German draft act contractual recognition of resolution authorities' powers and changes to insolvency waterfall
On 30 April 2015 the German Government published the draft "Resolution Mechanism Act".1 This will be introduced in the legislative process and discussed by Parliament. This draft replaces a predecessor draft, the so-called draft SRM Adaption Act2 published on 10 March 2015.
The primary purpose of the draft act is to harmonise German provisions implementing the Bank Recovery and Resolution Directive (BRRD) with the provisions of the single resolution mechanism (SRM). However, it goes beyond this purpose. This article focuses on two rules: (i) on contractual recognition, and (ii) on the subordination of senior unsecured debt.
The draft envisages that German institutions (including those that are part of a group) will have to provide expressly in financial contracts for contractual recognition of powers granted to resolution authorities suspend to temporarily certain rights (including termination rights). This obligation applies if (i) the contract is subject to the law of a "third country" (ie a country outside the EU) or (ii) if, in case of dispute, the place of jurisdiction for the contract is in a "third country". It will generally not affect obligations created prior to 1 January 2016.
The draft Resolution Mechanism Act significantly deviates from its predecessor draft, the SRM Adaption Act. Whereas the current draft expands the scope of the contractual recognition rule to all institutions (not only systematically important institutions, as under the SRM Adaption Act), it significantly limits its territorial scope. Under the draft SRM Adaption Act, contractual recognition would have applied to all financial contracts governed by any law other than German law and to any financial contract where one of the counterparties had its registered seat outside Germany.
Amendments to the Insolvency Waterfall
The draft Resolution Mechanism Act proposes amendments to the insolvency waterfall, to subordinate all unsecured debt issued by German CRR institutions. The draft proposes adding a new layer between the already existing subordination layers and the general layer of unsecured debt. Subordination would have retrospective effect. It will therefore not only affect newly issued debt instruments but also instruments issued before the entry into force of the act. In particular, debt issuance programmes are likely to be affected, if the notes issued are not already subordinated under their terms.
The draft has some exemptions from subordination:
- Subordination does not apply to debt instruments for which (i) the redemption or redemption amount is contingent on the occurrence or non-occurrence of an event that is uncertain at the issue date of the relevant instrument or that settlement shall be effected in a manner other than by cash payment, or (ii) the interest payment or interest amount is contingent on the occurrence or non-occurrence of an event that is uncertain at the issue date of the relevant debt instrument, unless the interest payment or interest amount is contingent solely on a fixed or floating reference interest rate and settlement will be effected by cash payment. This caveat is likely to exempt most of the securitised derivatives (so-called "certificates" – Zertifikate) issued by German banks.
- Money market instruments do not fall within the subordination clause.
- Subordination does not apply to registered bonds, if the bond qualifies as a covered deposit (ie a deposit eligible for deposit protection within the coverage level) or eligible deposit (ie a deposit generally eligible for protection in a deposit guarantee scheme). These deposits shall, under the BRRD, receive preferred status in an insolvency. This exception therefore upholds the priority given to these claims under the BRRD.
The latest draft expressly provides for Schuldschein loans (Schuldscheindarlehen) to also be subordinated. However, this does not necessarily mean that all Schuldscheine are subordinated as, for example, structured Schuldscheine may fall under one of these exemptions.
On 2 June 2015 the competent committees of the German Federal Assembly (Bundesrat) proposed reconsidering the just described draft amendments to the insolvency waterfall. The committees criticise the favourable treatment of structured debt instruments (in relation to straight debt). They further object to the retrospective effects of the proposed amendment. The committees suggest amending the provisions so "not to foster investment banking" but without proposing specific amendments to the wording of the draft provisions. It remains to be seen if and how the current draft will pass through the legislative process. Hearings of the German Federal Parliament (Bundestag) are scheduled for June and July 2015.
1. Gesetz zur Anpassung des nationalen Bankenabwicklungsrechts – Abwicklungsmechanismusgesetz.
2. Gesetzes zur Anpassung des nationalen Bankenabwicklungsrechts an die SRM-Verordnung – SRM-Anpassungsgesetz