Executive Summary On 15 March 2016, the Prudential Regulation Authority (PRA) issued a consultation paper on its proposed amendments to the contractual recognition of bail-in provisions in the PRA Handbook. This amendment follows the temporary ‘modification by consent’ direction issued by the PRA in November 2015. The direction, which remains valid until 30 June 2016, allows firms affected by Article 55 of the Bank Recovery and Resolution Directive (BRRD) to disapply the PRA bail-in rules in respect of phase 2 liabilities where compliance is considered ‘impracticable’.

Phasing in of requirements The PRA has phased in the requirements for BRRD firms to include a bail-in clause in certain contracts. For unsecured debt instruments, additional tier 1 and tier 2 instruments (described as “phase 1 liabilities”), the requirement to include a contractual recognition of bail-in provision has applied since 19 February 2015. For all other relevant liabilities (phase 2 liabilities, i.e. unsecured liabilities which are not debt instruments and may include, among other liabilities, trade finance and operational liabilities such as derivatives), the requirement to include a bail-in provision has applied from 1 January 2016.

The PRA consultation paper sets out how the PRA proposes to amend its rulebook to incorporate the ‘modification by consent’ direction and to align it with the European Banking Authority (EBA)’s draft Regulatory Technical Standards (RTS).

The PRA’s consultation closes on 16 May 2016, with the amended rules to be effective from 1 July 2016.

‘Impracticability’ The proposed rules would amend the ‘modification by consent’ direction with a requirement that a BRRD firm must include Article 55 bail-in language in its phase 2 liabilities unless it is impracticable (emphasis added).

The consultation sets out a number of examples where the inclusion of bail-in language may be considered ‘impracticable’, including where:

  • A bail-in provision may be considered illegal under the laws of the non-EEA country
  • The liabilities are governed by international protocols which the BRRD firm is unable to amend
  • Contractual terms are imposed on members of non-EU bodies on standard terms where it is impracticable to amend bilaterally
  • The relevant non-EEA country authorities inform the BRRD firm that they will not allow it to include a bail-in provision in the contract

Loss of competitiveness or profitability are not considered relevant grounds for ‘impracticability’. What is apparent from the PRA’s examples of ‘impracticable’ is that each has some demonstrable element of legal or quasi legal constraint, be it illegality or a risk of breaching some form of non-bilateral arrangement. In contrast, claims of loss of competitive status caused by non-BRRD firms being able to dispense with bail-in clauses, or the sheer costs of implementing bail-in clauses across a broad array of contracts, will not fall into the ‘impracticable’ category.

Regulatory technical standards The consultation also proposes to amend the PRA Rulebook in line with the EBA’s draft RTS. The proposed amendments to the Rulebook will be subject to any further amendments to the RTS on its adoption by the European Commission. The PRA’s consultation paper proposes to amend:

  1. The definition of secured and unsecured liabilities so that bail-in language be included in: (i) agreements where liabilities are not fully secured when created; and (ii) agreements where the liabilities are fully secured but the debtor is not obliged to maintain full collateralisation at all times.
  2. The application of ‘material amendments’ so that contractual recognition language be included in: (i) contracts governing debt instruments issued on or before 19 February 2015; and (ii) agreements governing liabilities created before 31 December 2015, but materially amended after 30 June 2016. A ‘material amendment’ is defined as any amendment that affects the substantive rights and obligations of a party to a relevant agreement. Typographical changes to correct drafting errors or an automatic adjustment of interest rates are not considered material amendments.
  3. The concept of ‘created’, such that references to liabilities ‘arising’ after a certain date be amended to capture liabilities ‘created’ after the relevant date, in order to align the language in the PRA Rulebook with the language in the RTS.

It is intended that both the PRA and the Bank of England will continue to seek updates from BRRD firms on the impact of including bail-in language in contracts and what difficulties they are encountering.

The consultation closes on 16 May 20161.

For more information on the practical impact of Article 55 of the BRRD, please see our previous client alert from January 20162.