EU Banking Union in the Balance?

If it were needed, proof positive once again that politics and economics don’t always mix is this link to an article published today in the FT.  It discusses the split developing within the EU between Brussels, Paris and the European Central Bank (ECB) on one hand, and Germany on the other.  The subject of the split is the future direction of EU banking union, specifically the design of the Single Resolution Authority, which together with the Single Supervisory Mechanism and the Common Deposit Guarantee Scheme, represents the three pillars of EU banking union.

The article describes the “German vision” for banking union – one of gradual integration where Member States remain largely responsible for supervision (albeit with coordination between national authorities) and wholly liable for costs (so as to protect the German taxpayer).  This contrasts with the EU vision for banking union which demands the creation of a centralised “heavyweight bank executioner” and implies a surrender of sovereignty with which Germany is uncomfortable.

If one considers that a single EU authority is a necessary step in relation to the supervision of credit institutions from birth and throughout life, it seems logical to conclude that a single authority should also govern them in their death.  Despite this, apparently logic has no place in this discussion and no compromise is in sight.  Add to this the fact that reformers are up against the deadlines of looming elections in Germany and at an EU level as well as a change of commission and EU banking union seems to be as far away as ever.

EU Council publishes final compromise SSM text

On 25 April 2013, the Council of the EU published the final compromise texts of a regulation conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions and the proposed regulation amending Regulation 1093/2010 (which established the European Banking Authority).  Together these texts establish the EU single supervisory mechanism (SSM).

Broadly, under the new regime, the European Central Bank (ECB) will assume responsibility for the supervision of “significant” credit institutions, with “less significant” credit institutions to remain subject to regulation by national supervisors.  “Significance” is to be based on the following criteria:

  • size;
  • importance for the economy of the EU or any participating Member State; and
  • significance of cross-border activities.

In addition, any credit institution will be regarded as “significant” if:

  • it has total assets of EUR 30 billion or more; or
  • the ratio of its total assets to the GDP of the participating Member State of establishment exceeds 20% (unless the total value of its assets is below EUR 5 billion); or
  • the ECB considers it to be of significant relevance; or
  • it has requested or received public assistance directly from the European Financial Stability Facility or the European Stability Mechanism;
  • it ranks amongst the three most significant credit institutions in a participating Member State.

The ECB will assume responsibility for, inter alia:

  • authorisations and withdrawal of authorisations;
  • the administration of certain activities currently carried out by home state regulators, such as the establishment of branches in non-participating Member States;
  • the assessment of applications for the acquisition and disposal of “qualifying holdings” (i.e. involving 10% or more of capital or voting rights);
  • the regulation of own funds requirements, securitisations, large exposure limits, liquidity, leverage, and reporting and public disclosure of information on those matters;
  • the enforcement of governance arrangements, risk management processes, internal control mechanisms, remuneration policies and internal capital adequacy assessment processes;
  • conducting supervisory reviews and stress testing;
  • consolidated supervision where parent companies are established in participating Member States; and
  • supervisory tasks in relation to recovery plans, early intervention and structural changes required to prevent financial stress or failure (but excluding any resolution powers).

Consideration of RRD Delayed Again

On 25 April 2013, the EU Parliament published an update to its procedure file confirming that its consideration of the Recovery and Resolution Directive (RRD) will now take place at the plenary session scheduled for 21 to 24 October 2013.  Previously it had been indicated that the RRD would be discussed at the plenary session to be held from 9 to 12 September 2013.

FCA Update on RRP and CASS

On 26 April 2013, the FCA published Policy Development Update No 157.  This summarises the anticipated publications dates for various pieces of regulatory guidance.  Of note are the following:

  • a policy statement (PS12/5) to CP11/16 on recovery and resolution plans, due for publication in Q2 2013;
  • a policy statement to part 2 of CP12/22 on the client assets regime (multiple client money pools), due for publication in Q2 2013 (had previously been noted as “TBD”); and
  • a policy statement to CP12/20 on client money rules for insurance intermediaries, due for publication in Q3/Q4 2013.

HM Treasury to Extend Special Administration and Resolution Regimes

On 25 April 2013, HM Treasury published a consultation paper on the introduction of a Special Administration Regime (SAR) for inter-bank payment systems (such as Bacs, CHAPS, Continuous Linked Settlement, CREST, LCH Clearnet Ltd, Faster Payments Service and ICE Clear Europe), operators of securities settlement systems (CREST being the only example in the UK) and key service providers to these firms (e.g. IT and telecommunications providers).  Responses are requested by Wednesday 19 June 2013.

The SAR would be a variant of a normal corporate administration and would be modelled on the special administration framework used in the utilities industries and the investment bank SAR.  However, it would be modified to allow the Bank of England to exercise control of the SAR process, to enable a special administrator to transfer all or part of the business to an aquirer on an expedited basis, and to facilitate the enforcement of restrictions on early termination of third party contracts.  Under the SAR, the special administrator would have the overarching objective of maintaining the continuity of critical payment and settlement services in the interest of UK financial stability. “Non-CCP FMI”, such as exchanges and trade repositories, and entities already covered by resolution powers for central counterparties (such as LCH and ICE) would be excluded from the regime.

On 25 April 2013, HM Treasury also published a statement confirming the fact that, before the end of the summer, it will consult on the extension of the special resolution regime (SRR) established under the Banking Act 2009 to group companies, investment firms and UK clearing houses.

US “megabanks”: Too-big-to-fail or just too big to survive?

This is a link to an article which appears in yesterday’s FT which describes a bill introduced into Congress by Sherrod Brown (Democrat) and David Vitter (Republican) under which banks with more than USD 500 billion in assets would be required to meet a new capital requirement of 15%.  At this stage, it seems that the prospects of the bill becoming law are slim, but ultimately only time will tell.

HM Treasury Accepts Initial Report on Investment Bank SAR

On 23 April 2013, HM Treasury published the initial report prepared by Peter Bloxham on the special administration regime for investment banks (SAR).  The independent review makes a number of immediate recommendations, which include:

  • The SAR should continue to have effect; 
  • The introduction of a mechanism to facilitate the rapid transfer of customer relationships and positions, where feasible; 
  • The bar date mechanism should be broadened to include client monies; 
  • The statutory objective in relation to client assets should be modified to include a reference to the “transfer” of assets to another institution in addition to the option of the “return” of client assets; 
  • SAR administrators should be permitted to make distributions of client assets during the period after the bar date process has commenced; 
  • Limited specific immunities to be introduced for SAR administrators; 
  • Good practice recommendations for firms, the FSA, and other institutions;
  • A number of recommendations relating specifically to the work of the Financial Services Compensation Scheme (FSCS).

The report also sets out further areas to be reviewed as part of a second phase of work which will be co-ordinated with the FSA’s review of its Client Assets Rulebook.  A final report is expected by the end of July 2013.  

HM Treasury made a further announcement in a written statement to the House of Commons on 23 April 2013, accepting the main recommendations of the report.  The Treasury agrees that SAR should be retained and accepts that amendments to that regime will be necessary in order to fulfil its objectives.

FRB and FDIC Raise the Bar in RRP

On 15 April 2013, the Federal Reserve Board (FRB) and Federal Deposit Insurance Corporation (FDIC) issued a press release providing revised guidance for large US banks and foreign banks with USD 250 billion or more in total nonbank assets in completing their 2013 resolution plan submissions and granting an extension to the filing date for 2013 resolution plans from 1 July 2013 to 1 October 2013.

The revised guidance details the format of submissions and requires firms to provide more detailed information on a wide range of issues pertaining to resolution; including obstacles to resolvability, interconnectedness, funding and liquidity.  In particular, there appears to be an increasing focus on derivatives trading risks, with banks being required to provide information on:

  • processes for obtaining waivers of contractual termination rights from counterparties, particularly with respect to the impact of cross-default clauses;
  • strategies to mitigate the impact of contractual triggers associated with parent company guarantees, cross-default clauses and ratings downgrades or withdrawals;
  • the management of the collateral processes in resolution, particularly with respect to the ability to quickly identify:
    • legal rights to collateral pledged to, pledged by, or held in custody by, the bank; and
    • the amount, level and type of collateral held by jurisdiction and the impact of rehypothecation rights (both on counterparty collateral held by the bank and collateral pledged to counterparties); and
    • quantification of the additional liquidity requirement (both actual and contingent) associated with contractual obligations such as guarantees.

Fortunately, the extraction of key legal and commercial data from derivatives documentation is a process which many banks have already begun to address for internal risk management purposes.  In addition, the revised US requirements largely mirror the UK RRP requirements as documented in FS12/1 and so are not completely without precedent.  Nonetheless, the FRB/FDIC revisions highlight the importance of unlocking the risks inherent in large portfolios of derivative documentation, presenting that information in a manner that can be readily accessed across an entire bank and by a regulator, and establishing robust procedures for the continuing capture of legal and commercial reference data from legal documentation.

First FSB thematic peer review report on resolution regimes

Introduction

On 11 April 2013, the Financial Stability Board (FSB) published its first “Thematic Review on Resolution Regimes” (the “Review”).

The objective of the Review is to evaluate FSB jurisdictions’ existing resolution regimes and any planned changes to those regimes using the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” (“KAs”) as a benchmark.  The Review compares national resolution regimes across individual KAs and across different financial sectors.  It uses responses to an FSB questionnaire as the primary source of information.

The Review concludes that, while major legislative RRP-related reforms have already been undertaken by some jurisdictions, implementation of the KAs is still at an early stage and additional guidance from the FSB is necessary in order to assist implementation efforts.  More specific conclusions, loosely grouped by topic, are provided below.

Recovery and resolution planning

The Review reported that, in most jurisdictions, there is no explicit requirement in statute or regulation for the submission of recovery and resolution plans (“RRPs”) by domestic systemically important financial institutions.  In addition, most authorities have the power to ask, but lack the power to require, firms to make changes to their organisational and financial structures solely in order to improve their resolvability and in advance of resolution.

Resolution Powers

The Review concluded that all jurisdictions have enacted some of the resolution powers specified in the KAs in relation to banks and insurers, but few are equipped with a full set of powers.  Moreover, resolution powers are considerably more developed for banks than for insurance and, especially, for securities or investment firms and financial market infrastructures (“FMIs”), where both mandates and powers “fall well short of the standards in the KAs”.  Furthermore, not all powers are exercisable solely by resolution authorities and the approval of resolution actions by courts is still often required.

Very few authorities have the statutory power to full effect bail-in within resolution with respect to banks, and powers to do so in relation to insurers, securities or investment firms and FMIs are generally not available.  Most jurisdictions also lack the power to impose a temporary stay on the exercise of contractual early termination rights or to take control of the parent or affiliates of a failed financial institution, particularly if its holding company or significant operational affiliates are unregulated.  On the plus side, within most jurisdictions, the exercise of resolution powers is accompanied by safeguards, such as respect for the creditor hierarchy and rights of judicial review.

Resolution Funding

The Review found that most jurisdictions rely on privately funded resolution funds.  In general, resolution funding arrangements are available for banks, but less so for insurance and securities firms, and are largely non-existent for FMIs.  Notwithstanding the existence of private sources of funding, public financial support remains an important component of resolution funding.  Mechanisms for recovery of public funds from shareholders, participants or creditors of the failed firm, or the wider financial industry, are less well developed.

Cross-Border Cooperation

The Review noted that national legal frameworks for cross-border cooperation in resolution are, overall, less well-developed across all sectors than other areas of the KAs.  In particular, the cross-border sharing of information is limited due to the fact that FSB jurisdictions lack clear and dedicated statutory provisions for domestic authorities to share confidential information with foreign resolution authorities.  On the plus side, the Review found that, in general, creditors are not discriminated against by virtue of the location of their claim.

FSB Recommendations

The FSB makes a number of recommendations, grouped into the following actions areas:

  • full implementation of the KAs;
  • additional clarification and guidance on the application of the KAs by the FSB; and
  • on-going implementation monitoring.

Conclusion

The Review doesn’t really tell us much that we didn’t already know.  However, it presents an interesting snap-shot of the current global state of RRP and provides a large amount of information in a very digestible form.  Section II of the Review provides a good summary of the development of RRP through the course of the financial crisis, and of particular use are the summaries of:

  • the selected powers for resolving banks across FSB jurisdictions (Table 2);
  • the recent major RRP legislative reforms in FSB jurisdictions (Annex A); and
  • the selected features of resolution regime in FSB jurisdictions (Annex B).

ECB Opinion Reveals Approach to “Principle of Proportionality” under RRP – in a Manner of Speaking

On 19 April 2013, pursuant to a request from the Austrian Ministry of Finance, the European Central Bank (“ECB”) published an opinion (dated 11 April 2013) on certain draft Austrian recovery and resolution planning (“RRP”) legislation – the draft Banking Intervention and Restructuring Act and associated amendments to the Federal Banking Act and the Financial Market Authority Act (the “Draft Law”).

In general, the ECB welcomed the Draft Law, but commented, amongst other things that it:

  • does not contain the resolution tools required by Title IV of the EU Recovery and Resolution Directive (“RRD”); and
  • requires credit institutions (“CIs”) to prepare and submit resolution plans to the Austrian Financial Market Authority (“FMA”), rather than make this a responsibility of the FMA itself.

On the principle of Proportionality, the ECB noted that the Draft Law provides for a complete exemption from a CI’s obligations to submit an RRP if that CI’s insolvency can be presumed not to have any material adverse impact on the financial markets, on other CIs or on funding conditions.  The ECB considers that Article 4 of the RRD does not allow such a complete exclusion, providing only for simplified obligations for certain less systemically important CIs.  Furthermore, the ECB itself remains of the view that it is perfectly possible to make all CI’s subject to RRP legislation, whilst merely simplifying RRP requirements for smaller CIs.  Nonetheless, the ECB acknowledges the ongoing discussions within Europe on the subject of enabling Member States to waive the requirement to maintain and update RRPs in certain cases and understands the benefit in avoiding overburdening small CIs.  As such, it recommends that any such exemption is granted only under “very strict conditions in accordance with the proportionality principle of the RRD”.

Not very helpful advice, given the admission that the proportionality principle of the RRD does not permit a full exemption.  The net result is that there is still no answer to the question as to whether a non-systemically important bank will be able to benefit from a complete exemption from RRP legislation.