bail-out has sent further shockwaves through the periphery of the eurozone.
Ordinary EU citizens are waking up to the reality that their savings could end
up as the target of their governments' desperate attempts to recapitalise their
ailing banking industries. This update analyses the provisions of the proposed
EU Directive Establishing a Framework for the Recovery and Resolution of Banks
and Investment Firms and considers whether the implementation of this directive
will make it more difficult in future for EU member state governments to raid
retail depositors' savings to bail out banks.
reigned in Ireland in response to the methods used to recapitalise Irish
financial institutions and the Greek situation is a constant pressure on the
global financial community. Spain recently implemented a 15-year scheme for the
recovery and recapitalisation of its key banks. Cyprus proposed the unthinkable
by attempting to place a levy on guaranteed deposits of retail depositors to
fund recapitalisation, but was forced to apply a levy only to deposits outside
of its deposit guarantee scheme.
the existing regulatory framework, including the protections from appropriation
of property under the European Convention of Human Rights, has proved unable to
cope with the extent of financial distress faced by financial institutions.
Consequently, the proposed directive has been drafted to establish a framework
for the recovery and resolution of credit institutions and investment firms.
The directive aims to prevent contagion between financial institutions and to
align national bank recovery schemes across Europe.
directive in brief
EU member states have taken matters into their own hands, such as the
Investment Bank Special Administration Regulations 2011 in the United Kingdom,
the current EU-wide framework is insufficient to deal with distressed
institutions where distress has a cross-border impact. Primarily, the proposed
directive looks to fill this void and extend the scope of the EU Credit
Institutions Reorganisation and Winding-up Directive (2001/24/EC) to investment
firms. If adopted, the directive will establish three pillars to manage and
resolve future European banking crises:
- early intervention; and
proposed directive aims to protect the financial system as a whole (rather than
individual institutions themselves) and to minimise taxpayer exposure to losses
in insolvency. The impact of the directive must be assessed in this context.
investment firms will be required to develop robust recovery plans ('living
wills') at both firm and group level. These will be used by national resolution
authorities to construct credible resolution plans. They will be tested against
a range of scenarios and frequently reviewed, while any deficiencies will
promptly be remedied.
with the aim of taking action before the onset of insolvency, the proposed
directive allows national resolution authorities to appoint a 'special manager'
to restore an institution's financial condition and improve the management of
its business. Special managers may act alongside or even replace the existing
management and are equipped with all of the management's powers.
proposed directive will make it easier for institutions to benefit from
intra-group financial support by removing legal barriers under restrictive corporate
law regimes. EU member states will be required to facilitate such arrangements,
regardless of any limitations imposed by domestic laws. Member states whose
corporate laws already permit such arrangements may face obstacles of mutual
undertakings and shareholder approval.
will be partly funded by national financing arrangements, to which banks and
investment firms must contribute. They will pay an annual levy as a proportion
of their total covered deposits. Where this proves insufficient, additional
funding may need to be recouped from surviving institutions after resolution.
The proposed directive will effectively create an EU-wide resolution fund by
requiring member states to provide cross-financing to each other where national
financing arrangements are exhausted.
proposed directive envisages cross-border cooperation where resolution is
concerned. The European Banking Association will have the ability to recognise
foreign resolution actions and resolution may be carried out on domestic
branches of third-country firms.
resolution situation, national resolution authorities will have the choice of
using one or more of the following tools:
- the Sale of Business Tool;
- the Bridge Institution Tool;
- the Asset Separation Tool; and
- the Bail-in Tool.
The Sale of
Business Tool provides a national resolution authority with the ability to sell
an institution, or the whole or part of its business, on commercial terms and
without following usual procedural requirements.
Institution Tool provides a national resolution authority with the ability to
transfer an institution's rights, assets and liabilities to a temporary
publicly controlled entity. The business continues to operate as a commercial
concern and may still operate its usual services. The purpose of this tool is
for the business eventually to be sold back to the private sector.
Separation Tool may be used to transfer problem assets from an institution to
an asset management vehicle where normal insolvency procedures would adversely
affect the financial markets.
Tool is the most controversial of these tools. It enables national resolution
authorities to restructure the liabilities of a distressed institution by
writing down unsecured debt or converting it to equity. It may be used where an
entity is failing or about to fail, with the aim of restoring viability.
tool would not come into effect until January 1 2018. Nevertheless, its scope
is broad and it is unclear whether it would catch existing debts due to mature
in 2018. However, European Central Bank President Mario Draghi has indicated
that he believes that this tool should come into force by 2015.
secured debt is exempt from the tool, covered bonds may be caught at member
states' discretion. Claims with original maturities of less than one month are
also excluded. This may incentivise very short-term funding and deter vital
contentious feature of this tool is its capacity to distort the hierarchy of
creditors and shareholders by way of a 'debt write-down'. Authorities will be
able to convert debt into common equity without consulting creditors. Debt
write-downs could trigger compensation claims for interference with contractual
rights. It would also amount to interference with individual property rights;
however, the proposed directive's broad definition of 'public interest' is
meant to justify such a write-down.
creditors will justifiably demand higher returns on investments to guard
against these risks and it may become more expensive for institutions to obtain
credit without offering security. However, one consolation to creditors is that
their losses under any of the resolution tools should not exceed those under
normal insolvency proceedings, as the resolution fund should compensate for any
losses over and above. This is already the case in countries such as the United
Kingdom, and such coverage calculations could take years for large financial
institutions where value can be highly contested.
anticipation of bail-in, banks and investment firms must set aside an
appropriate percentage of total liabilities that could be bailed in. An
appropriate percentage of total liability that could be subject to bail-in
could be equal to 10% of total liabilities (excluding regulatory capital).
proposed directive may be adopted by the European Parliament as early as
October 2013. The proposed deadline for the proposed directive to be transposed
into the laws of member states is December 31 2014, although the bail-in tool
will not be implemented until January 1 2018. However, Draghi's recent comments
on the subject suggest that this timetable may be brought forward, and that the
bail-in tool may be implemented as early as 2015.
information on this topic please contact Louise Verrill, Steven Friel, Neil
Micklethwaite or Jeffrey Jonas at Brown Rudnick LLP by telephone (+44 20 7851
6000), fax (+44 20 7851 6100) or email (email@example.com,
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