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.

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FSB Issues RRP Guidance

On 16 July 2013, the Financial Stability Board (FSB) published the following three papers intended to assist authorities and systemically important financial institutions (SIFIs) in implementing the recovery and resolution planning (RRP) requirements set out under the FSB’s key attributes of effective resolution regimes for financial institutions:

Guidance on developing effective resolution strategies

This paper describes key considerations and pre-conditions for the development and implementation of effective resolution strategies, dealing with such issues as:

  • the sufficiency and location of loss absorbing capacity (LAC);
  • the position of LAC in the creditor-hierarchy, particularly with respect to insured and uninsured depositors;
  • operational and legal structures most likely to ensure continuity of critical functions;
  • resolution powers necessary to deliver chosen resolution strategies;
  • enforceability, effectiveness and implementation of “bail-in” regimes;
  • treatment of financial contracts in resolution, specifically the use of temporary stays on the exercise of contractual close-out rights;
  • funding arrangements;
  • cross-border cooperation and coordination;
  • coordination in the early intervention phase;
  • approvals or authorisations needed to implement chosen resolution strategies;
  • fall-back options for maintaining essential functions and services in the event that preferred resolution strategies cannot be implemented;
  • information systems and data requirements;
  • post-resolution strategies;
  • single point of entry (SPE) versus multiple point of entry (MPE) resolution strategies; and
  • disclosure of resolution strategies and LAC information.

Guidance on identification of critical functions and critical shared services

This guidance is designed to assist authorities and CMGs in their evaluation of the criticality of functions that firms provide to the real economy and financial markets. It aims to promote a common understanding of which functions and shared services are critical by providing shared definitions and evaluation criteria.

After describing the essential elements of a critical function and a critical shared service, the annex to the guidance provides a non-exhaustive list of functions and shared services which could be critical:

Functions

  • Deposit taking;
  • Lending and Loan Servicing;
  • Payments, Clearing, Custody & Settlement;
  • Wholesale Funding Markets; and
  • Capital Markets and Investments activities.

Shared services

  • Finance-related shared services; and
  • Operational shared services.

Guidance on Recovery Triggers and Stress Scenarios

This guidance focuses on two specific aspects of recovery plans:

  • criteria triggering senior management consideration of recovery actions (“triggers”), specifically:  design and nature, firm’s reactions to breached triggers, and engagement by supervisory and resolution authorities following breached triggers; and
  • the severity of hypothetical stress scenarios and the design of stress scenarios generally.

Heat Turned Up Over US Living Wills

In a sign that the political tide may be turning, the FT is reporting that the Federal Reserve and the Federal Deposit Insurance Corporation have raised the prospect of taking severe action against banks that submit deficient living wills, including increased capital requirements or even forced break-ups.

Whereas previously, it was accepted that RRP was an iterative process that may take a number of years to get fully up to speed, it seems that truly credible plans will now be required when the next round of RRP are submitted in July 2013.  This is due, at least in part, to the regulators’ disappointment at the lack of detail and clear proposals for resolution in the 2012 submissions.

EU Parliament Proposes Amendments to RRD

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.

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.

EU to Adopt Liikanen Proposals and Non-Bank RRP in 2013

On 21 January 2013, the European Commission published a timetable for certain legislative proposals that it expects to adopt between 1 January 2013 and 31 December 2013, including the following:

Q3 2013:

  • Directive/Regulation on the reform of the structure of EU banks (i.e. the Liikanen reforms)

Q4 2013:

  • Framework for crisis management and resolution for financial institutions other than banks
  • Regulation on a single resolution authority and a single resolution fund within a Single Resolution Mechanism.

EU Parliament Proposes Amendments to RRD

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.