The Draft RRP Directive: A CCP’s Perspective

Introduction

On 25 July 2012, the European Association of Central Counterparty Clearing Houses (“EACH”) published a response document to the EU proposal for a directive on bank recovery and resolution (the “RRP Directive”).  The response document provides an interesting insight into the aspects of RRP which are of significance to a CCP.

EACH fully supports the RRP Directive, but feels that the proposal undermines the objectives of EMIR by weakening the risk protections of CCPs in the areas detailed below.

“Sale of Business Tool” and “Bridge Institution Tool”

These resolution tools state that the purchaser (in the case of the Sale of Business Tool – see Article 32.10) or the bridge institution (in the case of the Bridge Institution Tool – see Article 34.8) is to be “considered to be a continuation of the institution under resolution, and may continue to exercise any…right that was exercised by the institution under resolution in respect of the assets, rights or liabilities transferred, including the rights of membership and access to payment, clearing and settlement systems.”

EACH has concerns with respect to the situation where the institution under resolution is a clearing member of a CCP.   In these circumstances, EACH claims that it is vital for the safe operation of a CCP that the purchaser/bridge institution remains capable of fulfilling all of the membership requirements of the CCP as well as all resultant obligations.  Moreover, EACH maintains that the relevant CCP itself must retain the right to determine whether a purchaser/bridge institution meets these criteria so as to avoid unnecessary risk to the stability of the CCP.

“Bail-in Tool”

Article 38(4) of the proposed RRP Directive empowers the EU Commission to consider, under certain circumstances, whether exclusions to the scope and use of the Bail-in Tool are necessary in order to ensure that the resolution objectives specified in Article 26(2) of the proposed RRP Directive are protected.  One of the circumstances specifically contemplated in Article 38(4)(b)(ii) is the possible effect that the application of the debt write-down tool to derivatives that are cleared via a CCP would have on the operation of the CCP itself.

In these circumstances, EACH considers it vital that the CCP retains the right to call the institution under resolution into default.  This would allow the CCP to trigger its default procedures, potentially close-out or transfer positions, and enforce against collateral held by the CCP.  If this is not the case, EACH believes that the CCP’s survival could be threatened.

“Resolution Powers”

Article 62 of the Draft RRP Directive provides for the temporary power of resolution authorities to restrict the ability of creditors of an institution under resolution from enforcing against security interests.  However, CCPs are specifically excluded from this restriction.

Article 63 of the draft RRP Directive enable resolution authorities to temporarily suspend certain rights of a counterparty to an institution under resolution to terminate financial contracts.  Although all reasonable efforts must be made to ensure that margin and collateral calls are met, again, there is no express exclusion to recognise the unique position of CCPs.

Article 61 of the RRP Directive provides for the power to temporary suspend payment and delivery obligations of an institution under resolution, with no exemption being applied to recognise the unique situation of CCPs at all.

This, claims EACH, runs counter to the recommendations of the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” published in October 2011, specifically paragraph 3.2(xi) which recognises that “Resolution authorities should have at their disposal a broad range of resolution powers, which should include powers to…Impose a moratorium with a suspension of payments to unsecured creditors and customers (except for payments and property transfers to central counterparties (CCPs) and those entered into the payment, clearing and settlements systems) and a stay on creditor actions to attach assets or otherwise collect money or property from the firm, while protecting the enforcement of eligible netting and collateral agreements”.

Advertisements

CASS Resolution Pack Requirements Unaffected by FSA CASS Consultation Paper

On 25 July 2012, the FSA published consultation paper CP 12/15 on “Client Assets Firm Classification, Oversight, Reporting and the Mandate Rules”.  CP 12/15 is open for comment until 30 September 2012, and consults on possible changes in the following areas:

  • CASS firm classification and operational oversight:
    • clarifying that firms which only arrange safeguarding and administration of assets do not fall within the scope of CASS 1A;
    • clarifying the date on which a firm becomes a CASS firm for the firm time or when it changes CASS categories;
    • proposing changes to the procedure whereby a CASS small firm can opt to be treated as a CASS medium firm and a CASS medium firm can opt to be treated as a CASS large firm;
    • Client money and assets return (“CMAR”):
      • proposing amendments to the CMAR template regarding holding of safe custody assets and client money balances; and
      • Clarifying the scope of the mandate rules in CASS 8, confirming that the rules do not apply to:
        • a firm in relation to client money held by that firm in accordance with CASS 5 or CASS 7, or client money assets held by that firm in accordance with CASS 6; or
        • an operator of a regulated collective investment scheme, in relation to activities carried on for the purpose, or in connection with, the operation of the scheme.

Fortunately, for those affected by CASS matters, the changes do not impact on the informational requirements forming part of the CASS Resolution Pack initiative, or the creation/maintenance of a CASS Resolution Pack more generally.  The deadline for submission of a first CASS Resolution Pack remains as 1 October 2012.

EU Council to meet on 3 September to discuss RRP Directive

On 26 July 2012, the EU Council published a notice confirming that its Working Party on Financial Services will meet at 10:00 a.m. on 3 September 2012 to examine the Commission proposal for a Directive establishing a framework for the recovery and resolution of credit institutions and investment firms.

European Banking Federation Publishes Study on Reform of EU Banking Sector

Introduction

On 24 July 2012, the European Banking Federation (“EBF”) published a “Study on the issue of possible reforms to the structure of the EU Banking Sector”.  The report is related to the ongoing work of the High Level Expert Group established by the EU Commission to examine the same issue.

The report distinguishes regulatory reform (such as CRD IV, RRP, EMIR and MiFID) from structural reform – a reference to the Vickers report in the UK and the Volcker rule in the US.

Regulatory Reform

In general, the EBF is supportive of regulatory initiatives.  However, on the subject of RRP, it cautions that “a reasonable balance must be struck between effective, robust supervision and supervisory approaches which are overly intrusive into the normal, day-to-day running of a healthy business”.  The EBF also approves of the concept of “bail-in”, favouring a wide definition of bail-in-able debt so as to reduce the possibility of arbitrage and the need for a statutory minimum quantity of bail-in-able debt to be issued by firms.  However, the EBF believes that the “timing and the implementation of any bail-in mechanism…must…avoid imposing an excessive funding cost that could impair the provision of credit to the real economy and result in an excessive deleveraging”.

Structural Reform

The EBF believes that the objectives of the G20 and the EU are to:

  • increase the stability of the European financial sector by reducing risk;
  • ensure orderly resolution of financial institutions without taxpayer support; and
  • maintain the integrity of the Internal Market and to ensure the ability of banks to serve the real economy.

It claims that all of these objectives can be achieved by the finalisation and implementation of the regulatory reform agenda without the necessity of structural reform.  Citing the ECB’s report on EU Banking Structures, the EBF claims that “there is no convincing evidence that structural reform has a direct influence on systemic risk and would make restructuring or resolution easier in the event of a crisis.”  Quite the opposite, it expresses the view that “the disadvantages deriving from a potential adoption of UK- or US- style structural reforms for the EU would be much larger than the eventual benefits that they would generate” due to the possibility that it will lead to fragmentation of financial markets in the EU and create incentives to circumvent the rules.  As such, it concludes that any structural change should be delayed until the regulatory reform agenda has been completed so that its impact can be properly assessed.

Conclusion

The views of the EBF regarding the definition of bail-in-able debt are interesting.  They accord with opinions expressed by the buyside, such as AIMA,  and are undoubtedly correct.  The more narrow the definition, the greater the risk that the protection afforded by bail-in debt will be rendered toothless at the structuring desks of investment banks around the globe.

The reluctance of the EBF to embrace structural change is understandable.  Whilst the political benefits are clear and opinion both amongst regulators and the industry seems to be swinging behind these initiatives (see, for example, here), the economic case for reforms such as those proposed by Vickers has yet to be made definitively.  Unfortunately for the banks, however, neither the UK nor the US governments seem to have a reverse gear where Vickers and Volcker are concerned.

If you have an hour to spare I would recommend that you read this study for no other reason than it provides an excellent review of the history and developments across the entire regulatory landscape within the EU.

House of Lords Publishes Call for Evidence on EU Banking Reform

On 24 July 2012, EU Economic and Financial Affairs Sub-Committee A of the House of Lords European Union Committee published a call for evidence with respect to its inquiry into reform of the EU Banking Sector.

The call for evidence asks for responses on a number of questions posed under the following headings:

  • Banking reform, banking union and the euro area crisis;
  • Banking supervision;
  • European Deposit Insurance schemes; and
  • The proposed Directive for bank recovery and resolution.

The deadline for response is 1 October 2012.

The progress of the inquiry can be followed here.

The Cost of Bail-In for Smaller Lenders

This is a link to a short, but interesting, article in today’s FT regarding the disproportionate impact of proposed EU bail-in rules on small banks due to the requirement to restructure hybrid tier one capital to include contractual “bail-in” clauses.

EU Consultation on RRP for Non-Banks Now Expected in August 2012

On 23 July the EU Commission published an updated agenda regarding legislative proposals which it expects to adopt in the period between 18 July 2012 and 31 December 2012.  As part of its updated timetable, the consultation on possible recovery and resolution arrangements for systemically important financial institutions other than banks and large investment firms will now be published in August 2012, rather than July 2012.