EU Council and Parliament Reach Agreement Over SSM

On 18 April 2013, the EU Council published a press release confirming that agreement had been reached with the EU Parliament on the establishment of the single supervisory mechanism (SSM) with respect to EU credit institutions.

The European Central Bank (ECB) will be responsible for administration of the SSM, but national supervisors will retain responsibility for takes not conferred on the ECB, such as consumer protection, money laundering, payment services and branches of third country banks.  The ECB will assume its supervisory role with respect to the SSM either on 1 March 2013 or 12 months after entry into force of the legislation, whichever is later to occur.

RRD to be finalised in Q2 2013

On 15 March 2013, the EU Council published the conclusions of its meeting held on 14 to 15 March.  Among the many issues discussed, the following are particularly relevant to the banking sector:

  • finalisation of the legislative process on the Single Supervisory Mechanism within the coming weeks is a priority;
  • agreement of the Bank Recovery and Resolution Directive (RRD) and Deposit Guarantee Scheme Directive must be achieved before June 2013; and
  • a legislative proposal on the Single Resolution Mechanism is to be submitted by the EU Commission by summer 2013 with the intention of adopting it during the current parliamentary cycle.

EU Shying Away from Annual Updates of RRP?

Introduction

On 28 February 2013, the Presidency of the EU Council published a compromise proposal (dated 15 January 2013) relating to the proposed directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”).

The compromise proposal makes a large number of suggested changes to the text of the RRD, most of which are relatively small and insignificant in nature.  However, several of the proposed amendments are worthy of note, as detailed below.

Simplified obligations and waivers for certain institutions

A new Article 4(1a) to the RRD has been proposed.  Under this new article, where competent authorities and resolution authorities consider that, based on factors such as size, business model or interconnectedness, the failure of a specific institution would not have a negative effect on:

  • financial markets;
  • other institutions; or
  • funding conditions

a waiver may be granted in relation to the requirements:

  • for an institution or group to maintain a recovery or resolution plan (“RRP”), or
  • to update/review an RRP.

Whilst this does not go as far as the guidance recently published by the FSA (see this blogpost for a more detailed discussion) and would presumably not apply to the largest market participants in any event, the degree to which this is strictly compatible with the FSB’s “Key Attributes” document remains questionable.

Scope of bail-in tool

Article 38 of the original RRD excluded liabilities with an original maturity of less than one month from the list of liabilities which would be subject to write-down and conversion powers contained within the RRD.  The compromise proposal has deleted this section, with the result that liabilities with an original maturity of less than one month would now be included (if the proposals are ultimately approved).  Whilst this would undoubtedly limit arbitrage opportunities relating to the design of bail-inable liabilities and so would be welcome in this respect, the adverse effects on current bank funding practices remains unknown.

Minimum requirement for liabilities subject to the write-down and conversion powers

Article 39 of the original RRD required firms to maintain a minimum aggregate amount of own funds and eligible liabilities expressed as a percentage of “total liabilities”.  However, under the compromise proposal, this requirement has been amended so as to refer to “risk weighted assets”, a metric that some commentators feel materially underestimates the risk associated with financial institutions.

Assessment of required amount of bail-in

Article 39(3) of the original RRD specifies that the minimum amount of own funds and eligible liabilities a firm is required to maintain shall be determined, inter alia, on the amount that would be necessary to restore a firm to such as level as would “sustain sufficient market confidence in the institution”.  Similarly, under Article 41(2) or the original draft RRD, the bail-in tool would be applied to such an extent as would, inter alia, “sustain sufficient market confidence in the institution”.  Under the compromise proposal, both of these references have been removed.  This is a welcome amendment in that it removes a very subject standard.  However, on the flip side, it restricts a regulator’s flexibility to apply bail-in above the level that is necessary to make sure that the institution complies with its conditions for authorisation.  In doing so it also raises the prospect that a regulator might be required to effect a bail-in on more than one occasion, thus creating an additional layer of uncertainty which works to the detriment of the entire market.

The Single Supervisory Mechanism: “Singleness” a Question of Degree Only?

On 29 January 2013, Vítor Constâncio, Vice-President of the European Central Bank (ECB), gave a speech in Frankfurt to the Banker’s Association for Finance and Trade – International Financial Services Association Europe Bank-to-Bank Forum entitled “Establishing the Single Supervisory Mechanism”.

Broadly, the legislative framework establishing the Single Supervisory Mechanism (SSM) provides that, of Europe’s 6,000 banks, the ECB will have direct responsibility only for:

  • systemically important European banks; and
  • banks which have received or requested public financial assistance.

In fulfilling its duties, the ECB will be assisted by national competent authorities, acting in accordance with ECB instructions.  In practice, the ECB will assume direct responsibility for over 80% of the euro area banking system in terms of assets.  However, the actual number of banks coming under direct ECB supervision may be as low as 150, with the remaining banks continuing to be supervised by their national competent authorities.

This has raised concerns about the creation of an uneven playing field and the possible effects on the completion of the single market.  It is felt that this is driven in the main by a desire that the politically influential German Landesbanks escape direct ECB supervision.  Nonetheless, Sr Constâncio believes that the difference between the two systems of regulation “will concern only the degree of centralisation of supervisory responsibilities within the single supervisory mechanism composed by the ECB and the national supervisory authorities”.  The “singleness of the SSM” would be ensured by virtue of the fact that:

  • national supervisory authorities will have to comply with ECB regulations;
  • the ECB will have access to data concerning all credit institutions;
  • the ECB may decide at any time to exercise direct supervisory power over a bank; and
  • the ECB would in any event wield powers affecting banks “from their birth (i.e. the authorisation to operate) to their death”.

Subject to operational arrangements being in place, the ECB is due to assume its new supervisory role on 1 March 2014 or 12 months after entry into force of the legislation, which occurs later.  Currently, the SSM legislation is the subject of trialogue negotiations between the EU Council, EU Commission and EU Parliament.  This process is due to end soon, but unfortunately, it may be some time before we truly know the degree to which this is merely about ‘degrees of centralisation’ rather than a political compromises which threatens to give rise to a two-tier banking system within Europe.

EU Council Publishes Proposed Amendments to RRD

Introduction

On 13 January 2013, the Presidency of the EU Council published a compromise proposal regarding suggested amendments to Articles 1 to 36 of the Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”).  The most noteworthy amendments are highlighted below.

Early Intervention

Triggers to Early Intervention

Under Article 23 of the original RRD, it was proposed that a competent authority be authorised to take early intervention action when a firm does not meet, or is likely to breach, the requirements of the Banking Consolidation Directive.  Under the newly published draft, it is proposed to extend this authority to circumstances whereby the firm in question also no longer meets, or is likely to breach, the authorisation requirements under Title II of the MiFID Directive.  Two additional early intervention powers are also granted to competent authorities, being the power to:

  • appoint a manager who:
    • assumes certain tasks of the management of the institution, or
    • monitors the decisions and tasks of the management of the institution, or
    • is empowered to veto or authorize certain decisions of the management of the institution (note that this power appears to be separate from the “Special Management” powers granted under Article 24 of the RRD); and
  • require changes to the firm strategy or to the legal or operational structures of the institution.

Special Management

Amendments are proposed to Article 24 of the RRD in order to provide clarification that the appointment of a special manager shall not, of itself, make it possible for anyone to exercise any right or power to terminate, accelerate or declare a default or credit event under any agreement to which the institution is a party.  In addition, it is specifically noted that any special manager shall have no liability arising from action taken or not taken in discharge of its functions unless guilty of gross negligence or serious misconduct.

Group Recovery and Resolution

Proposed changes to Article 7 of the RRD would mean that group recovery plans would only be required with respect to (a) the group as a whole, and (b) individually for significant entities.  Previously, it was the case that all group entities would have been obliged to create a recovery plan.  The requirement to update group resolution plans pursuant to Article 12 has also been amended slightly to clarify that plans should be updated at least annually, and after any change to:

  • the legal or organisational structure of the parent company or of the group, or
  • the business or to the financial situation of the group as a whole or parts of the group that could have a material effect on or require a change to the plans.

Recovery Plan Triggers

A new Article 8a has been proposed under which competent authorities must ensure that each recovery plan includes a trigger framework which identifies the points at which appropriate actions referred to in the plan will or may be taken.  These triggers may be both quantitative or qualitative, must be forward looking and capable of being easily monitored, and should relate to the institution’s financial strength.   The European Banking Authority is to draft regulatory technical standards regarding these indicators within twelve months from the date of entry into force of the RRD.

Resolution Plans

Contents of Resolution Plans

It is proposed to amend the contents of Resolution Plans, as detailed under Article 9 of the RRD, in order to include the following additional information:

  • minimum amount of eligible liabilities required with respect to the exercise of the Bail-In Tool and a deadline to reach that level; and
  • a description of the staff who are essential for maintaining the continuous functioning of the institution’s operational processes.

Resolution Objectives

The Resolution Objectives under Article 26 of the RRP remain relatively unchanged except for the fact that the following have ceased to be ‘objectives’ and now appear as ‘general principles governing resolution’ pursuant to Article 29:

  • ensuring the continuity of critical functions; and
  • avoiding unnecessary destruction of value and seeking to minimise the cost of resolution.

In addition, it was previously the case that all Resolution Objectives were of equal significance.  In contrast, were the proposed changes to be adopted, it would be for the authorities to balance the objectives as appropriate to the nature and circumstances of each case.

Principles Governing Resolution

It is a general principle under Article 29 of the RRD that ‘no creditor should be worse off than in insolvency’.  However, in the latest draft of the RRD this principle only applies to the extent ‘not otherwise provided in this Directive’.  At this stage, the extent to which this principle is truly affected is not clear.

Resolution Tools

Of possible concern to some financial market infrastructures are the amendments to the Sale of Business Tool pursuant to Article 32 and the Bridge Institution Tool detailed under Article 34.  Broadly speaking, neither the purchaser of a business nor a bridge institution can be denied access to payment, clearing or settlement systems, stock exchanges or deposit guarantee schemes on account of the fact that they do not possess a particular rating or do not otherwise meet the relevant membership criteria.

RRD to be agreed by June 2013

On 14 December 2012, the European Council published its conclusions regarding the steps necessary to complete economic and monetary union (EMU).  These include:

  • the need for the rapid adoption and implementation of the single supervisory mechanism (SSM);
  • the agreement on the terms of the Recovery and Resolution Directive (RRD) and the Deposit Guarantee Schemes Directive by June 2013; and
  • the rapid follow-up to the proposals of the Liikanen Group.

EMU Roadmap Sheds Light on Future Resolution Initiatives

Introduction

On 6 December 2012, the EU Council published a report entitled “Towards a Genuine Economic and Monetary Union”, building on an interim report on the same topic published in October 2012.  It proposes a timeframe and a 3-stage approach to the completion of Economic and Monetary Union (EMU), describing the RRP-specific requirements which form part of this initiative, as detailed below.

Stage Timescale Description 
Stage 1 End 2012 – beginning 2013

Ensuring fiscal sustainability and breaking the link between banks and sovereigns.

From an RRP perspective, this would involve:

  •   The   establishment of a Single Supervisory Mechanism (SSM) for the banking sector;
  •   Agreement   on the harmonisation of national resolution and deposit guarantee frameworks;
  •   Ensuring   appropriate resolution funding from the financial industry; and
  •   Establishing   the operational framework for direct bank recapitalisation through the   European Stability Mechanism (ESM).
Stage 2 Beginning 2013 – end 2014

Completing the integrated financial   framework and promoting sound structural policies at national level.

RRP specific measures would include the establishment of:

  •   A   single resolution authority (SRA); and
  •   A   financial backstop, in the form of an ESM credit line to the SRA.
Stage 3 Post 2014

Establishing a mechanism to create the   fiscal capacity necessary to enable EMU members to better absorb future country-specific   economic and financial shocks.

Single Supervisory Mechanism

The Council regards it as imperative that preparatory measures with respect to the SSM commence at the beginning of 2013, so that the SSM can be fully operational from 1 January 2014 at the latest.  This will involve granting strong supervisory powers to the ECB.

Single Resolution Mechanism (SRM)

Measures to establish the SSM are to be complemented by an SRM, build around an SRA and established at the same time as the ECB assumes its supervisory responsibilities with respect to the SSM.  Whilst the SSM would provide a “timely and unbiased assessment of the need for resolution”, the SRA would ensure timely and robust resolution measures are actually implemented in appropriate cases.  In other words, the SRM would complement the SSM by making certain that failing banks are restructured or closed down swiftly.  The establishment of an SRM is regarded as an indispensable element in the completion of EMU as it would:

  • Promote a timely and impartial EU-level decision-making process: it is hope that this would mitigate many of the current obstacles to resolution, such as national interest and cross-border cooperation frictions;
  • reduce resolution costs;
  • break the link between banks and sovereigns; and
  • Increase market discipline by ensuring that the private sector and not the taxpayer bears the cost of bank resolution

The SRM would be financed via a European Resolution Fund.  In turn, the fund would be financed via ex-ante risk-based levies on all banks directly participating in the SSM.  As mentioned previously, the fund would be buttressed by an backstop in the form of an ESM credit line to the SRA.  However, any support provided via the ESM would be recouped in the medium term by way of ex-post levies on the financial sector.

Deposit Guarantee Schemes (DGS)

References to an EU-wide deposit guarantee scheme seem to have been dropped in favour of a proposal to ensure that sufficiently robust national deposit insurance systems are set up in each Member State.  This, it is hoped, will limit the contagion effect associated with deposit flight between institutions and across countries, and ensuring an appropriate degree of depositor protection in the EU.

Financial Shock absorption function (FSAF)

This stage 3 measure would likely take the form of a contract-based insurance system set up at an EU level. Whilst RRP-specific, the establishment of an FSAF is seen as contributing to macroeconomic stability and therefore providing important support to the effectiveness of bank resolution measures in stages 1 and 2.  However, the Council is keen to emphasise that the FSAF would not be an instrument for crisis management per se, as this is a role to be performed by the ESM.  Rather, the purpose of FSAF would be to improve the overall economic resilience of EMU and eurozone countries.  In other words, it would contribute to crisis prevention and make future ESM interventions less likely.

ECB Publishes Opinion on RRD

Introduction

On 5 December 2012, the European Central Bank (ECB) published its opinion on the EU’s draft directive establishing a framework for recovery and resolution of credit institutions and investment firms (the “Recovery and Resolution Directive” or “RRD”).

In general, the ECB fully supports the RRD, welcomes the fact that it is in line with the FSB’s “Key Attributes” document and believes that it should be adopted rapidly.  It also encourages the EU to take further steps to implement an independent European resolution mechanism, which it views as one of the three banking union pillars.  Beyond clarifying its general position, the ECB also made a number of more specific observations, a summary of which are provided below.

Definition of resolution

The ECB notes that “resolution” under the RRD involves, inter alia, restoring the viability of all or part of a failing institution.  However, it is of the opinion that, if there is no public interest element to a proposed resolution action, the institution in question should not be resolved as a going concern and instead should be liquidated under normal national insolvency law.  As such, the ECB is of the view that the RRD should be amended to clarify that the aim of resolution is not to preserve a failing institution, but to ensure the continuity of its essential functions.

Resolution conditions and the need for extraordinary financial public support

In the interests of “prompt and efficient resolution action”, the ECB believes that the relevant competent authority should have responsibility for determining whether an institution is failing or likely to fail (and thus has triggered the conditions for resolution).  Moreover, this determination should be based solely on an assessment of the situation of the institution in question.  It should not be based on an institution’s particular need for State aid, although the circumstances surrounding any grant of State aid would be relevant in assessing the institution’s general situation.

Involvement of central banks in recovery and resolution

In recognition of the role of central banks in promoting macro-prudential and financial stability, the ECB recommends that, where a central bank is not itself the resolution authority, the relevant competent authority and resolution authority engage in an “adequate exchange of information” with the central bank.

With respect to the use of the bridge institution and asset separation tools, the ECB believes that the RRD should clarify the fact that, where a central bank acts as a resolution authority, it will not assume any financing obligations with respect to either the bridge institution or the asset management vehicle created pursuant to the asset separation tool.

Involvement of national designated authorities in assessment of recovery plans

The ECB recommends that, when assessing recovery plans, competent authorities consult with competent national designated authorities (to the extent that they are separate entities).

Intra group financial support

The ECB considers that further investigation may be required into whether additional provisions are necessary in order to ensure the legal certainty and enforceability of voluntary intra-group financial support arrangements.

The bail-in tool and write down powers

The ECB believes that bail-in should be used predominantly for the resolution of institutions that have reached a point of non-viability.  Any use of the tool to restore a failing institution to the position of a going concern should only be considered in “exceptional and justified” circumstances.

The ECB also notes that the RRD requires the European Banking Authority (EBA) to report to the EU Commission on the implementation of the requirement for institutions to maintain an aggregate amount of own funds and eligible liabilities expressed as a percentage of total liabilities.  The ECB believes that further investigation, together with an impact assessment, should be conducted as to whether the minimum requirement should be expressed as a percentage of total liabilities or as a percentage of risk weighted assets – it being thought that the latter may represent a better measure of the riskiness of the assets of the institution in question.

The ECB further recommends that the EBA conduct an assessment of whether it would be beneficial to introduce a prohibition or limitation on the banking sector’s ability to hold instruments which are eligible for bail-in.  It also suggests amending Article 38(2) of the RRD to make clear that all liabilities to members of the European System of Central Banks (ESCB) are explicitly excluded from the application of the bail in tool, on the basis that EXCB members are public bodies whose basic tasks require them to have exposures to institutions.

Financing of resolution

The ECB is concerned that the proposal to set up a European system of resolution financing arrangements will not solve all cross-border resolution issues.  In particular, the current proposal for 27 national arrangements which can borrow from, and lend to, each other suffers from a lack on clarity with respect to details such as the rights and obligations of lenders and borrowers.

Deposit guarantee schemes (DGS)

The ECB supports the proposal that any available resources of a DGS should be available to finance resolution, but warns that this should not be allowed to compromise the core DGS function i.e. the protection of insured deposits.

In contrast to the proposed RRD, which requires Member States to ensure that DGS rank pari passu with unsecured non-preferred claims under national insolvency law, the ECB recommends that Member States should be allowed to establish preferential ranking of claims that the DGS has acquired by subrogation (i.e. after having paid out the amount corresponding to covered deposits).  This, it believes, would help ensure that sufficient funding is always available to the DGS.

Disclosure of marketing materials

The RRD currently allows for a delay in publication of any public disclosure regard the sale of any part of an institution under resolution.  The ECB recommends extending this power to facilitate a delay in the publication of any price sensitive information relating to publicly traded financial instruments of the institution under resolution.

Further harmonisation of recovery and resolution rules

The ECB supports the development of a recovery and resolution framework for systemically important non-bank financial institutions e.g. insurance companies and market infrastructures.

 

EU Council to meet on 3 September to discuss RRP Directive

On 26 July 2012, the EU Council published a notice confirming that its Working Party on Financial Services will meet at 10:00 a.m. on 3 September 2012 to examine the Commission proposal for a Directive establishing a framework for the recovery and resolution of credit institutions and investment firms.