On 6 January 2011, the European Commission released for public consultation the working document “Technical details of a possible EU framework for bank recovery and resolution”, with the a view to developing a formal legislative proposal by Summer 2011. The consultation follows the Commission’s communications on “An EU Framework for Crisis Management in the Financial Sector” of 20 October 2010 and on “Bank Resolution Funds” of 26 May 2010.
The European Systemic Risk Board (ESRB) welcomes the opportunity to contribute to the definition of the technical details of a possible EU framework for bank recovery and resolution. Full support to the objective of developing an EU resolution framework and addressing obstacles to the effective management of crisis of EU cross-border financial institutions was already expressed in February 2010. This contribution, nonetheless, should be considered without prejudice to the opinion that the ECB will adopt on the legislative proposals of the Commission once the ECB is formally consulted.
PART I – OVERALL STANCE
The ESCB supports the plans put forward by the Commission to develop a crisis management and resolution framework for EU financial institutions. The EU clearly needs better tools with well designed triggers to tackle problems in banks more effectively. National regimes should also be as harmonized as possible and arrangements for better coordination between Member States in crisis situations need to be found. In particular, the ESCB shares the view that the overriding policy objective of the new EU regime should be that all institutions can be allowed to fail in a way that safeguards the stability of the EU fi nancial system as a whole and minimises public costs and economic disruption.
The ESCB considers that this challenging objective should be based on three pillars, namely: (i) an improved and harmonised set of preventative and resolution tools; (ii) clearly defi ned roles of authorities at the national level accompanied by balanced coordination mechanisms at EU level; and (iii) financing arrangements that limit reliance on public budgets to future crises. It is also important to recognise the international context within which the possible EU framework is being developed. The ESCB would like to emphasise the importance of co-ordination taking into account the relevant initiatives of the Financial Stability Board (FSB) in order to promote the development of a globally consistent approach to bank recovery and resolution.
(i) An improved and harmonised set of preventative and resolution tools
The ESCB concurs with the Commission’s approach which puts weight on prevention and preparation to be improved in a number of ways. Stress tests which national supervisors carry out annually should be considered as a key element of the enhanced preparedness of authorities. In order to ensure their credibility and consistency, supervisory stress tests would need to be conducted in full autonomy as well as independently of authorities that provide resources for bank recapitalisation.
A holistic group-level perspective is essential for recovery and resolution plans (RRPs) to be effective in the case of cross-border banks. This should be achieved by giving group level authorities a strong mandate to coordinate the overall preparation of these plans regarding banking groups, without prejudice to the powers granted to the competent authorities responsible for supervision of subsidiaries of an EU parent credit institution or an EU parent financial holding company. The ESCB also believes that the microprudential viewpoint of the individual RRPs should be complemented by a macroprudential perspective on the authorities’ side, entailing a holistic analysis of the potential aggregate impacts on the financial system if, for instance, several plans are implemented simultaneously.
The ESCB considers that the proposal to base the intra group financial support arrangement on an ex ante agreement between the shareholders of the transferor is a step forward. It addresses the shareholder control issue, thus giving some protection to the board of directors of the transferor to approve such transfers. Nevertheless, the ESCB considers that the design of the “intra group financial support agreement” will be legally challenging. To be effective in a liquidity crisis within the group, it would need to have a substantial level of specificity, anticipating the future situations of its application, which might prove difficult. The respective legal obligations would need to be defined precisely, including the trigger conditions. Such precise ex ante definition of the parameters of the intragroup asset transfer would be essential to allow the shareholders to make an informed and deliberate decision. It would also have to give the board of directors of the transferor sufficient protection against civil liability and potential criminal responsibility in cases whereby future board resolutions approving the transfer on the basis of the agreement might be challenged.
Furthermore, it is diffi cult to see how the intra group transfer can be based on the “common interest of the group” as this is not yet a well defi ned legal concept and thus cannot provide the parties to the transfer with a clear framework for their respective rights and obligations. Basing the intra group financial support arrangement on the economic interests of the ‘group’ risks blurring the fundamental concept of separate corporate legal personality, on the basis of which the expectations of financial market participants are formed when trading with their counterparties. Also, the ESCB would like to draw the Commission’s attention to some unintended consequences that should be further explored. In particular, there is a risk that in certain situations the Commission’s proposals on intra-group support may not address contagion risk and ultimately could even have a negative impact on the financial stability of the transferor and other involved countries. This is mainly due to the fact that the mechanism foreseen could turn the granting of intra group support into a semiautomatic procedure, leaving very limited opportunity to consider the impact of the transfer.
The ESCB favours the expansion of early intervention powers of supervisors as proposed by the Commission. The additional powers should remain discretionary. In this context, the ESCB also deems that interference with third party rights should be as limited as possible at the early intervention stage.
The resolution toolbox proposed by the Commission appears to be sufficiently comprehensive but more elaboration is needed on the conditions that trigger resolution. They should be sufficiently clear so as to be predictable but also sufficiently broad to avoid a situation in which the resolution authority would want to act but could not legally do so. Furthermore, their assessment would require coordination in a cross-border context.
If the resolution authority is to have powers and tools to transfer all or certain of the assets and/or liabilities of the failing institution to another entity, it is important that this power – which significantly impacts on property rights – is supported by a legally robust set of safeguards for stakeholders. The ESCB supports the proposal to give the resolution authority the legal power to temporarily delay the exercise by any party of close out netting rights under a netting agreement with the failing institution in order to complete a transfer of certain financial markets contracts to another sound financial institution, a bridge bank or other public entity. Such temporary delay should be subject to a clear set of minimum safeguards for counterparties.
(ii) Clearly defined roles of national authorities accompanied by balanced coordination mechanisms on the EU level
At the domestic level, the ESCB suggests maintaining national discretion on the decision on which authorities should be responsible for resolution. Nonetheless, the national frameworks need to be designed in a way that minimises conflicts of interest and regulatory forbearance. Furthermore, for the sake of cross-border coordination, it is essential that a single point of contact is designated in each Member State.
Finding the proper role for central banks is highly important, taking into account their mandate to preserve financial stability in the EU. In this context, the ESCB sees a role for central banks in the systemic risk assessment in the resolution phase, and where appropriate, in the process of recovery and resolution planning.
At the cross-border level, the ESCB welcomes the intention to institutionalise cross-border stability groups (CBSGs) but also identifi es some gaps and shortcomings in the Commission’s plan. Both the mandate and the composition originally foreseen for CBSGs were broader than that of the planned resolution colleges. Furthermore, although it appears understandable that the so called group resolution scheme (which includes the measures that national authorities would take to jointly resolve the group) would be non-binding, the proposed regime should define the precise duties and responsibilities of those authorities that decide to act differently than previously agreed under the group resolution scheme.
(iii) Financing arrangements that limit exposure of public budgets to future crises
The ESCB considers that resolution funds would provide a useful means to support resolution based on clear, stringent and properly communicated conditions, but any form of bail-out of the previous shareholders should be excluded. The funds should be accumulated ex ante (via fees paid by the financial sector based on liabilities, net of equity and other insured sources of funding), and backed up with ex post arrangements. The implementation should fully take into account the impact of the new Basel III framework and have due regard to not jeopardising economic recovery.
(iv) Debt write-down (bail-in) tool
The ESCB shares the Commission’s view that the practical outcome of the bail-in approach would be to restore the going concern to financial health by providing a viable and economically efficient alternative to the liquidation of institutions when other resolution tools are judged not feasible, due to the overarching need to safeguard financial stability and market confidence.
The ESCB believes that it should be made clear that the tool could only be used for the future and follow the solution adopted in the context of the FSB. It is essential, however, that the write-down tool has a clearly (ex ante) defined legal framework, including transparent trigger conditions, in order to avoid legal uncertainty and market distortion. In this respect the bail in should not allow for discrimination among equally ranked creditors, in the sense of treating them differently without building this differentiation on objectively justified grounds, as this would conflict with the general principle of equal treatment and create legal uncertainty about the extent of creditor rights.
At present, the concrete ability of bail-in to achieve its stated purposes without unwarranted side-effects is hard to assess. The ESCB emphasizes the need to conduct accurate and detailed case studies that would shed light into the practical implications of bail-in. Realistic simulations are necessary to deliver a clear view on issues such as the feasibility of a rapid execution, the ability to respect the seniority waterfall in loss absorbency, the mechanics of conversion/write-down, etc.
From a central banking perspective, further analysis is warranted for the financial stability implications raised by a large scale introduction of this approach. This instrument could prove crucial, within the risk management and resolution toolkit, in successfully avoiding externalities and spillover effects linked to the liquidation option under distressed market conditions. As such, it could contribute to the safeguard of financial stability. However, the innovative character of bail-inable debt raises potential significant risks, including concerns that its design and triggers may have destabilising effects on the financial sector (e.g. risks of higher market segmentation, debt fire-sales, and contagion effects). The FSB-sponsored work on the bail-in related issues is fully supported by the ESCB.
(v) Derogations from shareholder rights under the EU company law directives
The ESCB considers that a number of EU company law related directives, particularly the 2nd Company law, Takeover bids and Shareholder rights directives contain certain shareholder rights provisions which are obstructive to efficient bank restructuring. The EU framework on bank recovery and resolution should include a set of derogations from these shareholder rights for credit institutions, which are undergoing restructuring.
PART II …