European Cross-Border Crisis Management Directive
Having been deferred for a year (possibly to avoid market concerns), the Commission has now published its European Cross-Border Crisis Management Directive1 (also known as the Recovery and Resolution Directive). It deals with bank resolution and marks an incremental step towards a European banking union (although movements towards banking union appear to be accelerating rapidly as a result of the EU summit on 28-29 June 2012). The proposed Directive represents an attempt to move towards a harmonised European regulatory framework for resolving failing banks without the use of taxpayer funds.
The European debt crisis inevitably casts a long shadow over this initiative, and the reality may now be that there are certain Southern European banks which are presently irresolvable — even with the application of resolution tools — without taxpayer support.
The aim of the Directive is to introduce UK Banking Act style resolution powers across Europe. These powers will allow banks to be split into “good bank — bad bank” structures either through the transfer of part of them (to a private sector purchaser, “bad bank” or “bridge bank” structure) leaving an insolvent residual company, or (most controversially) through the “bail-in” concept. This concept, which has been widely discussed over the past two and a half years, is creditor recapitalisation (ie the writing down of senior creditors) in order to enable the recapitalisation of a bank, so as to put it in a position where it can raise liquidity in the markets and meet its obligations.
On the draft Directive itself, the following points are of note:
- The proposals include detailed requirements for recovery and resolution plans (RRPs), or “living wills” (discussed in earlier Risk Notes). Effectively they fire the starting gun on the preparation of RRPs across Europe for those firms not already required to prepare them. Experience from working on a number of UK and international RRPs for clients illustrates that firms underestimate the scale of this exercise at their peril: an RRP involves a very substantial and detailed due diligence exercise, raises detailed and difficult strategic issues concerning a bank’s organisation and its potential resolvability, and requires careful planning and regulatory liaison from an early stage.
- Resolution powers override private law in the interests of financial stability. The powers need to be carefully circumscribed in order to avoid damaging legal certainty, and with it commercial efficiency. The Commission has made a concerted effort to consult on the resolution powers, and has largely landed in the right place? but inevitably there will be friction around the margins, and certain areas (particularly stays on payment obligations) need further consideration.
- “Bail-in” remains laudable in theory but controversial in practice. Bail-in subjects lenders/ creditors within scope to a regulatory call option whereby the resolution authority can, at its discretion, convert senior creditors into shareholders. This is potentially good news for financial stability, but bad news for holders of debt. Serious questions remain about the impact the introduction of bail-in powers may have on the pricing and availability of bank funding — particularly from institutional investors whose mandates or investment powers prohibit exposure to equity (see April 2012 Risk Note)
- “Bail-inable” debt also raises difficult questions for accounting and tax. The Commission has not said anything about these complex issues as they are largely outside its scope, but there are a number of hurdles to minimising the adverse impact of bail-in implementation. How investors treat such debt in accounting terms can be hugely important to any outside economic analysis (eg such treatment can embed derivatives). Further, there are a host of secondary issues that the Commission has yet to work through (such as the consequences of degrouping a bank through bail-in). Acknowledging the market impact concerns, the Commission has “kicked the can down the road” on implementation of the power to 2018 — we believe there is plenty of additional work to be done between now and then to make bail-in workable for anything other than simple group rescues (where creditors are bailed in at the parent level).
- Cross-border recognition – this is an important and praiseworthy proposal to introduce crossborder resolution recognition within Europe, and to introduce a framework for recognition with respect to EU branches of non-EU banks. The absence of cross-border recognition was described by the Financial Stability Board as “the greatest major impediment to resolution of cross-border institutions”. The Commission should be congratulated in seeking to lead the way to introduce cross-border recognition framework Regrettably, it remains doubtful that the U.S. will follow suit.
To aim of the Directive is to introduce UK Banking Act style resolution powers across Europe.