The EU's bank Recovery and Resolution Directive (BRRD) gives EU resolution authorities wide-ranging and potentially very invasive powers to mandate changes to banks' legal, operational and financial structures in order to improve resolvability, powers which allow resolution authorities a significant amount of discretion. In the wake of the recent announcements from the US FDIC and Federal Reserve, in which they expressed their dissatisfaction with the current state of large banks' resolution planning in the US, it would also appear that the resolvability hurdle may be higher than previously anticipated. Ensuring that banks are resolvable has been high on the policy agenda for several years, but the practical work needed to achieve this looks set to move forward in earnest over the next year.

Resolvability in practice

There is ongoing debate as to what makes a bank 'resolvable' and what action authorities should take to ensure banks have those characteristics. The Financial Stability Board will likely publish further updates on progress to address 'too big to fail' around the G20 meeting in Brisbane on 20 November, but intermediate results of its Resolvability Assessment Process have not been promised until early 2015. How resolvability will be treated in practice is otherwise largely an open question.

Against this backdrop, the EBA's draft guidelines on the use of specific BRRD powers to remove impediments to resolvability are significant, as the guidelines elaborate on the circumstances in which such powers should be used.

In general the focus is on reducing complexity, in order to simplify the task of separation in resolution. For example, firms with an operating structure that lends itself to a multiple points of entry resolution strategy may be required to reorganise legal entities along regional lines, or in line with critical functions. They may also see restrictions on cross-entity booking, and entities which will be resolved separately could be forced to have more standalone booking and risk management structures. Firms better suited to a single point of entry strategy may be required to ensure that non-critical business lines are separable (and therefore saleable if the resolution strategy requires their sale), which the EBA says in practice may mean requiring branches outside the EU to convert to subsidiaries, or to internally segregate their functions and business lines.

Of particular note is a power to require the EU operations of a non-EU headquartered bank to sit under an EU holding company. US authorities are already requiring a number of foreign banks to set up US intermediate holding companies to cover their US operations, but it is generally less well known that EU authorities are granted a similar, although much more discretionary, power through the BRRD, which they could apply to US or other non-EU banks. The EBA guidance says this power could be used where it is not feasible or credible to resolve the EU part of a non-EU bank due to the absence of an EU parent company, particularly if there is significant branch activity in the EU, or if debt issuance at the parent company level is required to provide enough loss absorbency for the EU part of the group. The use of this power may push further cross-border fragmentation of resolution, and non-EU banks with significant EU operations need to be aware of its existence.

One significant issue which is touched on only briefly is banks' information and data capabilities. Despite their central importance in any resolution process, little has been said publicly about expectations in this area. Resolution authorities can impose information requirements on a regular or ad hoc basis, including in relation to data that would be needed to support a credible valuation in resolution. While the EBA notes that banks' systems should be made to be capable of providing "all the data needed", further elaboration of the authorities' expectations would surely be welcomed by industry.

Proportionality

Authorities do need to have regard to proportionality before using these powers – regulatory action should be demonstrated to be the least intrusive measure necessary to "materially" reduce a "substantive" impediment. But there still needs to be a debate on how high to set the bar in general. Recent comments from US regulators to the effect that banks may be pushed to be more "bankruptcy compliant" suggest that at least in some quarters, the bar is very high. The question is: how resolvable is resolvable enough?
The links with other structural reform proposals are also clearly important, as any powers which affect legal, operation and financial structures will need to be reconciled with rules requiring the separation of retail and trading businesses. But it is potentially years before the shape of EU rules in this area become clear. The pragmatic solution would be for resolution authorities to wait and see what emerges from structural reform proposals before imposing any additional structural change, and indeed the EBA guidance makes clear that if structural reform rules are not deemed sufficient to ensure resolvability, resolution authorities should consider applying additional measures. This suggests that banks would do well to give resolvability considerations high importance within their structural reform plans.

What next?

Resolvability assessments will take place at least annually, in line with resolution planning, implying that the first EU resolvability assessments will be conducted in 2015. Clearly, global systemically important banks will already be engaging with the FSB's Resolvability Assessment Process, about which we will hear more early next year.

While the discretion provided for in this complex area is better than hard-wired rules, it leaves uncertainty over how resolution authorities will interpret the powers and the guidelines.  The way through this is early, constructive engagement between banks and resolution authorities.

But for banks falling under the eurozone Banking Union this means engagement with the new Single Resolution Board, adding a further element of uncertainty into the mix; its personnel have not yet even been appointed, let alone aired their views on resolvability.

In the meantime, banks should engage with the consultation (which is open until 9 October) push for more clarity and certainty where they think it's needed, and pay particular attention to the safeguards, including the proportionality principle.

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