Ensuring The Resolvability Of Banking Groups

I. Background

The lessons learned from the recent financial crisis have prompted the European legislator to introduce minimum standards for the resolution of credit institutions (recital 1 and 10 BRRD). In contrast to normal insolvency proceedings, an effective (and credible!) resolution regime could help to reduce the negative impact of an institution's failure on financial market stability, the real economy and taxpayers.

The core of a functioning resolution regime is the resolvability of failing banks. Since the resolvability does not already exist by nature, both regulatory requirements (BRRD including Level II and III Acts) and intensive supervisory intervention are required in certain cases. As these interventions significantly affect the freedom to carry on a business² and the right to property,³ the relevant determinants for the activities of the resolution authorities ensuring this kind of resolvability have to be discussed.

II. Legal bases

The provisions on resolvability can be found in Title II Chapter II (incl annex Section C) of the BRRD, which is implemented by Sections 27 to 31 of the Austrian Federal Act on the Recovery and Resolution of Banks (BaSAG). Of increased importance are also art 23 et seq of the Delegated Regulation (EU) 2016/1075⁴ (»Assessment of resolvability«) and the EBA/GL/2014/11.⁵ For the euro zone, the provisions of the SRM-Regulation⁶ have to be considered too.⁷

III. Overview

The BRRD essentially includes three interrelated procedure steps to ensure the resolvability of a banking group:

Assessment of the resolvability (hereinafter Chapters IV and V);
Removal of major impediments to the resolvability (Chapters VI and VII);
Detailed description⁸ of the resolvability in the group resolution plan (Chapter VIII).⁹

In order to make this complex subject area more comprehensible, the individual steps are presented separately. However, the most important networks and spillovers to other steps are pointed out in each case. This perspective is important for the presentation of the intervention determinants in chapters IX and X.

IV. The concept of resolvability

The concept of resolvability is set out in art 15 and 16 of the BRRD. According to art 16 para 1 second subparagraph BRRD, a group (art 2 para 1 no 26 BRRD) is to be regarded as resolvable

»if it is feasible and credible for the resolution authorities to either wind up group entities under normal insolvency proceedings or to resolve group entities by applying resolution tools and powers to group entities while avoiding to the maximum extent possible any significant adverse effect on the financial system, including in circumstances of broader financial instability or system wide events, of the Member States in which group entities are established, or other Member States or the Union and with a view to ensuring the continuity of critical functions carried out by the group entities, where they can be easily separated in a timely manner or by other means.«

Resolvability is therefore not an objective, but a subjective condition.¹⁰ The competent resolution authority decides solely and exclusively, if the bank is resolvable (taking into account the facts set out in Section C of annex C and, if applicable, art 88 BRRD) or not. In this context, the cumulative elements of the feasibility and credibility of the resolution regime are of elementary relevance.¹¹ While feasibility is based on the effectiveness the resolution tools in order to achieve the resolution aims (see appendix Section C no 21 BRRD), the term credibility refers in particular to the »possible impacts on creditors, counterparties, customers and employees and possible actions that third-country authorities may take« (appendix Section C no 24 BRRD).

By definition (but systematically irritating) » resolvability « does not only include the application of resolution instruments according to the BRRD, but also ordinary insolvency proceedings (art 2 para 1 no 47 BRRD).^{12, 13} In the spirit of the BRRD, liquidation through ordinary insolvency proceedings is always regarded as an alternative to the use of resolution tools (cf art 26 Delegated Regulation 2016/1075). If a banking group is actually put under resolution, it is a question of the public interest according to art 32 para 1 lit c BRRD. It is not a question of its resolvability. Indeed the definition of »resolvability« thus does not primarily aim at the use of resolution tools (art 2 para 19 BRRD), but at reducing adverse effects on other market participants (e.g. through the uncontrolled cessation of critical functions in accordance with art 2 para 1 no 35 BRRD) and the system (cf art 2 para 1 no 30 BRRD) as such (purpose). The term »resolvability« therefore does not correspond fully with the objectives of resolution according to art 31 para 2 BRRD, which ultimately requires the use of resolution tools or powers (art 31 para 1 BRRD).¹⁴

In essence, resolvability therefore only exists if, from the point of view of the resolution authority, the liquidation or the resolution of a banking group does not result in any significant adverse effects on the financial market¹⁵

If there is no possibility to resolve the bank, the resolution authority shall remove the impediments responsible for this (cf art 17 and 18 BRRD; see below), provided this is compatible with the principle of proportionality (art 17 para 6 lit b BRRD in conjunction with art 21 CFR; see below).

As already mentioned above, »resolvability« does not necessarily mean that the banking group will actually be put under resolution in the event of failure.¹⁶ »Resolvability« is thus only an indication for public interest (art 32 para 1 lit c BRRD).¹⁷

It is worth noting that the European legislator never directly assumes a scenario in which the resolvability of an institution or a group could not ultimately be established (cf also art 23 para 3 Delegated Regulation 2016/1075).¹⁸ Consequently – but nevertheless counterintuitively – the resolvability is therefore not a direct normative factor for the resolution or use of resolution tools (cf art 32 BRRD).¹⁹ Indirectly, however, the resolvability, albeit not equal, is required within the framework of the of the public interest test (art 32 para 5 BRRD).

Conversely, the European legislator thus assumes that any significant impediment to ensuring the resolvability can be eliminated either by the group itself (art 17 para 3 and art 18 para 3 BRRD) or by alternative measures by the resolution authority (art 17 para 4 and art 18 para 4 BRRD) – without a public bail-out or comparable tools.

V. Assessment of resolvability

The resolution authorities shall assess the resolvability when drawing the group resolution plan at the latest (art 12 para 4; see below).

The resolution authorities shall comply with the following testing stages when assessing the resolvability (art 23 para 1 of the Delegated Regulation 2016/1075):

Assessment of feasibility and credibility of liquidation of the institution or group under normal insolvency proceedings (art 24 of the Delegated Regulation 2016/1075);
Selection of a preferred resolution strategy for the assessment (art 25 of the Delegated Regulation 2016/1075);
Assessment of feasibility of the selected resolution strategy (art 26 to 31 of the Delegated Regulation 2016/1075);
Assessment of credibility of the selected resolution strategy (art 32 of the Delegated Regulation 2016/1075).²⁰

Lit a (art 24 of the Delegated Regulation 2016/1075) projects the general conditions for resolution and its principles, according to which no creditors shall incur greater losses by using the resolution tools than would have been incurred if the institution or entity had been wound up under normal insolvency proceedings (art 34 para 1 lit g BRRD).²¹ This first testing stage is consistent and emphasises the alternative character of the recovery regime (cf also art 32 para 5 BRRD).

Lit b requires the resolution authorities to define a resolution approach in principle (see below). This stage thus narrows the perspective of group resolution planning and allows a stronger focus on the activities that are absolutely necessary to ensure resolvability (cf art 25 of the Delegated Regulation 2016/1075).

The implementation of the third (lit c) and fourth (lit d) testing stage appears to be extremely complex and challenging for the resolution authorities. Accordingly, they have to analyse a large number of legally determined sub-aspects in order to qualify a banking group as resolvable (positive demarcation).

Thus, art 16 para 2 (in conjunction with annex Section C of the BRRD) requires the assessment of (group) internal control aspects and procedures (no 1 to 12), the assessment of internal and external financial support agreements (no 13 to 15 and 17) as well as the analysis of the complexity of the group (no 16), special cross-border aspects (no 20, 23) and the assessment of sub-aspects of the impacts on the financial system (no 24 to 28).²²

However, the obligation to analyse and the appropriate consideration of the aspects listed in Section C BRRD of the Annex does not mean that the resolution authority would have to give an affirmative opinion on each of the items referred to therein and to qualify the group as resolvable. The vague wording (»When assessing the resolvability of an institution or a group, the resolution authority shall take the following facts into account«) suggests a holistic valuation method in which the individual sub-aspects are to be analysed, but the resolvability is to be determined within the framework of the overall picture according to Section C BRRD.²³ This is also supported by art 31 para 3 BRRD, which in principle describes the resolution objectives as being of equal significance.^{24, 25}

The above definition of resolvability (feasibility, credibility, adverse effects on the system) also requires indirectly the assessment of resolvability to include a minimum of concrete projection with regard to the applied resolution tools (cf art 37 et seq BRRD). Consequently, within the framework of this projection, the resolution objectives (art 31) and their weighing against each other (note) as well as the general principles governing resolution (art 34 and 87 BRRD) must also be taken into account (expressly art 25 para 1 of the Delegated Regulation 2016/1075).

The resolution authorities nevertheless have a certain degree of discretion in the allocation of value and prioritisation of the different aspects (cf recital 19 of the Delegated Regulation 2016/1075). However, bail-out-related transactions must be compulsory disregarded (cf art 16 para 1 BRRD; negative demarcation).

Footnotes

2 Art 6 of the Basic Law on the General Rights of Citizens (StGG); at EU level see also art 16 Charter of Fundamental Rights (CFR) (»freedom of enterprise«). The European Convention of Human Rights (ECHR) itself does not contain »comparable provisions«.

3 Art 5 of the Basic Law on the General Rights of Citizens (StGG), art 1, 1st additional protocol ECHR with art 17 GRC.

4 Commission Delegated Regulation (EU) 2016/ 1075 of 23 March 2016 supplementing Directive 2014/59/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the content of recovery plans, resolution plans and group resolution plans, the minimum criteria that the competent authority is to assess as regards recovery plans and group recovery plans, the conditions for group financial support, the requirements for independent valuers, the contractual recognition of write-down and conversion powers, the procedures and contents of notification requirements and of notice of suspension and the operational functioning of the resolution colleges, OJ (EU) 2016 L 184, 1.

5 EBA, Guidelines on the specification of measures to reduce or remove impediments to resolvability and the circumstances in which each measure may be applied under Directive 2014/59/EU. EBA/GL/2014/11 (19. 12. 2014).

6 Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010, OJ (EU) 2014 L 225, 1.

7 See Haentjens/Wessels (Hrsg), Research handbook on crisis management in the banking sector (2014) 125 et seq.

8 See in particular art 22 of the Delegated Regulation 2016/1075 as well as EBA, Decision of the European Banking Authority on the settlement of a disagreement. Addressed to: Single Resolution Board and Banca Naţională a României, 2017 joint decision on group resolution plans and resolvability (27. 4. 2018) recital 31.

9 See also the case of the mediation procedure in EBA, Decision of the European Banking Authority on the settlement of a disagreement, recital 21 and art 1 of the decision.

10 Cf Jahn/Schmitt/Geier (Hrsg), Bankensanierung und -abwicklung (2016) Titel B Section VII recital 1 and 7.

11 Jahn/Schmitt/Geier (eds), Bankensanierung und -abwicklung (2016) Title B Section VII recital 4 talk about the »intimidating effect against moral hazard« here.

12 On the problem of the concept of regular insolvency proceedings, see Merler, Critical functions and public interest in banking services: Need for clarification? (November 2017) recital 4.2.

13 cf Jahn/Schmitt/Vulture (eds), Bankensanierung und -abwicklung (2016) Title B, Section VII, recital 6. See also Binder/Singh (eds), Bank resolution (2016) recital 2.23 et seq.

14 See also Binder/Singh (eds), Bank resolution (2016) recital 2.20 et seq.

15 Art 10 para 5 of the SRM Regulation provides a concrete definition: »For the purposes of paragraphs 3, 4 and 10, significant adverse consequences for the financial system or threat to financial stability refers to a situation where the financial system is actually or potentially exposed to a disruption that may give rise to financial distress liable to jeopardise the orderly functioning, efficiency and integrity of the internal market or the economy or the financial system of one or more Member States«. However, the definition differs from the concept of systemic risk under art 3 para 1 no 10 CRD IV.

16 In practice, the effective resolvability is probably only decided in the event of an actual emergency; cf Jahn/Schmitt/Vulture (eds), Bankensanierung und -abwicklung (2016) Title B, Section VII, recital 11.

17 This also underscores the absolute character of the resolvability: Either it exists or it does not exist – if there are major impediments. The public interest, on the other hand, is relatively conceived: The resolution tools have already been used, if they are the better alternative to the regular insolvency proceedings (cf art 32 para 5 BRRD).

18 Admittedly, from the point of view of time until the removal of the major impediments, there is no resolvability by definition. This case is likely to be dealt with in EBA, Decision of the European Banking Authority on the settlement of a disagreement (see recital 35).

19 Conversely, the effective use of resolution tools is one of the prerequisites for resolvability ( !). However, the assessment of resolvability shall include a mapping of the resolution tools to the resolution objectives (annex Section C no 21).

20 cf EBA, Decision of the European Banking Authority on the settlement of a disagreement recital 26.

21 cf Jahn/Schmitt/Geier (eds), Bankensanierung und -abwicklung (2016) Title B Section III recital 27.

22 See also for further details art 26 to 32 of the Delegated Regulation 2016/1075 (feasibility and credibility of the resolution strategy).

23 See also Jahn/Schmitt/Vulture (eds), Bankensanierung und -abwicklung (2016) Title B, Section VII, recital 30.

24 Jahn/Schmitt/Vulture (eds), Bankensanierung und -abwicklung (2016) Title B, Section III, recital 44.

25 Inconsistent, therefore, recital 29 BRRD, which grants increased relevance to the »overriding argument of public interest in financial stability« (cf art 31 para 2 lit b BRRD).

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