The European parliament has updated its BRRD procedure file, postponing the plenary consideration of the proposal to its 14-17th April session. The regulatory framework has been agreed, however the plenary vote is a very necessary formality. Any further delay would place this cornerstone of EU banking reform perilously close to the 22nd May EU election.
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.
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.
The EU Parliament has updated its procedure file on the RRD. It now appears that the first reading of the RRD proposals will take place at the plenary session due to be held between 9 to 12 September 2013. Previously, it had been indicated that the Parliament would consider the RRD at is plenary session scheduled for 10 to 13 June 2013.
On 5 February 2013, the EU Parliament’s Committee on Legal Affairs published a draft opinion proposing certain amendments to the ‘proposal for a directive of the European Parliament and of the Council establishing a framework for the recovery and resolution of credit institutions and investment firms’ (the “RRD”). The draft opinion is very short and the proposed amendments most worthy of note are detailed below.
Recital 18 of the RRD currently refers to the ability of less systemically important firms to produce “simplified” resolution plans. The Legal Affairs Committee proposes to amend this reference so that resolution planning is “proportionate” to systemic relevance. However, to date, there appear to be no consequential changes to Article 4 which deals with “simplified” recovery and resolution obligations for less systemically important firms.
Article 5 of the RRD includes an ability for regulators to require institutions to update recovery plans more frequently than annually. In a welcome development, the proposed amendment would only allow this to happen if it were “necessary for the stability of the financial markets” so as to avoid needlessly burdening firms with red tape.
Article 78 of the RRD enables any person affected by a decision of a resolution authority to take a resolution action to apply for judicial review of that decision. However, as currently drafted, notwithstanding the right to apply for judicial review, the actual decision of the resolution authority is “immediately enforceable and shall not be subject to a suspension order issued by a court”. The Committee on Legal Affairs proposes to delete this caveat. The justification for this proposal is that it is not appropriate to restrict a court’s right to suspend resolution actions if breaches of rules are detected. Whilst understandable in principle, the reality is that, by the very nature of resolution itself, one or more parties are always likely to feel aggrieved following the initiation of resolution action. This amendment does not seek to restrict itself to ‘breaches of rules’ and the lack of certainty it would introduce into the resolution process risks creating problems of a higher order than those it seeks to cure.
Last week the EU Parliament published a draft opinion of its Committee on Legal Affairs dated 14 December 2012 regarding the Proposal for a Directive of the European Parliament and of the Council establishing a framework for the recovery and resolution of credit institutions and investment firms” (the “RRD”).
The proposed amendments contained within the draft opinion do not alter the fundamental principles, or amend the core clauses, of the RRD. Rather they “seek to improve certain inaccuracies and aspects of the proposal drafted by the Commission”. Most noteworthy is the proposed amendment to remove the obligation to conduct an ex-post assessment of whether shareholders and creditors have received treatment no less favourable than would have been the case under normal insolvency proceedings. The EU Parliament has suggested that this assessment only be carried out following a request from such shareholders or creditors.
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.
The RRD needs to focus less on the issue of individual failing banks and more on ways to resolve a general banking crisis, according to an EU Parliament press release published on 6 November 2012.
In addition, the next priority should be to clearly define the point at which resolution is triggered and control of an institution passes from its management to resolution authorities. According to the EU Parliament, there must be no “grey zones” as to who is running a bank.
Beyond this, the question of resolution financing must be also addressed. Clear rules, which allow the use of public funds only once shareholders have been wiped out, should be established. These arrangements should be supported by the creation of a resolution fund, financed by way of ex ante industry contributions.
On 16 October 2012, the European Parliament’s Committee on Economic and Monetary Affairs (ECON) published a draft report (the “draft report”) on the EU Commission’s proposal for a Directive establishing a recovery and resolution framework for credit institutions and investment firms (the “RRD”). The overriding concern of the authors of the draft report relates to the level of interference with property rights permitted by the current draft of the RRD and the need to provide certainty to investors. There is a perceived need to draw a more definite distinction between the pre-resolution period, where management remains in control of the firm, and the post-resolution phase, where control passes over to the relevant authority. As a consequence, the draft report suggests far-reaching amendments to the RRD in areas such as:
- resolution authority powers during the recovery phase;
- preventative powers;
- early intervention powers;
- triggers to resolution; and
- resolution tools: proposing both new resolution tools and amendments to existing resolution tools, particularly bail-in.
A more detailed summary of the main proposals is provided below.
Role of resolution authorities
In order to safeguard legal certainty and avoid conflicts of interest, the draft report proposes that national supervisory authorities should not also be able to act as resolution authorities.
Replacement of management
Currently, the draft RRD authorises competent authorities to replace the management of a firm during the recovery phase. The draft report suggests replacing this power with a right to request the replacement of the management body, on the basis that, during recovery (as opposed to resolution) shareholders should retain full control of a company.
Assessment of recovery plans
Article 6 of the draft RRD empowers a resolution authority to take the following actions in the event that it considers deficiencies to exist in a firm’s recovery planning:
- the reduction of the risk profile of the institution;
- recapitalisation measures;
- changes to the firm strategy;
- changes to the funding strategy;
- changes to the governance structure of the institution.
The draft report proposes to remove all of these powers on the basis that they constitute too great an imposition on the way in which a firm is run during a recovery stage.
Group recovery planning
Article 7 of the draft RRD currently states that recovery plans must cover each entity in a group. The draft report suggests amending this provision so that the requirement applies only to relevant entities.
Article 14 of the draft RRD requires resolution authorities to notify firms about “potential substantive impediments to resolvability”. Once notified, a firm must formulate proposals to remove these impediments within four months, failing which the authority can suggest a number of alternative measures. The authors of the draft report believe that the current list of powers goes far beyond what is necessary and represent a “far reaching interference with property rights in banks”. Of the current list of powers detailed within the RRD, the draft report suggests deleting those highlighted in red below:
- requiring the institution to draw up service agreements to cover the provision of critical economic functions or services;
- requiring the institution to limit its maximum individual and aggregate exposures;
- imposing specific or regular information requirements relevant to resolution;
- requiring the institution to divest specific assets;
- requiring the institution to limit or cease specific existing or proposed activities;
- restricting or preventing the development or sale of new business lines or products;
- requiring changes to legal or operational structures;
- requiring a parent undertaking to set up a parent financial holding company in a Member State or a Union parent financial holding company;
- requiring a parent or holding company to issue subordinated debt/loans;
- where an institution is the subsidiary of a mixed-activity holding company, requiring that the mixed-activity holding company set up a separate financial holding company to control the institution.
Early intervention measures
Article 23 of the draft RRD allows for early intervention by a resolution authority if a firm does not meet, or is likely to breach, the terms of the Capital Requirements Directive (“CRD”). The draft report suggests amending this so that early intervention is triggered where a firm’s capital is reduced below an amount equal to 1.25% above the level required by CRD IV. In addition, the draft report proposes the removal of the early intervention power in Article 23(1)(g) of the RRD which allows authorities to contact potential purchasers in order to prepare for the resolution of the institution on the basis that this could damage attempts by management to restore the viability of the institution in question.
The draft report proposes moving Article 24 (Special Management) of the RRD in its entirety from the recovery phase to the resolution phase. The authors of the draft report believe that, during recovery, the owners should have full control over the institution and that this control should only pass to authorities once resolution has commenced.
Preparation of resolution plans
The report proposes that national competent authorities should be able to waive the requirement to prepare a resolution plan if a firm is judged to be not systemically important.
Conditions for resolution
Article 27 of the RRD triggers resolution in circumstances where a firm “is failing or likely to fail”. The authors of the draft report believe that the term “fail” is vague. Given the impact which application of the resolution tools can have on property rights, it is felt appropriate that resolution should only be used where a firm is very close to insolvency. However, the authors of the draft report remain keen to avoid liquidity related triggers to resolution due to the possible systemic effects of triggering resolution on this basis. Accordingly, the draft report proposes to:
- include an additional condition for resolution such that the firm is also no longer viable pursuant to CRD IV; and
- remove the trigger that the “institution will be, in the near future, unable to pay its obligations as they fall due”.
The draft report proposes the inclusion of a new resolution tool, the “government financial stabilisation tool”. This takes the form of a new Article 50 (replacing the current Article 50 which addresses contractual recognition of bail-in). Broadly, there are three elements to the government financial stability tool:
- Guarantee tool – which facilitates government guarantees of assets or liabilities of institutions in resolution;
- Equity support tool – which facilitates government recapitalisation of an institution in resolution; and
- Temporary public ownership.
The authors of the draft report view this very much as a last resort and state clearly that taxpayers must be the beneficiaries of any surplus that may result.
Use of the Bail-In Tool
The draft report suggests amending Article 37 of the RRD to clarify that bail-in must not be used until a firm is beyond the point of non-viability and then only to meet the objectives of resolution as specified by Article 26. Furthermore, a new Article 37(a) is proposed. This would require Member States to conduct an assessment of the potential impact on the stability of the EU financial system before the bail-in tool is applied.
Scope of the Bail-In Tool
The draft report proposes amending Article 38 of the RRD to:
- remove the exclusion relating to guaranteed deposits;
- specifically refer to covered bonds in the context of the exclusion relating to secured liabilities; and
- Extend the short-term exclusion from liabilities with an original maturity of less than one month to include liabilities with an original maturity of less than 6 months (so as to minimise the risk of bank runs).
Replacement of management
Recital 46 of the draft RRD states that, following application of the bail-in tool, management should always be replaced and the firm should be restructured. The draft report proposes removing the reference to ‘replacement of management’.
Minimum amount of bail-in
The draft RRD requires firms to hold a minimum amount of bail-in debt, calculated by reference to the total liabilities of the institution. The draft report of the Parliament proposes changing this to refer to the “risk exposure amount” (i.e. risk weighted assets) under CRD IV which is to be added to a firm’s minimum capital requirements. The report claims that the reference to “total liabilities” introduces a totally new capital requirement on firms. Moreover, in practice, this would operate as a leverage ratio which would not distinguish between low-risk banks and high-risk banks.
Assessment of amount of Bail-In
Article 41 of the draftRRD requires resolution authorities to calculate the amount of bail-in that would be necessary not only to restore the Common Equity Tier 1 capital ratio of the institution to regulatory minimums but also to “sustain sufficient market confidence in the institution and enable it to continue to comply with the conditions for authorisation”.
The authors of the report point to the uncertainty that application of the bail-in tool can cause to investors in a firm and the increased funding costs firms may experience as a result. The draft report highlights the need to strike a balance between providing certainty to investors on one hand and the need for creating capital for a bank under resolution on the other. It suggests removing reference to ‘amounts necessary to sustain market confidence’ on the basis that this is, by definition, an arbitrary assessment, which may be artificially high during times of market stress.
Hierarchy of Claims
In order to provide certainty to investors regarding the hierarchy of claims, the draft report proposes to clarify Article 43 of the RRD. Specifically, in order to avoid the unfair consequences associated with the upside potential of an equity position as opposed to the write down of a debt position, it is proposed that resolution authorities shall not write down the principal of one class of liabilities, while a class of liabilities that is subordinated to that class is converted into equities.
Contractual recognition of bail-in
In light of the fact that the RRD will apply to all capital and debt instruments regardless of any contractual provision, the draft report proposes the deletion of Article 50, which deals with contractual recognition of bail-in, believing it to be both irrelevant and potentially confusing.
Resolution Financing Arrangements
The draft report proposes that resolution should be funded ex-ante, rather than ex-post on the grounds that:
- large ex-post contributions might exacerbate systemic risk during a financial crisis; and
- properly managed banks would, in effect, be liable for the losses of failed banks.
The draft report also proposes using contributions to pay down public debt, rather than creating a formal fund with necessitates an investment strategy. The financing arrangements would effectively form the premia of an insurance scheme provided by Member States. The authors believe that a structure along these lines would render the target funding level of 1% of aggregate deposits within 10 years of the entry into force of the directive, as detailed within Article 93, irrelevant.
Borrowing between financing arrangements
Broadly, under Article 97, the RRD gives financing arrangements of one member state the right to borrow (and the obligation to lend) to other member state financing arrangements. The draft report proposes amending this so that financing arrangements have the opportunity to borrow and the authorisation (but no obligation) to lend.
Deposit Guarantee Schemes
The draft report proposes amending Article 99 of the RRD to make clear that DGS may not be used for resolution purposes (other than through a potential bail-in of the DGS) so as to “safeguard the credibility of the deposit guarantee scheme”.