On 25 February 2013, the EU Parliament’s Committee on Legal Affairs published its final opinion proposing certain amendments to ‘proposal for a Directive of the European Parliament and of the Council establishing a framework for the recovery and resolution of credit institutions and investment firms’ (the “RRD”). This is a follow up to the draft opinion published on 5 February 2013. The amendments proposed in the final opinion exactly mirror those detailed in the draft opinion, as summarised in our previous blogpost.
In a sign that the political tide may be turning, the FT is reporting that the Federal Reserve and the Federal Deposit Insurance Corporation have raised the prospect of taking severe action against banks that submit deficient living wills, including increased capital requirements or even forced break-ups.
Whereas previously, it was accepted that RRP was an iterative process that may take a number of years to get fully up to speed, it seems that truly credible plans will now be required when the next round of RRP are submitted in July 2013. This is due, at least in part, to the regulators’ disappointment at the lack of detail and clear proposals for resolution in the 2012 submissions.
On 27 February 2013, the European Commission published an updated summary of the legislative and non-legislative proposals it expects to adopt between 21 February and 31 December 2013.
Among the legislative acts expected to be adopted are a:
- Directive/Regulation on the reform of the structure of EU banks (i.e. Liikanen), expected in Q3 2013;
- Framework for crisis management and resolution for financial institutions other than banks, expected in Q4 2013; and
- Regulation on a single resolution authority and a single resolution fund within a Single Resolution Mechanism (SRM), expected in Q4 2013.
As previously reported on this blog, on 20 February 2013 the FSA published an update to its Recovery and Resolution Planning guidance. It was announced that, in the future, firms will not have to update their resolution information pack (RRP Modules 3-6) on an annual basis as a matter of process. Instead, they will only be required to respond to requests for resolution planning information from their supervisors.
It seems difficult to reconcile the FSA’s new position with other RRP guidance. The FSB’s “Key Attributes” document states clearly that “supervisory and resolution authorities should ensure that RRPs are updated…at least annually or when there are material changes to a firm’s business or structure”, a requirement which is echoed in the draft Recovery and Resolution Directive (RRD). More generally, given the enormous amount of data processing effort that goes into updating a resolution plan in practice, it is difficult to see how any firm which does not follow processes designed to facilitate the periodic updating of a resolution plan could ever be taken to be in compliance with the “Key Attributes” requirements that it must be able to demonstrate an ability to produce the essential information needed to implement a resolution plan within 24 hours or be capable of delivering sufficiently detailed, accurate and timely information to support an effective resolution.
Firms would also be forgiven for being confused as to how best to react to this guidance in light of other regulatory developments which offer incentives for those who are prepared to constantly seek to optimise their resolvability, including:
- the additional loss-absorbency requirements of Basel III for Global Systemically Important Banks;
- the Liikanen proposal that structural separation above and beyond that relating to ‘significant’ trading activities should be dependent on the robustness of RRPs; and
- the Vicker’s recommendation that an additional levy of up to 3% of equity capital be required of a UK banking group that is judged “insufficiently resolvable to remove all risk to the public finances”.
Enhancing resolvability demands a proactive, rather than a reactive, approach to RRP legislation. By its nature, the assimilation of resolution information is not a process that can be easily mothballed and simply dusted-down as and when required, particularly for firms operating in multiple jurisdictions. Rather, if it is to mean anything, optimising resolvability requires huge commitment and continued cooperation on the part of both firms and authorities. In light of the drafting of the “Key Attributes” document and particularly the RRD, it is at least questionable whether the new FSA guidance will survive the test of time. The message to firms must surely be to note the FSA’s new guidance with interest but to continue on a ‘business as normal’ footing with their RRP preparations.
On 25 February 2013, the FSA published Policy Development Update Number 156 detailing forthcoming publications from the FSA on a wide range of issues, including:
- RRP: Policy Statement to CP11/16 and PS12/5 on recovery and resolution planning. This is expected to be published in Q2 2013; and
- CASS RP: Policy Statement to CP 12/20, “Review of the client money rules for insurance intermediaries”. This will include finalised rules regarding CASS Resolution Packs for firms subject to CASS 5 and is expected to be published in Q3/Q4 2013.
The FSA has published an update to its Recovery and Resolution Planning (RRP) guidance dated 20 February 2013.
It expects to publish formal RRP rules “soon” after the FSA hands responsibility over to the Prudential Regulation Authority on 1 April 2013. An updated RRP information pack for firms can be expected soon thereafter with subsequent updates aimed at aligning UK domestic requirements with Financial Stability Board guidance and the EU Recovery and Resolution Directive also expected.
In light of the experience of RRP submissions to date and international policy development, the FSA update also details the following two policy changes:
- firms will be required to update recovery plans annually as part of their normal risk management procedures and submit it to supervisors for review when requested; and
- firms will not have to update their resolution information pack (RRP Modules 3-6) on an annual basis as a matter of process. Instead, they should respond to requests for resolution planning information from their supervisors.
On 12 February 2013, Julian Adams, FSA Director of Insurance, gave a speech at the Economist Insurance Summit in London on the lessons for insurance supervisors from the financial crisis.
Mr Adams explained that the overall objective of the FSA is to create an environment in which no insurer is too big, too complex or too interconnected to fail, and where participants are able to exit the market in an orderly fashion which ensures continuity of access to critical services.
He noted that the UK currently does not have a resolution regime for insurers, instead relying on ‘run-off’, Schemes of Arrangement and formal insolvency. However, each of these options carries attendant risks meaning that it is necessary to at least consider whether a resolution regime for insurers in necessary. Any such regime would be consistent with the Financial Stability Board’s ‘Key Attributes’ document and would also take a lead from the International Association of Insurance Supervisors, which is due to publish its initial list of Globally Systemic Important Insurers in the summer of 2013. The key challenge is to recognise the specificities of insurance compared to other financial sectors – particularly the factors that make an insurer ‘systemically important’. On this topic, Mr Adams highlighted three issues:
Use of Leverage – such as:
- engaging in stock lending in order to invest proceeds in higher yielding (and therefore higher risk) paper; or
- facilitating borrowing by non-insurance group members on the strength of an insurance business;
Asset Transformation – such as the sale of long-term investment products by life insurance companies; or
Assumption of Credit Risk – such as:
- the securitisation of corporate paper; or
- the funding of annuity liabilities through exposure to subordinated corporate debt.
If the answer to any one of these questions, alone or in combination, is positive then the FSA would “consider carefully” whether the firm in question was systemically significant.