UK regulators implemented the majority of the Bank Recovery and Resolution Directive from January 2015, using a combination of changes to primary legislation, new secondary legislation, along with regulatory rules and supervisory statements. Even though the British ‘living wills’ initiative had largely anticipated the BRRD, legislators and regulators needed to make several changes to ensure compliance with EU standards. Michael Wainwright and Josie Day outline how the UK’s BRRD legislative toolkit has developed.
Overview: the BRRD’s aims
The title of the Bank Recovery and Resolution Directive (the BRRD – 2014/59/EU) states its aim is to establish “a framework for the recovery and resolution of credit institutions and investment firms” (‘institutions’). As its recitals explain, in the financial crisis there was “a significant lack of adequate tools at Union level to deal effectively with unsound or failing credit institutions and investment firms.” So the directive sets out to remedy this in a number of ways. In summary it calls for tools, measures and powers:
- to ensure relevant institutions make plans to facilitate their recovery if they are in financial difficulty and so seek to prevent their insolvency;
- for early intervention by national competent authorities if problems arise at relevant institutions;
- “to minimise negative repercussions by preserving the systemically important functions of the institution concerned” and to resolve relevant institutions that become insolvent, in a way that minimises costs to the public and the impact on the financial system.
Why was the BRRD necessary?
Previously there were no harmonised procedures to resolve such institutions at Union level. The financial crisis showed that general corporate insolvency procedures were largely inadequate to resolve complex financial institutions. This meant a new toolkit was needed, for quick and early intervention in unsound or failing institutions, while aiming always to preserve the institution’s critical functions and minimise the impact of its failure on the economy and financial system.
In such a resolution, first the shareholders and then the institution’s creditors bear the losses. Importantly, no creditor is to end up worse off than it would have been had the institution been wound up under normal insolvency proceedings. Government bail outs (including temporary public ownership) are not banned: but are a last resort. Harmonised procedures would also make it possible to achieve consistency in the recovery and resolution planning across groups in the Union.
What does the BRRD do?
In principle, the BRRD provides a comprehensive recovery and resolution regime for banks and key investment firms. It sets minimum levels of requirement that each EU member state must adhere to and provides for regulatory co-operation.
The Financial Conduct Authority usefully summarises the BRRD as involving three main steps.
Preparation: Firms and regulators must put in place plans to prepare for situations that could lead to financial stress or failure. The plans should address how these situations would be dealt with if they were to arise.
- A recovery plan: firms must prepare and submit a recovery plan to their competent authority for the authority’s review.
- A resolution plan: firms must provide specified information to their resolution authority, on the basis of which the latter will draw up a resolution plan for the firm.
Firms may need to make changes to their structure or businesses to address any hurdles to resolvability the authorities identify during the planning process.
Early intervention: Much work has focused on early intervention if a firm breaches an identified ‘trigger’ requirement – as a result of which it will be deemed to face financial distress. When a firm breaches a trigger, the authorities have a range of possible actions. These include replacing the firm’s management, requiring the firm to draw up an action plan to mitigate the problems, implementing part, or all, of the firm’s recovery plan, and moving the firm into resolution.
Resolution: The resolution authority will step in if a firm is failing or likely to fail with no reasonable prospect of alternative private sector recovery measures. The resolution authority has a toolkit including selling or merging the business with another firm, setting up a temporary bridge bank, transferring the assets to a separate vehicle, as well as writing down and converting the liabilities (bail-in).
What was the situation in the UK pre-BRRD?
Since there was no harmonised resolution and recovery regime at Union level prior to the BRRD, the UK introduced its own special resolution regime (SRR) under the Banking Act 2009. The SRR gave power and responsibility to the Bank of England, HM Treasury and the Prudential Regulation Authority (and before it, the Financial Services Authority) for stabilising or winding down systemically important institutions. The institutions included banks, building societies and certain investment firms. The PRA had in place rules effective from the beginning of 2014 requiring firms to have recovery plans and resolution packs and had actively engaged with firms about their plans. It decided to bring its rules into force despite knowing the BRRD was approaching, but hoped implementation of the finalised BRRD would not lead to further significant change.
So, in the UK, the process has been not so much about implementation of entirely new rules as amending or in some cases replacing existing requirements that were already in place. At the level of primary and secondary legislation in the UK, as well as regulators’ rules, there have been extensive changes. We summarise some of the key changes below.
Amendments to primary and secondary legislation
The Banking Act 2009 – existing SRR arrangements were amended significantly to incorporate the requirements of the BRRD. To do so, Treasury published a number of statutory instruments relating to bail-in powers and changed the law to implement the BRRD:
- The Bank Recovery and Resolution Order 2014 took effect on 1 January 2015 and is the main piece of legislation implementing the BRRD into UK law. Much of the Order amends the Banking Act to align it with the BRRD and created the necessary new regulatory powers, but there were also some changes to the Financial Services and Markets Act 2000 broadly to give the FCA, PRA and Bank of England the powers they would need to discharge their functions as competent authorities (FCA and PRA) as well as resolution authority (Bank of England) under the BRRD;
- the Bank Recovery and Resolution (No 2) Order 2014 partly implemented the BRRD and took effect mainly on 10 January 2015, with part being deferred until 1 January 2016. It sets out procedural and other requirements with respect to planning and taking measures for the purpose of restoring the financial position of credit institutions, investment firms and certain related companies, along with achieving one or more resolution objectives;
- the Banks and Building Societies (Depositor Preference and Priorities) Order 2014 also partly implemented the BRRD and ensured that both deposits eligible for compensation under the Financial Services Compensation Scheme (eligible deposits) and other deposits that would be eligible deposits but for the fact they are made in branches of UK banks outside the EEA, are treated as preferential debts. The order additionally provides that eligible deposits get a higher priority within the class of preferential debts than other deposits. The order amends certain provisions in the Insolvency Act 1986 in respect of preferential debts. It also alters the priorities for the distribution of the assets of a building society on winding up;
- the Banking Act 2009 (Mandatory Compensation Arrangements Following Bail-in) Regulations 2014 took effect on 1 January 2015 and set out provisions that must, or may, be included in a compensation order made under the Banking Act as amended by the Financial Services (Banking Reform) Act 2013 (Banking Reform Act) following the exercise of the power to make special bail-in provision in respect of banks, banking group companies, investment firms or building societies;
- the Banking Act 2009 (Restriction of Special Bail-in Provision, etc) Order 2014 also took effect on 1 January 2015 and imposed restrictions on the making of special bail-in provisions to comply with the BRRD; and
- the Building Societies (Bail-in) Order 2014 took effect on 10 January 2015 and modified the Banking Act’s special resolution regime provisions following the application to building societies of the bail-in stabilisation option introduced by the Banking Reform Act.
New rules for regulators: PRA
Both the PRA and FCA had warned firms they would not be able to make final rules until the legislative amendments described above that allowed them to do so took effect. However, they had, during 2014, clearly signalled to firms what their final rules would be. Both regulators published their final rules in January 2015.
The PRA published a policy statement in January 2015 (PS1/15 (Implementing the Bank Recovery and Resolution Directive – response to CP13/14)) regarding its consultation on implementing the BRRD, containing the final rules together with supervisory statements on recovery planning and resolution planning as well as materials on intra-group financial support. The PRA said most of the responses it received focused on recovery planning requirements and contractual clauses recognising bail-in powers. Among the more controversial aspects of its proposals were:
- wind-down analysis: Respondents commented that the BRRD does not require a wind-down analysis, but the PRA noted it is a minimum harmonisation directive that allows member states to take additional measures. It considers that a wind-down analysis is important for firms with large trading books; and
- contractual recognition of bail-in powers: respondents favoured a phased implementation, and the PRA will allow this, over the next period until 1 January 2016.
Most of the PRA’s new rules and supervisory statements took effect from 19 January 2015, except those requiring contractual clauses in eligible debt instruments, for which the effective date was 19 February 2015.
The rules form part of the new-look PRA Rulebook. The previously existing PRA requirements for recovery plans and resolution packs are now replaced by a new application and definitions section along with rules on recovery plans, resolution packs, review of recovery plans and resolution packs as well as governance arrangements. There are separate modules in the rulebook for CRR firms and the rulebook for non-CRR firms within the PRA handbook.
New rules for regulators: FCA
The FCA’s new rules are also already in force, except for the agreed delay to the rules on contractual recognition of bail-in powers.
- The FCA published feedback on its consultation regarding implementation of the BRRD (or, as it calls it, the RRD) and its final rules in January 2015 (PS15/2). The FCA needed to implement the BRRD in respect of IFPRU 730K investment firms that are not PRA-regulated (around 230 firms) and group entities in a group that contains an IFPRU 730K firm or a credit institution.
- Following responses, the FCA said:
- the BRRD is not clear on whether the definition of a ‘financial institution’ may include an IFPRU 125K or 50K firm. For the time being, it has therefore not included them in its rules but will explore whether this is the legislators’ intention. It also excluded from its rules incoming EEA and any third-country firms;
- it cannot conduct a case-by-case assessment of each affected firm to assess precisely which obligations should apply. Its research showed that 83% of IPRU 730K firms will be able to use simplified obligations, and it will continue with its proposal to use its assessment approach to determine which firms must use the ‘general’ obligations;
- it agrees that some areas it suggested be covered in a recovery plan are not essential for firms using simplified obligations; and
- like the PRA, it will delay application of its rules on the contractual recognition of bail-in until 1 January 2016.
- The FCA also confirmed it will not make any rules to specify particular early intervention triggers, nor will it require firms to keep detailed records of financial contracts as part of recovery plans.
- Finally, it says it will discuss respondents’ views on the minimum requirement for own funds and eligible liabilities (MREL) with the Bank of England, which is the resolution authority, and so will determine the MREL. The FCA’s rule changes amend the Glossary, IFPRU and the Supervision Manual. The rule on recovery and resolution plans in IF-PRU 2.5 is now deleted.
Is that the end of the story?
No. The important new contractual bail-in requirements are not yet in force. Many provisions in the directive remain to be amplified by regulatory technical standards and guidelines prepared by the European Banking Authority (EBA). Some are already in draft and under consultation, but their final details that firms and regulators will need to follow remain a work in progress. The PRA and FCA have made note to firms that regulatory expectations and perhaps rules will change as the EBA further develops its thinking. Hopefully, though, UK institutions were prepared for this and many already have good liaison with the authorities. However, they cannot be complacent, given constant regulatory change.
This article first appeared in the March 2015 edition of Compliance Monitor. Written by Michael Wainwright and Josie Day in Dentons' London office.