European Requirements on Recovery and Resolution
The European Commission (EC) has yesterday (6 June 2012) published its long awaited draft directive on recovery and resolution of credit institutions and investment firms, including extensive powers for resolution authorities to bail-in a wide range of liabilities. The scope of the requirements to produce RRPs is broad, covering all credit institutions and investment firms subject to the Capital Requirements Directive (CRD) as well as financial holding companies. The EC has included simplified obligations for certain institutions, which we expect national authorities to use to exclude a number of firms. However, the flexibility available to national authorities to do this will depend on EC delegated acts which will specify more detailed criteria for inclusion. The introduction of the directive, and the scale of the involvement of the European Banking Authority (EBA) in both the implementation and ongoing management of all aspects of the recovery and resolution regime in Europe, is a clear indication that a more pan-European approach to crisis management in the financial services sector is intended.
Many of the core elements are similar to the current UK regulatory requirements in respect of:
- the core resolution objectives against which the resolution authorities will act;
- the conditions and triggers for resolution;
- the need for each institution to produce recovery plans;
- the requirement for resolution authorities to produce resolution plans based on information and analysis produced by the institution (although there are differences in relation to the contents and approach which are considered in more detail below); and
- safeguards against partial property transfer.
However, the directive also includes a number of proposals which will require changes to the UK approach. The primary areas of difference from the current UK approach or areas where the proposals will require changes are summarised below. Further details are given in the body of the document.
- The directive requires recovery and resolution plans to be prepared with reference to stress scenarios defined by the EBA. UK recovery and resolution planning is currently not performed by reference to specific defined scenarios.
- Group recovery plans will need to be drawn up by the parent institution and submitted to the consolidating supervisor along with the individual recovery plans for institutions subject to consolidated supervision. The production of recovery plans below the group level could create an additional burden for institutions.
- The directive puts particular emphasis on early intervention during the recovery stage and introduces the notion of a ‘special manager’, which can be appointed by a national competent authority to replace the existing management in the case of the ‘significant deterioration’ of a financial institution. This is highly controversial amongst some European countries.
- Intra-group financial support which is a key element of the EC’s recommendations regarding group level recovery is also a contentious issue among member states, with Germany and the UK both raising concerns about the impact such a rule would have on risk taking amongst financial institutions and insolvency law.
- Group resolution plans will be drawn up by resolution colleges led by the Group level resolution authority and including the resolution authority of each member state covered under consolidated supervision as well as the EBA as an observer. Although the EC has stressed a preference for a joint decision to be reached amongst relevant competent authorities, the EBA will have the power to intervene in the decision-making process. The mediation role for the EBA is likely to be highly controversial with several countries, including the UK, strongly against this in the consultation phase in early 2011.
- The directive includes significant developments regarding resolution funding. Member States will be required to have adequate financing arrangements in place, with a target resolution fund of 1% of insured deposits raised from contributions from authorised institutions on an ex ante basis over a ten year period. This will be a significant change to UK practices and is likely to increase the burden on firms. Where ex ante contributions are not sufficient, the directive also provides for ex post extraordinary contributions and borrowing powers enabling Member States’ resolution funds to borrow from one another, effectively taking the EU one step closer to an EU-wide resolution fund.
- Resolution authorities will be required to have an exhaustive range of resolution tools, and even countries such as the UK which have recently updated their legislation will have to amend their current framework. In the case of the UK, this will include adding an asset separation tool to allow certain assets to be transferred and managed in a stand-alone asset management vehicle; and a bail-in tool. Bail-in in particular has attracted a lot of recent attention. This will allow national competent authorities to write off, or dilute, existing equity, and either reduce claims of creditors or convert eligible liabilities into equity in order either to recapitalise an institution in resolution or to assist the transfer of assets to a bridge institution. The EC has stopped short of specifying a minimum amount of bail-inable debt a firm must hold, instead stating that this should be a ‘sufficient amount of eligible liabilities expressed as a percentage of total liabilities’. However, it remains to be seen how flexible this assessment will be, as the EBA must develop regulatory technical standards which will specify the detailed criteria by which ‘sufficient’ will be judged. This will likely be based on the firm’s size, business risk and the potential systemic impact of failure.
- The directive introduces a temporary stay on the rights of creditors and counterparties to close out, accelerate or otherwise terminate contracts until 5pm the following business day to facilitate the ability of the authorities to transfer. Currently the UK does not have such a power.
- Currently the UK authorities have limited resolution powers in relation to branches of third country institutions. While it is envisaged that member state authorities and EU resolution colleges will work in cooperation with third country resolution authorities, the directive includes proposals to allow member state resolution authorities to apply resolution tools to national branches of third country institutions where separate resolution is necessary for reasons of financial stability or the protection of local depositors.
In all of the above, the EBA will play a significant role through the preparation of approximately 28 technical standards and guidelines, as a non-voting attendee of all resolution colleges, as a mediator between resolution authorities and through relations with third country resolution authorities.
For further information download the full article ‘European Requirements on Recovery and Resolution’, which contains more detailed analysis of the key provisions.
European Requirements on Recovery and Resolution (PDF, 515 KB)