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.

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.

EBA Consults on Recovery Planning


On 20 May 2013, the EBA published two consultation papers regarding draft Regulatory Technical Standards (“RTS”) regarding the:

The consultations follow the previous consultation published by the EBA on 11 March 2013 regarding draft RTS on the content of Recovery Plans (see this blog post for more detail) and remain open for comment until 20 August 2013.  Final versions of both RTS will be submitted to the European Commission within 12 months of the date on which the “Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”) enters force, but may be amended after the consultation to take into account possible changes to the final RRD.

RTS on the Assessment of Recovery Plans

The draft RTS have been developed pursuant to Article 6(5) of the RRD.  Their main objective is to promote harmonisation across the EU regarding the assessment of recovery plans and to facilitate joint assessments of group recovery plans by different supervisory authorities.  They outline the three criteria that competent supervisors must take into account when reviewing individual and group recovery plans:

  • completeness;
  • quality; and
  • overall credibility.


The degree of completeness of a recovery plan is to be assessed against the following (non-exhaustive) list of factors:

  • whether it covers all the information listed in Section A of the Annex of the RRD (“Information to be Included in Recovery Plans”);
  • whether it provides information that is up to date with respect to any material changes to the institution or group to which the recovery plan relates;
  • where applicable, an analysis of:
    • how and when an institution may apply for the use of central bank facilities; and
    • available collateral; and
    • whether the recovery plan has been tested against a range of scenarios.

In addition to the information set out above as it applies in a group context, the completeness of group recovery plans is assessed against the following matters:

  • the establishment of arrangements for intra-group financial support;
  • the identification of obstacles, if any, to the implementation of recovery measures within the group; and
  • the identification of substantial practical or legal impediments to:
    • the prompt transfer of own funds or
    • the repayment of liabilities or assets within the group.


The quality of a recovery plan is assessed against the following (non-exhaustive) list of factors:

  • clarity;
  • relevance of information;
  • comprehensiveness; and
  • internal consistency.

Overall Credibility

Individual Recovery Plans

Overall credibility in the context of individual recovery plans is essentially an assessment of the extent to which:

  • the implementation of a recovery plan would be likely to restore the viability and financial soundness of the institution in question; and

  • the plan or specific options could be implemented effectively in situations of financial stress and without causing any significant adverse effect on the financial system.

 ‘Restoration of viability and financial soundness’ is assessed against the following (non-exhaustive) factors:

  • the level of integration and consistency of the recovery plan with the general corporate governance and risk management framework of the group;
  • whether the recovery plan contains a sufficient number of plausible and viable recovery options;
  • whether the recovery options included in the recovery plan address the scenarios identified;
  • whether the timescale to implement the options is realistic and has been taken into account in the procedures designed to ensure timely implementation of recovery actions;
  • the level of the institution`s or group`s preparedness;
  • the adequacy of the range of scenarios of financial distress against which the recovery plan has been tested;
  • the adequacy of the testing carried out using the scenarios of financial distress;
  • the extent to which the recovery options and indicators are verified by the testing carried out using scenarios of financial distress;
  • whether the assumptions and valuations made within the recovery plan are realistic and plausible.

‘Effective implementation’ is assessed against the following (non-exhaustive) factors:

  • whether the range of recovery options sufficiently reduces the risk that obstacles to the implementation of the recovery options or adverse systemic effects arise due to the recovery actions of other institutions or groups being taken at the same time;
  • the extent to which the recovery options may conflict with the recovery options of institutions or groups which have similar vulnerabilities and which might implement options at the same time;
  • the extent to which implementation of recovery options by several institutions or groups at the same time could negatively affect the impact and feasibility of recovery options.

Group Recovery Plans

Overall credibility in the context of group recovery plans is essentially an assessment of the extent to which:

  • the implementation of a recovery plan would achieve the stabilisation of the group as a whole, or any institution of the group; and
  • the plan identifies whether, within the group, there are:
    • obstacles to the implementation of recovery measures; and
    • substantial practical or legal impediments to the prompt transfer of own funds or the repayment of liabilities or assets.

‘Stabilisation’ is assessed against the following (non-exhaustive) factors:

  • the extent to which the group recovery plan can achieve stabilisation of the group as a whole and any institution of the group;
  • the extent to which arrangements included into the group recovery plan ensure coordination and consistency of measures between institutions within the group; and
  • the extent to which the group recovery plan provides solutions to overcome:
    • obstacles to the implementation of recovery measures; and
    • substantial practical or legal impediments to a prompt transfer of own funds or the repayment of liabilities or assets.

RTS specifying the range of scenarios to be used in recovery plans

These draft RTS have been developed pursuant to Articles 5(5) and 5(6) of the RRD.  They specify the range of scenarios to be designed by financial institutions when testing their recovery plans.  The overriding principle is that scenarios should be based on the events that are the most relevant to the institution or group in terms of activity, size, interconnectedness, business, funding model, etc.  Institutions are responsible for selecting an appropriate number of relevant scenarios (taking account of the principle of proportionality within the RRD) and national supervisors are responsible for assessing the adequacy of the chosen scenarios.  Each distress scenario should be based on events that are exceptional but plausible and would threaten to cause the failure of the institution or group if recovery measures were not implemented in a timely manner and should cover:

  • a system wide event;
  • an idiosyncratic event; and
  • a combination of system wide and idiosyncratic events.

Each distress scenario should also include an assessment of the impact of the events on at least each of the following aspects of the institution or group:

  • available capital;
  • available liquidity;
  • business model;
  • profitability;
  • payment and settlement operations; and
  • reputation.

EU Council Publishes Compromise Proposal on RRD

On 16 May 2013, the Presidency of the Council of the EU published a compromise proposal relating to the Recovery and Resolution Directive (RRD).

Additions to the original EU Commission proposal are underlined and additions to the most recent compromise proposal dated 14 February 2013 are shown in bold.

EU Commission Publishes Liikanen Consultation


On 16 May 2013, the EU Commission published “Reforming the structure of the EU banking sector”, a consultation paper which represents a follow-up to the recommendations made by the Liikanen High-Level Expert Group (the “HLEG”) in its report of October 2012.  The deadline for responses to the consultation is 3 July 2013.

The consultation paper only presents policy options with respect to the structural separation recommendations of the HLEG, noting that the HLEG’s other proposals have been at least partially addressed in other initiatives such as the Bank Resolution and Recovery Directive and the Capital Requirements Directive/Regulation, or will only become actionable after the completion of ongoing exercises such as the Basel Committee’s review of trading book capital requirements.  The Commission also accepts that structural reform will only affect a small subset of the approximately 8,000 EU banks.  In particular, most local and regional banks will be excluded as well as the banks that focus on customer related lending.  Moreover, separation requirements would not necessarily apply automatically to banks exceeding applicable thresholds but may be at the discretion of supervisors.

Policy Options

Against a “no action” baseline, the EU Commission is evaluating options grouped into three basic categories:

  • the scope of banks which should be subject to separation;
  • the scope of activities to be separated; and
  • the strength of separation.

Scope of banks subject to separation

Comments are requested on four options, all of which adopt differing definitions of “trading activity”, the separation criteria suggested by the HLEG:

  • using the original HLEG definition, under which assets ‘held for trading and available for sale’ are to be separated;
  • a narrower definition that excludes ‘available for sale’ assets;
  • a definition focused on gross volume of trading activity, which is likely to focus on proprietary trading and market-making activities; and
  • a definition focused on net volumes, designed to capture only those institutions which concentrate on proprietary trading.

Within each separation option, the Commission asks for responses as to the degree of supervisory discretion which should apply, with specific reference to the following sub-options:

  • ex-post separation determined by EU legislation but with the actual separation decision to be at the discretion of a supervisor;
  • ex-ante separation subject to supervisor discretion to exempt individual institutions or include additional firms in accordance with criteria and limits set out in EU legislation; and
  • ex-ante separation pursuant to which any bank with trading activities above the threshold would automatically be obliged to separate those activities.

The scope of activities to be separated

The Commission are considering three options which can be summarised as follows:

  • “Narrow” trading entity and “broad” deposit bank: under which, broadly, only proprietary trading and exposures to venture capital, private equity and hedge funds would be separated;
  • “Medium” trading entity and “medium” deposit bank: under which both proprietary trading and market making would be separated; or
  • “Broad” trading entity and “narrow” deposit bank: under which all wholesale and investment banking activities would be separated, including proprietary trading, market making, underwriting of securities, derivatives transactions and origination of securities.

Strength of separation

Three broad forms of separation, none of which are mutually exclusive, are considered:

  • accounting separation: the lightest form of separation (and considered unlikely to be sufficient by the Commission) under which a group would be required to make separate reports for each of its different business units but under which there would be no restrictions on intra-group legal and economic risks;
  • functional separation: under which some activities would need to be provided by separate functional subsidiaries with various sub-options available as to the degree of legal, economic, governance and operational separation which should apply; and
  • ownership separation: the strongest form of separation under which the services would have to be provided by different firms with no affiliations.

The three ‘strength of separation’ options proposed by the Commission can be summarised as follows:


Degree of Functional Separation

Degree of Ownership Separation 

Functional   separation with economic and governance links restricted according to current   rules (“Functional Separation 1”)
  • Separate legal entities required
  • Legal entities subject to capital, liquidity, leverage and large   exposure rules on an individual basis
  • Separate governance (unless waived) for each entity
Functional   separation with tighter restrictions on economic and governance links (“Functional   Separation 2”)
  • Separate legal entities required
  • Restrictions on ownership links between separated entities   within the group
  • Legal entities subject to capital, liquidity, leverage and large   exposure rules on an individual basis
  • Intra-group dealings to be at arms’ length
  • No waiver of large exposure restrictions in relation to intra-group   trades
  • Limits on intra-group guarantees from deposit taking entity to   trading entity
  • Limits on board directors acting for multiple entities within   the group
Ownership   separation  
  • Banks to divest themselves of certain activities

Overview of Options

The Commission provides the following matrix which summaries all of the possible permutations associated with each policy option:


Functional Separation 1 (current requirements) 

Functional Separation 2 (stricter requirements)

Ownership   Separation

Narrow Trading Entity/ Broad Deposit Bank

e.g. Proprietary trading +   exposures to venture capital/private equity/hedge funds

Option A

[approximate to   legislation in France and Germany]

Option B

[approximate to US   swaps push-out rule]

Option C

[approximate to US   Volcker rule]

Medium Trading Entity/ Medium Deposit Bank

e.g. proprietary trading +   market making

Option D

[approximate to   legislation in France or Germany if wider separation activated]

Option E

[Approximate to   HLEG recommendations]

Option F

Broad Trading Entity/ Narrow   Deposit Bank

e.g. all investment banking   activities

Option G

Option H

[approximate to US   Bank Holding Company Act and UK Banking Reform Bill]

Option I