The Bank Recovery and Resolution Directive (Directive 2014/59/EU) (BRRD) was introduced in light of concerns that insufficient tools and resources existed at EU-level to deal effectively with failing banks and investment firms, albeit many Member States, including Ireland, did have domestic resolution regimes in place. Given that the failure of a cross-border institution could severely affect the stability of the European financial markets, the BRRD was developed as a framework for resolving banks and large investment firms operating at both a national and cross-border level in the EU.
The BRRD has now been implemented into Irish law, and will supersede existing domestic resolution legislation where applicable.
This Briefing summarises the key aspects of the BRRD.
WHEN DID IT COME INTO FORCE?
The BRRD was due to be transposed by each Member State by 31 December 2014. It was transposed into Irish law by SI 289/2015 on 9 July 2015 (the Irish Regulations).
Not all Member States have yet transposed the BRRD, and in May 2015 the European Commission requested 11 Member States (not including Ireland, which had already demonstrated progress towards transposition by issuing a Consultation Paper in December 2014) transpose the BRRD or risk referral to the European Court of Justice.
WHAT ENTITIES DOES IT APPLY TO?
The BRRD applies to:
- banks;
- investment firms subject to the initial capital requirement in CRD IV; and
- certain other financial institutions and financial holding companies.
WHAT IS IT DESIGNED TO DO?
The BRRD:
- provides a framework for resolving failing banks and large investment firms;
- aims to reduce the use of taxpayer funds to rescue failing institutions, and eliminate (insofar as possible) the need for government-led bail-outs;
- enables authorities to intervene early to prevent the failure of an institution;
- enables authorities to take swift resolution action where a failure cannot be avoided; and
- facilitates cooperation between competent authorities across the EU.
AUTHORITIES
WHO IS THE COMPETENT AUTHORITY UNDER THE BRRD AND WHAT IS ITS ROLE?
The Central Bank of Ireland (CBI) was designated as the competent authority in Ireland under the Irish Regulations, save as regards the specific tasks conferred on the European Central Bank (ECB) as part of the Single Supervisory Mechanism, in which case the ECB will function as competent authority.
WHO IS THE RESOLUTION AUTHORITY AND WHAT IS ITS ROLE?
The Irish Regulations appoint the CBI as the resolution authority in Ireland for BRRD purposes. The Irish Regulations also require that the CBI publish internal rules (including rules on professional secrecy) on information exchanges between it as resolution authority and its other functional areas. These internal rules were published by the CBI on 17 August 2015 and are available here. The Irish Regulations also require structural separation and separate reporting lines for those CBI staff involved in the BRRD resolution authority function.
RECOVERY & RESOLUTION PLANNING
WHAT ARE RECOVERY PLANS AND WHEN ARE THEY REQUIRED?
Individual recovery plans
Each institution to which the BRRD applies must, where it is not part of a group that is subject to consolidated supervision under CRD IV, prepare a recovery plan setting out the measures that it would take if its financial position deteriorated significantly. That recovery plan must be updated each year, after any material structural change and on request from the relevant competent authority.
Such recovery plans must contemplate a range of stress-scenarios, and set out conditions and procedures to ensure that recovery options can be implemented quickly. Potential early intervention measures must also be included, together with options for recovery actions.
Recovery plans are subject to assessment by the competent authority, which can require revisions to the plan if deficiencies are identified. It is also open to the competent authority to direct an institution to take steps to reduce its risk profile, review its strategy and structure, change its governance structure, change its funding strategy and facilitate its timely recapitalisation.
Group recovery plans
Where a group is subject to consolidated supervision, the parent must submit a group recovery plan to the competent authority (and this can be circulated to other relevant competent authorities in other Member States). Group recovery plans must set out measures designed to stabilise the group, address or remove causes of the group's financial deterioration and restore the group's financial position. The group recovery plan must also, where applicable, include arrangements for the provision of intra-group financial support.
Group recovery plans are subject to assessment by the competent authority, and by other relevant competent authorities in other Member States (where, for example, the group has a significant branch).
WHAT ARE RESOLUTION PLANS AND WHEN ARE THEY REQUIRED?
The CBI, as resolution authority in Ireland, must prepare a resolution plan for each institution, following consultation with the competent authority and with the resolution authorities in other Member States in which the institution (or members of its group) has significant branches.
Each resolution plan will set out the actions that the CBI plans to take in the event that the institution in question meets the conditions for resolution (see below for details of these conditions).
Resolution plans must be updated by the CBI at least annually, and should contemplate scenarios where the institution fails due to a period of general financial instability, and also where the institution fails for institution-specific reasons. Resolution plans must (among other matters) also demonstrate how the institution's critical functions could be separated to ensure continuity on any failure of the institution, list any perceived impediments to the institution's resolvability, set out a process for determining how core functions could be transferred to a third party, set out how resolution options could be financed, analyse the resolution plan's impact on employees, and set the level of minimum requirement for own funds and eligible liabilities if the bail-in tool is used (further detail on the bail-in tool is set out later in this Briefing).
HOW IS RESOLVABILITY ASSESSED?
In conjunction with the development of resolution plans, the CBI must also assess whether an institution is resolvable (following consultation with other relevant resolution authorities and with the competent authority for the relevant institution). That assessment must be made having regard to, at a minimum, the matters set out in Part 3 of the Schedule to the Irish Regulations. If the CBI's assessment is that an institution is not resolvable, it must notify the European Banking Authority (EBA).
EARLY INTERVENTION (WHERE THERE IS A (POSSIBLE) BREACH OF PRUDENTIAL REQUIREMENTS)
WHAT ARE EARLY INTERVENTION MEASURES?
Early intervention measures are steps that the competent authority may take if an institution has breached, or is likely to breach, certain prudential requirements. Possible breaches could include a reduction in own funds, deteriorating liquidity, increased leverage, increased non-performing loans or an increased concentration of exposures. Early intervention measures may include:
- implementation of one or more measures from the institution's recovery plan;
- directing the institution or its management body to develop an action programme;
- directing the institution to convene a shareholders' meeting (the competent authority can directly convene the meeting if the institution fails to do so);
- directing the institution or its management body to draw up a plan for renegotiating/restructuring its debt;
- directing the institution to change its business strategy, legal structure or operational structure.
Where the above (and similar) measures are not regarded by the competent authority as sufficient to remedy the financial deterioration of the institution, the BRRD contains detailed provisions enabling the competent authority to remove senior management and to appoint a temporary administrator (on foot of an ex parte Court application for a temporary administration order).
IS INTRA-GROUP FINANCIAL SUPPORT PERMITTED?
Where a group member meets the conditions for early intervention, the BRRD also permits group entities to provide intra-group financial support in the form of loans, guarantees, the provision of assets for use as collateral or a combination of the foregoing. The intention behind this is to facilitate the stabilisation of the group (without adversely affecting the liquidity or solvency of the group entity providing the support).
RESOLUTION (WHERE THE INSTITUTION IS FAILING OR LIKELY TO FAIL)
WHAT CONDITIONS DETERMINE IF RESOLUTION IS NECESSARY?
The following conditions must be met for resolution of an institution to be regarded as necessary:
- the competent authority, having consulted with the CBI as resolution authority, must have determined that the institution is likely to fail. This may be because the institution has breached, or is expected to breach, its authorisation requirements on a scale likely to result in its authorisation being withdrawn, it is or is likely to become balance sheet insolvent, it is or is likely to become cash flow insolvent (a requirement for emergency liquidity assistance from the CBI should not, of itself, trigger this condition), or extraordinary public financial support is required;
- there must be no reasonable prospect of an alternative private sector measure (i.e. a sale to, or merger with, a private sector purchaser) which could remedy the situation;
- resolution must be necessary in the public interest (and it must be the case that a normal winding up could not ensure the continuity of important functions, the protection of public funds, depositors, client assets or client funds, or avoid a significant adverse effect on the financial system); and
- the Minister for Finance must be informed.
WHAT PRINCIPLES GOVERN RESOLUTION?
If the CBI as resolution authority intends to use one of the resolution tools at its disposal, any measures that it takes must have regard to certain overriding principles as follows:
- first losses are to be borne by shareholders, followed by creditors. Creditor losses are to be borne in line with the order of priority that would apply in a normal insolvency, and creditors of the same class are to be treated equitably (unless otherwise provided by the Irish Regulations). Creditors are not to incur losses greater than what they would have incurred in a normal insolvency;
- the management body and senior management must be replaced unless retention of one or more of those persons is necessary to achieve resolution;
- persons are to be made liable for any responsibility for the institution's failure; and
- covered deposits must be protected.
Before the CBI takes action, it must arrange an independent valuation of the institution's asset and liabilities. A provisional valuation is allowed in urgent cases where there may not be time to arrange a full independent valuation.
WHAT RESOLUTION TOOLS ARE AVAILABLE?
Four resolution tools are available (the sale of business tool, the bridge institution tool, the asset separation tool, and the bail-in tool), and they can be exercised individually or on a combined basis.
WHAT ORDERS CAN BE MADE/MUST BE MADE?
"Capital instruments order"
The CBI can apply to Court for a "capital instruments order" to write-down or convert relevant capital instruments into shares or other instruments of ownership in respect of an institution that requires resolution.
"Resolution order"
To avail of one of the four resolution tools detailed below, the CBI must make a "proposed resolution order" and then make an ex parte application to Court for a "resolution order". The institution itself, a shareholder, or the holder of a capital instrument or liability affected by a resolution order may apply to Court, within 48 hours of publication of the order, for the order to be set aside.
The resolution order may provide for (among other matters) the transfer of shares, assets and liabilities, the reduction of principal under a capital instrument or in respect of eligible liabilities (or their conversion into shares), the cancellation of debt instruments (other than secured liabilities), the close out or termination of financial contracts, and the removal and replacement of management by a special manager.
During the period of the resolution order, the rights of shareholders may be suspended.
HOW DO THE FOUR RESOLUTION TOOLS WORK?
Sale of business tool
A resolution order can transfer shares issued by the institution, and/or assets, rights and liabilities of that institution, to a purchaser (which cannot be a bridge institution). Neither shareholder nor third party consent is needed, and procedural requirements under company law or securities law do not need to be met (save as expressly set out in the Irish Regulations). The transfer must be on commercial terms. Where only some of the assets and liabilities are sold, the residual entity will be wound up.
Bridge institution tool
A resolution order can transfer shares issued by the institution, and/or assets, rights and liabilities of that institution, to a bridge institution. Again, neither shareholder nor third party consent is needed, and procedural requirements under company law or securities law do not need to be met. Where only some of the assets and liabilities are transferred, the residual entity will be wound up. A bridge institution would be established by the CBI under the Companies Act 2014, and would be wholly or partially owned by public authorities (which could include the CBI).
Asset separation tool
A resolution order may transfer all or any rights, assets or liabilities of an institution under resolution, or a bridge institution, to one or more asset management vehicles. Again, neither shareholder nor third party consent is needed, and procedural requirements under company law or securities law do not need to be met. The relevant asset management vehicle may be the subject of directions from the CBI, and must manage the assets with a view to maximising their value by selling them or winding them down.
Bail-in tool (not available until 1 January 2016)
The CBI may use the bail-in tool to recapitalise an institution which meets the conditions for resolution, or to convert to equity or write down the principal amount of claims or debt instruments that are transferred under the bridge institution tool, the sale of business tool or the asset separation tool.
Certain liabilities cannot be the subject of the bail-in tool. These are covered deposits (only as regards the amount actually covered – any excess may be bailed-in), covered bonds, liabilities used for hedging purposes which are secured in a manner similar to covered bonds, liabilities arising by virtue of the institution holding client monies or client assets, liabilities deriving from the institution acting as a fiduciary, liabilities to other institutions with a maturity of less than 7 days, certain liabilities to employees, liabilities to deposit guarantee schemes, preferred debts owing to the Revenue Commissioners or the Minister for Social Protection, liabilities to commercial or trade creditors in respect of goods and services that are critical to the institution's daily functioning, liabilities arising from client monies or client financial instruments where the institution is an investment firm, and liabilities to systems designated under the Settlement Finality Directive. Secured assets related to a covered bond pool cannot be the subject of a bail-in, and must be kept segregated with sufficient funding. In limited circumstances, where any secured liability in respect of a covered bond pool exceeds the value of the collateral secured, the excess part of the secured liability may be the subject of a bail-in.
From 1 January 2016 onwards, when an institution enters into an agreement in respect of liabilities or relevant capital instruments governed by the laws of a non-EU country, that institution must procure the inclusion in that agreement of a contractual term noting that the liability or instrument may be subject to write-down and conversion powers under the BRRD.
HOW WILL RESOLUTION BE FUNDED?
The Bank and Investment Firm Resolution Fund (the Irish Fund) was established under the Irish Regulations, and will be administered by the CBI. The CBI may use the Irish Fund in connection with the application of resolution tools, and it will be financed by annual contributions from all institutions authorised in the State (and branches of EU institutions operating in the State). The CBI has the ability to prescribe the level of annual contribution. If the Irish Fund is insufficient, the CBI is empowered to raise extraordinary contributions from those institutions (subject to a cap of 3 times the annual contribution target set for those institutions) and also to raise funds from other institutions and third parties (i.e. by way of debt).
This funding arrangement will change slightly when the Single Resolution Mechanism becomes effective on 1 January 2016 – the contributions raised by the CBI will instead be transferred to the Single Resolution Fund, rather than the Irish Fund.
ARE THERE RESTRICTIONS ON, OR PROTECTIONS FOR, CREDITORS AND COUNTERPARTIES?
Temporary restrictions may be imposed on creditors and counterparties, as part of the resolution framework, as regards exercising termination rights and enforcing security.
However, certain protections are also available under BRRD, including the following:
- the carrying out of a valuation to determine whether a shareholder or creditor incurred, as part of a resolution tool, losses greater than they would have incurred had the institution entered normal insolvency proceedings, with compensation payable if that is the case;
- in respect of modified contracts or partial property transfers:
- a restriction on a partial transfer of rights and liabilities under set-off, netting or title transfer financial collateral arrangements (either all or none may be transferred);
- where liabilities are secured under a security arrangement, everything must be transferred together, i.e. the assets, the liability and the benefit of the security;
- a partial property transfer cannot facilitate the transfer of some but not all of the assets, rights and liabilities which form part of a structured finance deal;
- there are also protections for trading, clearing and settlement systems in the case of partial transfers.
LEVEL 2 MEASURES
HOW ARE LEVEL 2 MEASURES PROGRESSING?
The BRRD requires the preparation, by the EBA, of a number of binding guidelines, together with regulatory technical standards (RTS) and implementing technical standards (ITS) which will form the basis of delegated regulations to be adopted by the European Commission.
Guidelines finalised by the EBA relate to the range of scenarios to be used in recovery plans; the minimum list of qualitative and quantitative recovery plan indicators; the specification of measures to reduce or remove impediments to resolvability; triggers for early intervention measures; tests, reviews and exercises that may lead to extraordinary public support measures; and how to interpret circumstances where an institution is failing or likely to fail.
RTS and ITS finalised to date (and awaiting publication as Commission Delegated Regulations) cover matters including the content and assessment of recovery plans and resolution plans; resolvability assessments; how information is to be provided for resolution plans; independent valuations; and the minimum requirement for own funds and eligible liabilities.
CONCLUSION
Banks that are subject to the BRRD regime are no longer subject to the existing Irish resolution regime under the Central Bank and Credit Institutions (Resolution) Act 2011 (the Resolution Act) (save for Part 7 of the Resolution Act, which deals with the liquidation of "designated credit institutions" (i.e. banks, building societies and credit unions)). Credit unions will continue to be subject to the Resolution Act as they are not subject to the BRRD regime.
The transposition of the BRRD by way of the Irish Regulations requires institutions, competent authorities and the CBI to actively continue to invest time and resources in developing, assessing and finalising recovery and resolution plans, and assessing resolvability. Further practical guidance will become available as Level 2 measures are developed and finalised, and we will be issuing further briefings as these Level 2 measures develop to highlight key aspects of those measures for institutions subject to the Irish BRRD regime.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.