Legislative Update

Recovery and Resolution Directive

On 29 May 2013, the Presidency of the EU Council published its latest Compromise Proposal with respect to the Recovery and Resolution Directive (RRD).  Additions to the original legislative proposal are underlined and additions to the most recent compromise proposal (dated 15 March 2013) are marked in bold.

EU Banking Union

On 30 May 2013, the EU Parliament updated its procedure file relating to the establishment of the single supervisory mechanism (SSM).  It now appears that the SSM proposal will be considered at the Parliament’s plenary session to be held from 9-12 September 2013 instead of the 20-23 May session, as had previously been the case.

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Paul Tucker Speech on Resolution

On 20 May 2013, Paul Tucker, Deputy Governor of Financial Stability at the Bank of England gave a speech entitled “Resolution and future of finance” at the INSOL International World Congress in the Hague.

Within the wider context of discussing solutions to the problem of “too big to fail”, the speech gives a useful summary of the ways in which both “single point of entry” and “multiple point of entry” resolution would operate in practice.  It also touches upon the interaction between resolution regimes and bank structural reform, noting the way in which bank ring-fencing, as will be implemented in the UK via the Financial Services (Banking Reform) Bill, represents a back-up strategy to resolution, under which essential payment services and insured deposits would be provided by a “super-resolvable” ring-fenced and separately capitalised bank.  This, it is believed, should make it easier for the UK authorities to “retreat to maintaining at least the most basic payments services” if a preferred strategy of top-down resolution of a whole group could not be executed.

Update on Banking Reform Bill

On 9 May 2013, the Financial Services (Banking Reform) Bill was reintroduced to Parliament, having been carried over to the 2013-14 session.  The text of the bill is the same as that originally published on 4 February 2013 (see this blog post for more detail).  The bill completed its committee stage on 18 April 2013 and will now proceed to the report stage, although the date upon which this is scheduled to take place is not yet known.

CCP Loss-Allocation Rules Under the Microscope

This is a link to an article in risk magazine regarding CCP recovery planning, and specifically loss allocation rules.

The article highlights differing views within the market regarding the extent to which loss-allocation rules within a recovery (but not necessarily a resolution) scenario should be flexible or prescriptive in nature.  The article points to a paper published by the Bank of England in April 2013, which states that loss-allocation rules should provide a full and comprehensive description of the way in which losses would be allocated and be capable of being implemented quickly.

CCP loss-allocation rules play an important part in the recovery of financial market infrastructures, such as CCPs.  However, as the CPSS/IOSCO paper on Recovery and resolution of financial market infrastructures makes clear, they are not one and the same thing.  General recovery planning options must remain flexible in nature so as to allow firms to respond appropriately to financial stress scenarios the exact nature of which are impossible to determine before the event.  Nonetheless, account must be taken of clearing members, given their systemic importance and the need for them to be able to effectively manage their own risks.  As such, it must surely be the case that CCP loss allocation rules applied as part of the recovery process must provide a clear, detailed and transparent description of the way in which clearing members which would be liable for shortfalls at the CCP.

Bail-In by 2016?

On 21 May 2013, the European Parliament’s Economic and Monetary Affairs Committee (ECON) published a press release detailing its negotiating position with respect to certain elements of the proposed Recovery and Resolution Directive (RRD).

The negotiation position was approved by 39 votes to 6 and states that:

  • the “bail-in” scheme should be operational by January 2016 at the latest;
  • insured deposits (i.e. those below EUR 100,000) can never be subject to bail-in;
  • uninsured deposits (i.e. those above EUR 100,000), can only be subject to bail-in “as a last resort”;
  • funds from deposit guarantee schemes will not be capable of being diverted in order to help pay for bank resolution measures;
  • taxpayer money can only be used to guarantee liabilities or assets, take a stake in a failing bank or institute temporary public ownership and only after all capital has been written down to zero and taxpayer intervention is necessary in order to:
    • prevent “significant adverse effects on financial stability”; or
    • protect the public interest;
  • bank-financed resolution funds must be established at a national level and must have a capacity equal to 1.5% of the amount of deposits of the participating banks within 10 years of the entry into force of the RRD; and
  • resolution funds will not be obliged to lend to each other.

The press release notes that the EU Council must now adopt its negotiating position, after which trialogue discussions between the Council, the Commission and the Parliament will commence.

Bail-in Highlights Need for CDS Reform

Here is a link to an article which reports that ISDA has drafted a proposal to add a new credit event for financial credit default swaps.  The proposal is in response to the:

  • introduction of the European Commission’s bail-in framework (part of a package of legislation aimed at bolstering bank recovery and resolution) which will enable governments to write down – or “bail-in” – bank debt of failing institutions in order to avoid bankruptcies and ensure bondholders shoulder bank losses rather than taxpayers; and
  • performance of credit default swaps in the lead-up to the nationalisation of SNS Reaal earlier this year.

The new credit event would be triggered in the event of a government authority using a restructuring and resolution law to write down, expropriate, convert, exchange or transfer a financial institution’s debt obligations.  The trigger would be subject to minimum thresholds in terms of the amount of debt affected, but once exceeded, the protection buyer would be able to deliver the:

  • written-down bonds (as valued on their outstanding principal amount prior to the write-down); or
  • proceeds or other instruments received following application of the ‘bail-in’ tool (provided that these would have qualified as ‘Deliverable Obligations’ immediately prior to the triggering event.

Senior debt will be subject to the EU bail-in provisions from 2018 although recent comment from the EU suggests that this could be brought forward to 2015.  ISDA’s proposals will now undergo consultation with new credit definitions expected by the end of 2013.