EU Commission to Propose Single Banking Supervisor by 2012 Year End

An article in today’s Financial Times reports that, on 12 September 2012, Jose Manuel Barroso, European Commission President, is set to unveil proposals to create a single EU banking supervisor by extending the powers of the European Central Bank (ECB).

Under the proposals, a 23-member ‘supervisory board’ of the ECB, separate from its governing council, would be given sweeping powers with respect to the authorisation, supervision and resolution of all 6,000 eurozone banks.  This, it is felt, would put Brussels on “a collision course” with the German government, which believes that the ECB should deal solely with the Eurozone’s 20-25 largest banks, leaving national supervisors with responsibility for smaller, non-systemically important (but sometimes more politically sensitive) banks.

Before the proposals can come into force they must be approved by all 27 EU states.  It is hoped that this can be accomplished before the end of 2012.

FSA Consults on CASS Resolution Packs for Insurance Intermediaries

On 28 August, the FSA published Consultation Paper CP12/10, “Review of the client money rules for insurance intermediaries”.

The Consultation Paper is aimed at all insurance intermediaries to which CASS 5 applies.  It attempts to address a number of concerns which arose during the FSA’s review of CASS 5, including:

  • inappropriate controls around the use of non-statutory trusts;
  • ineffective risk transfer documentation;
  • infrequent client money calculations; and
  • the segregation of client money.

As part of its Consultation Paper, the FSA proposes to introduce the “CASS 5 Resolution Pack”.  The FSA estimates that there are approximately 3,000 firms in the UK which operate with permission to hold client money.  These will be the firms most affected by the CASS 5 Resolution Pack proposals.  The proposal itself largely mirrors the CASS Resolution Pack requirements for firms which are subject to CASS 6 (custody rules) and/or CASS 7 (client money rules) as detailed in Policy Statement PS 12/6 published by the FSA in March 2012 (see blogpost “FSA Policy Statement on CASS Resolution Packs” dated 28 March 2012).  However, there are a few notable differences, such as the absence of:

  • an express right to exhibit documentation in the CASS RP of an affiliate[1];
  • an express right to exhibit documentation in electronic form[2];
  • a requirement to ensure that any systems for the provision of component documents within the CASS RP remain operational and accessible after the insolvency of the firm[3]; and
  • a requirement for the firm to provide information with respect to the affiliates and third parties on which it is dependent for the performance of its CASS obligations[4].

The purpose of the CASS 5 Resolution Pack is to assist an insolvency practitioner access information required to deal with client money in a timely manner.  It is proposed that insurance intermediaries must, at all times, be able to provide the documentation specified in the schedule below to an insolvency practitioner within 48 hours of the firm’s failure.

CASS 5 Resolution Packs must be reviewed on an ongoing basis to ensure that they remain accurate, and any material inaccuracies must be corrected within 5 business days of the inaccuracy occurring.  The firm must notify the FSA immediately if it is not able to comply with these requirements.

In practice, updating of a CASS 5 Resolution Pack is likely to represent less of a burden than is the case with respect to a ‘normal’ CASS Resolution Pack.  This is due to the fact that the documentation to be incorporated within the CASS 5 Resolution Pack is more static in nature.  Nonetheless, the FSA proposes to change the frequency with which client money calculations must be performed, from the current once every 25 business day period to:

  • where the firm holds client money under a non-statutory trust:
    • at least every 7 business days if the firm held more than GBP 250,000 of client money at any time during the calendar year prior to the year the calculation is made; or
    • at least every 14 business days if the firm held less than or equal to GBP 250,000 of client money at any time during the calendar year prior to the year the calculation is made; and
    • at least every 25 business days where the firm holds client money under a statutory trust.

As each firm to which the CASS 5 Resolution Pack rules apply is obliged to include the latest client money calculation and reconciliation within its pack, a degree of effort to maintain the CASS 5 Resolution Pack remains.

The Consultation Paper is open for comments until 30 November 2012.  The FSA expects to publish its feedback to the consultation, together with final rules, in the second quarter of 2013.  It seems likely that the rules themselves will not come into force until 12 months from the publication of the final rules for all provisions (except for separate proposals regarding unclaimed client money).

SCHEDULE

DOCUMENTS FORMING PART OF THE CASS 5 RESOLUTION PACK

  • a master document containing information sufficient to retrieve each document in the firm’s CASS resolution pack;
  • a document identifying all the institutions with which client money may be held, including approved banks, money market funds or other third parties to whom client money may be passed;
  • a document identifying each appointed representative, field representative or other agent of the firm which may receive client money in its capacity as the firm’s agent;
  • a document identifying each senior manager and director and any other individual and the nature of their responsibility within the firm who is critical or important to the performance of operational functions related to any of the obligations imposed on the firm under CASS 5;
  • for the institutions identified in (2) all trust letters;
  • the latest client money calculation;
  • the latest bank reconciliation;
  • a copy of the firm’s annual reconciliation down to individual client balances; and
  • any Non-Statutory Trust deeds.

[1] See CASS 10.1.6R

[2] See CASS 10.1.13G

[3] See CASS 10.1.9E(2)

[4] See CASS 10.2.1(6)

HM Treasury publishes draft legislative clauses for RRP for non-banks

On 23 August 2012, HM Treasury published draft clauses together with an explanatory note, to inform responses to its ‘Financial sector resolution: broadening the regime’ consultation paper, published in August 2012 (see previous blogpost “HM Treasury Consultation:  RRP for Financial Market Infrastructures” dated 8 August 2012), the purpose of which was to consult on extending RRP requirements to systemically important non-banks.

The draft clauses constitute proposed amendments to the Banking Act 2009 and the Financial Services and Markets Act 2000. They have been prepared on the basis that the Financial Services Bill 2012-13, as introduced to the House of Lords on 23 May 2012, has been enacted and is in force.

Broadly, the amendments seek to extend:

  • the resolution objectives in relation to which the Treasury, FSA and BoE must have regarding when using the stabilisation powers, to include:
    • the protection of client assets, and
    • the minimisation of adverse effects on institutions that support the operation of financial markets (e.g. exchanges and clearing houses);
  • stabilisation powers to the UK parent companies of banks, provided that certain conditions are met; and
  • the special resolution regime established under the Banking Act 2009 to investment firms and UK clearing houses.

EU Commission to propose single banking supervision mechanism on 11 Sept 2012

The EU Commission has issued a press release to the effect that, on 11 September 2012 (date still to be confirmed), it will present proposals for a single banking supervision mechanism in the euro area, focused around the European Central Bank.

The Commission expects the proposals to be adopted by the end of the year, in order for the new system to enter into force early in 2013.  It sees integrated EU banking supervision as the first step towards a true EU “banking union” involving common deposit guarantee systems and recovery and resolution plans.

FSB Launches RRP Peer Review

On 3 August 2012 the Financial Stability Board launched a peer review of member jurisdictions’ existing resolution regimes.  The objectives of the review are to:

  • assess the resolution regimes that apply to different types of financial  institutions;
  • highlight good practice, inconsistencies and gaps in national resolution regimes;
  • evaluate progress in implementing reforms to national resolution regimes and identify challenges arising from their implementation; and
  • clarify or revise resolution regime criteria, where necessary.

The review uses the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” (“Key Attributes”) as a benchmark, but does not directly assess jurisdictions’ compliance with the Key Attributes.  Rather, the intention of the review is to provide a comparative analysis of existing regimes and of progress made by different jurisdictions, both across individual Key Attributes and across different financial sectors (including banking, insurance, securities, financial market infrastructures).  The deadline for the receipt of feedback is 28 September 2012.

The primary source of information for the peer review will be member jurisdictions’ responses to a questionnaire. The questionnaire is divided into two sections.  Section 1 seeks general information about recent experiences, lessons learned and planned reforms with respect to the resolution of  systemically important financial institutions.  Specifically, information is requested as to whether:

  • resolution powers and funding arrangements were generally adequate;
  • public authorities were adequately prepared;
  • there was effective coordination and information sharing between resolution authorities; and
  • sufficient information about the institution and its related entities was available to the relevant authorities.

Section 2 seeks to create an overview of national resolution regimes and assess their consistency with the Key Attributes.  Specifically, it focuses on:

  • the scope and application of existing resolution regimes;
  • the way in which systemic importance is defined;
  • the identity, objectives and powers of resolution authorities;
  • the triggers to resolution;
  • safeguards for creditors;
  • funding of resolution regimes;
  • frameworks for cross-border cooperation;
  • requirements for the preparation of recovery and resolution plans and resolvability assessments; and
  • information access and sharing.

Resolution Planning: Identifying “non-standard terms” in Derivative Documentation

Introduction

Feedback Statement 12/1 (“FS 12/1”), published by the FSA in May 2012, provides detailed guidance to firms which are subject to the UK’s recovery and resolution planning rules.  In general, FS 12/1 is a superb roadmap document, assisting firms through the detailed data requirements which form the core of recovery and resolution planning.  Unfortunately, there remain a number of areas of FS 12/1 in which clarity is lacking.  One such area appears in the context of Module 3.7 (“Derivatives / Securities Financing”), which forms part of the ‘Group structure & key legal entity information’ section.

Module 3.7

Module 3.7 requires firms to provide information with respect to their derivatives exposures.  Exposures are to be split into three broad categories, being:

  • Exchange traded derivatives;
  • OTC but centrally cleared derivatives; and
  • OTC bilateral derivatives.

Within each category, detailed reporting is required in four main areas:

  • Counterparty details;
  • Exposure data;
  • Collateral data; and
  • Documentation.

Within the “Documentation” section, firms must provide, inter alia, information regarding “non-standard terms”.  Rather unhelpfully, the summary provided by the FSA to explain the background to the data requirement states simply that its purpose is to “determine requirements regarding trade termination etc”.  However, on the plus side, two examples of a “non-standard term” are provided, being:

  • Events of default, and
  • Cross-default clauses.

No other information is provided to assist firms with their submissions.  Additional FSA guidance was expected on 13 August 2012, but this seems unlikely to address this particular issue.  Consequently, many firms, particularly those with large portfolios of derivative documentation, have been left struggling to understand where to draw the line.

Unfortunately, there is no single correct answer to this question.  Nonetheless, it would seem possible to identify two general principles which will assist with the identification of “non-standard terms” in derivative documentation.  I would suggest that these principles are that:

  • an objective, rather than a subjective, measure of what is “non-standard” is appropriate; and
  • clauses should only be regarded as “non-standard” to the extent that they could:
    • have an adverse effect on the application of a resolution tool; or
    • constitute a barrier to resolution.

An objective measure of what is “non-standard”

ISDA negotiation practices have converged significantly over recent years on a number of issues with the result that it is possible to discern a number of ‘industry standard’ positions.  As such, the ISDA negotiation policy of a firm will often represent a good starting place to assist in understanding what can be regarded as ‘standard’.  Clauses in executed documentation which lie outside of an agreed negotiation policy should raise internal flags and merit further investigation.  Inevitably, however, this exercise is of limited assistance as it represents a firm’s subjective view of its own risk tolerance.  Despite the fact that recovery and resolution planning remains a very firm-specific exercise, if assessments of resolvability and the contents of resolution plans are to be meaningful and consistent across EU Member States, a truly objective benchmark is required.  An assessment of the effect of a contractual clause on the ultimate resolvability of a firm creates this objective standard.

“Non-standard” clauses must affect resolvability

The power to transfer, modify or cancel contractual arrangements entered into by a firm under resolution form the essence of the Resolution Powers conferred on resolution authorities pursuant to the draft RRP Directive.  Accordingly, in assessing whether a contractual provision could have an adverse effect on the resolvability of a firm or the application of a resolution tool, one should be primarily concerned with the ability of a resolution authority to transfer or terminate a derivatives transaction so as to help facilitate an orderly wind-down of the firm in question.

Towards defining a set of “non-standard” terms

With this in mind, it is possible to group contractual provisions into three main categories:

  • Probable Non-Standard Terms;
  • Possible Non-Standard Terms; and
  • Unlikely to be Non-Standard Terms.

The Schedule below applies the principals set out above to a number of clauses of the type typically found in derivatives documentation in order to generate the groupings referred to above.  However, it is important to recognise that, whilst an assessment of the effect of a contractual provision on the resolvability of a firm helps to create an objective benchmark regarding what is “standard”, the exact positioning of this benchmark will inevitably change over time.  What could be regarded as a “standard” provision, say, 5 years ago may well not be standard today.  Similarly, what is standard today may not be standard in another 5 years time.  As such, this aspect of recovery and resolution planning must be kept under periodic review.

SCHEDULE

 Group 1: Probable Non-Standard Terms

Clause

Explanation 

Events of Default

Specifically referred to in FS 12/1

Cross-default / Cross-acceleration

Specifically referred to in FS 12/1

Termination Rights Generally

Termination rights should be regarded in the same light as Events of Default 

Ratings Downgrade Clause

Often takes the form of an Event of Default / Additional Termination Event

Material Adverse Change Clause

Often takes the form of an Event of Default / Additional Termination Event

Credit Event Upon Merger linked to specific ratings or other factors

CEUM is a Termination Event under a standard ISDA Master Agreement

Unusual Governing Law

 

Effective application of resolution tools may be more difficult/impossible in certain jurisdictions which do not recognise the powers of resolution authorities

 

Group 2: Possible Non-Standard Terms

Clause

Explanation

Undisclosed Agency Arrangements

May make application of the resolution tools more difficult as the identity of the counterparty may be difficult to ascertain

Indemnities

 

Should not of itself prevent exercise of a resolution tool but may still constitute a barrier to resolution if indemnities are enforced

Illiquid CSA Collateral

 

Should not of itself prevent exercise of a resolution tool but may still constitute a barrier to resolution in terms of transferring or terminating transactions

ISDA First Method

Should not of itself prevent exercise of a resolution tool but may still constitute a barrier to resolution if a counterparty has a right to ‘walk away’ without making payment

Ratings Dependent CSA Credit Support Amounts

Should not of itself prevent exercise of a resolution tool but may still constitute a barrier to resolution if additional collateral must be posted

Unusually wide definition of “Specified Entities”

Widens the application of ISDA Events of Default and/or Termination Events

 

Group 3: Unlikely to be Non-Standard Terms

Clause

Explanation 

Automatic Early Termination

AET is primarily designed to protect against ‘cherry picking’.  However, in certain circumstances the automatic termination of trades could constitute a barrier to resolution.  Nonetheless, it is placed in Group 3 due to the fact that, under normal circumstances, resolution tools would have been implemented before insolvency (and therefore AET) occurs

Non-daily CSA calls

 

Should not be effective to prevent the exercise of the resolution tools

Non-zero/large CSA Thresholds/MTAs

Should not be effective to prevent the exercise of the resolution tools

Unusually large/small collateral haircuts

Should not be effective to prevent the exercise of the resolution tools

Non-assignment Provisions

Should not be effective to prevent the exercise of the resolution tools

 

An RRP Timeline

Here is a link to an RRP Timeline.  I hope that you find it useful.

The yellow flags highlight some of the events which resulted in the initial RRP initiative.  The green flags represent the regulatory initiatives related to RRP, and the red flags show some of the deadlines that will apply to market participants affected by RRP legislation.

Apologies for the fact that it’s rather cluttered – there has been a lot happening with respect to RRP recently!  However, I wanted to set a bit of a benchmark with the first timeline.  Over time, I will update this, but focus more on future regulatory initiatives and deadlines and less on past events.