European Union: Banks Must Keep Records Of Financial Contracts Under New Recovery And Resolution Rules

Last Updated: 19 October 2016
Article by Mariken van Loopik, Francine Schlingmann, Daniëlle Pos and Maurits Ter Haar

Most Read Contributor in Netherlands, November 2016

On 14 October 2016, new rules supplementing the Bank Recovery and Resolution Directive will come into force aimed at helping resolution authorities to effectively and efficiently apply resolution tools and powers to a failing bank. Many, mainly larger, banks and certain investment firms will have to keep available and maintain a minimum set of information on financial contracts. In this way, information can quickly be made available to the resolution authority when it needs this to take informed resolution decisions.

In drafting the new rules, the European Banking Authority (EBA) has aimed for maximum consistency with existing recordkeeping and reporting requirements, in particular under EMIR. This can greatly facilitate compliance with the new rules. However, the new rules extend to a broader category of contracts and require the collection of additional, BRRD-specific, information. The new rules are therefore still likely to require significant changes to banks' data recording processes and IT infrastructure. In addition, the new information fields may require in-depth analysis of documentation. The new rules also leave considerable discretion to resolution authorities, in particular in determining which banks should apply the rules, in addition to those automatically subject to the rules; which additional information fields may be required; and whether banks will be allowed an adequate phase-in period for compliance.

Background

The EU bank recovery and resolution framework

The Bank Recovery and Resolution Directive (BRRD) is part of the new EU bank recovery and resolution framework. This regime has been set up for the orderly resolution of failing banks (and investment firms) and should ensure that a failing bank's critical functions continue, that financial stability is preserved and that the burden of the failing of a bank is shifted from the taxpayer to a bank's shareholders and creditors (from bail-out to bail-in). In addition to the BRRD, the Single Resolution Mechanism Regulation (SRMR) and the Intergovernmental agreement on the Single Resolution Fund (IGA) are this regime's main pieces of legislation.

Under the BRRD, when it becomes clear that a bank is no longer viable and the conditions for resolution are met, a resolution authority can decide that the bank is to enter into resolution with the aim to resolve the bank in an orderly manner and ensure the continuity of its critical functions. A resolution authority has four resolution tools available: the sale of business tool, the bridge institution tool, the asset separation tool and the bail-in tool. In a recent In context article, we discussed the MREL requirement, which is related to the bail-in tool.

The power to temporarily suspend termination rights

To properly apply these resolution tools, the BRRD grants resolution authorities a number of resolution powers. One of these resolution powers is the right to impose temporary restrictions on termination rights ("temporary stays") of any party to a financial contract with the bank under resolution. This gives resolution authorities sufficient time to carry out the resolution tools (during the "resolution weekend") without parties that do business with the bank pulling out from their contracts.

The suspension of termination rights lasts from publication of the resolution order to midnight at the end of the following business day and is only allowed when the bank continues to perform its payment and delivery obligations, and provide collateral. The type of termination rights which can be suspended is broad and includes rights to terminate a contract, rights to accelerate, close out, set-off or net obligations, or any similar provision that modifies an obligation of a party to the contract or prevents an obligation under the contract, that would otherwise arise, from arising. As statutory powers under the BRRD cannot always be exercised with regard to contracts subject to third country (this is a non-EU country's) law, resolution authorities can require such contracts to include contractual resolution stay provisions. In close coordination with various parties, the International Swaps and Derivatives Association (ISDA) has developed the 2016 ISDA resolution stay modular protocol to aid banks in complying with such obligations.

The new rules on the minimum set of detailed information on financial contracts

For resolution authorities to effectively and efficiently exercise the power to suspend termination rights and to take informed decisions on the application of resolution tools, they need to have easy and swift access to information on financial contracts. For this reason, competent authorities and resolution authorities may require a bank to collect and maintain detailed records of financial contracts in advance, which can be made available to the authorities upon request. The minimum set of information to be maintained and the circumstances in which this requirement should be imposed has now been further specified by means of Regulatory Technical Standards (RTS) in Delegated Regulation (EU) 2016/1712, published in the Official Journal of the EU on 24 September 2016 and entering into force on 14 October 2016.

Banks in scope of the requirement

Under the new rules, the resolution authority must impose the requirement to maintain detailed records on all banks that have a group resolution plan which foresees the taking of resolution actions. This group will include most larger banks. In order to ensure proportionality and avoid unnecessary additional burdens, the new rules do not automatically apply to the, generally smaller, banks whose resolution plan foresees that upon failure, they would be put into regular bankruptcy instead of resolution. However, this does not mean that smaller banks are off the hook. Competent authorities and resolution authorities may, at their discretion, decide to impose the same rules to any bank when considered necessary to ensure comprehensive and effective planning.

Contracts in scope of the requirement

The new requirement applies to all of a bank's financial contracts as defined in the BRRD. The scope of this definition is particularly broad and includes the following contracts:

  • securities contracts, including for sale, purchase, loan, options and repos;
  • commodities contracts, including for sale, purchase, loan, options and repos;
  • futures and forward contracts;
  • swap agreements, including relating to interest rates, foreign exchange, an equity or debt index and debt or equity and including total return, credit spread or credit swaps;
  • inter-bank borrowing agreements with a term of up to three months; and
  • master agreements for any of the abovementioned agreements.

Required minimum set of information

The minimum set of information required under the new rules consists of 43 information fields. This includes, first of all, general information on the identity of the counterparties, the value of the contract, its collateralisation and whether it is cleared by a central counterparty (CCP). Second, the new rules unsurprisingly also require certain BRRD-specific information, information which is specifically important for resolution purposes, to be maintained. This includes information on:

  • contractual recognition: whether, in case of contracts governed by the law of a third country, contractual recognition has been included for (i) write down and conversion powers (bail-in), (ii) suspension of termination rights, (iii) other resolution powers;
  • core business lines: identification of the core business line or core business lines to which the financial contract relates;
  • termination rights: whether the other counterparty's termination rights under the financial contract are based on the insolvency or financial condition of the institution under resolution; and
  • type of liability/claim: whether or not liabilities arising from the financial contract are (partially) excluded from bail-in pursuant to relevant rules under the BRRD.

The new rules, however, merely specify the minimum set of information to be maintained. Competent authorities and resolution authorities may require additional information to be recorded where they consider this necessary to ensure that resolution powers can be applied effectively. Conversely, where an information field is not applicable to a certain type of financial contract and the bank can demonstrate this, this information field is excluded from the requirement for that type of contract. As the information fields have been largely written with derivatives in mind and do not distinguish between the various types of financial contracts, this is particularly relevant for financial contracts for the outright sale and purchase of securities or for interbank borrowing, for which a large number of information fields are not relevant.

Consistency and overlap with existing recordkeeping and reporting obligations

Recordkeeping and reporting obligations already exist for a variety of financial contracts. EBA, which has prepared the new rules, has indicated that in view of the availability of data under the existing rules on recordkeeping and reporting, the additional burden on banks should be limited. EBA has taken great care to minimise the additional burden on banks by ensuring consistency of the information requirements with other obligations, in particular those under EMIR. This consistency helps to mitigate the additional compliance burden. However, a number of the information fields, especially those related to the necessity and possibility of the application of resolution powers, are new and are expected to require significant compliance costs and efforts from banks.

EMIR

Under Regulation No 648/2012 on OTC derivative transactions, central counterparties and trade repositories (EMIR), counterparties to derivatives contracts are required to keep records and report information on derivatives transactions to trade repositories on derivatives contracts. The reporting obligation is further specified in Delegated Regulation (EU) No 148/2013 supplementing EMIR with regard to RTS on the minimum details of the data to be reported to trade repositories and Implementing Regulation (EU) No 1247/2012 laying down ITS with regard to the format and frequency of trade reports to trade repositories. These RTS and ITS are currently being revised (see ESMA's final report on review of the EMIR reporting RTS and ITS).

In principle, all derivative contracts in the scope of EMIR also fall within the scope of the new rules. As mentioned above, EBA has taken care in drafting the RTS to ensure consistency with the information required under the EMIR RTS (including its proposed amendments) so as to reduce the compliance burden for banks. As a result, the new rules largely use the same language and structure and the obligation to maintain most of the data already exists. However, the new BRRD rules extend to additional BRRD-specific information which will need to be collected.

SFTR

Under Regulation (EU) 2015/2365 on transparency of securities financing transactions and of reuse (SFTR), counterparties to securities financing transactions (SFTs) are required to keep records and report information on SFT transactions to trade repositories. The reporting obligation has yet to enter into force and the European Securities and Markets Authority (ESMA) is currently developing RTS further specifying the reporting obligation. After receiving feedback on its discussion paper on these RTS published in March 2016, the ESMA published its consultation document on the RTS on 30 September 2016. The RTS are expected to become applicable from 2018.

SFTRs, which includes repos, securities lending and margin lending transactions, are in principle all covered by the new rules. In developing the new rules, EBA was not able to take into account the SFTR as at the time, negotiations of its level 1 text were taking place. The SFTR reporting obligation itself is modelled on EMIR, as a result of which to the extent possible the required information will correspond to the information to be maintained under the new BRRD rules. Again, however, the records must now include the additional BRRD-specific information.

MiFIR

As of 3 January 2018 the Markets in Financial Instruments Directive (MiFID II) and the Regulation on markets in financial instruments and amending EMIR (EU) (No 600/2014) (MiFIR), will become applicable. MiFIR contains the obligation to maintain records and to report most transactions in financial instruments to competent authorities. This replaces the current reporting obligations under MiFID I which are narrower in scope. On 28 July 2016, the European Commission adopted the RTS under Article 26 of the MiFIR relating to the obligation to report transactions together with its draft Annexes.

The MiFIR reporting obligation will apply to nearly all transactions in financial instruments, including the sale and purchase of securities and the conclusion of derivatives contracts. However, SFTs under the scope of the SFTR are excluded and transactions already reported under EMIR need not also be reported under MiFIR. The information fields proposed under MiFIR, focused as it is on trading data, differ substantially from those under the new rules. That said, apart from the BRRD-specific information fields, for financial contracts under its scope, most information should be available from MiFIR reports.

MMSR

Under Regulation No 1333/2014 of the European Central Bank (ECB) concerning statistics on the money markets (MMSR) a number of banks need to report statistical data on money market transactions to the ECB or the relevant national central bank, in order for statistics to be produced by the ECB and the national central banks on the money markets.

Under the MMSR banks need to report on transactions in money market instruments (repos, lending and borrowing and foreign exchange and overnight index swaps, all with maturity of up to a year) with financial counterparties and certain non-financial wholesale counterparties. Again, there is substantial overlap with the scope of the new rules. The information to be reported under the MMSR also to a large extent corresponds to the information to be maintained under the new BRRD rules.

Conclusion

As of 14 October 2016 new rules will become applicable under the BRRD requiring many banks (and certain investment firms) to keep detailed records of financial contracts. This should ensure the quick availability of this information to resolution authorities when necessary for making informed resolution decision. Our key takeaways on the burden of compliance with these new rules are as follows:

  • In drafting the rules, EBA has aimed to strike a proportionate balance by only automatically applying the rules to larger banks, those whose resolution plan foresees the taking of resolution actions in case of failure. As other banks are less likely to be resolved, and would instead be expected to enter regular bankruptcy upon failure, extending the requirement to those banks was considered disproportionate.
  • EBA has striven to further mitigate the burden of compliance by ensuring consistency, to the extent possible, with already existing recordkeeping and reporting obligations, in particular those under EMIR. As derivatives and SFTs form a substantial part of the financial contracts category to which the new rules apply, information already collected under EMIR and soon the SFTR will significantly aid in limiting compliance costs. There is also overlap with reporting obligations under MiFIR and the MMSR. As the new rules do not specify the format in which the information is to be recorded, banks can also continue to do so in accordance with their existing practices.
  • Despite the above, the new rules have a different objective from existing transaction reporting requirements. They therefore are not merely a duplication of existing rules but require additional BRRD-specific information to be collected. It is expected that these new information requirements will still require significant changes to banks' data recording processes and IT infrastructure. Furthermore, these information fields require the mining and monitoring of a number of sources, including master agreements, protocols, individual trades or agreements, and counterparties and in particular the "termination rights" and "type of liability/claim" information fields may require in-depth analysis of documentation.
  • Finally, the new rules leave a lot to the discretion of resolution authorities, in particular which additional banks should apply the rules and which additional information fields may be required. The authorities also have the discretion as relates to the phase-in period. Although the new rules do not foresee a generally applicable phase-in period, resolution authorities are expected to take into account, when imposing the requirement set out in the rules on individual banks, the period considered necessary for compliance. However, this cannot be guaranteed and banks expected to fall within the scope of the rules are advised to start planning for their own compliance and not wait for actions by resolution authorities.

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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