EU Bank Insolvency Governance


A recent EU proposal on bank insolvency would require that if a bank fails, shareholders bear the first losses followed by creditors; and that the top managers be fired and face personal financial losses under either civil or criminal proceedings.
 
That said, the main thrust of the proposal is to ensure that Europe’s financial system is equipped with mechanisms and funds so that government bail-outs are not needed in the future - and so that taxpayers are not left with the bill should financial institutions run into trouble.
 
Under the proposed new insolvency law, Member States would be obliged to bail out one another's struggling banks, and local regulators would be granted tough new powers to take control of troubled banks.
 
The law could potentially come into effect as early as 2014.

Context 

The current euro-denominated financial crisis has seen a number of large banks bailed out with public funds. While this may have been necessary to prevent widespread disruption to the markets, the Commission believes it is undesirable for public funds to be used in this way at the expense of other public objectives.

Objectives and scope

The Proposal has three objectives: 
• Maintaining financial stability and confidence 
• Ensuring the continuity of essential financial services 
• Minimising losses for taxpayers 
 
The Directive would apply to the following institutions:
a) credit institutions (banks),
b) investment firms,
c) financial holding companies and
d) financial institutions when they are a subsidiary of a credit institution or investment firm.

Contents

The proposal’s objectives would be achieved through the following measures:

Competent authorities for the supervision of credit institutions and capital requirements would be empowered to apply the resolution tools and exercise the resolution powers.

Each institution would be required to draw up and maintain a recovery plan containing measures to restore a potential deteriorated financial situation. A resolution plan would be also required; this plan would set out options for resolving the institution in different scenarios.

The competent authorities would assess and approve both plans. Resolution authorities may require institutions to take measures in order to improve its resolvability.

The proposal would include rules on cross-border groups aimed at an efficient resolution for groups and at protecting financial stability in the related Member States. These rules would allow intra-group agreements for financial support. However, since the group-level resolution authority would have a prominent role in the resolution process of a group, host Member State resolution authorities would have the power to restrict transfers with the purpose of intra-group financial support.

The Directive would expand the powers of competent authorities to intervene at an earlier stage, if the financial situation or solvency of an institution is deteriorating. Such powers would include the execution of measures set out in the recovery plan.

In case of significant deterioration in the financial situation, the competent authority would have the power to appoint a special manager to replace the management of the institution. The appointed manager would have all the powers of the management of the institution.

Finally, the plan proposes closer ties between national funds, moving towards the creation of a common EU scheme. This could oblige a scheme in the UK, for example, to lend to a fund in France, if a bank with operations in both countries were to face collapse.

Resolution actions

Resolution actions would be carried out if: 
• The competent authority or resolution authority has to determine that the institution is failing or likely to fail
• Only a resolution action would prevent the failure of the institution within reasonable timeframe
• A resolution action is deemed necessary to the public interest
 
The resolution of an institution would aim to ensure the continuity of critical functions, avoid significant adverse effects on financial stability and minimise reliance on extraordinary public financial support. It would ultimately aim to protect depositors, client funds and client assets.

Resolution authorities would be obliged to respect a number of principles. For example:
• Losses would first be allocated in full to the shareholders and then to creditors, which would be treated equally unless provided otherwise in the Directive
• Creditors would never bear greater losses than in the case of the institution being winded-up under normal insolvency proceedings
• Senior management of an institution under resolution would be replaced,
• Senior managers of an institution under resolution would bear losses according to civil or criminal law

Resolution tools

If the conditions for resolution are satisfied, resolution authorities would have the power to apply four different resolution tools. All the tools would have to be applied in accordance with EU State aid rules.
• Sale of business tool: This would consist of the sale of the institution or part of its business on commercial terms, without requiring the consent of the shareholders
• Bridge institution tool: Resolution authorities would be allowed to transfer all or part of the business of an institution to a publicly controlled entity with the aim of selling the business to the private sector
• Asset separation tool: This tool would consist of the transfer of deteriorated assets to an asset management vehicle.  This tool would only be applied together with the other tools
• Bail-in tool: The bail-in tool would give resolution authorities the power to write down the claims of unsecured creditors of a failing institution and to convert debt claims to equity. The tool would be used with the purpose of recapitalising the institution under resolution or providing capital for a bridge institution. This tool would be applied to all liabilities of an institution which are not: (a) guaranteed deposits, (b) secured liabilities, (c) liabilities to employees, to tax and social security authorities and to commercial or trade creditors which provide essential services or goods for the functioning of the institution operations 

Restrictions

Resolution authorities would be allowed to impose a temporary stay on the exercise by creditors and counterparties of rights to enforce claims or terminate contracts against an institution under resolution. The temporary suspension would last no longer than until 5pm on the next business day.

Decisions taken by any resolution authority would be subject to judicial review. However, the judicial review would not affect any administrative act or transaction concluded on the basis of an annulled decision. This restriction aims at protecting third parties who have bought assets or liabilities of the institution under resolution.

Financing Arrangements

The Commission considers it necessary to create a funding arrangements scheme, which would be financed by private institutions to prevent public funding. The proposed Directive would set out a framework for financing arrangements, which would have: 
• Power to raise ex ante contributions with a view to reach the target of 1% of the amount of deposits of all credit institutions
• If the available financial means are not sufficient, power to raise ex post extraordinary contributions
• Power to contract borrowings and other forms of support from financial institutions, the central bank, or third parties
 
Deposit Guarantee Schemes (DGS) would also play a role in the resolution framework. They would contribute to ensure the continuous access to covered deposits. Also, Member States would be able to use their DGS for resolution funding.