It is based on UEFA coefficient.
The club coefficient is determined by the results of a club in European club competition in the last five seasons, and the league coefficient. The club coefficient is 33% of the league coefficient plus the number of points earned by the club in the five seasons. Before 2004 the contribution of the country coefficient was 50%. The points earned by a club in the preliminary rounds are not counted.
The clubs get two points for a win and one point for a draw in games of the main stage of European competitions. Participation in the group stage of the UEFA Champions League is rewarded with three points. Reaching every knockout round of Champions League or quarter-finals and every further rounds of UEFA Cup is rewarded with a point.
This ranking is used by UEFA to determine which pot the club belongs to in the preliminary and first rounds of the Champions League, and the preliminary, first and second rounds of the Europa League.
Before 1999 a number of strong teams in the UEFA Cup were seeded such that those teams do not meet in the first two rounds. To determine these teams, the sum of, the ratio of the number of points achieved to the number of games played by each team, was calculated for the past five years.
Full article on UEFA coefficient
http://en.wikipedia.org/wiki/UEFA_coefficients#Club_coefficient
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