you're starting to get the idea that this may be particularly relevant to Chelsea. Other than that, it lays out a very simple method for determining if a club is losing money, profiting, or "breaking even". It's also worth noting that clubs can still gain a license if they are losing money. Article 61 lays out the acceptable deviation from a true "break even" result in regards to the rules:

Article 61 – Notion of acceptable deviation

1 - The acceptable deviation is the maximum aggregate break-even deficit possible for a club to be deemed in compliance with the break-even requirement as defined in Article 63.

2 - The acceptable deviation is EUR 5 million. However it can exceed this level up to the following amounts only if such excess is entirely covered by contributions from equity participants and/or related parties:

a) EUR 45 million for the monitoring period assessed in the licence seasons 2013/14 and 2014/15;

b) EUR 30 million for the monitoring period assessed in the licence seasons 2015/16, 2016/17 and 2017/18;

c) a lower amount as decided in due course by the UEFA Executive Committee for the monitoring periods assessed in the following years.

3 - Contributions from equity participants and/or related parties (as specified in Annex X D) are taken into consideration when determining the acceptable deviation if they have occurred and been recognised:

a) in the financial statements for one of the reporting periods T, T-1 or T-2; or

b) in the accounting records up to 31 December of the year of the reporting period T.

The onus is on the licensee to demonstrate the substance of the transaction, which must have been completed in all respects and without any condition attached. An intention or commitment from owners to make a contribution is not sufficient for such a contribution to be taken into consideration.

4 - If contributions from equity participants and/or related parties occurring up to 31 December of the year in which the UEFA club competitions commence are recognised in a club’s reporting period T+1 and have been taken into consideration to determine of the acceptable deviation in respect of the 36 monitoring period (T-2, T-1 and T) assessed in the licence season commencing in that same calendar year, then for later monitoring periods the contributions will be considered as having been recognised in reporting period T.

The highlighted section is something many of you may have heard about. It simply lays out the exact deviation that UEFA feels will be acceptable by year as clubs work towards conforming to the guidelines that UEFA has laid out. The regulations go on to lay out what is considered income and expenses, but we'll gloss over it because it's all fairly obvious stuff. Player sales, gate receipts, advertising dollars are all considered income, things like player purchases and wages are considered expenses. There are other incomes and expenses, but it's fairly dry reading with nothing really of note mentioned. There is also no punishment for non-compliance mentioned, you are simply directed here for a list of possible penalties for failure to do so. It doesn't list exclusion from UEFA competitions as the only possible punishment, but it is certainly a real possibility.

To this point, the new rule looks like it means just what the media says...stop spending more than you earn or you can't come to the party anymore. There is a large amount of wiggle room built into the rule as well, which should allow a cushion for the club to ease into conformity. As hinted at earlier in this discussion though, Annex X will provide us with a little more detail on any exceptions to the rules. It's a long section of the regulations, and the first 12 pages of the annex break down even further the items which are considered expenses and income under the rule. Once again, this is painfully dry and fairly obvious stuff. We then get to section D of the annex, which is where the relevant information to this discussion begins. This section deals with "Contributions from equity participants and related parties". In short, this section covers contributions by owners or shareholders. The very first part of this section opened my eyes a little bit when I read it:

Acceptable deviation can exceed EUR 5 million up to the amounts described in Article 61(2) in a monitoring period only if such excess is entirely covered by contributions from equity participants and/or related parties.

As a reminder, Article 61-2 was highlighted earlier and dealt with acceptable loss levels under the new rule. So right here we have a piece of the regulations telling us that we can lose more than UEFA's acceptable guidelines if ownership is willing to cover it. There must be more to it than this I thought, and sure enough it is expanded upon later that page when it describes acceptable capital contributions:

a) Capital contributions being a contribution by a related party: that is an unconditional gift made to the reporting entity by a related party which increase the reporting entity’s equity without any obligation for repayment or to do anything in consideration for receiving them. For example, a waiver of inter-company or related party debt constitutes a capital contribution, as it results in an increase in equity; and/or

b) Income transactions from a related party: the amount to be considered as a contribution will be no more than an amount equivalent to the difference between the actual income in a reporting period and the fair value of the transaction(s) in a reporting period as already recognised in the calculation of the break-even result (see part B(1)(j)). The monies must have been received by the reporting entity, rather than just some form of promise or commitment from the related party.

We don't have to break even, we just have to somewhat reduce our losses by the time the rule comes into effect (after writing off almost 1 billion euros worth of debt the last two seasons, is there any real doubt Abramovich would "gift" the club a mere 40 million Euros to make them compliant?). Last year we reported a loss of about 60 million Euros. We trimmed about 25 million Euros worth of wages this past summer, so our losses for next year will likely continue to decline even if the signing of David Luiz happens later today. While it's unlikely that we reach the point where our losses are at less than 5 million Euros per year in 2 more seasons, it's certainly possible that we are within reach of that 45 million Euro loss over a three year period. While the English press constantly harps on this point, simply continuing to read the regulations give a much overlooked "out" to Chelsea if we still haven't met that criteria. The final passage in the regulations give us this:

For the purpose of the first two monitoring periods, i.e. monitoring periods assessed in the seasons 2013/14 and 2014/15, the following additional transitional factor is to be considered by the Club Financial Control Panel: Players under contract before 1 June 2010

If a licensee reports an aggregate break-even deficit that exceeds the acceptable deviation and it fulfils both conditions described below then this would be taken into account in a favourable way.

i) It reports a positive trend in the annual break-even results (proving it has implemented a concrete strategy for future compliance); and

ii) It proves that the aggregate break-even deficit is only due to the annual break-even deficit of the reporting period ending in 2012 which in turn is due to contracts with players undertaken prior to 1 June 2010 (for the avoidance of doubt, all renegotiations on contracts undertaken after such date would not be taken into account).

Most of our contracts were done prior to June 1, 2010 at this point (ironically several key players were extended last May just prior to this deadline). While largely overlooked at the time, it looks like brilliant planning now. It's also worth nothing that the club's losses have been declining every year (and with the players allowed to leave will likely continue to do so). While it's unlikely at this point that we'd meet the acceptable deviation laid out earlier in the regulations if we sign Luiz soon, it's highly unlikely that we'd fail to meet the two exception requirements listed at the end of the rule. What that means is that we likely don't have to worry about being "self sufficient" until the 2015/2016 season at the earliest. By that point, I'd guess we've either decided to build a new stadium or sold the naming rights to Stamford Bridge. Either way, our financial situation ought to have cleared itself up as most of our aging squad will likely be off our books and gate receipts or advertising dollars should increase.

Frankly, in this blogger's opinion, the UEFA financial fair play regulations aren't likely to have any tangible effect on Chelsea. While down the road we will likely need to be self sufficient and far less reliant on Roman, for the moment it looks as if we have another 4 1/2 seasons before this becomes a huge concern. Either way, the newfound policy of buying young will likely help to assure we continue to feature prominently in UEFA's biggest competition. The club has been taking major steps in the right direction over the last three years, and as guys like Nicolas Anelka, Didier Drogba, John Terry, and Frank Lampard move on, the wage scale will likely correct itself enough that we are quite close to compliant. Reaching a stadium deal will certainly put some extra clarity on the situation, but for now let's just be happy that unlike the teams up north, we aren't likely to have any players on over 250,000 per week (or likely even half of that) when the exceptions to the rule are no longer available for us to exploit.