On 21 November 2014 the draft Dutch Implementation Act for the European Framework for the Recovery and Resolution of Banks and Investment Firms (the "Implementation Act") and draft guidelines were published for public consultation purposes. The Implementation Act is designed to implement the Bank Recovery and Resolution Directive ("BRRD") and to apply the Single Resolution Mechanism ("SRM").
This newsletter outlines how the Implementation Act in its current consultative form provides for implementation and application of the rules in the BRRD and the SRM with regard to early intervention, resolution and legal protection.
2. Method of Implementation
There are various differences between the BRRD and the SRM that are relevant in terms of their implementation and application respectively:
- The BRRD is a directive that has to be implemented in the national legislation of the Member States, whereas the SRM is a regulation that has direct effect.
- The BRRD covers European banks, large investment firms and groups containing such a bank or investment firm, whereas the SRM covers banks seated in the eurozone and groups containing such a bank.
- The BRRD has to be implemented and be given effect by 1 January 2015 at the latest (except for the bail-in resolution tool, which must be given effect by 1 January 2016). The SRM rules on preparation and planning enter into force on 1 January 2015, whereas the rules on recovery and resolution enter into force on 1 January 2016.
- The BRRD contains rules based on minimum harmonisation, whereas the SRM provides for maximum harmonisation of the resolution procedure and tools.
- The primary supervisory authority responsible for application of the BRRD rules is the national resolution authority (in the Netherlands: the Dutch Central Bank, DNB). Various measures have been put in place to prevent possible conflicts of interest between DNB’s supervisory and resolution roles. The SRM has assigned the most important tasks to the Single Resolution Board (to be established) which will be responsible for decisions to recover and resolve banks that are under the direct supervision of the ECB.
The Dutch legislator has decided to base implementation on the situation in which the regulation is fully in force, and has made reference, where possible, to the provisions of the SRM. The only elements of the BRRD to be implemented in Dutch legislation will be those aspects not covered by the SRM.
A new part 3A will be added to the Dutch Financial Supervision Act (Wet op het financieel toezicht, "DFSA") under the heading "Special prudential measures for financial institutions" (Bijzondere prudentiële maatregelen financiële ondernemingen) in order to implement the various BRRD resolution tools. Although this heading could perhaps suggest a wider scope, the rules set out will apply only to the institutions covered by the BRRD. The rules on early intervention will be implemented in existing chapters in parts 1 and 3 of the DFSA.
3. Consequences for the Intervention Act
As a result of the Implementation Act, the existing sections 3.5.4a (on transfer plans) and 3.5.8 (on the rights of counterparties after an intervention measure) in the DFSA will apply only to insurers and no longer to banks. It should be noted in this respect that, according to the draft guidelines, the Dutch legislator intends to declare the resolution regime in the BRRD also applicable to insurers in the future.
Interestingly, neither the Implementation Act nor the draft guidelines state what is to happen to the intervention tools provided for in part 6 of the DFSA: the immediate measures and expropriation. The legislator appears to be intending to retain these instruments, also with regard to banks and large investment firms. The question, however, is to what extent this relates to the legislator’s stated intention to base implementation on the situation applying from 1 January 2016. That is the date from which the SRM will provide a set of maximum harmonised resolution instruments for failing banks.
4. Implementation Act
Certain aspects of the Implementation Act are discussed below in more detail.
Early intervention measures (part of the crisis prevention measures)
If an institution’s financial position deteriorates, the resolution authority can deploy early intervention measures to restore the institution’s financial position and prevent the need for resolution. These include amongst others instructing the institution to carry out its recovery plan or to replace its senior management. If these measures prove to be insufficiently effective, a temporary administrator may be appointed to act alongside or instead of the institution’s board of directors. This temporary administrator is similar to the special administrator provided for in Section 1:76 of the DFSA. A significant difference, however, is that the appointment of the temporary administrator under the BRRD will in principle have to be made public.
Write down or conversion of capital instruments (part of the crisis prevention measures)
If the early intervention measures do not improve the institution’s financial position and the institution satisfies some but not all of the resolution conditions, the resolution authority may proceed or may even be required to proceed to write down (i.e. reduce the principal amount) or convert (into equity) capital instruments of the institution under resolution. This tool is referred to in the draft guidelines as "AFOMKI" (afschrijving en omzetting van kapitaalinstrumenten, i.e. the write down or conversion of capital instruments).
If all the resolution conditions have been met, the draft guidelines require AFOMKI to be applied before proceeding to resolution. Under the SRM and BRRD, however, prior application of AFOMKI is required only if application of a resolution tool in such a situation would result in a loss for a creditor or in conversion of a claim of the creditor against a failing institution. The question then is how compulsory application of AFOMKI, as provided for in the draft guidelines, relates to the uniform resolution procedure set out in the SRM.
Resolution tools (part of crisis management measures)
If AFOMKI is considered or proves to be insufficient to make the institution viable and all resolution conditions have been met, the resolution authority may proceed to resolution and may make use of the following resolution tools:
- sale of business;
- bridge institution;
- asset separation;
In the case of the first three resolution tools listed above, the action taken will involve the sale of shares, assets or liabilities to a third party or a bridge institution, or the separation of assets in order to create a bad bank.
In the event of a bail-in, eligible liabilities of a failing institution will be written down or converted. A bail-in is not restricted to the institution’s capital instruments (which, according to the draft guidelines, should have been written down or converted via AFOMKI before a bail-in could be applied), but is also possible in respect of other liabilities, insofar as these have not been excluded. For example, covered deposits, secured liabilities and amounts owed to employees are excluded.
Exclusion and suspension of contractual rights
Certain contractual rights (such as a right to terminate or set-off) and rights arising from a security interest cannot be exercised if the specific right has arisen as a result of a crisis prevention or crisis management measure or an event directly linked to such measures. This applies, however, only insofar as the institution under resolution continues to meet its substantive obligations, including payment and delivery obligations and the provision of collateral. The BRRD also explicitly states that rights arising as a result of an event that is not a crisis prevention or crisis management measure or an event directly linked to such measure will not be affected. This is not stated, however, in the Implementation Act. On the contrary, the draft guidelines state, in apparent contradiction to the BRRD, that the exclusion applies to all termination rights.
In addition, DNB may suspend certain payment or delivery obligations of an institution under resolution or the rights of a counterparty to terminate an agreement or to enforce a security interest until the end of the business day after the day on which the suspension decision is published. However, termination rights may be suspended only if the institution under resolution continues to meet its substantive obligations to its counterparty.
Both the SRM and the BRRD provide certain safeguards for shareholders and creditors of institutions under resolution.
- No creditor worse off
The principle of no creditor worse off applies to all resolution tools; it means that if rights of a shareholder or creditor of an institution are not transferred as part of a partial transfer of the institution’s shares, assets or liabilities or if such rights are written down or converted under AFOMKI or bail-in, such shareholders or creditors must not suffer greater losses than they would have suffered if the institution had been wound up under normal insolvency proceedings or became subject to the emergency regime immediately before the decision to resolve the institution.
According to the draft guidelines, provisions in secondary legislation (in accordance with the BRRD) will ensure that a bail-in of liabilities relating to derivative transactions will be able to be applied only after close-out netting. Unfortunately, this provision has not been extended to other transactions in which set-off can play a significant role, such as securities financing transactions entered into under a master agreement. In that respect it is not entirely clear how the principle of no creditor worse off will apply in situations in which set-off would have been possible in the event of an emergency regime or insolvency, but which is not taken into account in the bail-in of certain liabilities.
- Linking of assets and liabilities upon transfer
A safeguard has been created for creditors facing partial transfer of the assets or liabilities of an institution under resolution. The rights arising from certain agreements and arrangements (such as financial collateral agreements, netting agreements and security arrangements) will not be affected by any such partial transfer of assets or liabilities, or by the termination, cancellation or modification of the terms of any agreement, or if an institution under resolution is replaced as a party to an agreement. From 1 January 2015, the Financial Markets Amendment Act 2015 (Wijzigingswet Financiële Markten 2015) will provide similar protection (also applying in the event of expropriation) for set-off and security interests under agreements relating to financial instruments. However, the safeguard provided for in the BRRD in respect of the resolution tool for transfers has wider scope, given that it also extends to, for example, netting agreements and related agreements in respect of deposits or other instruments that do not qualify as financial instruments.
In addition, the legislation will state that if DNB uses its powers to effect a transfer of assets or liabilities under certain agreements, it will not transfer any asset without the corresponding covered liability. It will also transfer “the benefit of the security” (in the case of security arrangements) and will not terminate or modify rights and obligations protected under certain agreements.
How all of this will work in practice, however, is not yet clear from the Implementation Act:
- What is meant by “the benefit of the security”? This concept does not exist as such in Dutch property law.
- Will compensation be available for a party buying an asset who faces a (successful) claim for set-off by a counterparty?
- DNB will be granted additional powers to terminate or modify the terms of an agreement. The above safeguard, however, entails that the rights of a creditor will not be affected by termination, cancellation or modification of the terms of certain agreements. Under the Implementation Act, DNB is also not permitted to terminate or modify rights or obligations protected under such agreements (i.e. rights and obligations that can be set-off or netted). This raises the question as to how these various provisions relate to each other (i.e. terms versus rights and obligations) and whether the relevant safeguard will also extend to bail-in, so that protected (and already non-excluded) obligations arising under certain agreements will not be affected by bail-in.
5. Legal protection
Provision has been made for various forms of legal protection against decisions taken by the Single Resolution Board and DNB:
- Appeals against decisions by the Single Resolution Board can be submitted to an appeals panel with the Single Resolution Board or to the European Court of Justice.
- Objections against decisions taken by DNB in its capacity as the national resolution authority (whether on instruction of the Single Resolution Board or otherwise) can be submitted to the District Court of Rotterdam and, in the event of a subsequent appeal, to the Trade and Industry Appeals Board. An appeal against (i) decisions to write down or convert capital instruments (i.e. AFOMKI) or (ii) resolution of an institution can be submitted directly to the Trade and Industry Appeals Board, and accelerated procedures are available.
In contrast to the provisions for transfer plans in the current Intervention Act, judicial approval (or review) is not required before a resolution tool may be applied. The Dutch legislator has chosen not to use the option available to member states to require ex ante judicial approval.
6. Entry into force
The Dutch legislator is not expected to achieve implementation and the entry into force of the legislation by 1 January 2015. This is because the version of the Implementation Act currently available has only been issued for consultation purposes. The legislator’s actual target date for implementation is not yet known. Nor is it known whether – as was the case with the Intervention Act in 2012 – the legislation will enter into force with retroactive effect. It is also unclear as to whether the bail-in resolution tool will enter into force at the same time as the other resolution tools or whether it will be delayed until 1 January 2016.