On 27 May 2015, the bill for the Act implementing the European framework for the recovery and resolution of banks and investment firms (the "Implementation Act") and the explanatory memorandum thereto (the "Explanatory Memorandum") were published. The purpose of the Implementation Act is to implement the Bank Recovery and Resolution Directive ("BRRD") and to facilitate the application of the Single Resolution Mechanism Regulation ("SRMR"). This newsletter highlights certain important aspects of the Implementation Act and follows on from our previous newsletter regarding the consultation version of the Act.
1. ENTRY INTO FORCE
The BRRD should have been implemented by 1 January 2015 and, for the most part, should also have entered into force by that date. The Netherlands did not meet this deadline. According to the Explanatory Memorandum, the Implementation Act will enter into force in the course of 2015. It was previously announced that the intended date of entry into force is 1 November 2015. The 1 January 2015 deadline does not apply to bail-ins (a resolution tool to be discussed below), which must be available as from 1 January 2016.
Like the BRRD, the SRMR will enter into force in phases. For instance, the rules on preparation and planning entered into force on 1 January 2015, while the rules on resolution and on the financing of a resolution through the single resolution fund will enter into force on 1 January 2016.
2. RELATIONSHIP AND DIFFERENCES BETWEEN THE BRRD AND THE SRMR
The SRMR implements part of the BRRD at European level for Member States participating in the Single Supervisory Mechanism ("SSM"), i.e. Member States within the Eurozone. The Implementation Act implements only those parts of the BRRD that are not covered by the SRMR. In most cases this means that, in practice, both the Implementation Act and the SRMR will have to be consulted in order to determine one's legal position.
The most important differences between the BRRD and the SRMR are the following:
- The BRRD must be implemented in the Member States’ national legislation, whereas the SRMR has direct effect.
- The BRRD contains rules based on minimum harmonisation, which means that Member States may impose more stringent provisions. The SRMR has direct effect and provides for maximum harmonisation in respect of the resolution procedure and resolution tools.
- The BRRD and the SRMR have different scopes of application. The BRRD covers European banks, large investment firms, groups of companies containing such a bank or investment firm and branches of banks and investment firms that are incorporated outside the European Union. The SRMR covers banks incorporated within the Eurozone and groups containing such a bank.
- The national resolution authority is the primary supervisor of compliance with the BRRD rules (in the Netherlands: the Dutch Central Bank, "DNB"). Pursuant to the BRRD, DNB (as the national resolution authority and, in addition, the authority responsible for prudential supervision) must put in place measures to prevent possible conflicts of interest between its resolution and supervisory roles. For example, it will appoint a "Resolution Director", who will act independently from DNB in the latter’s supervisory capacity. The SRMR assigns the most important tasks to the Single Resolution Board (the "Board"), which will be responsible for decisions regarding the recovery and resolution of banks that are under the ECB’s direct supervision.
3. METHOD OF IMPLEMENTATION
A new Part 3A will be added to the Dutch Financial Supervision Act (Wet op het financieel toezicht, "DFSA") under the heading "Special measures and provisions regarding financial institutions" (Bijzondere maatregelen en voorzieningen betreffende financiële ondernemingen), which will mainly provide for the resolution tools introduced by the BRRD. Although the heading refers to financial institutions and therefore seems to suggest a broader scope than the BRRD, the rules set out in Part 3A will apply solely to the institutions covered by the BRRD.
As a result of the introduction of Implementation Act, Chapter 3.5.4a of the DFSA (which relates to transfer plans) and Chapter 3.5.8 of the DFSA (relating to the rights of counterparties after an intervention measure) will only apply to insurers and will cease to apply to banks. The BRRD rules on preparation and early intervention will be implemented in existing chapters of Parts 1 and 3 of the DFSA.
4. RELATIONSHIP TO THE INTERVENTION ACT, EMERGENCY REGULATIONS AND BANKRUPTCY PROCEEDINGS
The intervention measures provided for in Part 6 of the DFSA - immediate measures (onmiddellijke voorzieningen) and expropriation (onteigening) - will remain applicable to banks. This seems to be incompatible with the SRMR, which (i) provides for maximum harmonisation of the resolution tools with respect to failing banks, (ii) has direct effect and therefore prevails over Netherlands law and (iii) grants exclusive power to the Board (and not to DNB or the Minister of Finance) to decide upon the resolution of significant banks. The Explanatory Memorandum finds a way around this issue by labelling Part 6 of the DFSA as emergency legislation (staatsnoodrecht). However, the Explanatory Memorandum acknowledges that Part 6 of the DFSA will in practice be of little or no importance for banks and groups of companies containing a bank due to the SRMR’s priority over Netherlands law.
Under the current legal framework for banks (and insurers), two types of insolvency proceedings exist alongside the intervention measures based on the Dutch Intervention Act: the special emergency regime (noodregeling) and bankruptcy (faillissement) proceedings. Although the special emergency regime will for now remain applicable to banks (and insurers), its relevance in addition to the resolution tools under the Implementation Act will be assessed at a later stage.
5. RECOVERY AND RESOLUTION TOOLS
In the following paragraphs, we will elaborate on certain aspects of the recovery and resolution tools as provided for in the Implementation Act.
5.1 Phase I: Preparation
Both the SRMR and the Implementation Act impose certain ongoing obligations regarding (i) recovery plans, (ii) intragroup financial support and (iii) resolution plans.
5.2 Phase II: Early Intervention Measures
If an institution's financial position deteriorates, the resolution authority may apply early intervention measures to restore the institution’s financial health and to prevent the need for resolution. These measures include, among others, instructing the institution to implement a recovery plan or to replace or remove members of its senior management or management body if those persons are found unfit to perform their duties.
Under certain circumstances a temporary administrator may be appointed. In such a case, its role, duties and powers will be specified by the resolution authority at the time of appointment. A temporary administrator is somewhat similar to a special administrator within the meaning of Section 1:76 of the DFSA. However, an important difference is that the appointment of a temporary administrator will, in principle, have to be made public, while the appointment of a special administrator will often remain undisclosed.
The conditions under which a temporary administrator may be appointed pursuant to the Implementation Act seem to differ - probably unintentionally - from those set out in the BRRD. Under the BRRD, the resolution authority may require the institution to replace its the senior management or management body (in whole or in part) in the event of a significant deterioration in the institution’s financial situation or a serious infringement of the law or the institution's articles of association. The resolution authority may only appoint a temporary administrator if it deems the replacement of management to have been insufficient. If a temporary administrator is appointed, he can work alongside or assume the powers of the institution’s management body. Under the Implementation Act, the prior replacement (in whole or in part) of senior management or the management body is not required. Under the Act, a temporary administrator may be appointed if (i) the appointment of a special administrator is insufficient (a condition which is not contained in the BRRD) and (ii) if there is a significant deterioration in the institution’s financial situation or a serious infringement of the law or the institution's articles of association (a condition which under the BRRD applies to the replacement (in whole or in part) of senior management or the management body prior to the appointment of a temporary administrator).
5.3 Phase III: Resolution
5.3.1 Conditions for resolution
The SRMR and the Implementation Act provide that an institution shall be subject to resolution if three conditions are met: (i) the institution is failing or is likely to fail, (ii) there is no reasonable prospect that any alternative private sector or supervisory action would prevent the failure of the institution within a reasonable timeframe and (iii) resolution of the institution is necessary in the public interest.
5.3.2 Write down or conversion of capital instruments
If all conditions for resolution as described in the previous paragraph are met or conditions (i) and (ii) are met, the resolution authority must proceed to write down (i.e. reduce the principal amount) or convert (into equity) capital instruments of the institution under resolution. This is referred to in the Explanatory Memorandum as AFOMKI (i.e. the Dutch abbreviation for writing down or converting capital instruments).
If all conditions for resolution are met, AFOMKI must be applied before applying the resolution tools. Unlike the consultation version of the Implementation Act, and in line with the SRMR and BRRD, the Implementation Act stipulates that prior application of AFOMKI is only allowed if application of a resolution tool would result in a loss for a creditor or in conversion of a claim of a creditor against the failing institution.
5.3.3 Resolution tools
If the resolution authority anticipates that AFOMKI will be insufficient for restoring the viability of the institution and all conditions for resolution are met, the SRMR and the Implementation Act require the resolution authority to proceed to resolution and to make use of (a combination of) the following resolution tools:
- the sale of business tool;
- the bridge institution tool;
- the asset separation tool; and
- the bail-in tool.
In the case of the sale of business tool or the bridge institution tool, the action taken will either involve the sale of shares or other equity instruments or the sale of assets and/or liabilities to a private party for a purchase price or to a bridge institution, respectively. The asset separation tool will be used in order to create a bad bank. This resolution tool can only be used in combination with another resolution tool. These resolution tools (except for the bail-in tool) are somewhat similar to the current transfer plan under the Intervention Act. As stated above, the transfer plan will, after the entry into force of the Implementation Act, cease to apply to banks and only apply to insurers.
Bail-in is a new resolution tool under Netherlands law. In the event bail-in is applied, eligible liabilities of a failing institution may be written down or converted. Bail-in is not restricted to the institution's capital instruments (which instruments may have already been written down or converted as a result of AFOMKI before bail-in is applied), but may be applied in respect of other liabilities, insofar as it does not concern excluded liabilities. Examples of excluded liabilities are covered deposits, secured liabilities (that, in our view, also include financial collateral agreements such as GMRAs and GMSLAs) and amounts owed to employees. Specific rules apply to derivatives in the context of bail-in, as only the liabilities after close-out of the derivative may be subject to bail-in and, where a derivative is subject to a netting agreement (such as close-out netting), only on a net basis.
5.3.4 Exclusion and suspension of contractual rights
The Implementation Act provides that certain contractual rights, such as a right to terminate a contract or close-out, set-off or net obligations, and security interests cannot be exercised if that right has arisen as a result of a crisis prevention measure or crisis management measure or any event directly linked to the application of such a measure, provided that the substantive obligations under the contract, including payment and delivery obligations and the provision of collateral, continue to be performed. The BRRD explicitly states that rights arising as a result of an event that is not a crisis prevention measure or crisis management measure or an event directly linked to such measure, will not be affected. According to the Explanatory Memorandum, it is not necessary to explicitly include such exception in the Implementation Act.
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.
Under the BRRD, a termination right includes a right to accelerate, close-out, set-off or net obligations. However, the Implementation Act does not define this term nor does the Explanatory Memorandum clarify this concept. This may be problematic, since, under Netherlands law, it is not self-evident that a termination right includes a right to accelerate and to close-out, set-off or net obligations. Finally, we point to the fact that temporary suspension of termination rights may, under certain circumstances, obtain a permanent character for instance because a termination right may only be exercised if a resolution tool is applied and, subsequently, an enforcement event occurs on the part of the transferee.
5.3.5 Safeguards for contractual counterparties
Both the SRMR and the Implementation Act provide for certain safeguards for shareholders and creditors of institutions under resolution.
The principle of no creditor worse off applies to all resolution tools. This means that if rights of a shareholder or creditor of an institution are not transferred in conjunction with a transfer of the institution’s shares, assets or liabilities or if such rights are written down or converted under AFOMKI or a 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 resolution decision was taken. We expect that the principle of no creditor worse off will have limited impact in practice during resolution. The effect of this principle will only materialize after resolution of an institution when an independent party will assess whether certain creditors are "worse off". If this is the case, these creditors have the right to be compensated for the difference by the single resolution fund, i.e. a fund financed by the sector in order to limit the funding of resolutions by public means.
In addition to this principle, the BRRD has created a safeguard for creditors facing partial transfer of the assets or liabilities of an institution under resolution, for example assets and liabilities subject to close-out netting. This safeguard has been set out in more detail in the Implementation Act by providing that rights arising from (i) financial collateral agreements (including GMRA and GMSLA), (ii) covered bonds, (iii) structured financing arrangements, (iv) netting agreements, (v) set-off agreements and (iv) security agreements "will not be affected" (i.e. can be exercised continuously) by any such partial transfer of assets or liabilities or if an institution under resolution is replaced as a party to an agreement.
Furthermore, the Implementation Act stipulates that if DNB decides to partially transfer assets or liabilities, or to terminate, cancel or modify the terms of any agreement, or if an institution under resolution is replaced as a party to an agreement, DNB (i) will only transfer assets and liabilities under certain agreements jointly, (ii) will not transfer any asset without the corresponding covered liability and "the benefit of the security" (in the case of security arrangements) and (iii) will not terminate or modify rights and obligations protected under certain agreements (such as a right resulting from a set-off agreement).
We point out that the Financial Markets Amendment Act 2015 (which entered into force as of 1 January 2015 and also applies in case of expropriation) already provides for a similar safeguard regarding set-off and security rights resulting from an agreement pertaining to financial instruments. The safeguard of the Implementation Act has a broader scope. Firstly, the safeguard provided for by the Implementation Act does not allow a partial transfer, whereas the Intervention Act does allow such transfer as long as the partial transfer does not result in an infringement of set-off and security rights. Secondly, the safeguard of the Implementation Act applies to set-off and netting agreements relating to deposits, loans or other instruments that do not qualify as financial instruments. The safeguard as provided for in the Implementation Act does not apply to expropriation under Part 6 of the DFSA. In our view, the scope of this safeguard should also apply in case of expropriation.
If linked assets or liabilities are not transferred jointly, the transfer of assets and liabilities will not be invalid, but these rights "cannot be affected". This means that the rights resulting from, for example, set-off agreements and financial collateral agreements can be exercised although assets and/or liabilities may have been transferred to a third party. Furthermore, the transfer of assets, rights or liabilities of an institution under resolution to another entity using a resolution tool or exercising a resolution power cannot be affected on the basis of actio Pauliana (fraudulent preference) either.
Payment systems are protected by the Implementation Act as well. Consequently, a measure cannot lead to the reversal of transfer orders that have already been entered into such system. In other words, transfer orders that have entered a system cannot be revoked despite such measures. The protection provided by the Implementation Act as it now stands, is limited to "Dutch" systems. Since the BRRD safeguard applies to "European" systems, the reference to "Dutch" systems seems to be too narrow.
6. 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 at the Single Resolution Board or to the European Court of Justice. In some instances, appeal can be submitted directly to the European Court of Justice.
- Objections against decisions taken by DNB in its capacity as the national resolution authority (whether on the instruction of the Single Resolution Board or otherwise) can be submitted to DNB, in the event of appeal to the District Court of Rotterdam and, in the event of a subsequent appeal, to the Trade and Industry Appeals Board. Objections against (i) decisions taken by DNB to write down or convert capital instruments (i.e. AFOMKI) or (ii) decisions taken by DNB regarding resolution of an institution cannot be submitted to DNB. Appeal against these decisions must be submitted directly to the Trade and Industry Appeals Board, where expedited proceedings are available. In this way, a judgement on the legitimacy of these decisions, which have a high impact, can be received promptly.
- The Implementation Act provides for the introduction of administrative appeal with DNB against decisions of the (i) liquidator, (ii) special administrator and (iii) special director.
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.
With the entry into force of the Implementation Act, the Dutch intervention framework will be replaced by an European intervention framework. A new resolution tool will be introduced: bail-in. The introduction of a European framework has several implications for the exclusion and suspension of contractual rights and the safeguards for contractual counterparties.
Although some of the flaws in the consultation version of the Implementation Act have been remedied, the current version still contains some imperfections. The decision to retain the instrument of expropriation (provided for in Part 6 of the DFSA) as an intervention tool with respect to failing banks can, in our view, be challenged on the ground that the SRMR contains an exhaustive set of intervention tools. Furthermore, the Implementation Act seems to be inconsistent with the BRRD regarding the conditions under which a temporary administrator may be appointed. In addition, the safeguard provided for payment systems seems too restricted since it is limited to "Dutch" systems only. It remains to be seen whether these defects in the Implementation Act will be remedied as it makes its way through the Dutch Parliament.