Europe's response BRRD – resolution recognition for non-EEA liabilities of EEA financial institutions
The EU Bank Recovery and Resolution Directive (the BRRD) was required to be implemented by Member States as of 1 January 2015. For EU banks and investment firms not already subject to such requirements, this fires the starting gun on the production of recovery and resolution planning. The BRRD also contemplates the introduction of bail-in powers by or before 1 January 2016 (the UK has chosen to implement bail-in powers early). There is a sting in the tail, however, which will require EU firms that have liabilities governed by non-EEA laws to take action over the course of 2015 – and may pose some difficult questions for relationships with non-EEA clients and counterparties.
The issue – achieving recognition of resolution for non-EEA liabilities As discussed in the previous edition of the Risk Note, the absence of cross-border recognition of resolution remains a key barrier to resolution.
To help resolve this barrier, Article 55 of the BRRD requires the inclusion of a contractual term in any new liability of a relevant EU institution governed by a third country law (non-EEA liability), whereby the counterparty agrees to be bailed in.
The rule will apply to new non-EEA liabilities incurred after the date on which a Member State adopts bail-in powers (at the latest, 1 January 2016) (the effective date). It will apply to all liabilities except for (in broad terms) secured liabilities (to the extent of the security), liabilities under deposits to individuals and SMEs, liabilities under covered bonds and fiduciary arrangements, liabilities to employees, certain commercial or trade creditors, tax authorities, and deposit guarantee schemes and certain short-term liabilities to banks, investment firms, and EU-designated financial market utilities (FMUs). It will not apply where the competent authority is satisfied that the non-EEA jurisdiction in question recognises bail-in (rendering contractual recognition unnecessary). The European Banking Authority (EBA) is consulting on aspects of the requirements, which may result in pre-effective date liabilities being brought within the scope of the rule where the agreement governing them is amended.
The job ahead
To meet the requirement, affected firms will need to:
- identify all their in-scope non-EEA liabilities;
- locate the contract or other instrument governing each liability;
- determine whether to amend the governing law, introduce a recognition provision, or discontinue the arrangement so as not to incur new liabilities after the effective date of the requirement; and
- where appropriate, renegotiate or terminate the arrangement and (if required by the regulator) obtain an opinion confirming enforceability of the recognition clause.
If the EBA determines that pre-effective date liabilities should be brought within scope when the agreement governing them is amended, then firms will also need to put in place procedures to monitor contractual changes to ensure that recognition provisions are included whenever a relevant contract is amended.
For banks with significant non-EEA presences or exposures this may be a substantial exercise.
Beyond the practical challenges associated with the exercise, there will be commercial risks associated with the exercise. As has been well documented following the introduction of the ISDA Resolution Stays Protocol, a number of buy-side participants in the U.S. have vocally expressed opposition to being required to sign up to resolution in this way.1 It is unclear how the buy-side will react to requests to renegotiate contracts.
This issue is particularly exacerbated in the case of agreements with running balances, such as deposit arrangements and master agreements governing derivatives and securities financing activities. Any amendment to these will necessarily have to apply recognition to all liabilities under the agreement, rather than new liabilities incurred after the effective date. Market participants may wish to consider arrangements to run-off pre-effective date liabilities under the “old” master agreement and enter into a new agreement to capture post-effective date transactions, with a master netting arrangement between them, to preserve the counterparty’s rights in relation to pre-effective date liabilities while retaining the netting benefits associated with the relationship as a whole.
Europe’s reaction to the “too big to fail” issue
Further difficulties may be encountered in relation to FMUs. The BRRD does not exclude non-EEA financial market utilities from the recognition requirement. It seems highly unlikely that FMUs will rewrite their rules to accommodate the requirement. This may cast doubt on the ability of EU financial institutions to participate in non-EEA FMUs direct.
While the policy objectives of Article 55 are laudable in seeking to improve resolvability, there may be real ’first mover’ disadvantages in the EU introducing widespread recognition requirements before the rest of the world. We expect that implementation will be time-consuming, and may be controversial with larger buy-side market participants.