Explanatory Memorandum to COM(2012)280 - Framework for the recovery and resolution of credit institutions and investment firms

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dossier COM(2012)280 - Framework for the recovery and resolution of credit institutions and investment firms.
source COM(2012)280 EN
date 06-06-2012


1. CONTEXT OF THE PROPOSAL

The financial crisis severely tested the ability of national and Union-level authorities to manage problems in banking institutions. Meanwhile, financial markets in the Union have become integrated to such an extent that domestic shocks in one Member State may be rapidly transmitted to other Member States.

Against this background, the Commission issued a Communication 1 in October 2010 setting out plans for a Union framework for crisis management in the financial sector. The framework would equip authorities with common and effective tools and powers to tackle bank crises pre-emptively, safeguarding financial stability and minimising taxpayer exposure to losses in insolvency.

At international level, G20-Leaders have called for a “review of resolution regimes and bankruptcy laws in light of recent experience to ensure that they permit an orderly wind-down of large complex cross-border institutions.” 2 In Cannes in November 2011, they endorsed the Financial Stability Board (FSB) 'Key Attributes of Effective Resolution Regimes for Financial Institutions' ('Key Attributes") 3 . These set out the core elements that the FSB considers to be necessary for an effective resolution regime. Their implementation should allow authorities to resolve financial institutions in an orderly manner without taxpayer exposure to loss from solvency support, while maintaining continuity of their vital economic functions. In June 2012, the G20 is set to start work on evaluating progress in implementing these provisions in the different jurisdictions.

In June 2010, the European Parliament adopted an own-initiative report on recommendations on cross-border crisis management in the banking sector 4 . It stressed the need for a Union-wide framework to manage banks in financial distress and recommended moving toward greater integration and coherence in the resolution requirements and arrangements applicable to cross-border institutions. In December 2010, the Council (ECOFIN) adopted conclusions 5 calling for a Union framework for crisis prevention, management and resolution. The conclusions stress that the framework should apply in relation to banks of all sizes, improve cross-border cooperation and consist of three pillars (preparatory and preventative measures, early intervention, and resolution tools and powers). These should "aim at preserving financial stability by protecting public and market confidence; putting prevention and preparation first; providing credible resolution tools; enabling fast and decisive action; reducing moral hazard and minimising to the fullest possible extent the overall costs to public funds, by ensuring fair burden sharing among the financial institutions' stakeholders; contributing to a smooth resolution of cross border groups; ensuring legal certainty; and, limiting distortions of competition."

In addition, a high-level group is due to report to the Commission in the second half of 2012 on whether, on top of on-going regulatory reforms, structural reforms of Union banks would strengthen financial stability and improve efficiency and consumer protection 6 . The group's proposals will be assessed separately upon completion of the work.

Finally, on 30 May 2012 the Commission indicated that it will initiate a process to 'map out the main steps towards full economic and monetary union (including), among other things, moving towards a banking union including an integrated financial supervision and a single deposit guarantee scheme' 7 .

2. RESULTS OF CONSULTATIONS WITH THE INTERESTED PARTIES AND IMPACT ASSESSMENTS

In the period between 2008 and 2012 the Commission services organised a number of consultations and discussions with experts and key stakeholders concerning bank recovery and resolution. As the last public consultation before the adoption of the proposal, a Commission Staff Working Paper describing in detail the potential policy options under consideration by the Commission services was published for consultation in January 2011. The consultation ended on the 3rd of March 2011. On one of the resolution tools, the so called bail-in or debt write down tool, targeted discussions were organised with experts from Member States, banking industry, academic world and legal firms in April 2012. The discussions concerned the key parameters of the debt write-down tool, including in particular the resolution triggers, the scope of bail-in, its potential minimum level, resolution of groups as well as grandfathering. Documents related to public consultations can be found on the website of the European Commission. 8

On this basis, the Commission has prepared the attached legislative proposal. The Commission services have also prepared an Impact Assessment (IA) for the proposal, which can be found on the website of the European Commission. 9

The comments by the Impact Assessment Board (IAB) expressed in their first and second opinion in May and June 2011 have been taken into account. In addition, the text of the IA has been updated reflecting latest developments in international fora as well as incorporation of results of the discussions on the bail-in tool that took place in April 2012. Concretely, the revised IA improves the presentation of the legal and institutional context by describing the responsibilities of national supervisors and resolution authorities and the relationships between the proposal for bail-in and the planned CRD IV requirements. The text of the IA better explains the content of options, in particular the one related to the bail-in/debt-write down tool. Also the impacts of the bail-in tool on the costs of funding for banks and non-financial firms (SMEs) have been added. A section related to the coherence of the proposal with other regulatory proposals has been completed. Finally, monitoring and evaluation arrangements were further clarified by singling out the most relevant indicators to be monitored.


The IA concludes the following:

• The proposed Union bank resolution framework will achieve the objectives of enhancing financial stability, reducing moral hazard, protecting depositors and critical banking services, saving public money and protecting the internal market for financial institutions.

• The framework is expected to have a positive social impact: first, by reducing the probability of a systemic banking crisis and avoiding losses in economic welfare that follow a banking crisis; and, second, by minimising taxpayer exposure to losses from insolvency support to institutions.

• The costs of the framework derive from a possible increase in funding costs for institutions due to the removal of the implicit certainty of state support, and from the costs related to resolution funds. Institutions might transmit those increased cost to customers or shareholders by pushing rates on deposits lower, increasing lending rates and banking fees or reducing returns on equity. However, competition might reduce ability of institutions to pass on the costs in full. The potential benefits of the framework in terms of economic welfare over the long term in terms of a reduced likelihood of a systemic crisis are substantially higher than the potential cost.

3. general explanation: a recovery and resolution framework

Contents

1.

The need for an effective recovery and resolution framework


Banks and investment firms (hereinafter institutions) provide vital services to citizens, businesses, and the economy at large (such as deposit-taking, lending, and the operation of payment systems). They operate largely based on trust, and can quickly become unviable if their customers and counterparties lose confidence in their ability to meet their obligations. In case of failures, banks should be wound down in accordance to the normal insolvency procedures. However, the extent of interdependencies between institutions creates the risk of a systemic crisis when problems in one bank can cascade across the system as a whole. Because of this systemic risk and the important economic function played by institutions, the normal insolvency procedure may not be appropriate in some cases and the absence of effective tools to manage institutions in crisis has too often required the use of public funds to restore trust in even relatively small institutions so as to prevent a domino effect of failing institutions from seriously damaging the real economy.

Accordingly, an effective policy framework is needed to manage bank failures in an orderly way and to avoid contagion to other institutions. The aim of such a policy framework would be to equip the relevant authorities with common and effective tools and powers to address banking crises pre-emptively, safeguarding financial stability and minimising taxpayers' exposure to losses.

2.

Preparation and prevention, early intervention and resolution


To this end, the range of powers available to the relevant authorities should consist of three elements: (i) preparatory steps and plans to minimise the risks of potential problems (preparation and prevention 10 ); (ii) in the event of incipient problems, powers to arrest a bank's deteriorating situation at an early stage so as to avoid insolvency (early intervention); and (iii) if insolvency of an institution presents a concern as regards the general public interest (defined in Articles 27 and 28), a clear means to reorganise or wind down the bank in an orderly fashion while preserving its critical functions and limiting to the maximum extent any exposure of taxpayers to losses in insolvency (resolution). Together, these powers constitute an effective framework for the recovery and, where appropriate, the resolution of institutions. Since the risk posed by any individual bank to financial stability cannot be fully ascertained in advance, these powers should be available to the relevant authorities in relation to any bank, regardless of its size or the scope of its activities.

3.

Resolution - a special insolvency regime for institutions


In most countries, bank and non-bank companies in financial difficulties are subject to normal insolvency proceedings. These proceedings allow either for the reorganization of the company (which implies a reduction, agreed with the creditors, of its debt burden) or its liquidation and allocation of the losses to the creditors, or both. In all the cases creditors and shareholders do not get paid in full. However, the experience from different banking crises indicates that insolvency laws are not always apt to deal efficiently with the failure of financial institutions insofar as they do not appropriately consider the need to avoid disruptions to financial stability, maintain essential services or protect depositors. In addition, insolvency proceedings are lengthy and in the case of reorganization, they require complex negotiations and agreements with creditors, with some potential detriment for the debtors and the creditors in terms of delay, costs and outcome.

Resolution constitutes an alternative to normal insolvency procedures and provides a means to restructure or wind down a bank that is failing and whose failure would create concerns as regards the general public interest (threaten financial stability, the continuity of a bank's critical functions and/or the safety of deposits, client assets and public funds) 11 . Accordingly, resolution should achieve, for institutions, similar results to those of normal insolvency proceedings taking into account the Union State aid rules, in terms of allocation of losses to shareholders and creditors, while safeguarding financial stability and limiting taxpayer exposure to loss from solvency support. In the process, it should also ensure legal certainty, transparency and predictability regarding the treatment of shareholders and bank creditors and preserve value which might otherwise be destroyed in bankruptcy. In addition, by removing the implicit certainty of a publicly-funded bail out for institutions, the option of resolution should encourage uninsured creditors to better assess the risk associated with their investments. Moreover, a design of the national financing arrangements for resolution in line with State aid rules will ensure that the overall objectives of the resolution framework can be met.

4.

A balance between predictability for investors and discretion for authorities


In order to safeguard existing property rights, a bank should enter into resolution at a point very close to insolvency, i.e. when it is on the verge of failure. However, the judgement on the point of entry into resolution may depend on several variables and factors linked to prevailing market conditions or idiosyncratic liquidity or solvency issues, implying the need for a degree of discretion for the resolution authority. Likewise, the concrete actions to be taken in resolution should not be pre-determined in relation to any bank but should rather be taken on the basis of the concrete circumstances.

A Union framework with similar tools, principles and procedures is needed to provide sufficient convergence in how national authorities implement resolution. In designing this framework, a balance must be found between the necessary discretion for supervisors to reflect the specificities of each particular case and to ensure a level playing-field and to preserve the integrity of the single market. The European Banking Authority (EBA) should be vested with a clear role to issue guidelines and technical standards to ensure consistent application of the resolution powers, to participate in resolution planning in relation all cross-border institutions, and to carry out binding mediation between national authorities in the event of disagreement on the application of the framework.

Finally, successful resolution requires sufficient funds, for example to issue guarantees or provide short-term loans to help the critical parts of a resolved entity regain viability. These funds should, as a matter of principle, be provided for by the banking sector in a fair and proportionate manner and as far as possible (taking account of the economic cost) contributed in advance. Taken together, these steps ensure that regardless of the appropriate resolution action undertaken, its costs are primarily borne by the institutions themselves and their owners and investors.

5.

The internal market - Treatment of cross border groups


Cross border groups are composed of institutions established in different Member States. The resolution framework recognises the existence of cross border groups in Europe as one of the key drivers for the integration of the Union financial markets. The framework establishes special rules for cross border groups covering preparation and prevention Articles 7, 8, 11, 12 and 15), early intervention (Article 25) and the resolution phase (Articles 80 to 83). It also establishes rules concerning the transfer of assets between entities affiliated to a group in times of financial distress (Articles 16 to 22).

The rules on groups aim at balancing the interest of achieving, where necessary, an efficient resolution for the group as a whole with the protection of financial stability in both the Member States where the group operates and the Union. Efficient methods for the resolution of cross border groups are the only way to achieve financial stability in the Union and consequently improve the functioning of the Single market also in times of crisis. In particular, and without disregarding the necessary safeguards for the host member States, an efficient speedy resolution of a group that minimises the loss of value for the group should be ensured by giving a prominent role to the group level resolution authority.

Notwithstanding the prominent role given to the group resolution authority, the interests of the host resolution authorities will be sufficiently considered through: a) the establishment of arrangements for cooperation between resolution authorities through the creation of the colleges of resolution authorities; b) the recognition that the financial stability in all Member States where the group operates has to be considered when taking decisions relative to groups; c) the design of clear decision making process that allow for all authorities to convey their views whilst ensuring that a single decision is taken with regards to the resolution of a group; and d) the establishment of mechanisms for the resolution of conflicts between resolution authorities (EBA mediation).

The EBA 12 will perform a binding mediation role as foreseen in Regulation N° 1093/2010 EBA regulation, in particular Article 19. In this context, all the relevant rules of that regulation apply, including articles 38 and 44 i.

All those mechanisms should ensure that the resolution of a group, or the provision of financial support between affiliated institutions, is not detrimental to any parts of the groups and the financial stability of the Member State where a subsidiary is located is not disregarded.

4. LEGAL ELEMENTS OF THE PROPOSAL

4.1.Legal basis

The legal base for this proposal is Article 114 of the TFEU, which allows the adoption of measures for the approximation of national provisions which have as their object the establishment and functioning of the internal market.

The proposal harmonises national laws on recovery and resolution of credit institutions and investment firms to the extent necessary to ensure that Member States have the same tools and procedures to address systemic failures. In this way, the harmonised framework should foster financial stability within the Internal Market by ensuring a minimum capacity for resolution of institutions in all Member States and by facilitating cooperation between national authorities when dealing with the failure of cross-border groups.

Article 114 of the TFEU is, therefore, the appropriate legal base.

4.2.Subsidiarity

Under the principle of subsidiarity set out in Article 5.3 of the TEU, in areas which do not fall within its exclusive competence, the Union should act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level.

Only action at Union level can ensure that Member States use sufficiently compatible measures to deal with failing institutions. Although the Union banking sector is highly integrated, systems to deal with bank crises are nationally-based and differ significantly. Many national legal systems do not currently confer the powers necessary for authorities to wind down financial institutions in an orderly manner while preserving those services essential for financial stability while minimising taxpayers’ exposure to losses from solvency support. Such divergent national legislation is ill-suited to dealing adequately with the cross-border dimension of crises, complicating any arrangements for home-host cooperation..

Moreover, substantial differences in national procedures for resolution could result in unacceptable risks to financial stability and jeopardise the effective resolution of cross border groups. As establishing adequate resolution arrangements at the Union-level require a significant harmonisation of national practices and procedures, it is appropriate that the Union should propose the necessary legislative action. However, resolution is closely linked to non-harmonised areas of national law, such as insolvency and property law. Therefore, a directive is the appropriate legal instrument since transposition is necessary to ensure that the framework is implemented in a way that achieves the intended effect, within the specificities of relevant national law.

4.3.Proportionality

Under the principle of proportionality, the content and form of Union action should not exceed what is necessary to achieve the objectives of the Treaties.

In principle, a failed bank should be subject to normal insolvency procedures like any other business. However, the banking sector is different to most other business sectors insofar as it performs critical functions in the economy and is particularly vulnerable to systemic crises. Because of these features, the liquidation of a bank can have more serious consequences than the exit of other businesses from the market. This may justify recourse to special rules and procedures in the event of a banking crisis.

As the systemic importance of a bank failure cannot be determined with full certainty in advance, the proposed crisis management framework should apply in principle to all banking institutions, irrespective of their size and complexity. If it is certain that the failure of an institution of global size, market importance, and global interconnectedness would cause significant disruption in the global financial system and adverse economic consequences across a range of countries, it is also clear that the simultaneous failure, in a widespread crisis, of many small institutions making up a significant part of the banking sector in a country may have equally devastating effects on the economy. The framework therefore ensures that supervisors and resolution authorities have special rules and procedures at their disposal for dealing efficiently with the failure or near-failure of any bank in circumstances of systemic risk. However, the risk, size and interconnectedness of a bank will be taken into account by national authorities in the context of recovery and resolution plans and when using the different tools at their disposal, making sure that the regime is applied in an appropriate way.

The provisions are therefore proportionate to what is necessary to achieve the objectives. Furthermore, limitations to the right to property that the exercise of the powers proposed may entail must be consistent with the Charter of Fundamental Rights as interpreted by the European Court of Justice. It is for this reason that the point of entry into resolution should be as close as possible to insolvency, and the use of the resolution powers should be limited to the extent necessary in order to meet an objective of general interest, namely preserving financial stability in the Union.

4.4.Detailed explanation of the proposal

6.

4.4.1.Subject matter and scope of application (Article 1)


The proposal addresses crisis management (preparation, recovery and resolution) in relation to all credit institutions and certain investment firms. The scope of the proposal is identical with that of the Capital Requirements Directive 13 (CRD), which harmonises prudential requirements for institutions including financial institutions included in a banking group, and investment firms. Investment firms need to be part of the framework since, as shown by the failure of Lehman Brothers, their failure can have serious systemic consequences. . In addition, the powers of resolution authorities should also apply to holding companies where one or more subsidiary credit institution or investment firm meet the conditions for resolution and the application of the resolution tools and powers in relation to the parent entity is necessary for the resolution of one or more of its subsidiaries or for the resolution of the group as a whole.

7.

4.4.2.Resolution authorities (Article 3)


The proposal requires Member States to confer resolution powers on public administrative authorities to ensure that the objectives of the framework can be delivered in a timely manner. The proposal does not specify the particular authority that should be appointed as resolution authority, since this is not necessary to ensure effective resolution and would interfere with the constitutional and administrative orders of Member States. It is therefore open to Member States to designate as their resolution authorities, for example, national central banks, financial supervisors, deposit guarantee schemes, ministries of finance, or special authorities.

Resolution authorities will need to have adequate expertise and resources to manage bank resolutions at national and cross border level. Given the likelihood of conflicts of interest, functional separation of resolution activities from the other activities of any designated authority is mandated.

8.

4.4.3.Recovery and resolution plans (Articles 5 to 13)


Early action based on recovery plans can prevent the escalation of problems and reduce the risk of a bank failure. Institutions will be required to draw up recovery plans setting out arrangements and measures to enable it to take early action to restore its long term viability in the event of a material deterioration of its financial situation. Groups will be required to develop plans at both group level and for the individual institutions within the group. Supervisors will assess and approve recovery plans.

Resolution plans will allow an institution to be resolved minimising taxpayer exposure to loss from solvency support while protecting vital economic functions. A resolution plan, prepared by the resolution authorities in cooperation with supervisors in normal times, will set out options for resolving the institution in a range of scenarios, including systemic crisis. Such plans should include details on the application of resolution tools and ways to ensure the continuity of critical functions. Group resolution plans will include a plan for the group as well as plans for each institution within the group.

9.

4.4.4.Powers to address or remove impediments to resolvability (Articles 14 to 16)


Based on the resolution plan, the resolution authorities shall assess whether an institution or group is resolvable. If resolution authorities identify significant impediments to the resolvability of an institution or group, they may require the institution or groups to take measures in order to facilitate its resolvability.

Such measures might include inter alia: reducing complexity through changes to legal or operational structures in order to ensure that critical functions can be legally and economically separated from other functions; drawing up service agreements to cover the provision of critical functions; limiting maximum individual and aggregate exposures; imposing reporting requirements; limiting or ceasing existing or proposed activities; restricting or preventing the development of new business lines or products; and issuing additional convertible capital instruments.

Assessment of resolvability for groups rests upon coordination, consultation and joint assessment of group resolution authorities with the resolution authorities of the subsidiaries, other relevant competent authorities and the EBA.

To ensure that the assessment of resolvability and the use of preventative powers by relevant authorities are uniformly applied across the Member States, the EBA will play an important role. Concretely, it will need to draft technical standards defining parameters needed for the assessment of resolution plans' systemic impact and it will need to draft technical standards specifying issues to be examined in order to assess the resolvability of an institution or group.

10.

4.4.5.Intra-group financial support (Articles 17-23)


The proposal aims to overcome current legal restrictions to the provision of financial support from one entity within a group to another. Institutions that operate in a group structure will be able to enter into agreements to provide financial support (in the form of a loan, the provision of guarantees, or the provision of assets for use as collateral in transaction) to other entities within the group that experience financial difficulties. Such early financial help can address developing financial problems within individual group members. The agreement may be submitted for approval in advance by the shareholders' meetings of all participating entities in accordance with national law and will authorise the management bodies to provide financial support if needed within the terms of the agreement. On this basis, legal certainty will increase as it will be clear when and how such financial support can be provided. The agreements are voluntary, allowing banking groups to assess whether such arrangements would be in the group interest (a group might be more or less integrated and pursue more or less strongly a common strategy) and to identify the companies that should be party to the agreement (it may be appropriate to exclude companies that pursue riskier activities).

As a safeguard, the supervisor of the transferor will have the power to prohibit or restrict financial support pursuant to the agreement when that transfer threatens the liquidity or solvency of the transferor or financial stability.

4.4.6.Early intervention – Special management (Articles 23-26)

The proposal expands the powers of supervisors to intervene at an early stage in cases where the financial situation or solvency of an institution is deteriorating. The powers contemplated in the proposal supplement those conferred on supervisors under Article 136 of the CRD. These powers do not derogate any rights or procedural obligations established in accordance with Company Law.

Powers of early intervention include the power to request the institution to implement arrangements and measures set out in the recovery plan; draw up an action program and a timetable for its implementation; request the management to convene, or convene directly, a shareholders' meeting, propose the agenda and the adoption of certain decisions; and request the institution to draw up a plan for restructuring of debt with its creditors.

In addition, the supevisor would have the power to appoint a special manager for a limited period, when the solvency of an institution is deemed to be sufficiently at risk. The primary duty of a special manager is to restore the financial situation of the institution and the sound and prudent management of its business. A special manager will replace the management of the institution and have all its powers without prejudice to ordinary shareholder rights. The power to appoint a special manager will serve as an element of discipline for the management and shareholders and as a means to foster private sector solutions to problems which, if not addressed, could lead to the failure of an institution.

11.

4.4.7.Resolution conditions (Article 27)


The proposal establishes common parameter for triggering the application of resolution tools. The authorities shall be able to take an action when an institution is insolvent or very close to insolvency to the extent that if no action is taken the institution will be insolvent in the near future.

At the same time, it is necessary to ensure that intrusive measures are triggered only when interference with the rights of stakeholders is justified. Therefore resolution measures should be implemented only if the institution is failing or likely to fail, and there is no other solution that would restore the institution within an appropriate timeframe. In addition, the intervention by means of resolution measures must be justified by reasons of public interest as defined under Article 28.

4.4.8.General principles – In particular the no creditor worse off (article 29)

The framework sets up a number of general principles that will have to be respected by the resolution authorities. These principles refer, inter alia, to the allocation of losses and the treatment of shareholders and creditors and to the consequences that the use of the tools could have on the management of the institution.

The framework establishes that the losses, once identified through a valuation process (article 30) are to be allocated between the shareholders and the creditors of the Institution in accordance with the hierarchy of claims established by each national insolvency regime. However, and as it has been pointed out above (see heading 3) normal insolvency regimes do not sufficiently take into account financial stability or other public interest concerns. Therefore, the resolution framework establishes certain principles for the allocation of losses that would have to be respected irrespective of what each national insolvency regime establishes. These principles are: a) that the losses should first be allocated in full to the shareholders and then to the creditors and b) that creditors of the same class might be treated differently if it is justified by reasons of public interest and in particular in order to underpin financial stability. These principles apply to all the resolution tools. In addition, and with regards to the bail-in tool, the framework establishes a more detailed hierarchy of claims (article 43). This more detailed hierarchy will complement and where necessary supersede the one established in each national insolvency law.

In those cases where the creditors receive less in economic terms, than if the institution had been liquidated under normal insolvency proceedings, the authorities have to ensure that they receive the difference. This compensation, if any, shall be paid by the resolution fund. The principle that losses have to be allocated to first to shareholders and then to creditors together with the fact that resolution action has to be taken prior to availing any extraordinary public financial support is, in principle instrumental to ensuring the effectiveness of the objective of minimising taxpayers’ exposure to losses (article 29).

12.

4.4.9.Valuation (Article 30)


The implementation of the resolution tools and powers is based on an assessment of the real value of the assets and liabilities of the institution that is about to fail. To this end, the framework incorporates a valuation based on the principle of market value. This will ensure that the losses are recognised at the moment when the institution enters into resolution.

The valuation should be done by an independent expert, unless there are reasons of urgency, in which case the resolution authorities would proceed with a provisional valuation that will, afterwards, be complemented by a definitive valuation with the involvement of an independent expert. The resolution authorities have been granted the necessary powers to modify their resolution actions 14 in accordance with possible discrepancies, if any, between the provisional and the definitive valuation.

13.

4.4.10.Resolution tools and powers (Articles 31-64)


When the trigger conditions for resolution are satisfied, resolution authorities will have the power to apply the following resolution tools:

(a)sale of business;

(b)bridge institution;

(c)asset separation;

(d)bail-in.

In order to apply those tools, resolution authorities will have powers to take control of an institution that has failed or is about to fail, take over the role of shareholders and managers, transfer assets and liabilities and enforce contracts.

The resolution tools can be applied singly or in conjunction. All entail a degree of restructuring of the bank. Such restructuring is not a feature accompanying the bail-in only. The asset separation tool has to be applied in all circumstances in conjunction with the other tools (Article 32). When applicable, the use of any of the resolution tools will need to be consistent with the Union State aid framework. In this respect, any recourse to public support and/or the use of the resolution funds to assist in the resolution of failing institutions will have to be notified to the Commission and will be assessed in accordance with the relevant State aid provisions in order to establish its compatibility with the internal market.

The proposal set out a minimum set of resolution tools that all Member States should adopt. However, national authorities will be able to retain, in addition, specific national tools and powers to deal will failing institutions if they are compatible with the principles and objectives of the Union resolution framework and the Treaty on the functioning of the European Union and if they do not pose obstacles to effective group resolution 15 . National resolution authorities would only be able to use those national tools and powers if they justify that none of the tools (singly or in conjunction) included in the Union framework allows them to take effective resolution action.

The sale of business tool enables resolution authorities to effect a sale of the institution or the whole or part of its business on commercial terms, without requiring the consent of the shareholders or complying with procedural requirements that would otherwise apply. As far as possible in the circumstances, the resolution authorities should market the institution or the parts of its business that are to be sold.

The bridge institution tool enables resolution authorities to transfer all or part of the business of an institution to a publicly controlled entity. The bridge institution must be licensed in accordance with the Capital Requirements Directive and will be operated as a commercial concern within any limits prescribed by the State aids framework. The operations of a bridge institution are temporary, the aim being to sell the business to the private sector when market conditions are appropriate.

The purpose of the asset separation tool is to enable resolution authorities to transfer impaired or problem assets to an asset management vehicle to allow them to be managed and worked out over time. Assets should be transferred at market or long term economic value (in accordance with Article 30) so that any losses are recognised at the moment when the transfer takes place. In order to minimise competitive distortions and risks of moral hazard, this tool should only be used in conjunction with another resolution tool.

14.

The bail-in tool (articles 37 to 51)


The bail-in tool will give resolution authorities the power to write down the claims of unsecured creditors of a failing institution and to convert debt claims to equity. The tool can be used to recapitalise an institution that is failing or about to fail, allowing authorities to restructure it through the resolution process and restore its viability after reorganisation and restructuring. This would allow authorities greater flexibility in their response to the failure of large, complex financial institutions. It would be accompanied by removal of management responsible for the problems of the institution, and the implementation of a business restoration plan.

The resolution authorities should have the power to bail-in all the liabilities of the institution. There are, however some liabilities that would be excluded ex-ante (such as secured liabilities, covered deposits and liabilities with a residual maturity of less than one month). Exceptionally and where there is a justified necessity to ensure the critical operations of the institution and its core business lines or financial stability (Article 38) the resolution authority could exclude derivatives' liabilities. Harmonised application of the possible exclusion at Union level would be ensured by Commission delegated acts.

In order to apply the bail in tool it is necessary that the resolution authorities can ensure that institutions would have a sufficient amount of liabilities in their balance sheet that could be subject to the bail in powers. The minimum amount will be proportionate and adapted for each category of institutions on the basis of their risk or the composition of its sources of funding (Article 39). Harmonised application of the minimum requirement at Union level would be ensured by Commission delegated acts. As an example, and on the basis of evidence from the recent financial crisis and of performed model simulations, an appropriate percentage of total liabilities which could be subject to bail in could be equal to 10% of total liabilities (excluding regulatory capital).

As explained in 4.4.8, Articles 43 and 44 establish a detailed hierarchy that complements and were necessary supersedes the one established in each national insolvency law. In principle, Shareholders claims should be exhausted before those of subordinated creditors. It is only when those claims are exhausted that the resolution authorities can impose losses on senior claims (Articles 43 and 44). However, there might be circumstances when the resolution authorities could interfere on creditors’ rights without having exhausted shareholders’ claims. These circumstances are specific to the bail in tool and could occur when an institution under resolution might have some residual capital (according to the conditions for resolution an institution would be failing or likely to fail if it has depleted all or substantially all of its capital). In this case, the resolution authorities could, after having allocated the losses to the shareholders and reduced or cancelled most of the shareholders’ claims, convert into capital subordinated and, if necessary, senior liabilities. This conversion will have to take place in a manner that seriously dilutes the remaining shareholders’ claims.

15.

4.4.11.Restrictions on termination and safeguards for counterparties (Articles 68-73 and 77)


For the effective application of resolution tools, it is necessary to allow resolution authorities to impose a temporary stay on the exercise by creditors and counterparties of rights to enforce claims and close out, accelerate or otherwise terminate contracts against a failing institution. Such a temporary suspension, which would last no longer than until 5pm on the next business day, gives authorities a period of time to identify and value those contracts that need to be transferred to a solvent third party, without the risk that financial contracts would be changing in value and scope as counterparties exercised termination rights. Termination rights for those counterparties remaining with the failed institution would resume at the end of the stay. However, transfer to a performing third party should not qualify as an event of default that triggers termination rights.

These necessary restrictions on contractual rights are balanced by safeguards for counterparties to prevent authorities from splitting linked liabilities, rights and contracts: under a partial property transfer, linked arrangements must either all be transferred, or not at all. Arrangements include close out netting agreements, set-off arrangements, title transfer financial collateral arrangements, security arrangements and structured finance arrangements.

16.

4.4.12.Restriction on judicial proceedings (Articles 78 and 77)


In accordance with Article 47 of the Charter of Fundamental Rights, the concerned parties have a right to due process and to having an effective remedy against the measures affecting them. Therefore, the decisions taken by the resolution authorities should be subject to judicial review. However, in order to protect third parties who have bought assets, rights and liabilities of the institution under resolution by virtue of the exercise of the resolution powers by the authorities and to ensure the stability of the financial markets, the judicial review should not affect any administrative act and/or transaction concluded on the basis of the annulled decision. Remedies for a wrongful decision should therefore be limited to the award of compensation for the damages suffered by the affected persons.

Furthermore, it is necessary to prevent the opening or pursuit of other legal actions in relation to a bank that is under resolution. To this effect, the framework provides that, before the national judge opens the insolvency proceedings in relation to an institution, it notifies the resolution authority of any application; the resolution authority has then the right, within a period of 14 days form the notification, to decide to take a resolution action with regard to the institution concerned.

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4.4.13.Cross border resolution (Articles 80-83)


The recovery and resolution framework takes into account the cross border nature of some banking groups, with an objective to create a comprehensive and integrated framework for bank recovery and resolution in the Union.

Accordingly, recovery and resolution plans need to be prepared agreed and implemented for the group as a whole while taking into account the particularities of each group's structure and the division between the responsibilities of host and home national authorities. This will be done through measures that will require enhanced cooperation between national authorities and creation of incentives for applying a group approach in all phases of preparation, recovery and resolution.

Resolution colleges will be established with clearly designated leadership and with the participation of the European Banking Authority (EBA). The EBA will facilitate cooperation of authorities and mediate if necessary. The objective of the colleges is to coordinate preparatory and resolution measures among national authorities to ensure optimal solutions at Union level.

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4.4.14.Relations with third countries (Articles 84-89)


Because many Union institutions and banking groups are active in third countries, an effective framework for resolution needs to provide for cooperation with third country authorities. The proposal provides Union authorities with the necessary powers to support foreign resolution actions of a failed foreign bank by giving effect to transfers of its assets and liabilities that are located in or governed by the law of their jurisdiction. However, such support would only be provided if the foreign action ensured fair and equal treatment for local depositors and creditors and did not jeopardise financial stability in the Member State. Union resolution authorities should also have the power to apply resolution tools to national branches of third country institutions where separate resolution is necessary for reasons of financial stability or the protection of local depositors. The proposal provides that support for foreign resolution actions will be given where resolution authorities have a cooperation agreement with the foreign resolution authority. Such agreements should be a means to ensure effective planning, decision-making and coordination in respect of international groups.

EBA should develop and enter into framework administrative arrangements with authorities of third countries in accordance with Article 33 of Regulation No 1093/2010 and national authorities should conclude bilateral arrangements that are as far as possible in line with the EBA framework arrangements.

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4.4.15.Resolution funding (Articles 90-99)


Resolution allows a better burden sharing of the resolution costs by the shareholders and creditors in the process of resolution when insolvency procedures are deemed inappropriate in light of possible risks to financial stability. However, this might not always be sufficient and might have to be supplemented by additional funding in order, for example, to provide liquidity to a bridge bank. Based on past experience, it is necessary to establish funding arrangements financed by institutions themselves in order to minimize taxpayer's exposure to losses from solvency support. Articles 90 to 99 lay down the necessary provisions to that purpose.

Article 89 provides for the setting up of financing arrangements in each Member State. The purposes for which they may be used are listed under article 89, paragraph 2 and range from guarantees to loans or contributions. Losses are primarily borne by shareholders and creditors, but other financing arrangements cannot be excluded in principle.

Article 90 lays down the rules on the contributions to the financing arrangements, and involves a mix of ex ante contributions, supplemented by ex post contributions and, where indispensable, borrowing facilities from financial institutions or the central bank. In order to ensure that some funds are available at all times, and given the pro-cyclicality associated with ex post funding, a minimum target fund level is set, to be reached through ex ante contributions in a time span of 10 years. Based on model-calculation, an optimal minimum target fund level is set at 1% of covered deposits.

In order to enhance the resilience of national financing arrangements, Article 97 provides for a right for national arrangements to borrow from their counterparts in other Member States. In order to reflect the distribution of competences among the various national authorities in the resolution of groups, Article 98 lays down rules on the respective contributions of national financing arrangements to the resolution of groups. This contribution will be based on the one previously agreed in the context of the group resolution plans. National financing arrangements, together with borrowing mechanisms and the mutualisation of national arrangements in the case of the resolution of cross border groups (Article 98) make up a European system of financing arrangements.

Article 99 deals with the role of Deposit Guarantee Schemes (DGS) in the resolution framework. DGS may be called to contribute to resolution in two manners.

First, deposit guarantee schemes must contribute for the purpose of ensuring continuous access to covered deposits. Deposit Guarantee Schemes are currently established in all Member States in accordance with Directive 94/19/EC. They compensate retail depositors up to EUR100,000 in respect of unavailable deposits, before being subrogated to them in liquidation proceedings. By contrast, resolution avoids the unavailability of covered deposits, which is preferable from the depositor's point of view. It is therefore desirable that the DGS contributes for an amount equivalent to the losses that it would have had to bear in normal insolvency proceedings, as reflected in paragraph 1 of Article 99. In order to provide for sufficient funding, the ranking of deposit guarantee schemes in the hierarchy of claims is introduced, with DGS ranking pari passu with unsecured non-preferred claims. The DGS contribution must be made in cash in order to absorb the losses pertaining to covered deposits.

Secondly, while Member States must at least use DGS for the purpose of providing cash to ensure continuous access to covered deposits, they retain discretion as to how to fund resolution: they may decide to create financing arrangements separate from the DGS, or use their DGS also as financing arrangements under Article 91. Indeed, there are synergies between deposit guarantee schemes and resolution. When a resolution framework that limits contagion is in place, it reduces the number of bank failures, and therefore the likeliness of DGS pay-outs. The proposal therefore allows Member States to use DGS for resolution funding in order to reap economies of scale. Where the two arrangements are separate, the DGS is liable for the protection of covered depositors to the extent and in the conditions laid down in Article 99, paragraphs 1 to 4, while supplementary funding is provided by separate financing arrangements established under Article 91. By contrast, where they opt for a single financing arrangement, it will cover both the losses affecting covered deposits, and other purposes under Article 92. In that case, the DGS has to comply with all the conditions on contributions, borrowing and mutualisation laid down under Articles 93 to 98.

In any case, if following a contribution by the DGS, the institution under resolution fails at a later stage and the DGS does not have sufficient funds to repay depositors, the DGS must have arrangements in place in order to raise the corresponding amounts immediately from its members.

State aid is likely to be present in the intervention of the resolution funds irrespective of the type of national financial arrangements (i.e. a resolution fund separate from the Deposit Guarantee Scheme or using the Deposit Guarantee Scheme as a resolution fund).

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4.4.16.Compliance with Articles 290 and 291 TFEU


On 23 September 2009, the Commission adopted proposals for Regulations establishing EBA, EIOPA, and ESMA 16 . In this respect the Commission wishes to recall the Statements in relation to Articles 290 and 291 TFEU it made at the adoption of the Regulations establishing the European Supervisory Authorities according to which: 'As regards the process for the adoption of regulatory standards, the Commission emphasises the unique character of the financial services sector, following from the Lamfalussy structure and explicitly recognised in Declaration 39 to the TFEU. However, the Commission has serious doubts whether the restrictions on its role when adopting delegated acts and implementing measures are in line with Articles 290 and 291 TFEU.'

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4.4.17.Changes to the Winding Up Directive, Company Law Directives and EBA Regulation (Articles 104 - 111)


Directive 2001/24/EC provides for the mutual recognition and enforcement of reorganization or winding up measures in relation to credit institutions that have branches in other Member States. The Directive seeks to ensure that a credit institution and its branches in other Member States are reorganised or wound up according to the principles of unity and universality ensuring that there is only one set of insolvency proceedings in which the credit institution is treated as one entity. Unity and universality of proceedings ensure the equal treatment of creditors irrespective of their nationality, place of residence or domicile. In order to ensure the equal treatment of creditors also in resolution processes, Directive 2001/24/EC is amended to extend its scope to investment firms and to the use of the resolution tools to any entity covered by the resolution regime.

The Union Company Law Directives contain rules for the protection of shareholders and creditors. Some of these rules may hinder rapid action by resolution authorities.

The Second Company Law Directive requires that any increase in capital in a public limited liability company be agreed by the general meeting, while Directive 2007/36 (the Shareholders' Rights Directive) requires a 21 day convocation period for that meeting. Restoring the financial situation of a credit institution rapidly by means of capital increase is therefore not possible. The proposal therefore amends the Shareholders' Rights Directive to allow the general meeting to decide in advance that a shortened convocation period will apply for a general meeting to decide on an increase of capital in emergency situations. Such authorisation will be part of the recovery plan. This will allow rapid action while retaining shareholders' decision-making powers.

Moreover, Company Law Directives require that increase and decrease of capital, mergers and divisions are subject to shareholders' agreement, and pre-emption rights apply whenever the capital is increased by consideration in cash. In addition, the Takeover Bids Directive requires mandatory bids when any person – including the State - acquires shares in a listed company above the control threshold (usually 30-50%). To address these obstacles, the proposal allows Member States to derogate from those provisions that require consent from creditors or shareholders or otherwise hinder the effective and rapid resolution.

In order to ensure that the authorities responsible for resolution are represented in the European System of Financial Supervision established by Regulation (EU), No 1093/2010 and to ensure that EBA has the expertise necessary to carry out the tasks provided for in this directive, Regulation (EU) No 1093/2010 should be amended in order to include national resolution authorities as defined in this Directive in the concept of competent authorities established by that Regulation.

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4.4.18.Entry into force


The Directive will enter into force on the twentieth day following its publication in the OJ.

In line with common practice, the transposition deadline of the Directive is set at 18 months, i.e. 31 December 2014.

The provisions on the bail-in tool are subject to a longer transposition period and should be applied as from 1 January 2018. That date takes into account the observed maturity cycles of existing debt, the need to avoid deleveraging and the need for institutions to implement new capital requirements by 2018.

In accordance with the Joint Political Declaration of Member States and the Commission of 28 September 2011 on explanatory documents, Member States should accompany the notification of the implementing measures with correlation tables. This is justified in view of the complexity of the Directive, which covers different subjects and is likely to require a plurality of implementing measures and in view of the fact some Member States have already adopted legislations partially implementing this Directive.

5. BUDGETARY IMPLICATION

The above policy options will have implications for the budget of the Union.

The present proposal would require EBA to (i) develop around 23 technical standards and 5 guidelines (ii) take part in resolution colleges, make decisions in case of disagreement and exercise binding mediation and (iii) provide for recognition of third country resolution proceedings according to Article 85 and conclude non-binding framework cooperation arrangements with third countries according to Article 88. The delivery of technical standards is due 12 months after the entry into force of the Directive which is estimated to be between June and December 2013. The proposal of the Commission includes long-term tasks for EBA that will require the establishment of 5 additional posts (temporary agents) as from 2014. In addition, 11 seconded national experts 'SNE' are foreseen to carry out temporary tasks limited to 2014 and 2015 years.