On 22 October 2013, the EU Parliament updated it procedural file on the recovery and resolution framework for non-bank institutions. The indicative first or single reading plenary session scheduled for 13 January 2014 has been moved forward to 9 December 2013.
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:
- 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;
- Single Point of Entry (SPE) versus Multiple Point of Entry (MPE) may be the most important innovation in banking policy in decades;
- 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;
- Some impediments to smooth cross-border resolution need to be removed; and
- The resolution agenda is not just about banks and dealers. It is about central counterparties too, for example.
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.
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.
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:
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.
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:
- Deposit taking;
- Lending and Loan Servicing;
- Payments, Clearing, Custody & Settlement;
- Wholesale Funding Markets; and
- Capital Markets and Investments activities.
- Finance-related shared services; and
- Operational shared services.
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.
On 20 June 2013, the Presidency of the Council of the EU published a note on the current “state of play” with respect to the Recovery and Resolution Directive (RRD), together with a compromise RRD proposal. It also invited the EU Council to agree the compromise and mandate the Presidency to undertake negotiations with the EU Parliament with a view to reaching an agreement on the RRD as soon as possible.
The “state of play” summary focuses on the need to achieve an optimal balance between three interlinked elements of the RRD, dubbed the “Resolution Triangle”:
- the design of the bail in tool;
- minimum requirements for own funds and eligible liabilities (MREL); and
- financing arrangements.
The Presidency has proposed a “mixed approach” to each ‘angle’ of the triangle, as set out below.
The Design of the Bail-in Tool (Article 38)
The Presidency is seeking to strike a balance between harmonisation and flexibility with respect to bail-in, proposing:
- a limited discretionary exclusion for derivatives – this would only apply in particular circumstances and only where necessary to achieve the continuity of critical functions and avoid widespread contagion; and
- a power for resolution authorities, available in extraordinary circumstances and limited to an amount equal to 2.5% of the total liabilities of the institution in question, to exclude certain other liabilities from bail-in where it is not possible to bail them in within a reasonable time, or for financial stability reasons.
Minimum Requirements for Own Funds and Eligible Liabilities (Article 39)
In recognition of the general consensus around the need for adequate MREL, but in an effort to marry the need for harmonisation in this area with the practical difficulty of defining an appropriate level of MREL (particularly with respect to different banking activities and different business models), the Presidency proposes that the MREL of each institution should be determined by the appropriate resolution authority on the basis of specific criteria, including:
- its business model;
- level of risk; and
- loss absorbing capacity.
The concept of a minimum percentage of MREL for global SIFIs will not be pursued.
Financing Arrangements (Articles 92 and 93)
The key features of the Presidency proposal in this area are that:
- Member States should be free to keep Deposit Guarantee Schemes (DGS) and resolution funds separate or to merge them; and
- a resolution fund should have a minimum target level of:
- 0.8% of covered deposits (and not ‘total liabilities’ of a Member State’s banking sector as suggested by some Member States) where kept separate from the DGS, or
- 1.3% where combined with the DGS.
The Presidency proposes to maintain the current 2018 date for the introduction of bail-in, rather than bring that date forward to 2015 as suggested by some Member States.
On 20 May 2013, Paul Tucker, Deputy Governor of Financial Stability at the Bank of England gave a speech entitled “Resolution and future of finance” at the INSOL International World Congress in the Hague.
Within the wider context of discussing solutions to the problem of “too big to fail”, the speech gives a useful summary of the ways in which both “single point of entry” and “multiple point of entry” resolution would operate in practice. It also touches upon the interaction between resolution regimes and bank structural reform, noting the way in which bank ring-fencing, as will be implemented in the UK via the Financial Services (Banking Reform) Bill, represents a back-up strategy to resolution, under which essential payment services and insured deposits would be provided by a “super-resolvable” ring-fenced and separately capitalised bank. This, it is believed, should make it easier for the UK authorities to “retreat to maintaining at least the most basic payments services” if a preferred strategy of top-down resolution of a whole group could not be executed.
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.
On 26 April 2013, the FCA published Policy Development Update No 157. This summarises the anticipated publications dates for various pieces of regulatory guidance. Of note are the following:
- a policy statement (PS12/5) to CP11/16 on recovery and resolution plans, due for publication in Q2 2013;
- a policy statement to part 2 of CP12/22 on the client assets regime (multiple client money pools), due for publication in Q2 2013 (had previously been noted as “TBD”); and
- a policy statement to CP12/20 on client money rules for insurance intermediaries, due for publication in Q3/Q4 2013.