EBA Consults on Recovery Planning

Introduction

On 20 May 2013, the EBA published two consultation papers regarding draft Regulatory Technical Standards (“RTS”) regarding the:

The consultations follow the previous consultation published by the EBA on 11 March 2013 regarding draft RTS on the content of Recovery Plans (see this blog post for more detail) and remain open for comment until 20 August 2013.  Final versions of both RTS will be submitted to the European Commission within 12 months of the date on which the “Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”) enters force, but may be amended after the consultation to take into account possible changes to the final RRD.

RTS on the Assessment of Recovery Plans

The draft RTS have been developed pursuant to Article 6(5) of the RRD.  Their main objective is to promote harmonisation across the EU regarding the assessment of recovery plans and to facilitate joint assessments of group recovery plans by different supervisory authorities.  They outline the three criteria that competent supervisors must take into account when reviewing individual and group recovery plans:

  • completeness;
  • quality; and
  • overall credibility.

Completeness

The degree of completeness of a recovery plan is to be assessed against the following (non-exhaustive) list of factors:

  • whether it covers all the information listed in Section A of the Annex of the RRD (“Information to be Included in Recovery Plans”);
  • whether it provides information that is up to date with respect to any material changes to the institution or group to which the recovery plan relates;
  • where applicable, an analysis of:
    • how and when an institution may apply for the use of central bank facilities; and
    • available collateral; and
    • whether the recovery plan has been tested against a range of scenarios.

In addition to the information set out above as it applies in a group context, the completeness of group recovery plans is assessed against the following matters:

  • the establishment of arrangements for intra-group financial support;
  • the identification of obstacles, if any, to the implementation of recovery measures within the group; and
  • the identification of substantial practical or legal impediments to:
    • the prompt transfer of own funds or
    • the repayment of liabilities or assets within the group.

Quality

The quality of a recovery plan is assessed against the following (non-exhaustive) list of factors:

  • clarity;
  • relevance of information;
  • comprehensiveness; and
  • internal consistency.

Overall Credibility

Individual Recovery Plans

Overall credibility in the context of individual recovery plans is essentially an assessment of the extent to which:

  • the implementation of a recovery plan would be likely to restore the viability and financial soundness of the institution in question; and

  • the plan or specific options could be implemented effectively in situations of financial stress and without causing any significant adverse effect on the financial system.

 ‘Restoration of viability and financial soundness’ is assessed against the following (non-exhaustive) factors:

  • the level of integration and consistency of the recovery plan with the general corporate governance and risk management framework of the group;
  • whether the recovery plan contains a sufficient number of plausible and viable recovery options;
  • whether the recovery options included in the recovery plan address the scenarios identified;
  • whether the timescale to implement the options is realistic and has been taken into account in the procedures designed to ensure timely implementation of recovery actions;
  • the level of the institution`s or group`s preparedness;
  • the adequacy of the range of scenarios of financial distress against which the recovery plan has been tested;
  • the adequacy of the testing carried out using the scenarios of financial distress;
  • the extent to which the recovery options and indicators are verified by the testing carried out using scenarios of financial distress;
  • whether the assumptions and valuations made within the recovery plan are realistic and plausible.

‘Effective implementation’ is assessed against the following (non-exhaustive) factors:

  • whether the range of recovery options sufficiently reduces the risk that obstacles to the implementation of the recovery options or adverse systemic effects arise due to the recovery actions of other institutions or groups being taken at the same time;
  • the extent to which the recovery options may conflict with the recovery options of institutions or groups which have similar vulnerabilities and which might implement options at the same time;
  • the extent to which implementation of recovery options by several institutions or groups at the same time could negatively affect the impact and feasibility of recovery options.

Group Recovery Plans

Overall credibility in the context of group recovery plans is essentially an assessment of the extent to which:

  • the implementation of a recovery plan would achieve the stabilisation of the group as a whole, or any institution of the group; and
  • the plan identifies whether, within the group, there are:
    • obstacles to the implementation of recovery measures; and
    • substantial practical or legal impediments to the prompt transfer of own funds or the repayment of liabilities or assets.

‘Stabilisation’ is assessed against the following (non-exhaustive) factors:

  • the extent to which the group recovery plan can achieve stabilisation of the group as a whole and any institution of the group;
  • the extent to which arrangements included into the group recovery plan ensure coordination and consistency of measures between institutions within the group; and
  • the extent to which the group recovery plan provides solutions to overcome:
    • obstacles to the implementation of recovery measures; and
    • substantial practical or legal impediments to a prompt transfer of own funds or the repayment of liabilities or assets.

RTS specifying the range of scenarios to be used in recovery plans

These draft RTS have been developed pursuant to Articles 5(5) and 5(6) of the RRD.  They specify the range of scenarios to be designed by financial institutions when testing their recovery plans.  The overriding principle is that scenarios should be based on the events that are the most relevant to the institution or group in terms of activity, size, interconnectedness, business, funding model, etc.  Institutions are responsible for selecting an appropriate number of relevant scenarios (taking account of the principle of proportionality within the RRD) and national supervisors are responsible for assessing the adequacy of the chosen scenarios.  Each distress scenario should be based on events that are exceptional but plausible and would threaten to cause the failure of the institution or group if recovery measures were not implemented in a timely manner and should cover:

  • a system wide event;
  • an idiosyncratic event; and
  • a combination of system wide and idiosyncratic events.

Each distress scenario should also include an assessment of the impact of the events on at least each of the following aspects of the institution or group:

  • available capital;
  • available liquidity;
  • business model;
  • profitability;
  • payment and settlement operations; and
  • reputation.
Advertisements

EU Council Publishes Compromise Proposal on RRD

On 16 May 2013, the Presidency of the Council of the EU published a compromise proposal relating to the Recovery and Resolution Directive (RRD).

Additions to the original EU Commission proposal are underlined and additions to the most recent compromise proposal dated 14 February 2013 are shown in bold.

Further Guidance on Bail-in

On 14 May 2013, the Economic and Financial Affairs Committee of the EU Council published a press release following a debate on the proposed Recovery and Resolution Directive (RRD).  The discussion focused on the design of the bail-in tool, identified as a central issue.  A summary of the key points include:

  • General agreement on the scope for bail-in and a limited list of defined exclusions;
  • General agreement that the level of loss absorbing capacity must be adapted to match the scope of exclusions;
  • Agreement amongst most Member States that the deposit guarantee schemes (for deposits under EUR 100.000) should benefit from depositor preference (i.e. last category of assets to be bailed in);
  • Overall support for deposits over EUR 100.000 to also benefit from depositor preference (with some reservations towards preference given to large corporate deposits);
  • The need for a balance between a harmonised approach to bail-in and limited national flexibility in its application;
  • Country-specific concerns regarding euro area vs. non-euro area issues should be addressed.

The Council is expected to reconvene on 21 June, with the hope of reaching an agreement on the directive.

Bail-in Begins to Take Shape

Introduction

On 8 May 2013, the EU Council published a note regarding the “state of play” of on the proposed Recovery and Resolution Directive (RRD).

The design of the bail-in tool has been identified as a central issue with three main approaches (all of which adopt preferential treatment for insured depositors and provide for a broad scope of bail-in with a limited list of defined exclusions) being defined:

  • the Harmonised Approach;
  • the Discretionary Approach; and
  • the Mixed Approach.

Harmonised Approach

The Harmonised Approach defines a limited set of exclusions from bail-in.  Insured depositors would benefit from preference treatment (with Deposit Guarantee Schemes (“DGS”) substituting for insured depositors), meaning in practice that they would be unlikely to be bailed in as other classes of creditors would have to absorb losses first.  The only discretionary exclusion from the bail-in regime relates to derivatives.  It is designed to provide a high degree of harmonisation across Member States by promoting ex ante predictability and legal certainty to markets regarding the treatment of creditors.

A variation of the Harmonised Approach (which reflects the original Commission Proposal) would still see DGS substituting for insurance depositors but being bailed-in pari passu with all other all other senior unsecured creditors, rather than on a preference basis.  However, it is felt that, in these circumstances, the low size of DGS funds compared to insured depositors balances would mean that the DGS would not be able to cover the losses in the event of a bail-in of a large bank, potentially making the bail-in tool unusable.

The EU Council notes that many Member States feel that the Harmonised approach suffers from a lack of flexibility.  Specifically, there is a belief that the inability to exclude a creditor or class of creditors from the scope of bail-in may have adverse consequences in terms of financial stability.  In turn, this may damage the practical usefulness of bail-in as a tool with the result that resolution authorities have no option but to resort to using the resolution fund or taxpayer funded bail-outs.

Discretionary Approach

The Discretionary Approach attempts to address the flexibility deficiencies of the Harmonised Approach by providing resolution authorities with a degree of discretion on how the bail-in tool is used.  A number of alternative models are possible.  These include:

  • A small number of discretionary exclusions, e.g. relating to:
    • eligible deposits;
    • short term debt;
    • liabilities related to the participation in payment, clearing and settlement systems; and
    • OTC derivatives.
  • A general exclusion from bail-in of eligible deposits (over €100,000) of a natural person unless inclusion is necessary in order to absorb losses and where it does not raise financial stability risks; and
  • Providing a resolution authority with the discretion to exclude any liability from bail-in on a case by case basis (subject to strict criteria and perhaps limiting the actual exclusion to a percentage of the total pool of bail-inable liabilities).

What the Discretionary Approach gains in terms of flexibility, it loses in terms of harmonisation of the bail-in regime across Member States and providing legal uncertainty for investors and other unsecured creditors.  It is likely that the Discretionary Approach would also require an institution to hold a higher minimum amount of own funds and bail-inable liabilities in order to ensure it maintained sufficient and appropriate loss-absorbency capacity.

Mixed Approach

The Mixed Approach defines a limited set of exclusions, some mandatory and some discretionary, from the scope of the bail-in tool.  It seeks to provide a compromise solution to the issue of harmonisation.  The EU Commission believes that it makes the bail-in tool more credible, as it removes the risk that Resolution Authorities will not deploy the bail-in tool due to concerns about the impact on public confidence.

Consideration of RRD Delayed Again

On 25 April 2013, the EU Parliament published an update to its procedure file confirming that its consideration of the Recovery and Resolution Directive (RRD) will now take place at the plenary session scheduled for 21 to 24 October 2013.  Previously it had been indicated that the RRD would be discussed at the plenary session to be held from 9 to 12 September 2013.

Barnier Tries to Force the Pace of EU Banking Reform

On 11 April 2013, Michel Barnier, European Commissioner for Internal Market and Services, gave a speech on the EU’s long-term financing needs, during which he touched upon the current status of the Recovery and Resolution Directive (RRD) and EU banking reform.

M Barnier remains open to the introduction of the EU bail-in regime before 2018, its original start date.  More to the point, he believes that the adoption of the main body of the RRD is “truly urgent” and should take place “within the next few weeks”.   However, given that the EU Parliament is not scheduled to consider the RRD until its plenary session of 9 to 12 September 2013, this seems unlikely.

On the subject of the Single Resolution Mechanism (SRM) – comprising a single resolution authority and a common resolution fund – M Barnier confirmed that the EU Commission would present a legislative proposal in the summer of 2013 (probably in June).  He also believes that the SRM can be established within the framework of current EU treaties.  However, if this FT article is to be believed, Germany may insist that revision to EU treaties is necessary, a position which the UK will use in order to secure the repatriation of powers from the EU to the UK.  If that proves to the case, EU banking reform risks being swallowed up in a political bun fight and we are unlikely to see its introduction any time soon.

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.