ECB Opinion Reveals Approach to “Principle of Proportionality” under RRP – in a Manner of Speaking

On 19 April 2013, pursuant to a request from the Austrian Ministry of Finance, the European Central Bank (“ECB”) published an opinion (dated 11 April 2013) on certain draft Austrian recovery and resolution planning (“RRP”) legislation – the draft Banking Intervention and Restructuring Act and associated amendments to the Federal Banking Act and the Financial Market Authority Act (the “Draft Law”).

In general, the ECB welcomed the Draft Law, but commented, amongst other things that it:

  • does not contain the resolution tools required by Title IV of the EU Recovery and Resolution Directive (“RRD”); and
  • requires credit institutions (“CIs”) to prepare and submit resolution plans to the Austrian Financial Market Authority (“FMA”), rather than make this a responsibility of the FMA itself.

On the principle of Proportionality, the ECB noted that the Draft Law provides for a complete exemption from a CI’s obligations to submit an RRP if that CI’s insolvency can be presumed not to have any material adverse impact on the financial markets, on other CIs or on funding conditions.  The ECB considers that Article 4 of the RRD does not allow such a complete exclusion, providing only for simplified obligations for certain less systemically important CIs.  Furthermore, the ECB itself remains of the view that it is perfectly possible to make all CI’s subject to RRP legislation, whilst merely simplifying RRP requirements for smaller CIs.  Nonetheless, the ECB acknowledges the ongoing discussions within Europe on the subject of enabling Member States to waive the requirement to maintain and update RRPs in certain cases and understands the benefit in avoiding overburdening small CIs.  As such, it recommends that any such exemption is granted only under “very strict conditions in accordance with the proportionality principle of the RRD”.

Not very helpful advice, given the admission that the proportionality principle of the RRD does not permit a full exemption.  The net result is that there is still no answer to the question as to whether a non-systemically important bank will be able to benefit from a complete exemption from RRP legislation.

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Can the FSA’s RRP Guidance Survive the Test of Time?

As previously reported on this blog, on 20 February 2013 the FSA published an update to its Recovery and Resolution Planning guidance.  It was announced that, in the future, firms will not have to update their resolution information pack (RRP Modules 3-6) on an annual basis as a matter of process.  Instead, they will only be required to respond to requests for resolution planning information from their supervisors.

It seems difficult to reconcile the FSA’s new position with other RRP guidance.  The FSB’s “Key Attributes” document states clearly[1] that “supervisory and resolution authorities should ensure that RRPs are updated…at least annually or when there are material changes to a firm’s business or structure”, a requirement which is echoed in the draft Recovery and Resolution Directive[2] (RRD).  More generally, given the enormous amount of data processing effort that goes into updating a resolution plan in practice, it is difficult to see how any firm which does not follow processes designed to facilitate the periodic updating of a resolution plan could ever be taken to be in compliance with the “Key Attributes” requirements that it must be able to demonstrate an ability to produce the essential information needed to implement a resolution plan within 24 hours[3] or be capable of delivering sufficiently detailed, accurate and timely information to support an effective resolution[4].

Firms would also be forgiven for being confused as to how best to react to this guidance in light of other regulatory developments which offer incentives for those who are prepared to constantly seek to optimise their resolvability, including:

  • the additional loss-absorbency requirements of Basel III for Global Systemically Important Banks;
  • the Liikanen proposal that structural separation above and beyond that relating to ‘significant’ trading activities should be dependent on the robustness of RRPs; and
  • the Vicker’s recommendation that an additional levy of up to 3% of equity capital be required of a UK banking group that is judged “insufficiently resolvable to remove all risk to the public finances”.

Enhancing resolvability demands a proactive, rather than a reactive, approach to RRP legislation.  By its nature, the assimilation of resolution information is not a process that can be easily mothballed and simply dusted-down as and when required, particularly for firms operating in multiple jurisdictions.  Rather, if it is to mean anything, optimising resolvability requires huge commitment and continued cooperation on the part of both firms and authorities.  In light of the drafting of the “Key Attributes” document and particularly the RRD, it is at least questionable whether the new FSA guidance will survive the test of time.  The message to firms must surely be to note the FSA’s new guidance with interest but to continue on a ‘business as normal’ footing with their RRP preparations.


[1] “Key Attributes”, paragraph 11.10

[2] Article 9(3)

[3] “Key Attributes”, paragraph 12.2(iii)

[4] “Key Attributes”, Annex II, paragraph 4.14

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.

“Key Attributes of Effective Resolution Regimes”: a Case of the Emperor’s New Clothes?

The FT is reporting that the Federal Reserve and the Federal Deposit Insurance Corporation have warned banks which are required to produce Recovery and Resolution Plans (RRP) not to assume that regulators will co-operate to avoid the failure of a financial group.  In contrast, they are being required to detail the types of legal filings, notices and applications they would need to submit in each jurisdiction to ensure co-operation among regulators and are being expected to describe the legislation in force within specific countries that would facilitate co-ordination.

If this is indicative of the likely response of authorities during a crisis, it would be a very worrying development indeed.  It is in stark contrast to the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions”, published in October 2011.  This sets the benchmark for national RRP regimes and requires the:

  • establishment of Crisis Management Groups (CMGs) between home and key host authorities with the objective of facilitating the management and resolution of a failing cross-border G-SIFI; and
  • creation of institution-specific cooperation agreements between home and host authorities to govern the development of RRPs and detail procedures concerning notification and consultation prior to an authority taking action against a failing firm.

Unfortunately, if authorities choose not to work together during a crisis, CMGs and cooperation agreements will count for nothing.  Without regulatory co-operation, RRP has some residual value as a data-gathering exercise but will fail to meet its primary objective of facilitating the orderly resolution of a globally significant financial institution in a way that ensures continuity of critical economic functions and minimises taxpayer exposure.  Will anyone tell the G20 that they risk being measured up for the Emperor’s new clothes before it’s too late?

FSA Policy Statement on RRP Expected in Q2 2013

On 25 January 2013, the FSA published Policy Development Update Number 155.  This confirms that a Policy Statement on Recovery and Resolution Plans is now due to be published in Q2 2013.  The Policy Statement is the long-awaited follow-up to CP 11/16: “Recovery and Resolution Plans” published in August 2011.

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.