SSM Proposals Being Watered Down?


On 8 October 2012, the EU Parliament’s Committee on Economic and Monetary Affairs (ECON) published a draft report proposing amendments to the European Commission’s draft regulation establishing a single supervisory mechanism (SSM).

The most significant amendment proposed by the EU Parliament would restrict the number of banks coming under direct ECB supervision.  Whilst subject to safeguards (and admittedly still in draft form) these proposals nonetheless have the potential to undermine the effectiveness of the SSM as a mechanism for ensuring a coordinated cross-border response to bank resolution within the EU.  As such, it will be important to monitor the way in which these proposals develop.  More detail on the contents of the draft report is provided below.

Scope of the SSM Regulation

As drafted by the EU Commission, the ECB would have been given supervisory responsibility for “all banks of participating Member States”.  In contrast, the EU Parliament amendment proposes that the ECB’s powers be limited to exercising “specific and clearly defined supervisory tasks” in relation to:

  • systemically important European banks (measured by reference to size of exposures, systemic risk for the relevant domestic economy and scale of cross-border activity); and
  • banks which have received or requested public financial assistance.

Under the EU Parliament’s proposed amendments, national competent authorities would continue to supervise all banks falling outside the scope of direct ECB supervision.  However, the ECB would establish a supervisory framework under which national supervision would take place and would be responsible for monitoring national authorities’ compliance with this framework.  The framework would be supported by a requirement on national authorities to report to the ECB on a quarterly basis, and provide notification “without delay” where:

  • serious concerns exist about the safety and/or soundness of a credit institution falling outside the scope of direct ECB supervision;
  • the stability of the financial system is or is likely to be endangered by a credit institution falling outside direct ECB supervision; or
  • a credit institution for which they are competent ceases to fall outside the scope of direct ECB supervision.

The ECB would commence supervision from 1 July 2013 but may, by way of notification, exercise its powers before this date in relation to any credit institution which has received or requested public financial assistance.  In addition, the ECB would also retain the right to exercise supervisory power of any Member State credit institution if:

  • national authorities failed to perform their obligations under the SSM regulation;
  • there was evidence that a credit institution posed, was likely to pose, or would exacerbate  a threat to the single market or financial stability; or
  • a credit institution falls under the scope of direct ECB supervision.


IMF Speech on Global Financial Sector Reform

On 26 October 2012, the IMF published a speech given in Toronto by its Managing Director, Christine Lagarde, on global financial sector reform.

Ms Lagarde noted that progress had been made on implementing financial sector reform, specifically referring to Basel III and improved standards for the resolution of banks.  In particular, she welcomed the EU’s moves to adopt a legal framework for a single supervisory mechanism by the end of 2012 as well as provisions regarding national resolution and deposit guarantee frameworks.  However, she noted that a globally coordinated discussion and response was still required in a number of areas, including:

  • current efforts to resolve the issue of “too important to fail” through structural reform as proposed by Volcker, Vickers and Liikanen; and
  • international agreement on methodologies to assess compliance of recovery and resolution planning for large cross-border institutions.

HM Treasury Publishes Summary of Responses to Consultation on Non-bank resolution


On 17 October 2012, HM Treasury published a summary of responses received to its August 2012 consultation paper, entitled “Financial Section Resolution: Broadening the Regime” (the “Consultation Paper”).  Broadly, the Consultation Paper had proposed the widening of resolution regimes to systemically important non-banks, specifically:

  • Investment firms and parent undertakings;
  • Central counterparties (CCPs);
  • Non-CCP financial market infrastructures (non-CCP FMIs); and
  • Insurers.

For a full summary of the Consultation Paper, please see our previous blogpost “HM Treasury Consultation:  RRP for Financial Market Infrastructures” dated 8 August 2012.

Summary of Responses

HM Treasury received 45 responses to the Consultation Paper prior to the 24 September 2012 deadline.  Broadly, respondents were supportive of the original position of the Government, which reconfirmed its intention to develop the UK regime in advance of European legislation.  The main changes to be implemented in light of the Consultation Paper are set out below.

Investment firms and parent undertakings

The Government proposes:

  • to narrow the definition of investment firms which are subject to the resolution regime proposals so as to promote consistency with the Recovery and Resolution Directive by excluding small investment firms that are not subject to an initial capital requirement of €730,000; and
  • an extension of stabilisation powers to group companies in order to facilitate resolution, but subject to certain conditions, such as limiting such powers to financial groups (rather than financial elements of any group that contains a bank, as was proposed in the Consultation Paper).

Central Counterparties

The Government proposes to include an additional objective for intervention in a failing CCP, which seeks to maintain the continuity of critical services.  It notes the mixed response from the industry regarding the intervention power generally but continues to regard this as justified given the systemic consequences which closure of a CCP’s critical functions could have, particularly where there are no obvious substitutes for the CCP.  However, the Government also accepts that recognised clearing houses that do not provide central counterparty clearing services should be excluded from the regime altogether, meaning that they are likely to be covered by proposals relating to non-CCP FMIs.

The Government also noted the strong industry opposition to its proposal to allow resolution authorities to impose on the clearing members of a CCP any losses which were above and beyond those dealt with by the CCP’s existing loss allocation provisions.  It was felt that this proposal would cause uncertainty, could potentially lead to distorted incentives such as the early termination and exit of members, might put UK CCPs at a competitive disadvantage and could have capital and liquidity implications for clearing members.  In light of this, the Government has decided not to pursue the proposal, but remains of the view that taxpayers should not be expected to meet the cost of restoring a failed CCP.  As such, it proposes to make loss allocation rules mandatory for the purposes of authorisation as a Recognised Clearing House within the UK and will re-consult on this new proposal in due course.

Non-CCP FMIs and Insurers

The government accepts that the case for a full resolution regime for Non-CCP FMIs or insurers is less clear cut.  Most Non-CCP FMIs have no financial exposure, similar to those faced by CCPs, and any failure is more likely to be operational or technological in nature.  In addition, there seems to be a general recognition that traditional insurance activities – whether general or life insurance business – do not generate or amplify systemic risk.  In contrast, non-traditional insurance and non-insurance activities (such as derivative trading) are regarded as sources of systemic risk.

It seems that the Government accepts that a strengthening of the existing regimes appears to be the most appropriate option and will engage in further dialogue to determine how best this can be achieved.

Next Steps

The changes to proposals regarding investment firms and their parent undertakings, deposit taking institutions and CCPs will be effected by changes to the Financial Services Bill that is currently before Parliament.  For non-CCP FMIs and insurers, the government will take further time to consider the arguments presents by respondents to the Consultation Document and decide the best way to proceed.

European Parliament Publishes Draft Report on RRD


On 16 October 2012, the European Parliament’s Committee on Economic and Monetary Affairs (ECON) published a draft report (the “draft report”) on the EU Commission’s proposal for a Directive establishing a recovery and resolution framework for credit institutions and investment firms (the “RRD”).  The overriding concern of the authors of the draft report relates to the level of interference with property rights permitted by the current draft of the RRD and the need to provide certainty to investors.  There is a perceived need to draw a more definite distinction between the pre-resolution period, where management remains in control of the firm, and the post-resolution phase, where control passes over to the relevant authority.  As a consequence, the draft report suggests far-reaching amendments to the RRD in areas such as:

  • resolution authority powers during the recovery phase;
  • preventative powers;
  • early intervention powers;
  • triggers to resolution; and
  • resolution tools: proposing both new resolution tools and amendments to existing resolution tools, particularly bail-in.

A more detailed summary of the main proposals is provided below.

Role of resolution authorities

In order to safeguard legal certainty and avoid conflicts of interest, the draft report proposes that national supervisory authorities should not also be able to act as resolution authorities.

Recovery Phase

Replacement of management

Currently, the draft RRD authorises competent authorities to replace the management of a firm during the recovery phase.  The draft report suggests replacing this power with a right to request  the replacement of the management body, on the basis that, during recovery (as opposed to resolution) shareholders should retain full control of a company.

Assessment of recovery plans

Article 6 of the draft RRD empowers a resolution authority to take the following actions in the event that it considers deficiencies to exist in a firm’s recovery planning: 

  • the reduction of the risk profile of the institution;
  • recapitalisation measures;
  • changes to the firm strategy;
  • changes to the funding strategy;
  • changes to the governance structure of the institution.

The draft report proposes to remove all of these powers on the basis that they constitute too great an imposition on the way in which a firm is run during a recovery stage.

Group recovery planning

Article 7 of the draft RRD currently states that recovery plans must cover each entity in a group.  The draft report suggests amending this provision so that the requirement applies only to relevant entities.

Preventative Powers

Article 14 of the draft RRD requires resolution authorities to notify firms about “potential substantive impediments to resolvability”.  Once notified, a firm must formulate proposals to remove these impediments within four months, failing which the authority can suggest a number of alternative measures.  The authors of the draft report believe that the current list of powers goes far beyond what is necessary and represent a “far reaching interference with property rights in banks”.  Of the current list of powers detailed within the RRD, the draft report suggests deleting those highlighted in red below:

  • requiring the institution to draw up service agreements to cover the provision of critical economic functions or services;
  • requiring the institution to limit its maximum individual and aggregate exposures;
  • imposing specific or regular information requirements relevant to resolution;
  • requiring the institution to divest specific assets;
  • requiring the institution to limit or cease specific existing or proposed activities;
  • restricting or preventing the development or sale of new business lines or products;
  • requiring changes to legal or operational structures;
  • requiring a parent undertaking to set up a parent financial holding company in a Member State or a Union parent financial holding company;
  • requiring a parent or holding company to issue subordinated debt/loans;
  • where an institution is the subsidiary of a mixed-activity holding company, requiring that the mixed-activity holding company set up a separate financial holding company to control the institution.

Early Intervention

Early intervention measures

Article 23 of the draft RRD allows for early intervention by a resolution authority if a firm does not meet, or is likely to breach, the terms of the Capital Requirements Directive (“CRD”).  The draft report suggests amending this so that early intervention is triggered where a firm’s capital is reduced below an amount equal to 1.25% above the level required by CRD IV.  In addition, the draft report proposes the removal of the early intervention power in Article 23(1)(g) of the RRD which allows authorities to contact potential purchasers in order to prepare for the resolution of the institution on the basis that this could damage attempts by management to restore the viability of the institution in question.

Special Management

The draft report proposes moving Article 24 (Special Management) of the RRD in its entirety from the recovery phase to the resolution phase.  The authors of the draft report believe that, during recovery, the owners should have full control over the institution and that this control should only pass to authorities once resolution has commenced.

Resolution Phase

Preparation of resolution plans

The report proposes that national competent authorities should be able to waive the requirement to prepare a resolution plan if a firm is judged to be not systemically important.

Conditions for resolution

Article 27 of the RRD triggers resolution in circumstances where a firm “is failing or likely to fail”.  The authors of the draft report believe that the term “fail” is vague.  Given the impact which application of the resolution tools can have on property rights, it is felt appropriate that resolution should only be used where a firm is very close to insolvency.  However, the authors of the draft report remain keen to avoid liquidity related triggers to resolution due to the possible systemic effects of triggering resolution on this basis.  Accordingly, the draft report proposes to:

  • include an additional condition for resolution such that the firm is also no longer viable pursuant to CRD IV; and
  • remove the trigger that the “institution will be, in the near future, unable to pay its obligations as they fall due”.

Resolution Tools

The draft report proposes the inclusion of a new resolution tool, the “government financial stabilisation tool”.  This takes the form of a new Article 50 (replacing the current Article 50 which addresses contractual recognition of bail-in).  Broadly, there are three elements to the government financial stability tool:

  • Guarantee tool – which facilitates government guarantees of assets or liabilities of institutions in resolution;
  • Equity support tool – which facilitates government recapitalisation of an institution in resolution; and
  • Temporary public ownership.

The authors of the draft report view this very much as a last resort and state clearly that taxpayers must be the beneficiaries of any surplus that may result.


Use of the Bail-In Tool

The draft report suggests amending Article 37 of the RRD to clarify that bail-in must not be used until a firm is beyond the point of non-viability and then only to meet the objectives of resolution as specified by Article 26.  Furthermore, a new Article 37(a) is proposed.  This would require Member States to conduct an assessment of the potential impact on the stability of the EU financial system before the bail-in tool is applied.

Scope of the Bail-In Tool

The draft report proposes amending Article 38 of the RRD to:

  • remove the exclusion relating to guaranteed deposits;
  • specifically refer to covered bonds in the context of the exclusion relating to secured liabilities; and
  • Extend the short-term exclusion from liabilities with an original maturity of less than one month to include liabilities with an original maturity of less than 6 months (so as to minimise the risk of bank runs).

Replacement of management

Recital 46 of the draft RRD states that, following application of the bail-in tool, management should always be replaced and the firm should be restructured.  The draft report proposes removing the reference to ‘replacement of management’.

Minimum amount of bail-in

The draft RRD requires firms to hold a minimum amount of bail-in debt, calculated by reference to the total liabilities of the institution.  The draft report of the Parliament proposes changing this to refer to the “risk exposure amount” (i.e. risk weighted assets) under CRD IV which is to be added to a firm’s minimum capital requirements.  The report claims that the reference to “total liabilities” introduces a totally new capital requirement on firms.  Moreover, in practice, this would operate as a leverage ratio which would not distinguish between low-risk banks and high-risk banks. 

Assessment of amount of Bail-In

Article 41 of the draftRRD requires resolution authorities to calculate the amount of bail-in that would be necessary not only to restore the Common Equity Tier 1 capital ratio of the institution to regulatory minimums but also to “sustain sufficient market confidence in the institution and enable it to continue to comply with the conditions for authorisation”.

The authors of the report point to the uncertainty that application of the bail-in tool can cause to investors in a firm and the increased funding costs firms may experience as a result.  The draft report highlights the need to strike a balance between providing certainty to investors on one hand and the need for creating capital for a bank under resolution on the other.  It suggests removing reference to ‘amounts necessary to sustain market confidence’ on the basis that this is, by definition, an arbitrary assessment, which may be artificially high during times of market stress.

Hierarchy of Claims

In order to provide certainty to investors regarding the hierarchy of claims, the draft report proposes to clarify Article 43 of the RRD.  Specifically, in order to avoid the unfair consequences associated with the upside potential of an equity position as opposed to the write down of a debt position, it is proposed that resolution authorities shall not write down the principal of one class of liabilities, while a class of liabilities that is subordinated to that class is converted into equities.

Contractual recognition of bail-in

In light of the fact that the RRD will apply to all capital and debt instruments regardless of any contractual provision, the draft report proposes the deletion of Article 50, which deals with contractual recognition of bail-in, believing it to be both irrelevant and potentially confusing.

Resolution Financing Arrangements

Ex-ante contributions

The draft report proposes that resolution should be funded ex-ante, rather than ex-post on the grounds that:

  • large ex-post contributions might exacerbate systemic risk during a financial crisis; and
  • properly managed banks would, in effect, be liable for the losses of failed banks.

The draft report also proposes using contributions to pay down public debt, rather than creating a formal fund with necessitates an investment strategy.  The financing arrangements would effectively form the premia of an insurance scheme provided by Member States.  The authors believe that a structure along these lines would render the target funding level of 1% of aggregate deposits within 10 years of the entry into force of the directive, as detailed within Article 93, irrelevant.

Borrowing between financing arrangements

Broadly, under Article 97, the RRD gives financing arrangements of one member state the right to borrow (and the obligation to lend) to other member state financing arrangements.  The draft report proposes amending this so that financing arrangements have the opportunity to borrow and the authorisation (but no obligation) to lend.

Deposit Guarantee Schemes

The draft report proposes amending Article 99 of the RRD to make clear that DGS may not be used for resolution purposes (other than through a potential bail-in of the DGS) so as to “safeguard the credibility of the deposit guarantee scheme”.

Single Supervisory Mechanism to Commence on 1 January 2013

The BBC reports that EU leaders have agreed to phase in a single supervisory mechanism, under the auspices of the ECB, for eurozone banks during the course of 2013.  However, according to the report, it is not clear whether the ECB will have direct responsibility for all 6,000 eurozone banks – specifically, whether German Landesbanks will continue to be subject to national supervision on a day-to-day basis.

This FT article sees the timetable for implementation as a victory for the group of nations, led be France, which had been pushing for a speedy first step towards banking union.  However, it notes that there is still no agreement as to when the European Stability Mechanism will be empowered to recapitalise troubled banks directly, thus relieving sovereigns of the burden of debt.  The German government insists that this can only happen once the new bank supervisor is established and running effectively.  The ECB itself estimates that this would take between 6 and 12 months.

Banking Reform Under Fire

The effectiveness of both the proposed Vickers and Liikanen ringfenced were questioned yesterday during evidence given by Paul Volcker to the UK Parliamentary Commission on Banking Standards.

According to this FT article, Mr Volcker described the Vickers ringfence as “difficult to sustain” and full of holes “likely to get bigger over time”.   The article also suggests that the future direction of the legislation designed to enact Vickers may diverge from a wholescale adoption of its proposals.

Elsewhere, the FT also reports that legal advice provided to the EU Council has concluded that plans to create a single eurozone banking supervisor may be illegal unless treaty change is enacted so as to broaden the scope of governance rules at the ECB.  Moreover, non-eurozone countries that wish to opt into the new regime would not legally be entitled to vote, making it less likely that those countries would wish to join and so undermining the effectiveness of the initiative from the outset

Basel Committee publishes framework for D-SIBs


On 11 October 2012, the Bank for International Settlements (BIS) published a framework for identifying and dealing with domestic systemically important banks (D-SIBs).

The purpose of the framework is to reduce the probability of D-SIB failure compared to non-systemic institutions.  In furtherance of this goal, 12 principles have been identified.  These establish a minimum set of requirements in relation to treatment of D-SIBs, whilst recognising the need for a degree of national discretion.  They can be applied both to consolidated groups and to branches within a host jurisdiction.  Broadly, the principles fall into two categories which define:

  • the assessment methodology for D-SIBs; and
  • higher loss absorbency (HLA) requirements for D-SIBs.

Assessment Methodology

Assessment methodologies should be public and clearly articulated with a focus is on the impact D-SIB failure would have on both the domestic financial system and the domestic economy.  In determining systemic importance, home authorities should consider banks from a (globally) consolidated perspective and host authorities should assess foreign subsidiaries in their jurisdictions on a consolidated basis which includes any downstream subsidiaries, some of which may be in other jurisdictions.  Annual assessments of the systemic importance of domestic banks should be conducted by reference to the following bank-specific factors:

  • size;
  • interconnectedness;
  • substitutability/financial institution infrastructure; and
  • complexity.

National authorities can also consider other factors that would inform the above list, such as the size of a bank relative to domestic GDP.

Higher Loss Absorbency

From January 2016, any institution identified as a D-SIB will be subject to an HLA requirement, which must be met fully by Common Equity Tier 1 through an extension of the Basel III capital conservation buffer.   Banks that are both D-SIBs and Global SIBs should be subject to the higher HLA requirement, but double counting should be avoided.  Specific HLA requirements should be commensurate with the D-SIB’s degree of systemic importance and could be affected by:

  • the resolution regimes (including recovery and resolution plans) in and between jurisdictions; and
  • available resolution strategies and any specific resolution plan in place for the firm.