European Union: Bail Out The Sea Of Paper In Your In-Box – Understanding Article 55 Bail-In Clauses

From 1 January 2016, European Economic Area (EEA) member states are required to implement Article 55 of the European Union Bank Recovery and Resolution Directive (2014/59) (BRRD).

This compels certain EEA financial institutions to include language in applicable contracts acknowledging the possibility that the institution's liabilities may be subject to 'bail-in' - a process whereby the claims of a bank's shareholders and unsecured creditors are written down and/or converted into equity in order to protect the solvency of the financial institution and avoid a bail-out by the taxpayer.

The requirements and effect of Article 55 have caused confusion given the complexity of the legislation. This note addresses questions we have received in response to bail-in notices being received by some of our clients who are customers of financial institutions and seeks to answer some of the most common questions.

  1. I am located outside the EEA and keep receiving requests from banks in the EEA to sign 'bail-in clause' or 'Article 55' amendments to documents. What are these and why am I getting them now? From 1 January 2016,1 certain banks2 within EEA member states are required to include language in their contracts, acknowledging that their obligations and liabilities may be subject to 'bail-in'. The requirement to include such language only impacts contracts where their governing law is that of a non-EEA country. It essentially puts the bank's counterparties 'on notice' that the bank's liabilities may be the subject of bail-in by its national regulator.

    You are receiving these requests because the bank you are contracting with is affected by Article 55 and is now required to include bail-in clauses in its non-EEA law governed contracts.
  2. I am a borrower – I owe the money – why does the bank want to change the agreement? The requirement to include a bail-in clause extends to agreements where a bank has or may incur any potential liabilities. It captures not only contractual and non-contractual liabilities, but also future and contingent liabilities3. This means that a bank may even request that a bail-in clause be included in documentation where it has only an administrative role or in unilateral trade finance documents. You can expect to see requests to incorporate a bail-in clause in any non-EEA governed document which contain, for example, confidentiality provisions, indemnities, lending commitments, and inter-creditor provisions.

    You may also receive requests from banks to incorporate a bail-in clause in existing agreements. This will arise if that agreement is subject to a 'material' amendment or the liabilities within the agreement only arise on or after 1 January 20164.

    In its draft report on regulatory and technical standards, the European Banking Authority (EBA) defines a 'material amendment' as any amendment that affects the substantive rights and obligations of a party to a relevant agreement. A change to the contact details of a party or an automatic adjustment of interest rates would not constitute a material amendment
  3. If they are coming from the same piece of legislation, why is each bank's wording different? The BRRD is an EU Directive, and, as such, each EEA member state must implement it into its respective national law through appropriate legislation. (In the UK, the BRRD was implemented through amendments to the Banking Act 2009, among other legislation.) Each member state will therefore have slightly different bail-in legislation and each resolution authority will have slightly different 'write-down and conversion powers'. Ultimately, however, whatever legislation is adopted in each member state, they will all share a common goal.

    In its draft report on regulatory and technical standards on Article 55, the EBA has set out some minimum requirements that all bail-in clauses should contain. As there is no prescribed form of language, you can expect that 'standard' bail-in clauses may vary from jurisdiction to jurisdiction to align with the relevant legislation (but please note our answer to Question 7 below).
  4. If the requirement only applies to non-EEA law governed documents, why am I being asked to amend EEA law governed docs? It may be the case that a bank's lending commitments are governed by an EEA law governed facility, but its security or ancillary documents are governed by non-EEA law. In this instance, a bank may prefer to include the bail-in clause in its facility agreement and then incorporate the clause into its security documents by reference to the facility, or by applying it to all 'finance documents'; so in some instances there may be a good reason for a bail-in clause appearing in EEA law governed documents. Caution should be taken on incorporating clauses by reference, as this approach does not work in all jurisdictions.

    Some banks may also take the precautionary approach and incorporate a bail-in clause in all of their documents regardless of the governing law, to ease the administrative and compliance burden.

    Bail-in clauses will not be required in situations where the law of the particular non-EEA country would permit EEA resolution authorities to exercise their write down and conversion powers or, similarly, where there is a binding agreement or treaty in place between the EEA and non-EEA country permitting the same. That said, given the uncertainties surrounding Article 55, we would expect most banks to err on the side of caution when sending amendments out.
  5. What if I don't sign? What about existing arrangements? Can the bank terminate the agreement? A refusal to sign could result in the requesting bank walking away from the proposed agreement or seeking to have the governing law changed to that of an EEA country. Banks may face sanction by their regulatory body for failing to incorporate a bail-in clause, so it is unlikely that a bank's internal compliance team would permit the bank to enter into relevant contracts without one.

    As mentioned above, banks may request that a bail-in clause be incorporated into existing agreements where a material amendment is being (or is expected to be) made or a new liability may arise. In these circumstances, you may have more bargaining power to resist the incorporation of a bail-in clause. Unless there is a termination clause permitting termination on the basis of legal or regulatory changes, it is unlikely that a bank would be able to walk away from an existing agreement without breaching the agreement because you refuse to incorporate a bail-in provision. However, if you refuse to incorporate a bail-in clause, the resolution authorities will still have the power under the BRRD to bail-in in the absence of a bail-in clause, and the bank may refuse to deal with you in the future in light of your refusal.
  6. What about my hedging contracts? Article 77 of the BRRD provides a safeguard by requesting that EEA member states have appropriate protection for title transfer financial collateral arrangements and set-off and netting arrangements to: (i) prevent the transfer of some, but not all, of the rights and liabilities thereunder; and (ii) prevent the modification or termination of rights and liabilities protected thereunder. This ensures that the resolution authorities cannot 'cherry pick' certain contracts subject to netting and set-off when exercising the stabilisation tools conferred on them by the BRRD.

    In relation to exercising their write-down and conversion powers, Article 49 of the BRRD prescribes that resolution authorities shall only apply those powers to derivative transactions after they have closed out the derivative contract; with the resolution authorities being empowered to terminate and close out any derivative contract for that purpose. Certain derivative liabilities are excluded from the scope. The EBA has prepared draft guidelines for the valuation of derivative liabilities, with compensation being available where the resolution authorities have not bailed-in the transaction in the proper course.
  7. Will I be worse off if I sign up? No, provided that the proposed bail-in clause aligns with what is required under Article 55. As noted above, a resolution authority has the ability to bail-in an eligible liability regardless of whether the document governing that liability contains a bail-in clause. Further, the BRRD provides a safeguard at Articles 73-75, that no shareholder or creditor should be worse off following a bail-in than they would be if the institution had been wound up under normal insolvency proceedings in the relevant jurisdiction.

    Any shareholder or creditor that is worse off will be entitled to compensation from the resolution financing arrangements. In the UK, compensation will be calculated by an independent valuer. They will assess the treatment creditor/shareholders would have received had the bank been put into an insolvency process and the treatment they have received, are receiving or are likely to receive if no compensation (or further compensation) is paid. This valuation should be carried out as soon as possible after the resolution action has been effected.
  8. Will I be receiving anything else because of the BRRD? Under the BRRD, resolution authorities are able to impose temporary stays on the enforcement of security or the termination of contracts affected by a resolution. Unlike the contractual recognition of the bail-in power however, the BRRD does not impose a requirement that there should be a contractual recognition of temporary stays.

    The Financial Stability Board (FSB) has led a separate initiative, part of the result of which is the ISDA 2015 Universal Resolution Stay Protocol (Protocol). Parties that adhere to the Protocol (typically, large global banks) are opting to abide by the overseas national resolution regimes and agreeing to recognise, and be subject to, any stay. The requirement to recognise stays contractually will also be reflected in the PRA Rulebook. While only systemically important banks are expected to adhere to the Protocol, smaller institutions will have to comply with the PRA handbook.

    The Prudential Regulation Authority (PRA) released a policy statement in November on the contractual recognition of stays in respect of termination rights in financial contracts governed by non-EEA law. This indicated that the requirement to include a contractual recognition of stays would be effective from 1 June 2016 for counterparties that are credit institutions or investment firms. In addition, there will be a separate protocol, the ISDA Jurisdictional Modular Protocol, directed towards other types of counterparties to facilitate compliance with regulatory requirements for the contractual recognition of stays.


1. Article 55 was meant to come into force on 1 January 2016 and will do so in most (but not all) EEA jurisdictions. As of 13 January 2016, legislation has not yet been implemented in Czech Republic, Lithuania, Luxembourg, Poland, Romania, Sweden, Iceland, Liechtenstein or Norway.

2. Article 55 applies to entities described at Article 1(b)-(d) of the BRRD, which includes any EEA incorporated credit institution or investment affiliate, including holding companies, mixed financial holding companies and mixed activity holding companies. This will capture most large banks and financial institutions incorporated in the EEA, but may also catch smaller institutions if considered systemically important. EEA branches of non-EEA incorporated institutions are not covered by this requirement.

3. The requirement to include a bail-in provision will not apply to 'excluded liabilities', as defined in Article 44(2) of the BRRD. These exclusions include, among others, certain deposits, secured liabilities (to the extent the security is provided by the subject financial institution), fiduciary liabilities, short term liabilities (with an original maturity of less than seven days) and liabilities to employees and commercial and trade creditors providing goods or services critical to the daily functioning of its operations.

4. For more guidance, please see the draft regulatory technical standards published by the European Banking Authority on 3 July 2015.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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