In addition to financial issues, the debate on cross- border reorganisations of financial institutions is also focused on how to overcome the legal barriers still in existence. Currently, it can still be concluded that national resolution authorities do not yet have sufficient powers. In particular, they are not able to fully recognise measures taken by foreign resolution authorities, if at all, nor can they implement them effectively. Most will be subject to a time-consuming recognition process in the national courts. As well as the question of equal treatment of domestic creditors, underlying national values also play a role.
Steps have recently been taken in Germany to overcome these obstacles.
On 30 April 2015, the German government published a draft version of the Resolution Mechanism Act (Gesetz zur Anpassung des nationalen Bankenabwicklungsrechts an den Einheitlichen Abwicklungsmechanismus und die europäischen Vorgaben zur Bankenabgabe (Abwicklungsmechanismusgeset, AbwMechG) which is still in legislative process and being discussed by the German Parliament, and is expected to be adopted in late 2015.
The AbwMechG, intends to introduce a new section 60a into the German Act on the Reorganisation and Liquidation of Credit Institutions (Gesetz zur Sanierung und Abwicklung von Instituten und Finanzgruppen, Sanierungs- und Abwicklungsgesetz – SAG).
The draft section 60a of the saG envisages that Capital Requirement Regulation – Institutions (CRR – institutions)1 – including those that are part of a group – will have to expressly provide in their financial contracts for contractual recognition of powers granted to resolution authorities to temporarily suspend certain rights (including termination rights). This obligation applies if (i) the contract is subject to the law of a “third country” (i.e. a country outside the EU) or (ii) if, in case of dispute, the place of jurisdiction for the contract is in a “third country”. This will generally not affect obligations created prior to 1 January 2016.
The background of the draft section 60a SAG is that in the case of financial contracts, the financial distress of an CRR Institution may trigger termination rights, such as close-out or cross-default rights of counterparties. If, with the start of resolution proceedings by a resolution authority, early termination rights were automatically triggered, this would for example lead to the maturity and offsetting of all positions with that institution at market values (close out). For an institution in resolution, the amount of net liabilities that then become immediately payable can be substantial. This can hinder the resolution process given that after ordering resolution proceedings, the resolution authority could be immediately confronted with hefty payment demands arising from a terminated financial derivatives portfolio. Therefore, an effective reorganisation regime requires the power of the reorganisation authority to temporarily suspend such termination rights in certain circumstances.
The intention is to create enough time for reorganisation measures. The SAG, as it is already in force today, provides for a suspension power in sections 82 to 84 (suspension power for contractual obligations, limitation of security rights and temporary suspension of termination rights), section 144 (suspension of certain contractual conditions in the case of early intervention and resolution) and section 169 (recognition and enforcement of third country resolution proceedings). In the case of cross-border contracts, however, uncertainties exist regarding the extent to which such suspension is recognised by the other relevant jurisdiction. It seems possible that the absence of the enforceability of the suspension power may impair the institution’s reorganisation.
Therefore, the draft section 60a SAG requires CRR Institutions to ensure, by way of contractual agreement, the recognition of a suspension by the resolution authority in the case of financial contracts subject to foreign law or entered into with a counterparty domiciled abroad.
The same shall apply to CRR Institutions which form part of an international a group.
Contractual recognition in the aforementioned sense shall be achieved through a clause, whereby the counterparty recognises that a suspension of the termination right may take place and states its agreement to a suspension which the resolution authority effects pursuant to sections 82 to 84, 144 or 169 of the SAG. This allows the resolution authority to implement resolution proceedings in an orderly manner.
It should be noted that section 60a shall only apply to new contracts. The relevant key date of 1 January 2016 refers to the respective contracts. The obliged CRR Institutions that are subject to section 60a SAG may fulfil their obligation through contractual clauses negotiated bilaterally or through accession to the protocol of the International Swaps and Derivatives Association (ISDA) on the cross-border recognition of the suspension of termination rights (the Resolution Stay Protocol).
On 12 November 2014, the 18 largest global systemically important banks signed the Resolution Stay Protocol, a supplementary protocol to the ISDA Master Agreement on the treatment of derivatives in the event of the resolution of an institution. Under the Resolution Stay Protocol, institutions have voluntarily committed themselves to complying with stays on early termination rights implemented by foreign resolution authorities for over-the-counter derivatives that fall under the ISDA Master Agreement. In addition, they temporarily waive their right to immediately terminate financial derivatives contracts in the event of a parent company or another affiliated company of a counterparty becoming subject to US insolvency proceedings (cross-default clause).
If the contractual parties have acceded to the Resolution Stay Protocol, this results (in contracts that are subject to the material and personal scope of application of the Resolution Stay Protocol) in the recognition of the resolution authority’s suspension rights. Upon accession, already existing contracts are automatically adjusted, and a related reference to the Resolution Stay Protocol is to be incorporated in new contracts. Legally, the mutual cross-border recognition of such stay orders operates with the parties to the Resolution Stay Protocol acting, purely as regards these measures, as though the regulations agreed in the ISDA Master Agreement were that of the resolution regime to which the institution in resolution is subject (opt-in).
The practical question in the future will be whether contractual counterparties will accept the required contractual agreements, and whether the intended section 60a of the SAG has an impact on the German derivatives market. The current practice with regard to the Resolution Stay Protocol shows that counterparties are mainly not willing to sign the protocol weakening their contractual position.