1 January 2016 was the latest possible date for EU Member States to adopt and publish implementing legislation and regulations to implement bail-in powers for resolution authorities under the EU Bank Recovery and Resolution Directive (2014/59/EU) ("BRRD"). This client alert provides a brief overview of the BRRD bail-in powers. It also outlines an associated issue likely to have more day-to-day relevance for EU financial institutions and their non-EU counterparties going forward, the mandatory contractual recognition clause in contracts governed by non-EU law.
BRRD was part of a series of EU banking reforms borne out of the 2007-2008 financial crisis, which sought to establish a harmonized European framework governing the resolution of failing financial institutions. BRRD was driven largely by an attempt to avoid taxpayer money being used to rescue failing banks deemed “too big to fail”. The precise scope of BRRD is a matter of local law, but very broadly, it applies to EU banks and large, systemically important, investment firms, and in each case their EU holding companies, certain EU subsidiaries, their branches whether established inside or outside the EU and certain affiliates (for the purposes of this note, “EU Institutions”). It may also apply to non-EU subsidiaries of EU Institutions in certain circumstances. The exact scope of the institutions covered will be determined as the rules are interpreted. Non-EU firms and their EU branches are out of scope.
BRRD has equipped “resolution authorities” across Europe (typically, the national financial regulators) with the same resolution toolkit. These resolution tools were first gifted to resolution authorities on 1 January 2015 (31 December 2014 being the deadline for member states to adopt and publish legislation and regulations to implement BRRD). However, one tool was held back until 1 January 2016 (unless member states wished to adopt it earlier): the power to “bail in” certain liabilities of failing EU Institutions.
“Bail-in” refers to the power of resolution authorities to write down and/or convert into equity certain liabilities of a failing EU Institution. It is intended to be used to recapitalize all or part of an EU Institution that has reached the point of non-viability, in order, without recourse to the taxpayer, to restore it to a stable financial footing and to avoid splitting up the EU Institution’s business. It is controversial since it effectively imposes the failing EU Institution’s losses on shareholders and unsecured creditors.
BRRD does not expressly state which liabilities are within the scope of the bail-in power. Rather, it states that a bail-in may apply to “all liabilities” of an EU institution, except those expressly excluded by the Directive (those not excluded, the “Relevant Liabilities”). The types of liabilities which are expressly excluded are limited, but include certain deposits, secured liabilities (e.g. covered bonds), liabilities arising from the holding of client money/assets, liabilities arising out of a fiduciary relationship, short-term liabilities to non-affiliated EU Institutions (under seven days), and liabilities to employees, certain trade creditors and tax and social security authorities. There are detailed regulatory technical standards (“RTS”) produced by the European Banking Authority which provide further guidance on the scope of Relevant Liabilities but, notwithstanding that the commencement date has now passed, at the time of writing, the RTS remain in draft.
At the time BRRD was being drafted, there was deliberation about how best to ensure the bail-in tool could legally be applied to the Relevant Liabilities of a failing EU Institution. For Relevant Liabilities created under agreements governed by the laws of an EU member state, a bail-in will be effective. Concern centered on the legal application of a bail-in to Relevant Liabilities under agreements governed by non-EU law, and the willingness of non-EU courts to recognize such powers. In an attempt to address this concern, the bail-in tool has been bolstered by a contractual recognition clause requirement.
Contractual recognition clause
Article 55 of the BRRD, like the bail-in tool, was required to be implemented across Europe by 1 January 2016. Broadly, it applies in relation to Relevant Liabilities issued or entered into after implementation and governed by non-EU law, and requires that EU Institutions ensure that any agreement governed by nonEU law which creates Relevant Liabilities includes a contractual term by which the parties recognize that the liabilities will be subject to BRRD bail-in powers.
BRRD does not itself set out the required form of the contractual recognition clause. The RTS provides guidance, but these remain in draft. Due to the nature of these requirements and their breadth of application to a potential wide variety of liabilities, it is not thought possible to draft a one-size-fits-all clause. However, industry associations, such as the LMA, LSTA and AFME, have produced model clauses for use in prescribed circumstances.
BRRD was published back in 2014, and the wider impact on EU Institutions’ operations (outside the scope of this alert), and requirement to include contractual recognition clauses within certain agreements should be known to EU Institutions by now. However, counterparties to EU Institutions, who are not themselves EU Institutions, are now seeing such clauses inserted into agreements which are not covered by EU law.
Whilst it is too early to predict market practice, counterparties are likely to have limited success in protesting the inclusion of contractual recognition clauses in commercial negotiated agreements within the scope of a bail-in, since failure to include the clause will amount to a regulatory breach on the part of the EU Institution. The prospect of using a heavily caveated recognition clause is also likely to be resisted, since EU Institutions can be required by the relevant resolution authorities to obtain a legal opinion on the enforceability and effectiveness of such clause.
The risk of a bail-in is likely to be seen by counterparties as a cost of doing business with EU Institutions. Whilst this might cause indignation amongst some, it should be remembered that a bail-in is a tool of last resort, when all resolution planning has failed. In any event, while the inclusion or not of the contractual recognition clause is unlikely to determine whether a resolution authority seeks to exercise its bail-in powers in a rescue situation, it is intended to reduce the risk of a bail-in being held unlawful by a non-EU court.