Bank of England Provides its Take on Bail-In

Introduction

The Bank of England (BoE) has published a speech given by Andrew Gracie, Director of the BoE’s Special Resolution Unit, to the British Bankers’ Association on 17 September 2012 entitled “A practical process for implementing a bail-in resolution power”, a summary of which is provided below.

By way of introduction, Mr Gracie noted that bail-in was only one among a suite of resolution tools, but that it may be of particular use in resolving G-SIFI’s whose operations are too large, complex or interconnected to resolve without threatening critical functions (although he also recognised that there may be cases where the failure of a firm is so comprehensive as to mean that it would need to be wound down instead of being bailed-in).  Nonetheless, Mr Gracie warned that, whilst it can be valuable in restoring a firm’s solvency and so allowing critical functions to continue during a reorganisation, bail-in alone cannot restore a firm’s viability.

Principles behind the exercise of the bail-in tool

Any exercise of the bail-in tool would have to:

  • respect creditor hierarchies;
  • protect secured claims and netting arrangements;
  • be proportionate (in order to minimise the risk of compensation claims);
  • be clear and transparent to creditors; and
  • satisfy clearly defined public interest objectives (e.g. the maintenance of financial stability and the protection of depositors).

The trigger for bail-in

Bail-in would only be used if a firm had reached the point of non-viability i.e. where a supervisory authority identifies that the institution is:

  • failing or likely to fail, and
  • no other solution, absent the use of resolution tools, would restore the institution to viability within a reasonable timeframe.

Bail-in in practice

Assuming that the pre-resolution efforts of a firm to restore its own viability had failed, Mr Gracie identified four stages in the application of the bail-in tool.

1. Stabilisation

Stabilisation of a firm would include some or all of the following steps:

  • suspension of the listing and trading of the firm’s shares and debt;
  • Communication with all stakeholders, confirming:
    • that the firm had reached the point of non-viability and had met the conditions for resolution;
    • the broad resolution strategy for the firm;
    • the range of liabilities that would be completely written down without conversion;
    • the range of liabilities that would be subject to potential write-down and/or fully or partially converted into equity;
    • that the firm would be restructured;
    • that all of the firm’s core functions would continue without disruption;
    • that any insured depositors would be fully protected; and
    • the proposed timing for the announcement of the final terms for the bail-in (including the final extent of creditor write-downs, and rates of conversion to equity).

2. Valuation and exchange

Immediately following the stabilisation phase, a valuation exercise would need to be carried out in order to determine the extent of losses incurred or likely to be incurred by the firm.  In turn, this would be used to calculate the appropriate terms of the bail-in.  Subsequently, the creditors identified in the stabilisation announcement would be subject to write-downs in an aggregate amount sufficient to cover all of the firm’s losses.  Next, the authorities would determine the amount of capital that would be necessary to help restore the firm to viability. This amount would likely exceed minimum prudential capital requirements in order to ensure market confidence in the firm.  The actual recapitalisation would be effected by the conversion of eligible liabilities into equity.

In passing, Mr Gracie confirmed the BoE’s objection to the principle enshrined within the RRP Directive requiring, at all times, the pari passu treatment of creditors within the same class.  Rather, the BoE believes that it is important for resolution authorities to retain some discretion in deciding which liabilities to bail-in, to take account of any potential adverse impact on the stability of the financial system.

3. Relaunch

Once the valuation had been completed, and creditors written-down as appropriate, equity would need to be transferred to affected creditors as a quid pro quo for the recapitalisation. This could be effected by the issuance of new shares or by the transfer of existing de-listed shares from shareholders who had been fully written down.  At this point, trading of the firm’s equity and debt in the primary market could resume.  In the event that it was subsequently found that any bailed-in creditor or shareholder had suffered a loss greater than that which would have occurred on the insolvency of the firm, an ex-post adjustment mechanism would be applied to the capital structure of the firm in favour of the affected party by way of compensation.

4. Restructuring

Any relaunch would be accompanied by a “concrete and effective” restructuring strategy.  In the simplest cases this strategy may take a matter of months to implement, but may take much longer in relation to more complex failures.  Any strategy would be designed to prevent disruption to critical economic functions while also addressing the causes of the firm’s failure.  In all instances, culpable management would be replaced.

 

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BBA Seeks Clarification on CASS RP from FSA

On 3 September 2012, the British Bankers’ Association (“BBA”) published a letter to the Client Assets Unit of the FSA seeking clarification with respect to several sections of the recently finalised CASS Resolution Pack rules contained within Chapter 10 of the FSA’s Client Assets Sourcebook, specifically:

  • CASS 10.3.1(11): Retail and Professional Agreements – whether a firm is permitted to include in its CASS RP only those agreements relating to clients where money or assets are actually held, or alternatively whether all agreements for all investment business clients should be included within the CASS RP;
  •  CASS 10.1.16R: FSA Notification – whether there is some concept of ‘materiality’ behind the requirement to notify the FSA immediately if a firm has not complied with, or is unable to comply with, the requirement to maintain and be able to retrieve a CASS Resolution Pack, or alternatively whether all breaches, no matter how small, must be notified to the FSA;
  • CASS 10.1.9E(2): Reliance on CASS Systems – under this rule, firms are obliged to put in place arrangements to ensure that systems upon which the firm is reliant for the performance of its CASS RP obligations remain operational and accessible after insolvency.  Noting the difficulty in securing the legal enforceability of this type of clause, the BBA asks for clarification as to whether a firm can instead rely on Section 14 of the Investment Bank Special Administration Regulations 2011 on Continuity of Supply, which obliges suppliers of key services to continue to supply those services to the administrator of a firm;
  • CASS 10.1.11R(2): Correction of Inaccuracies – this rule requires correction of inaccuracies within a CASS RP within 5 business days of the inaccuracy occurring.  The BBA seeks clarification as to whether the reference in the regulations to “material” implies that the FSA is only concerned with the correction of errors or mistakes, or alternatively whether it requires prompt updating of the entire CASS RP.  The BBA also seeks guidance on what is to be considered “material”, and an explanation of why 5 business days has been chosen as the applicable updating period instead of “…a more workable ‘monthly’ basis…”;
  • CASS 10.2.1R(3): Representatives and Agents – this rule requires the firm to identify each appointed representative, tied agent, field representative or other agent of the firm which receives client money or safe custody assets.  The BBA is seeking clarification of what is meant by “other agents”; and
  • CASS 10.2.1(6): CASS RP Affiliates and Third Parties – this rule requires a firm to identify group members and third parties “involved in operational functions relating to any obligations imposed on the firm under CASS 6 or CASS 7”.  The BBA is seeking clarification with respect to the meaning of the phrase “…operational functions…” together with examples of the types of third parties to which the regulation would apply.