knowledge | 14 August 2015 |
Ireland Implements the Bank Recovery and Resolution Directive
The Bank Recovery and Resolution Directive1 (“BRRD”) has been implemented into Irish law by the European Union (Bank Recovery and Resolution) Regulations 2015 (the “Regulations”). The Regulations have important implications for those credit institutions and investment firms, holding companies and subsidiaries which are within scope (“Institutions”), as well as their shareholders, creditors and contractual counterparties.
An Overview of the Regulations
The Regulations entered into force, for the most part, on 15 July 2015. This followed a public consultation that commenced in December 2014 and which sought both to inform stakeholders about BRRD and to seek their views on several questions relating to the exercise of a number of discretions provided in that Directive.
The Regulations apply to credit institutions and large investment firms authorised in the State and their subsidiary financial institutions, as well as to EU branches of third country credit institutions and large investment firms. The Regulations also apply to different types of financial holding companies established in the State, and in some cases to their subsidiary financial institutions.
The Regulations confer key functions on two authorities, namely the “competent authority” and the “resolution authority”. As the Central Bank of Ireland (“Central Bank”) is entrusted with the functions of both these authorities2, the Regulations contain a number of provisions designed to ensure the operational independence of the two authorities and to avoid conflicts of interest between the Central Bank’s functions as a resolution authority and, in particular, its supervisory functions in respect of credit institutions and investment firms and their related entities.
The Regulations are based on three pillars; preparatory and preventative measures, early intervention measures and resolution measures.
Preparatory and Preventative Measures
Each Institution must prepare and regularly update a recovery plan setting out the measures to be taken by the Institution for the restoration of its financial position following a significant deterioration in that position. The resolution authority must prepare a resolution plan setting out its proposed actions in the event that an Institution meets the conditions for resolution stipulated in the Regulations.
Early Intervention Measures
The competent authority is empowered totake early action to address a deteriorationin an Institution’s financial and economicsituation. This includes powers to requirean Institution to implement its recoveryplan and to replace existing managementwith a temporary administrator.
The Regulations provides for four resolution tools, namely, a sale of business tool, a bridge institution tool, an asset separation tool and a bail-in tool. The bail-in tool is the cornerstone of the Regulations and is designed to minimise the cost to taxpayers of the resolution of a failing Institution. It enables a resolution authority to write-down the value of certain liabilities or convert them into equity in order to absorb losses and recapitalise the Institution. However, not all liabilities may be bailed-in. For example, secured liabilities such as covered bonds are protected to the extent that the secured liabilities do not exceed the value of the secured assets. Moreover, the Regulations contain several safeguards which are designed to protect the interests of shareholders and creditors, and the integrity of financial markets.
While the Regulations transpose BRRD into Irish law, BRRD itself confers the European Commission (“Commission”) and the European Banking Authority (“EBA”) with the power to adopt delegated acts relating to certain requirements set out in BRRD. These delegated acts also inform the requirements of the Regulations.
The Regulations have several imminent implications for Institutions, as well as their shareholders, creditors and contractual counterparties. Specifically, Institutions must:
- include in a relevant agreement that creates a liability after 1 January 2016 and that is governed by a third country law, a contractual term by which the creditor or party to the agreement recognises that liabilities may be subject to the write-down and conversion powers and agrees to be bound by any reduction of the principal or outstanding amount due, conversion or cancellation that is effected by the exercise of the bail-in powers by a resolution authority ("Contractual Recognition Requirement");
- put in place a recovery plan setting out the measures to be taken by the Institution for the restoration of its financial position following a significant deterioration of that position;
- cooperate with the resolution authority in the preparation of a resolution plan setting out its proposed actions in the event that an Institution enters into resolution; and
- contribute to the Bank and Investment Firm Resolution Fund (“Fund”) established under the Regulations.
The Regulations also have a number of implications for counterparties to Institutions regarding their contractual arrangements.
Contractual Recognition Requirement
The Regulations confer a number of powers on the resolution authority including the power to write-down and convert an Institution’s relevant capital instruments.
In some cases, an Institution’s liabilities may be governed by the law of a third country which will not necessarily recognise the application of the write-down and conversion powers by the resolution authority. Consequently, the Regulations require Institutions to include in relevant agreements contractual recognition of these powers.
On 3 July 2015 the EBA published its finalised draft regulatory technical standards (“RTS”) regarding the contractual recognition of write-down and conversion powers, which include a list of mandatory components which must be present in the relevant contractual term. These include provisions specifying the express acknowledgement, agreement and consent of the counterparty to the application of write-down and conversion powers by the resolution authority and their potential effects in terms of the liability under the agreement.
The contractual recognition requirement only arises in respect of liabilities issued or entered into after the 1 January 2016. According to the RTS, this includes:
- liabilities under agreements entered into after the transposition date;
- liabilities created after the transposition date under agreements entered into before that date;
- liabilities under agreements entered into before the transposition date and liabilities under debt instruments issued before that date, which are subject to a material amendment after that date; and
- liabilities under debt instruments issued after the transposition date.
The Commission must now endorse the draft RTS after which they will be published in the Official Journal of the European Union. According to the text of the draft RTS, they will apply from the twentieth day following that publication.
Significantly, the contractual recognition requirement does not apply to all agreements. In particular, there is no requirement to include such a term where the agreement relates to excluded liabilities such as covered deposits, secured or collateralised liabilities to the extent of the security or collateral, short-term liabilities (ie less than seven days) owed to non-affiliated institutions or settlement systems, and certain other specific types of liabilities.
Nor does that requirement apply where the resolution authority determines that the liabilities or instruments can be subject to the write-down and conversion powers as a result of national law in the third country or a binding agreement with that third country. The RTS specify key elements which the resolution authority must assess as present before making such a determination.
The Regulations provide that an Institution’s failure to include a contractual recognition provision will not prevent the exercise of write-down and conversion powers in relation to that liability.
Each Institution must draw up a recovery plan which sets out the measures it would adopt to restore long-term financial viability in case of severe distress. The plan’s purpose is to ensure that the Institution itself assesses, prior to a crisis, the potential options that it could implement to restore financial strength and viability in the event that it comes under severe stress. A key assumption is that recovery plans must not assume that extraordinary public financial support would be provided.
The recovery plan must meet the requirements of Schedule 1 of the Regulations as to the type of information covered, including details on the types of measures proposed and on how the recovery plan is integrated into the Institution’s governance structures, timeframes for implementing each material aspect of the plan and a detailed description of any significant impediment to the plan’s effective and timely execution.
The Institution must submit the recovery plan to the competent authority for review and assessment. Where the competent authority identifies material deficiencies in a recovery plan, it may require the Institution to submit a revised plan. If it fails to do so, or if the competent authority deems the revised plan to be inadequate, that authority may direct the Institution to make changes to its business, including in relation to its capital and liquidity resources, its risk profile and its governance arrangements.
While the competent authority may direct an Institution to update its recovery plan at any time, it must in any event update its plan at least annually and following any circumstances affecting the Institution which could have a material effect on its plan.
Each resolution authority must prepare a resolution plan setting out its proposed actions in the event that an Institution meets the conditions for resolution stipulated in the Regulations. The main purpose of the resolution plan is to identify options to restore financial strength and viability when an Institution comes under severe stress.
While the resolution authority is responsible for preparing the resolution plan, it may require the relevant Institution to cooperate in its preparation and implementation. The resolution authority may also direct an Institution to remove any substantive impediments to resolvability.
The resolution authority must update the resolution plan at least annually and in the event of any circumstances affecting the Institution which could have a material effect on the plan.
For the purpose of financing resolution arrangements, the Regulations establish the Fund. During the period up until 31 December 2024, the Fund’s available financial means must reach at least 1% of the amount of covered deposits of all Institutions authorised in the State3
All Institutions authorised in the State will be required to contribute to the Fund, at least annually, including those operating in the State through a branch. The level of an Institution’s annual contribution will be in the same proportion as the amount of its liabilities (excluding own funds and covered deposits) relative to the aggregate liabilities (excluding own funds and covered deposits) of all Institutions authorised in the State. The resolution authority must make regulations setting out detailed rules on the calculation of the contributions. The Central Bank, as resolution authority, has not yet published such regulations. Any such regulations must take into account relevant delegated acts adopted at EU level including the Commission’s Delegated Regulation setting out the detailed rules on the calculation of contributions under BRRD4.
The Regulations also empower the resolution authority to raise extraordinary ex-post contributions to the Fund, where the available financial means of the Fund are not sufficient to cover losses, costs or other expenses incurred by the Fund.
Other Contractual Implications
Counterparties to agreements with Institutions should also take note of a number of other provisions of the Regulations, and their consequences for contractual arrangements, including in particular, their implications for enforcement events and the ability to suspend contractual obligations. Parties to derivative agreements and netting arrangements should also be aware of how these may be impacted under the bail-in tool. On a positive note, the Regulations also contain a number of safeguards, in particular the "no creditor worse off" principle and protections in the case of partial transfers. Each of these provisions and safeguards, as set out in the Regulations, track the relevant articles in BRRD.
Where the resolution authority takes a crisis prevention measure or crisis management measure in relation to an entity, this is not by itself an enforcement event permitting the collateral taker to realise or appropriate financial collateral or giving effect to a close-out netting provision, provided that the substantive obligations under the contract continue to be performed.
The Regulations confer widespread powerson the resolution authority with regard toan Institution under resolution, includingpowers to suspend contractual paymentsand delivery obligations, restrict theenforcement of security interests andtemporarily suspend termination rights.In each case, the suspension or restrictiontakes effect from the publication of therelevant suspension or restriction noticeuntil midnight at the end of the businessday following that publication.
The resolution authority’s powers to write-down the value of certain liabilities or convert them into equity encompass derivatives transactions subject to certain conditions. In particular, before being bailed-in, the derivatives must be closed-out and in instances where the derivatives are subject to a netting arrangement5, they must also be valued. The EBA’s consultation on its draft RTS defining the valuation of derivative liabilities for the purpose of bail-in closed on 13 August 2015.
Safeguards - No Creditor Worse Off
One of the fundamental principles of the Regulations is that no creditor should be worse off when an Institution is the subject of resolution than that creditor would have been had the Institution been wound up under normal insolvency proceedings. Moreover, a partial transfer of an Institution's rights, assets and liabilities should not result in shareholders and creditors whose claims have not been transferred receiving less than they would have received if normal insolvency proceedings had applied. The Regulations also provide for the payment of compensation for any losses that arise, in accordance with an independent valuation mechanism.
Safeguards - Partial Transfers
There are certain restrictions on the extent to which a resolution measure can effect a partial transfer of the Institution's assets, rights and liabilities ("resolution partial transfer") or result in the modification or cancellation of a contract to which an Institution under resolution is party or the substitution of the Institution as a party to that contract ("resolution modification"). Specifically:
- a resolution partial transfer cannot operate to transfer some, but not all of the rights and liabilities under certain types of set-off arrangements, netting arrangements or title transfer financial collateral arrangements (the definitions of which track the terms of BRRD), subject to specified exceptions relating to certain guaranteed deposits. A resolution modification is also subject to these restrictions;
- in respect of certain security arrangements, under which a person has by way of security an actual or contingent interest in the assets or rights that are subject to transfer, resolution partial transfers and resolution modifications must not operate to separate secured assets from the secured obligations; and
- in respect of certain structured finance arrangements and covered bonds, resolution partial transfers and resolution modifications must not operate to permit the transfer of some but not all of, or the termination or modification through the use of ancillary powers of, the assets, rights and liabilities which constitute or form part of that arrangement.
An application may be made to the High Court of Ireland to set aside or modify a partial property transfer or a modification of contracts made in contravention of the foregoing, if the applicant's property rights or liabilities have thereby been adversely affected.
While the primary purpose of BRRD, and the transposing Regulations, is to ensure that unsound or failing Institutions can be effectively wound-down without recourse to public funds, their focus on prevention as well as cure means that they have ongoing implications for all Institutions and not just those experiencing financial deterioration.
In particular, Institutions will need to invest significant resources, including senior management involvement, in producing a recovery plan and liaising with the competent authority regarding that plan, as well as in cooperating with the resolution authority in the development of a resolution plan. In addition, Institutions, their creditors and counterparties will need to take into consideration the requirements of the Regulations when negotiating contracts and when assessing their remedies in the event of a contractual breach.
The Regulations themselves largely track the requirements set out in BRRD and, like BRRD, are highly complex. Consequently, the details of a number of requirements imposed under the Regulations will only become clear as the Commission and the EBA finalise the relevant delegated acts. All those affected by the Regulations should pay close attention to the developments in this area over the coming months and years.
- Directive 2014/59 of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council, OJ L 173, 12 June 2014, p. 190
- The European Central Bank is designated as the competent authority with regard to specific tasks conferred on it by Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions, OJ L 287, 29 October 2013, p. 63
- In the banking union, the national resolution funds set up under BRRD will be replaced by the Single Resolution Fund as of 1 January 2016
- Commission Delegated Regulation (EU) 2015/63 of 21 October 2014 supplementing Directive 2014/59/EU of the European Parliament and of the Council with regard to ex ante contributions to resolution financing arrangements OJ L 11, 17 January 2015
- The definitions of both "derivatives" and "netting arrangements" in the Regulations ref lect those in BRRD
This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.