Throughout the 1990s, stocks of the energy conglomerate Enron were an essential part of a long-term portfolio. Investors battled to get their hands on a piece of the company that managed energy across the United States—every year its profits seemed to soar, its debts seemed to wash away. Everyone made money hand over fist.
Then it stopped.
In 2001 Enron went from being a blue-chip stock, one of the hottest investments on the Street to being completely worthless, triggering the biggest bankruptcy the United States had ever seen. So how did a company this unhealthy mask its situation for so long? How was every accountant and every regulator blind to the catastrophe that was rumbling to their doorstep?
The answer to this question informs a lot of modern financial regulation, and, perhaps even more importantly, it informs UEFA’s vision for enforcing its Financial Fair Play rules.
As the world struggled to recover from the financial crisis that had spread like a virus from the United States across the Atlantic and the Pacific, then-UEFA President Michel Platini made a trip to the United States to visit with financial regulators and sports team owners. He was desperate to determine how, exactly, American sports teams had managed to come out of the crisis and the Great Recession that followed relatively unscathed. This trip was the birthplace of Financial Fair Play.
Financial Fair Play is a misleading name for a regulatory structure aimed at ensuring teams are sustainably managed because it seems to imply that teams must operate fairly in the marketplace for players. In reality, FFP is merely a loosely enforced regulatory structure that theoretically ensures teams will remain economically viable, and won’t fail or fall into ruin because of financial mismanagement (as happened with a number of professional sides at the height of the crisis and the recession). Thus, the critical tool in UEFA’s FFP bag is the annual team audit to ensure compliance with the so-called “break even” formula. Prior to this July, neutral observers (including myself) thought that this tool was the only one in UEFA’s bag at all. It was not.
On July 3, UEFA announced that it was re-opening its previously closed FFP investigation into Paris St-Germain because of concerns that €200m of sponsorship contracts had not been properly valued.
Most people shrugged off this announcement; to some nerds like me (and some people who work in finance and lived through Enron, Worldcom, Lehman and the financial crisis), this move was an earthquake. UEFA was signaling—to PSG and the world of football—that it was coming for that most sacred of financial golden geese, the accounting trick that allowed Enron to hide all of its losses and that allowed Lehman to prop up its balance sheet: the so-called “related party transaction”.
What is a related party transaction? It’s easy enough to understand: any financial transaction (say a loan) between two parties that are related to (under common control with) each other in some way is a related party transaction. For example, PSG is owned by Qatar Sports Investments; Qatar Sports Investments is one of a number of companies the is owned by the Qatari government through their sovereign wealth fund (SWF); the Qatari SWF owns Qatar Airways; Qatar Airways pays PSG to be PSG’s kit sponsor. That’s a basic related party transaction.
Historically speaking related party transactions are fertile ground for fraud and mismanagement—Enron created thousands of related party transactions to shelter its debts and prop up its balance sheet, for example. Lehman did similar things, and we have seen many accounting fraud cases in the years since these bankruptcies that focus on these transactions. These transactions are not only good for covering up holes in balance sheets through outright fraud, they’re also dangerous because they entangle the original party with other entities that might be less financially stable—so, if one of these outside entities that are contractually wrapped up with the main entity fail, they are liable to take the main entity down with them.
During his trip through the United States to design FFP, Michel Platini must have stumbled across the various parts of American law that regulate related party transactions because it seems to me (and I am admittedly no longer working in banking law) that the regulatory regime that most resembles what UEFA have constructed with FFP is the American banking laws.
Here’s the main reason: the banking laws are designed for the same purpose as FFP. Both regimes are designed to make sure entities (banks and clubs) don’t combust when things get tough. The American banking laws stringently regulate these related party transactions because of their potential to take down an otherwise stable bank should something go wrong (AIG is a classic example of this). Section 23A of the Federal Reserve Act, for example, forces regulators to look through the legal fiction of separate corporate structures and to the base-level transaction, ensuring that each entity is not related, and if it is, making sure that the transaction follows the law. Sure, it may seem like Big Bank sold an asset to Acme Corporation; but Acme Corporation is owned by an entity that owns Big Bank—so in reality, that entity is using Acme Corporation to prop up Big Bank.
This is where things begin to get complicated for PSG—and, assuming they don’t make some radical moves to increase their revenue streams, Juventus, who are now on the hook for E60m per year to one (very good) player. Allow me to explain.
Here is a chart of Juventus’ balance sheet for the last three years:
Look, I’m not an economist. I spent a couple years working in financial law, but I don’t anymore and I haven’t in a few years. But it doesn’t take a genius to figure out what’s going on here: as we can see, their revenues have steadily grown, but so have their costs. In fact, over this three year period Juve posted an operating profit (revenues – (costs + amortization)) of about €67m in 2016/17 and an operating loss of about €9m in 2017/18. Because FFP is a three year retrospective analysis, with a break-even threshold of no more than €30m total over 3 years, Juve can afford to lose €80m in 2018/19 and avoid FFP scrutiny.
All this sounds good—or, at least, manageable. The problem for Juve will really come in 2019/20, when their very good year (2016/17) will be wiped off the books for FFP purposes. Assuming Juve post a €88m loss in 2018/19 (it might be more than that if they choose not to sell a number of players), they will be staring at a three-year FFP calculation that looks very grim—an operating loss of almost €100m for the two years preceding 2019/20, and an additional €60m per year in player salary. This would require Juve to post a €130m operating profit in 2019/20 or risk being barred from UEFA competition. And that’s when Ronaldo’s salary and amortized transfer fee becomes a massive weight around the team’s neck: and because transfer fees aren’t paid in one lump sum, Juve can’t just count on selling Paolo Dybala for exactly that much money to make up the difference.
So what can Juve do? Aside from selling a number of their elite players for fire-sale prices, the best option is probably to renegotiate some of their sponsorship contracts. Because Juve’s revenues are close to maxed out (they sell out every match, their TV contract is locked in, their kit sponsorship is locked in, etc) they will need to renegotiate in order to see a chunk of the money from the exposure their new signing will bring them.
But what companies would renegotiate their sponsorship deals when they have a long-term contract at a favorable rate with a team that suddenly got much more popular worldwide? Well, related parties of course!
Juventus is owned, in part, by the Agnelli family. This family is also one of the controlling shareholders of Fiat-Chrysler, the massive worldwide auto conglomerate that also happens to own Juve’s kit sponsor, Jeep. Additionally, there has been talk of Ferrari (another Agnelli family property) footing some of Ronaldo’s wage bill through sponsorship agreements. These would all constitute related party transactions—and given UEFA’s new interest in enforcing its related party FFP rules, Juve will need to tread carefully if it wants to avoid scrutiny that could leave it without UEFA competitions (like its rival, AC Milan).
Even with all of these issues, the Ronaldo deal is obviously still a no-brainer. When a player of his calibre is available, any team with major aspirations would make the call first and figure out the finances second. But hopefully for Juve fans their board has done some hard thinking about how to make the numbers add up in the long term—otherwise, we might see a fire sale of Juve’s elite talent that could defeat the point of bringing in Cristiano Ronaldo.
The opinions expressed are the author’s alone and are not those of his employer. This article does not constitute legal advice. Gabe is the Editor-in-Chief emeritus of Managing Madrid and a co-host of the Managing Madrid Podcast.
Editor’s Note: This article was written in late June of 2018, shortly after Cristiano Ronaldo signed with Juventus.