On 15 May 2014, the European Parliament adopted a new directive, the Banking Recovery and Resolution Directive (‘BRRD’), which establishes a framework for the recovery and resolution of credit institutions and investment firms.1 This Alert highlights certain key changes required to be made to existing English legislation in furtherance of the implementation duty in the United Kingdom under the BRRD. It further explores, on an EU level, to what extent stakeholders generally and creditors in particular of institutions affected by the BRRD should be concerned about the extensive powers set forth in the BRRD and considers what avenues exist to challenge the exercise of any of these powers and what remedies might be available.
While more guidance on the BRRD is still in preparation and how exactly the BRRD will be implemented in each EU Member State is still unclear, creditors should be concerned because the exercise of the resolution tools contemplated by the BRRD can significantly affect creditors’ rights, and remedies available for impaired creditors are limited and far from straightforward.
Which Institutions Are Affected by the BRRD?
The BRRD affects the following institutions throughout the entire EU (the ‘BRRD Institutions’): (1) credit institutions (i.e. in the UK banks and building societies); (2) so-called 730k investment firms (as defined under the Capital Requirements Regulation (or ‘CRR’));2 (3) certain holding companies of credit institutions and investment firms; (4) certain financial institutions (as defined under the CRR); and (5) certain branches of credit institutions and significant investment firms.
What Is the BRRD?
The BRRD provides a minimum set of tools (the ‘Resolution Tools’) to ensure all EU Member States will deal effectively with unsound or failing BRRD Institutions. It also requires preparatory and preventative measures and early supervisory intervention be implemented and maintained by all BRRD Institutions with the objective of preventing the need for the exercise of the Resolution Tools.
- Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms.
- Investment firms that are subject to an initial capital requirement of EUR730k as further defined in point of Article 2 of the regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms.
Two of the main policy objectives behind the BRRD are:
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All EU Member States are required to implement local legislation for the Resolution Tools by 1 Jan.
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the Netherlands) already have fairly long-standing legislation addressing some of the principal components of the Resolution Tools, whilst other EU Member States will require wholesale implementation to be in compliance. Power to exercise the Resolution Tools will be granted to the relevant EU Member States’ delegated authorities6 (the ‘Resolution Authorities’). The BRRD will ensure a minimum level of harmonisation amongst all EU Member States in respect of Resolution Tools.
The key Resolution Tools allow the Resolution Authorities power to implement the following actions in respect of the BRRD Institutions in their EU Member State:7
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Key Amendments to the Current UK Recovery and Resolution Regime8
In the United Kingdom there is already legislation relating to the recovery and resolution of BRRD Institutions. The Special Resolution Regime (‘SRR’) as set forth in the Banking Act 2009 already provides the UK authorities with a permanent set of tools to deal with UK BRRD Institutions that are faced with
- Recital 1 BRRD.
- Article 130 BRRD. Note that no ‘grandfathering’ is contemplated, and therefore the BRRD may apply in respect of instruments issued prior to its commencement.
- The good bank (‘Novobank’)/bad bank split conducted by the Portuguese authorities of the recently failed Banco Espirito Santo was conducted pursuant to local legislation and was asserted to have been in compliance with current EU rules. However, it seems as if the taxpayer ‘bailout’ component at least would not have been in compliance with the BRRD.
- In the United Kingdom, the delegated Resolution Authority will be the Bank of England (‘BoE’), in accordance with its current role under the Banking Act 2009. The Prudential Regulation Authority (‘PRA’) and the Financial Conduct Authority (‘FCA’) will carry out the functions of the competent authority specified in the BRRD, many of which they currently undertake already. The Treasury will be the competent ministry, performing any functions specified in the BRRD.
- Article 37(3) BRRD.
- See generally HM Treasury’s ‘Transposition of the Bank Recovery and Resolution Directive’ of July 2014.
financial difficulties. However, extensive amendments to the Banking Act 2009 are contemplated to conform with the BRRD, including:
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- Article 45 BRRD: This sets out the minimum requirement for own funds15 and liabilities that may be bailed in using the bail-in tool (the ‘eligible liabilities’). The minimum requirement (or MREL) will be calculated as the amount of own funds and eligible liabilities expressed as a percentage of the total own funds and liabilities of the BRRD Institution. The European Supervisory Authority (the European Banking Authority) (the
- According to Section 4 of the Banking Act 2009, the five objectives are: (1) protect and enhance the stability of the financial systems in the United Kingdom; (2) protect and enhance public confidence in the stability of the banking systems in the United Kingdom; (3) protect depositors; 4) protect public funds; and 5) avoid interfering with property rights in contravention of a Convention right (within the meaning of the Human Rights Act 1998).
- The five objectives are: (1) ensuring the continuity of critical functions; (2) avoiding a significant adverse effect on the financial system, in particular by preventing contagion, including to market infrastructures and by maintaining market discipline; (3) protecting public funds by minimising reliance on extraordinary public financial support; (4) protecting certain depositors and investors; and (5) protecting client funds and client assets.
- ‘Relevant capital instruments’ are Additional Tier 1 instruments and Tier 2 instruments (Article 2(1)(74) BRRD).
- Article 59 & 60 BRRD.
- Guidelines from the European Supervisory Authority (the European Banking Authority) are expected by 3 Jan. 2016 (see Articles 50(4) and 60(3)(d) BRRD).
- In this context, ‘bail-in’ should be understood as a tool to enable the relevant authorities to recapitalise a failing BRRD Institution through the impairment in value of its liabilities (including by a write-down and/or conversion to equity). Bail-in will potentially apply to any liabilities (including senior liabilities) not backed by assets or collateral of the BRRD Institution (but not deposits guaranteed in accordance with the Deposit Guarantee Schemes Directive) and not short-term liabilities.
- As defined in Article 4(1)(118) CRR.
‘EBA’) is tasked to draft technical regulatory standards which will further specify the assessment criteria on the basis of which the minimum requirement is to be determined. The EBA is required to submit those draft regulatory technical standards to the European Commission by 3 July 2015.
- Article 55 BRRD: This sets out the express contractual recognition of the bail-in requirement in respect of eligible liabilities governed by the law of a third country. In short, such liabilities issued or entered into after implementation must include a contractual term stating that the liability may be subject to write-down and conversion powers and the creditor agrees to be bound by any actions of the relevant Resolution Authority relating to such liability. It may be due to the controversial and wide-ranging effect, apparently intended by Article 55, that the United Kingdom is not including this measure in an early implementation.
Threshold for the Exercise of Resolution Powers
The conditions16 for the Resolution Authority using a Resolution Tool are, in summary, that the
Resolution Authority has made the determination that:17
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- The Resolution Tool is necessary in the public interest, which will be the case if:
- It is necessary for the achievement of one or more of the resolution objectives;
- It is proportionate to one or more of the resolution objectives; and
- Winding up of the BRRD Institution under normal insolvency proceedings would not meet those resolution objectives to the same extent.20
When applying and exercising Resolution Tools, the relevant Resolution Authorities must:
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- Article 33 BRRD sets forth how these conditions for resolution apply to financial institutions and holding companies.
- Article 32 BRRD.
- This determination can be made either by the competent authority after consulting the Resolution Authority or by the Resolution Authority after consulting the competent authority. Circumstances are listed in Article 32(4) BRRD, the existence of one or more of which will result in a BRRD Institution being deemed to be failing or likely to fail. By 3 July 2015, EBA shall issue guidelines regarding the interpretation of the different circumstances when a BRRD Institution will be considered to be failing or likely to fail.
- Please note that private sector measures in this context include early intervention measures or the write-down or conversion of relevant capital instruments in accordance with Article 59(2) BRRD. See also Article 37(2) BRRD.
- Article 32(5) BRRD.
While there are nine general principles governing the use of a Resolution Tool by a Resolution Authority,22 arguably the more important feature of the resolution process is the mandatory valuation that must take place.23 The point of reference for valuation is liquidation value: Articles 73 and 75 BRRD provide that no creditor shall incur greater losses than would have been incurred if the BRRD Institution had been wound up under normal insolvency proceedings. Given the conditions required for an exercise of a Resolution Tool, liquidation value appears to be the correct benchmark.
Before using a Resolution Tool, the Resolution Authorities must ensure that a fair, prudent and realistic valuation of the assets and liabilities of the BRRD Institution is carried out by a person independent from any public authority and the BRRD Institution.24 Where such an independent valuation is not possible, Resolution Authorities may carry out a provisional valuation of the assets and liabilities of the BRRD Institution.25 Such a provisional valuation shall include a buffer for additional losses, with appropriate justification.26
The objective of the valuation process is to assess the value of the assets and liabilities of the BRRD Institution so as to facilitate the Resolution Authority’s decision as to the appropriateness of exercising any of the Resolution Tools and the terms on which it should exercise such rights.27
A valuation conducted in full compliance with Article 36 BRRD will be considered definitive. While the valuation itself is not subject to a separate right of appeal, it may be subject to an appeal made in accordance with Article 85 BRRD (which is further addressed below).28
Remedies for Affected Stakeholders of BRRD Institutions
Whilst the BRRD does contain certain explicit safeguards, the remedies for affected stakeholders are limited. Challenges to the application of Resolution Tools are further limited by provisions such as:
- Article 31 BRRD.
- According to Article 34 BRRD, the nine general principles governing resolution are: (1) Shareholders of the BRRD Institution bear first losses;
- unless stated otherwise in the BRRD, creditors of the BRRD Institution bear losses after the shareholders in accordance with the priority waterfall under normal insolvency proceedings; (3) unless retention (in whole or in part) of existing management of the BRRD Institution is considered to be necessary for the achievement of the resolution objectives, existing management of the BRRD Institution is replaced; (4) existing management of the BRRD Institution shall provide all necessary assistance for the achievement of the resolution objectives; (5) subject to Member State law, natural and legal persons are made liable under civil and criminal law for their responsibility for the failure of the BRRD Institution; (6) unless stated otherwise in the BRRD, creditors of the same class are treated in an equitable manner; (7) in accordance with the safeguards set forth in Articles 73 and 75 BRRD, no creditor shall incur greater losses than would have been incurred if the BRRD Institution had been wound up under normal insolvency proceedings; (8) covered deposits are fully protected; and (9) any resolution action is taken in accordance with the safeguards in the BRRD.
- Article 36 BRRD.
- Article 36(1) BRRD.
- Article 36(2) BRRD.
- Article 36(9) BRRD. See also Article 36(10) which clarifies that a valuation that does not comply with all the requirements laid down in Article 36 BRRD will be considered to be provisional until the valuation has been conducted in full compliance with Article 36 BRRD. Such ex-post definitive valuation must be carried out as soon as practicable.
- Article 36 BRRD contains more detailed provisions about the valuation exercise, including the purposes, requirements and the obligation on the EBA to develop, by 3 July 2015, draft regulatory technical standards to specify the circumstances in which a person is considered independent for the purpose of conducting a valuation (see Article 36 (14) and (16) BRRD).
- Article 36(13) BRRD.
- Article 37(8) BRRD – claw back rights disapplied: EU Member States are required to ensure that rules under national insolvency law relating to voidability or unenforceability of legal acts detrimental to creditors do not apply to transfers of assets, rights or liabilities from a BRRD Institution under resolution to another entity by virtue of the application of a Resolution Tool or use of a government financial stabilisation tool;
- Article 72(4) BRRD – shadow/de facto director laws disapplied: Resolution Authorities will not be deemed to be shadow directors or de facto directors under national law; and
- Article 86(1) BRRD – restrict opening of normal insolvency proceedings:29 EU Member States are required to ensure that with respect of a BRRD Institution under resolution normal insolvency proceedings may not be commenced except at the initiative and consent of the Resolution Authority.
In addition, the typical contractual safeguards stakeholders may have negotiated will largely be ineffective. The BRRD provides broad powers to exclude the effectiveness of certain contractual terms (such as default provisions),30 suspend certain contractual terms (for example, turning off the coupon),31 restrict the enforcement of security rights32 and suspend termination rights.33 However, specific protections do exist under the BRRD in respect of:
- Financial collateral, set off and netting agreements (Article 77);
- Security arrangements (Article 78);
- Structured finance arrangements and covered bonds (Article 79); and
- Trading, clearing and settlement systems (Article 80).
Nevertheless, Article 85(3) BRRD requires EU Member States to ensure that all persons affected by a Resolution Tool34 have the right to appeal against that decision (‘Appeal’). Article 82(2) BRRD provides what information must be contained in a decision of the Resolution Authority to exercise a Resolution Tool.35 The Appeal must entail a review that is expeditious. Significantly, the national courts of the applicable EU Member State are required to use the economic assessments of the facts carried out by the Resolution Authority as a basis for their own assessment.
- Article 2(47) BRRD defines ‘normal insolvency proceedings’.
- Article 68 BRRD. Therefore, the typical ipso facto clauses (i.e. provisions in a contract which purport either to terminate a contract automatically or to confer on a contracting party the right to terminate the contract when its counterparty enters into an insolvency proceeding) will not work.
- Article 69 BRRD.
- Article 70 BRRD.
- Article 71 BRRD.
- Article 2(1)(102) BRRD defines ‘crisis management measure’.
- For the procedural obligations of resolution authorities, see Article 83 BRRD.
The launching of an Appeal will not alter the immediate effectiveness and enforceability of the Resolution Tool. The burden of proof will lie with the person launching the Appeal and, in certain circumstances, the remedy will be limited to monetary compensation.36
For the purpose of assessing whether shareholders and creditors would have received better treatment if the BRRD Institution under resolution had entered into normal insolvency proceedings, Article 74 BRRD requires Member States to ensure that a valuation (the ‘Treatment Valuation’) is carried out by an independent person as soon as possible after the Resolution Tool has been effected. The Treatment Valuation is different from the valuation under Article 36 BRRD.37 The Treatment Valuation is to be conducted based on the following assumptions. These assumptions significantly limit the scope of enquiry capable of being made by the valuer conducting the Treatment Valuation:38
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If the Treatment Valuation determines that any shareholder or creditor has incurred greater losses than it would have incurred in a winding-up under normal insolvency proceedings, the shareholder or creditor is entitled to the payment of the difference from the resolution financing arrangements.39
Cross-Border Considerations and Implications
As well as the harmonisation of the Resolution Tools, the BRRD establishes a comprehensive framework for information sharing, consultation and co-operation between EU Member States, as well as the appointment of a consolidating supervisor to oversee recovery plans of BRRD Institutions with locations in more than one EU Member State.
The cross-border components of the BRRD will supplement the Credit Institution and Winding Up Directive of 4 April 2001 (‘CIWUD’)40 which already ensures that an EU Member State’s locally implemented legislation effecting a restructuring of a credit institution in that EU Member State will be recognised and given effect in each other EU Member State.41 The EU Member States’ implementation
- The restrictions set forth in Article 85(4) BRRD include: (1) The lodging of the Appeal shall not entail any automatic suspension of the effects of the challenged decision; (2) The challenged decision shall be immediately enforceable; (3) The challenged decision shall give rise to a rebuttable presumption that a suspension of its enforcement would be against public interest; (4) Where it is necessary to protect the interests of third parties acting in good faith, the annulment of a challenged decision shall not affect any subsequent administrative acts or transactions concluded by the resolution authorises concerned which were based on the annulled decision; and (5) In the case described in point 4 above, the remedies for a wrongful decision or action by the Resolution Authorities shall be limited to compensation for the loss suffered by the challenging affected stakeholder as a result of the decision or act.
- According to Article 74(4) BRRD, the EBA may develop draft regulatory technical standards specifying the methodology for carrying out the Treatment Valuation.
- Article 74(3) BRRD.
- Article 75 BRRD.
- Directive of the European Parliament and of the Council of 4 April 2001 on the Reorganisation and Winding up of Credit Institutions (2001/24/EC).
- So, for example, when Ireland applied the Credit Institution Stabilisation Act (Ireland) to impair rights of English law-governed bonds in Allied Irish Banks PLC, it did so in reliance on CIWUD. In invoking CIWUD, the Irish government expected the English courts to recognise and give
into local legislation of the BRRD may still rely on CIWUD for recognition and implementation in all other EU Member States of certain Resolution Tools.
The short answer to the question posed in the title of this Alert is that creditors of a BRRD Institution should worry about the extensive Resolution Tools set forth in the BRRD. Clearly, the exercise of the Resolution Tools can significantly affect creditors’ rights, and available remedies are limited and far from straightforward. While there are thresholds that need to be met before Resolution Tools can be employed (including a valuation by an independent party), in practice, it will be difficult for creditors to be aware of, let alone influence, the relevant decision-making process. Once the decision to exercise a Resolution Tool is made, it typically will be too late to do something about it, as a reversal of such a decision is not really contemplated and therefore highly unlikely. That, in effect, leaves an impaired creditor who was forced into ‘burden sharing’ with only a damages claim after the fact (assuming it can satisfy the high burden of proof).
Although the BRRD provides a comprehensive outline for the restructuring landscape for BRRD Institutions across the entire EU, a lot of the detail is yet to be filled in by each EU Member State in accordance with its implementation obligations, and significant BRRD guidance is still awaited from the EBA. As far as the implementation obligations of each EU Member State is concerned, it should be noted that each EU Member State will have a certain discretion as to how exactly the BRRD is implemented in its jurisdiction. Likewise, it will be interesting to see how each Member State’s Resolution Authority and its courts interpret and apply their powers and discretions under the locally implemented legislation.
However, despite these existing uncertainties, the following two initial conclusions can be reached:
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effect to the impairment. In the end, this expectation was never tested by the English courts. Absent CIWUD, Ireland would have had no power unilaterally to impair instruments governed by a foreign law.
- Article 50(4) BRRD.
- The scope for a creditor to test the accuracy of the Resolution Authority’s view of the conditions43 required for the exercise of a Resolution Tool appears to be limited;
- The scope for a creditor to test the accuracy of a valuation will be limited by reason of the assumptions implied to apply. Further difficulty will lie in the transparency of the valuation process and forcing disclosure of information required to effectively launch an Appeal. In particular the Treatment Valuation is meant to be a BRRD safeguard for an impaired creditor, but it is unclear what (if any) role the impaired creditor will be able to play in the Treatment Valuation process;
- Whether the usual protections for an impairment of value or expropriation of a property right as provided by human rights legislation will (continue to) apply will need to be tested; and
- Whether the ability to test the lawfulness of EU Member States’ implementing legislation by reference to administrative laws and constitutional laws has been impaired will need to be the subject of further analysis and opinion as well.