Hong Kong Consults on New Resolution Regime

Introduction

On 7 January 2013, the Hong Kong Monetary Authority (HKMA) issued a press release announcing the publication of its first stage public consultation, drafted in conjunction with the Securities and Futures Commission (SFC) and the Insurance Authority (IA), on establishing an effective resolution regime for financial institutions, including financial market infrastructures, in Hong Kong. 

RRP: PRA Gently Turns the Screw (but to what end?)

Introduction

On 19 December 2013, the Prudential Regulation Authority (PRA) issued Policy Statement PS8/13 together with two Supervisory Statements, SS18/13 on recovery planning, and SS19/13 on resolution planning.  Together, this guidance details the PRA’s final RRP rules for UK banks, building societies and UK designated investment firms. Their publication follows on from the FSA’s original consultation paper (CP11/16) and Feedback Statement (FS12/1).  The final rules are set out in the PRA Rulebook Recovery and Resolution Instrument 2013 (PRA 2013/37), which is annexed to PS8/13 and come into force 1 January 2014.

RRD Compromise Text Published

On 22 December 2013 the Council of the EU published a note attaching the final compromise text of the proposed Recovery and Resolution Directive (RRD) agreed with the European Parliament.  Agreement in trialogue had previously been reached on 11 December 2013.

On 20 December 2013, the Permament Representatives Committee (COREPER) of the Council of the EU also published a press release confirming that it had approved (on the Council’s behalf) the compromise text agreed with the Parliament.  The text of the RRD now needs to be formally adopted by the EU Parliament and the Council.

Trilogue Agreement Reached on RRD

On 12 December 2013, the European Commission published a press release announcing that on 11 December 2013, Parliament and Council Presidency negotiators reached political agreement in trilogue on the proposed Recovery and Resolution Directive (RRD). The Directive will enter into force on 1 January 2015 and will introduce the bail-in principle which will apply from 1 January 2016. The Directive now needs official approval by the Parliament and Council of the EU at first reading.

CS Takes the Sub Way

This is a link to an FT article explaining the changes currently being implemented by Credit Suisse to its legal structure in response to the resolution planning requirements of its main regulator.

FMLC Provides Additional Commentary on RRD

On 25 October 2013, the Financial Markets Law Committee (FMLC) published a second discussion document on the EU Commission’s General Approach to the proposed Recovery and Resolution Directive (RRD).

The document is generally supportive of the changes made within the General Approach, but highlights a few remaining areas of concern with respect to legal uncertainty, including those set out below:

• Bail-in: The RRD does not provide a set of principles to guide a resolution authority’s choice as to whether to convert debt to equity or whether to write-down debt.  In addition, contractual bail-in provisions may not operate in the same way as statutory bail-in provisions;
• Valuation:  It is unclear on what basis the valuation (which must be independent) is to be carried out, notwithstanding that Article 30 of the RRD provides that the valuation should be fair and realistic.  This drafting ambiguity gives rise to legal uncertainty as to the status of a resolution action which is taken when a valuation at the proscribed standard has not been carried out, owing to practical difficulty or impossibility; and
• General Resolution Powers:  Articles 56(1)(h) and 56(1)(l) of the RRD give a resolution authority the power to cancel or amend the terms of “debt instruments”.  However, this definition is wider than that of “capital instruments” – the term used to describe the instruments that are eligible to be ‘bailed-in’.

Non-bank RRP Update

On 25 October 2013, the Financial Stability Board (FSB) published a list of:

• responses to its 12 August 2013 consultation on the Application of the Key Attributes of Effective Resolution Regimes to non-bank financial institutions; and
• responses to its 12 August 2013 consultation on Information sharing for resolution purposes.

DB Experience Highlights RRP Challenge

Risk Magazine has published an article in which Deutsche Bank highlights the issues it has experienced in complying with global recovery and resolution plan (RRP) requirements.

This is an all too common story.  The lack of guidance from regulators, absence of globally coordinated regulatory requirements and the move towards subsidiarisation combine to pose a significant challenge to firms which are subject to RRP rules.  From experience, the only real solution lies in the creation of a robust yet flexible data architecture, capable of serving up only that view of information which is necessary for the particular audience and with the capacity to adapt to meet future regulatory developments.

SPE and MPE – which are you?

Introduction

On 14 October, the Bank of England published a speech given by Paul Tucker, Deputy Governor Financial Stability, at the Institute of International Finance 2013 Annual Membership meeting on 12 October 2013 on the subject of ‘too big to fail’.

Mr Tucker made five general points:

1. The US authorities could resolve most US SIFIs right now on a ‘top-down’ basis pursuant to the powers granted under Title II of the Dodd Frank Act;
2. Single Point of Entry (SPE) versus Multiple Point of Entry (MPE) may be the most important innovation in banking policy in decades;
3. There is no such thing as a “bail-in bond”.  Bail in is a resolution tool.  All creditors can face having to absorb losses.  What matters is the creditor hierarchy;
4. Some impediments to smooth cross-border resolution need to be removed; and
5. The resolution agenda is not just about banks and dealers.  It is about central counterparties too, for example.

Reorganisation

Mr Tucker noted that Europe is not far behind the US in its enactment of resolution powers.  However, of more interest to the industry will be his belief that most banking groups will have to undergo some kind of reorganisation, irrespective of the camp into which they fall.  SPE groups will need to establish holding companies from which loss-absorbing bonds can be issued.  In addition, key subsidiaries will need to issue debt to their holding companies that can be written down in times of distress.  MPE groups will need to do more to organise themselves into well-defined regional and functional subgroups.  In addition common services, such as IT will need to be provided by stand-alone entities that can survive the break-up of an MPE group.  Capital requirements for regional subsidiaries forming part of an MPE group may also be higher due to the absence of a parent/holding company that can act as a source of strength through a resolution process.

Bail-in

On the subject to bail-in, creditors of SPE groups will be interested to read Mr Tucker’s comments about how, within the context of a top-down resolution, bonds issued by a holding company will absorb losses before debt issued by an operating subsidiary.  In effect, the holding company’s creditors are structurally subordinated to the operating company’s creditors.

Impediments to Resolution

On the subject to impediments to cross-border resolution, Mr Tucker noted that, in order to provide clarity on its previous ‘in principle’ commitment, the Bank of England needs to set down detailed conditions under which it would step aside and allow US authorities to resolve the UK subsidiaries of a US banking group.  In turn, other resolution authorities, and particularly the US, need to make the same ‘in principle’ commitment as the Bank of England.

Extension of the Resolution Regime

Finally, on the subject of the resolution agenda, Mr Tucker confirmed that CCPs are the most important example of where resolution regimes need to apply.  However, he did not rule out resolution regimes being extended to cover shadow banking, funds and SPVs.

HM Treasury Publishes Draft Annex to SRR Code of Practice

Introduction

On 8 October 2013, HM Treasury published a draft annex on the new bail-in option to the Special Resolution Regime (SRR). The bail-in tool is being introduced through amendments to the Banking Act 2009 by the Banking Reform Bill 2013 for the purpose of offering a new stabilisation option to the Bank of England as lead resolution authority. It will be available to failing banks and investment firms, with necessary modifications to building societies via secondary legislation and under specified conditions to banking group companies.

The draft annex to the Code of Practice supports the legal framework for the SRR and provides guidance as to when and how the bail-in tool may be deployed by authorities in practice.

A summary of the key points include:

General and Specific Conditions for Use of SRR Tools (Section 7)

The conditions for use of the bail-in option are identical to those for the stabilisation options set out in the existing Code :

• the regulator must determine that the institution is failing or likely to fail;
• it is not reasonably likely that action will be taken by or in respect of the bank to avoid its failure; and
• the Bank of England is satisfied that exercising the bail-in power is necessary having regard to the public interest.

When choosing between the original resolution tools, the Bank of England will consider the relative merits of the stabilisation options and the bank insolvency procedure given the circumstances in addition to general considerations . The Bank of England may also choose resolution by way of bail-in for situations where the use of another stabilisation power would threaten financial stability or confidence in the banking systems.

Use of the Bail-in Powers (Section 8)

The bail-in option gives the Bank of England the power to cancel or modify the terms of any contract in a resolution scenario for the purposes of reducing or deferring a liability of the bank (“special bail-in provision”). A conversion power also exists that allows for liabilities to be converted into different forms. Certain liabilities are excluded from the scope of the power to make special bail-in provision including:

• deposits covered by the Financial Services Compensation Scheme (FSCS) or an equivalent overseas scheme;
• liabilities to the extent they are secured;
• client assets, including client money;
• liabilities with an original maturity of less than seven days which are owed to a credit institution or investment firm (save in relation to credit institutions or investment firms which are banking group companies in relation to the bank);
• liabilities arising from participation in a designated settlement system and owed to such systems, or to operators or participants in such systems;
• liabilities owed to central counterparties recognised by the European Securities and Markets Authority (ESMA) in accordance with Article 25 of Regulation (EU) 648/2012;
• liabilities to employees or former employees in relation to accrued salary or other remuneration (with the exception of variable remuneration);
• liabilities owed to employees or former employees in relation to rights under a pension scheme (with the exception of discretionary benefits); and
• liabilities to a creditor arising from the provision of goods or services (other than financial services) that are critical to the daily functioning of the bank’s operations (with the exception of creditors that are companies which are banking group companies in relation to the bank).

Prior to taking resolution action or converting liabilities, resolution authorities are expected to carry out a valuation of the assets and liabilities of the institution as is reasonably practicable.

The UK has chosen to exercise the discretion granted to it under the Recovery and Resolution Directive and has included derivatives in the list of liabilities which can be bailed-in. Specific power to make special bail-in provision to derivatives and similar financial transactions can be found in Sections 8.14 – 8.17 of the Annex. The Bank of England will, where appropriate, exercise its power to close-out contracts before they are bailed in with any applicable close-out netting being taken into account. If a liability is owed, it will be excluded from bail-in so far as it is secured and compensation arrangements will follow the “no creditor worse off” principle. This ensures that no person is worse off as a result of the application of the bail-in option than they would have been had the bank gone into insolvency.