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.
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.
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.
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.