Further Blow Dealt to Liikanen

The FT reports that the German finance ministry has proposed legislation dealing with banking reform that has been interpreted as a rejection of the concept of ringfencing as contemplated by the Liikanen report.  Instead, the draft bill would require banks to set up a separate unit for proprietary trading activities that accounted for either EUR 100 billion of assets or 20% of balance sheet.  If passed by the German parliament, the measures would likely come into force by mid-2015.

The draft bill largely mirrors French proposals, published in December 2012, to ringfence speculative trading activities.  However, it is in contrast to both the Vickers proposals in the UK (pursuant to which deposit taking activities would be ringfenced) and the Liikanen proposals (which require the ringfencing of all trading activities above a certain threshold).

EU Signals Retreat from Liikanen Reforms?

The FT is reporting that Michel Barnier, EU Commissioner responsible for the internal market and services, has hinted that the EU may not require banks to erect a ringfence around their trading activities, confirming that any reforms would have to preserve the diversity of EU banks and avoid penalising those that were supporting economic growth.

We will know more in the summer of 2013, following completion of an impact analysis of the proposed Liikanen reforms, when M. Barnier confirms the EU’s preference for implementation in more detail.

FSB to Complete G-SIFI RRP Reforms Before Concentrating on Non-Banks

The Financial Stability Board (FSB) has published a press release regarding the meeting which took place in Zurich on 28 January 2013 to discuss vulnerabilities affecting the global financial system and progress to strengthen global financial regulation.

On the subject of resolving failing financial institutions, the FSB confirmed that, in April, it will publish its final peer review of resolution regimes.  Thereafter, the FSB’s work on resolution in 2013 will focus on three main objectives:

  • addressing remaining obstacles to the implementation of resolution strategies for G-SIFIs;
  • launching an effective resolvability assessment process for G-SIFIs; and
  • developing guidance for the resolution of non-bank financial institutions.

EBA Template Highlights the Data Challenge of RRP

Introduction

On 23 January 2013, the European Banking Authority (EBA) published its recommendation on the development of recovery plans.

The recommendation is a follow-up to the EBA’s Discussion Paper on recovery plans published on 15 May 2012 and is primarily for the benefit of national competent authorities pending the finalisation of the EU directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”).  It aims to ensure consistency and convergence on highest standards across the EU.

The requirement to complete the template recovery plan outlined in the recommendation applies to a list of 39 banks, as detailed in Schedule 1 to this article.  The template itself must be completed no later than 31 December 2013.

Summary of Recovery Plan Template

The template recovery plan itself is divided into three sections:

  • General overview – providing background information on the structure of the group and the governance processes supporting the recovery plan;
  • Core of recovery plan – dealing with the design and implementation of credible recovery options; and
  • Follow-up – addressing the measures that can be taken to optimise successful resolution strategies.

A more detailed summary of the requirements is provided in Schedule 2 to this article.

The Data Challenge

Whilst much inevitably depends on the specific drafting of an individual group’s recovery plan, the EBA template does raise the prospect that a number of EU banks will be required to effectively produce two recovery plans.  Taking the UK as an example, broadly speaking, banks preparing recovery plans pursuant to FS12/1 will find that they have already undertaken most of the analysis necessary in order to produce an EBA compliant recovery plan.  Thankfully, much of the required data will have been generated as part of their Module 2 (Recovery Plans) submissions.  However, firms may need to look further afield into Modules 3, 4 and 5 in order to meet certain other requirements of the EBA template, such as those regarding:

  • group legal structure diagrams;
  • functional mappings;
  • intra-group dependencies; and
  • information management processes.

In addition, certain other aspects of the EBA template are not specifically addressed under FS12/1.  This includes the requirement to produce an “Operational Contingency Plan” explaining in detail how internal operations and access to market infrastructure will be maintained during the implementation of a recovery option.

The practical difficulties presented by the EBA template recovery plan are symptomatic of a wider issue hampering the ability of firms to meet the RRP needs of regulators.  This stems from the absence of any kind of real agreement amongst national regulators as to the set of information to be generated by firms in support of their RRPs.  Unfortunately, current indications are that any chance of uniformity with respect to RRP data requirements is actually receding yet further, with authorities in jurisdictions such as Canada and Hong Kong largely declining to follow earlier precedents set by regulators such as the FSA.  Given the administrative and financial burden associated with RRP production, the challenge to firms in the future will be to find a way to create a flexible enough view of underlying data so as to avoid having to completely reinvent the wheel for each regulator.  A technology led solution would seem to be the answer and is long overdue.

Schedule 1

List of Banks Subject to the EBA Recommendation on Recovery Plans

 

 

  • ABN AMRO Group NV
  • Allied Irish Banks, Plc
  • Alpha Bank AE
  • Banco Bilbao Vizcaya Argentaria, SA
  • Banco Comercial Portugues SA
  • Banco Santander SA
  • Bank of Cyprus Public Company Limited
  • Bank of Ireland
  • Barclays PLC
  • Bayerische Landesbank
  • BNP Paribas SA
  • Commerzbank AG
  • Credit Agricole Group
  • Cyprus Popular Bank Public Co Ltd
  • Danske Bank A/S
  •  Deutsche Bank AG
  • Deutsche Zentral-Genossenschaftsbank AG
  • Dexia
  • DNB Bank AB
  •  Erste Group Bank AG
  • Eurobank Ergasias
  • Group BPCE
  •  HSBC Holdings PLC
  • ING Bank N.V.
  • Intesa Sanpaolo SpA
  •  KBC Group NV
  • Lloyds Banking Group Plc
  • National Bank of Greece
  •  Nordea Bank AB
  • OTP Bank Nyrt
  • Piraeus Bank
  • Rabobank Group
  • Raiffeisen Zentralbank AG
  • Royal Bank of Scotland Group Plc
  • Skandinaviska Enskilda Banken AB
  • Societe Generale SA
  • Svenska Handelsbanken AB
  • Swedbank AB
  • UniCredit SpA

 

Schedule 2

Summary of EBA Template Recovery Plan

 

The EBA template is divided into three main sections, as detailed below.

1. General Overview

1.1 Summary

This should include at least:

  • the key elements presented in each section of the plan;
  • the main changes since the last update, if applicable;
  • an overview of the steps to be taken before finalisation/update of the plan.

1.2 Description of the group

This section should provide a:

  • general overview of the institution’s:
    • legal structure (including significant branches);
    • business model;
    • activities and jurisdictions in which it is active;
    • main core business lines; and
    • interdependencies;
  • mapping of:
    • legal and operational structures i.e.:
      • significant legal entities and branches;
      • activities conducted;
      • business units; and
      • employees by business unit;
    • legal and financial structures i.e.:
      • significant legal entities and branches;
      • turnover;
      • cash flows;
      • liquid assets;
      • funding needs;
      • large exposures;
      • P&L;
      • Tier 1 capital;
  • description of:
    • intra-group financial links, including:
      • material intra-group exposures;
      • material intra-group funding relationships;
      • capital mobility; and
      • intra-group guarantees;
    • critical or systemically relevant group functions, including:
      • external functions:
        • payment systems;
        • services provided to other institutions;
      • centralised functions
        • treasury;
        • collateral management;
        • IT;
        • access to market infrastructures;
        • administrative;
        • operational;
        • outsourcing.

1.3   Discussion of internal governance

This section addresses internal governance issues regarding the design of the recovery plan, providing a summary of:

  • how the plan was developed, including:
    • identification of persons responsible for the different sections; and
    • discussion of how the plan is integrated into corporate governance and risk management frameworks;
  • by whom the plan was approved, including:
    • involvement of senior management;
    • whether the plan was presented to internal/external auditors;
    • whether the plan was presented to the risk committee; and
    • confirmation of approval by Board of Directors and/or Supervisory Board;
  • the governance of recovery options during a crisis, including:
    • a description of escalation processes; and
    • the decision making process surrounding plan activation;
  • how the plan is to be updated, including:
    • responsible individuals;
    • frequency of updating; and
    • a description of the updating process in response to material changes affecting the institution or its environment.

2. Core of recovery plan

This section requires firms to provide a “menu of recovery options” enabling an institution to respond to financial stress, whether idiosyncratic or systemic, and to assess the feasibility and impact of each option.  At a minimum, the information detailed below is to be provided.

2.1 General overview of recovery options

Firms are required to provide a general description of:

  • all available recovery options; and
  • the actions that would be taken to enable timely execution of each option.

2.2 Recovery indicators

Recovery indicators determine the point at which, in a given situation, an institution starts to consider appropriate recovery options. They are both quantitative and qualitative in nature and tend to relate to the solvency and liquidity of the institution in question under stressed scenarios.  However, they do not automatically activate a specific recovery option, instead acting as an early identification of the best way forward.  This part of the recovery plan should detail how recovery indicators:

  • are incorporated into an institution’s risk management framework;
  • align with liquidity or capital contingency plan triggers;
  • align with the institution’s risk appetite framework.

2.3 Assumptions and scenarios

The objective of this section is to define a set of stress scenarios (idiosyncratic, systemic and a combination of the two) under which the efficiency of the different recovery options can be assessed by reference to their impact on such factors as:

  • solvency;
  • liquidity;
  • funding;
  • profitability; and
  • operations.

2.4 Recovery options

Recovery options are extraordinary in nature and can include:

  • external recapitalisation;
  • divestment of assets, subsidiaries or business units (or the whole institution);
  • voluntary restructuring of liabilities;
  • reduction of balance sheet;
  • strengthening of liquidity position.

With respect to each recovery option, a firm is required to perform:

  • an impact assessment, addressing:
    • financial and operational impact; and
    • external impact;
  • a risk assessment, addressing:
    • feasibility i.e. the risk that an option cannot be implemented; and
    • systemic consequences i.e. the risks resulting from implementation; and
  • a decision making process regarding implementation of recovery options.

2.5 Operational contingency plan

For each recovery option an institution is expected to provide an operational contingency plan detailing the way in which its operations can be maintained following implementation of a recovery option.  This includes at least an analysis of:

  • internal operations. e.g.:
    • IT systems;
    • Suppliers; and
    • HR operations; and
  • access to market infrastructure, e.g.:
    • clearing and settlement facilities;
    • payment systems; and
    • additional requirements in terms of collateral.

2.6 Communication plan

Firms are expected to provide a detailed communication plan regarding both internal and external stakeholders, addressing:

  • implementation of the communication plan under each recovery option; and
  • the potential impact on the business and on general financial stability.

2.7 Information management

Firms are required to describe general policy with respect to information management together with an analysis of specific information needs in relation to each recovery option.  Furthermore, each institution must be able to demonstrate an ability to satisfy not only its own information needs under each recovery option, but also the needs of its regulators.  Information required by a regulator would include:

  • intra-group exposures;
  • trades booked on a back-to-back basis;
  • amounts of liquid assets in parent banks and subsidiaries;
  • off balance sheet activities; and
  • large exposures.

3. Follow-Up

Follow-up measures focus primarily on:

  • preparations that can be taken in advance of the implementation of a recovery option; and
  • areas for improvement.

“Key Attributes of Effective Resolution Regimes”: a Case of the Emperor’s New Clothes?

The FT is reporting that the Federal Reserve and the Federal Deposit Insurance Corporation have warned banks which are required to produce Recovery and Resolution Plans (RRP) not to assume that regulators will co-operate to avoid the failure of a financial group.  In contrast, they are being required to detail the types of legal filings, notices and applications they would need to submit in each jurisdiction to ensure co-operation among regulators and are being expected to describe the legislation in force within specific countries that would facilitate co-ordination.

If this is indicative of the likely response of authorities during a crisis, it would be a very worrying development indeed.  It is in stark contrast to the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions”, published in October 2011.  This sets the benchmark for national RRP regimes and requires the:

  • establishment of Crisis Management Groups (CMGs) between home and key host authorities with the objective of facilitating the management and resolution of a failing cross-border G-SIFI; and
  • creation of institution-specific cooperation agreements between home and host authorities to govern the development of RRPs and detail procedures concerning notification and consultation prior to an authority taking action against a failing firm.

Unfortunately, if authorities choose not to work together during a crisis, CMGs and cooperation agreements will count for nothing.  Without regulatory co-operation, RRP has some residual value as a data-gathering exercise but will fail to meet its primary objective of facilitating the orderly resolution of a globally significant financial institution in a way that ensures continuity of critical economic functions and minimises taxpayer exposure.  Will anyone tell the G20 that they risk being measured up for the Emperor’s new clothes before it’s too late?

FSA Policy Statement on RRP Expected in Q2 2013

On 25 January 2013, the FSA published Policy Development Update Number 155.  This confirms that a Policy Statement on Recovery and Resolution Plans is now due to be published in Q2 2013.  The Policy Statement is the long-awaited follow-up to CP 11/16: “Recovery and Resolution Plans” published in August 2011.

EU Council Publishes Proposed Amendments to RRD

Introduction

On 13 January 2013, the Presidency of the EU Council published a compromise proposal regarding suggested amendments to Articles 1 to 36 of the Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”).  The most noteworthy amendments are highlighted below.

Early Intervention

Triggers to Early Intervention

Under Article 23 of the original RRD, it was proposed that a competent authority be authorised to take early intervention action when a firm does not meet, or is likely to breach, the requirements of the Banking Consolidation Directive.  Under the newly published draft, it is proposed to extend this authority to circumstances whereby the firm in question also no longer meets, or is likely to breach, the authorisation requirements under Title II of the MiFID Directive.  Two additional early intervention powers are also granted to competent authorities, being the power to:

  • appoint a manager who:
    • assumes certain tasks of the management of the institution, or
    • monitors the decisions and tasks of the management of the institution, or
    • is empowered to veto or authorize certain decisions of the management of the institution (note that this power appears to be separate from the “Special Management” powers granted under Article 24 of the RRD); and
  • require changes to the firm strategy or to the legal or operational structures of the institution.

Special Management

Amendments are proposed to Article 24 of the RRD in order to provide clarification that the appointment of a special manager shall not, of itself, make it possible for anyone to exercise any right or power to terminate, accelerate or declare a default or credit event under any agreement to which the institution is a party.  In addition, it is specifically noted that any special manager shall have no liability arising from action taken or not taken in discharge of its functions unless guilty of gross negligence or serious misconduct.

Group Recovery and Resolution

Proposed changes to Article 7 of the RRD would mean that group recovery plans would only be required with respect to (a) the group as a whole, and (b) individually for significant entities.  Previously, it was the case that all group entities would have been obliged to create a recovery plan.  The requirement to update group resolution plans pursuant to Article 12 has also been amended slightly to clarify that plans should be updated at least annually, and after any change to:

  • the legal or organisational structure of the parent company or of the group, or
  • the business or to the financial situation of the group as a whole or parts of the group that could have a material effect on or require a change to the plans.

Recovery Plan Triggers

A new Article 8a has been proposed under which competent authorities must ensure that each recovery plan includes a trigger framework which identifies the points at which appropriate actions referred to in the plan will or may be taken.  These triggers may be both quantitative or qualitative, must be forward looking and capable of being easily monitored, and should relate to the institution’s financial strength.   The European Banking Authority is to draft regulatory technical standards regarding these indicators within twelve months from the date of entry into force of the RRD.

Resolution Plans

Contents of Resolution Plans

It is proposed to amend the contents of Resolution Plans, as detailed under Article 9 of the RRD, in order to include the following additional information:

  • minimum amount of eligible liabilities required with respect to the exercise of the Bail-In Tool and a deadline to reach that level; and
  • a description of the staff who are essential for maintaining the continuous functioning of the institution’s operational processes.

Resolution Objectives

The Resolution Objectives under Article 26 of the RRP remain relatively unchanged except for the fact that the following have ceased to be ‘objectives’ and now appear as ‘general principles governing resolution’ pursuant to Article 29:

  • ensuring the continuity of critical functions; and
  • avoiding unnecessary destruction of value and seeking to minimise the cost of resolution.

In addition, it was previously the case that all Resolution Objectives were of equal significance.  In contrast, were the proposed changes to be adopted, it would be for the authorities to balance the objectives as appropriate to the nature and circumstances of each case.

Principles Governing Resolution

It is a general principle under Article 29 of the RRD that ‘no creditor should be worse off than in insolvency’.  However, in the latest draft of the RRD this principle only applies to the extent ‘not otherwise provided in this Directive’.  At this stage, the extent to which this principle is truly affected is not clear.

Resolution Tools

Of possible concern to some financial market infrastructures are the amendments to the Sale of Business Tool pursuant to Article 32 and the Bridge Institution Tool detailed under Article 34.  Broadly speaking, neither the purchaser of a business nor a bridge institution can be denied access to payment, clearing or settlement systems, stock exchanges or deposit guarantee schemes on account of the fact that they do not possess a particular rating or do not otherwise meet the relevant membership criteria.