Recovery and resolution
On 1 January 2015, the German Act on the Recovery and Resolution of Credit Institutions (Gesetz zur Sanierung und Abwicklung von Kreditinstituten – SAG) and several accompanying acts came into effect. The SAG transposes the European Recovery and Resolution Directive, which itself implements in the EU the requirements of the Key Attributes of Effective Resolution Regimes, as defined by the Financial Stability Board (FSB) for credit institutions and investment firms (hereinafter: “institutions”).
This is intended to facilitate the management of a crisis at an institution without jeopardising financial stability or falling back on taxpayers’ money.
The key changes introduced by the SAG include the participation of shareholders and creditors in an institution’s losses and in the costs for its resolution. In addition, the SAG expands the scope of the obligation to prepare a recovery plan. It also introduces rules on early intervention by the supervisory authorities, on intragroup financial support and on cross-border cooperation between national supervisory and resolution authorities.
Germany leads the way
The German legislator already introduced several of the Directive’s key provisions in 2013, through its Ringfencing Act (Abschirmungsgesetz); see expert article from July 2013. In particular, this stipulated requirements for recovery and resolution planning and resolvability assessment and authorised the removal of impediments to resolvability.
Even before the Ringfencing Act, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) had produced a draft version of the Minimum Requirements for the Contents of Recovery Plans (Mindestanforderungen an die Ausgestaltung von Sanierungsplänen – MaSan), held consultations and on this basis requested recovery plans from potentially systemically important institutions. BaFin also helped to overcome resolution obstacles for institutions. For instance, on the initiative of BaFin and other supervisory authorities 18 major banks of global systemic importance – including Deutsche Bank – recently declared that they would sign the additional protocol to the Master Agreement of the International Swaps and Derivatives Association (ISDA), which considerably facilitates handling of derivatives in resolution (see expert article from December 2014).
Together with several other countries, Germany has thus played a leading role in international regulation of the recovery and resolution of institutions and financial groups right from the start. BaFin has contributed its expertise to the European legislative process for the Recovery and Resolution Directive, the Single Resolution Mechanism and related acts. Germany has thus played a key role in defining European standards. Early transposition of the Directive into German law underlines its leading position. Particularly through its introduction of the bail-in tool from 1 January 2015, Germany is leading the way in the EU – transposition of the Directive is not required until 1 January 2016.
Key provisions of the SAG
- Preparation of recovery plans
- Early intervention
- Intragroup financial support
- Conditions for resolution
- Resolution measures (including bail-in)
- Cross-border cooperation between national supervisory and resolution authorities
An important principle of the SAG is to avoid the resolution of institutions right from the outset. An effective recovery plan that offers the institution an adequate range of recovery options to handle a crisis on by its own efforts is a key tool for this purpose. For this reason, the recovery planning provisions are at the heart of the SAG, which will have the greatest practical relevance. The Ringfencing Act already enabled BaFin to require potentially systemically important credit institutions to prepare a recovery plan. The SAG has now expanded this obligation to include all credit institutions and investment firms.
BaFin will intensively assess institutions’ recovery plans and actively encourage their qualitative improvement. However, institutions are only obliged to prepare recovery plans once the supervisory authority asks them to do so. From this moment onwards, they will have a time limit of six months. The institution may apply for an extension of up to six months. The institution will also be notified in the request of whether it is required to fulfil simplified requirements, and the nature of these requirements.
Subject to agreement with the Deutsche Bundesbank, on a case-by-case basis BaFin may stipulate simplified requirements for the contents of the recovery plan, the time limit for its preparation and the frequency of updates. In particular, the key issue is the possible effect of an institution’s failure. For this purpose BaFin considers in particular its size, complexity, risk profile and its interconnectedness with other institutions. It also considers whether the institution is a member of a institutional protection scheme and whether its winding up is possible through normal insolvency proceedings, without this having a negative impact on the financial system. The European Banking Authority (EBA) will specify in guidelines the criteria for determining the institutions which are only required to fulfil simplified requirements. It is currently holding public consultations on these guidelines. The contents of these simplified requirements, however, will be determined by the competent supervisory authorities.
Subject to agreement with Bundesbank, BaFin may waive the obligation to prepare a recovery plan for institutions which are members of an institutional protection scheme if they have not been classified as potentially systemically important. In such cases, the institutional protection scheme will be required to prepare a recovery plan.
Early intervention and group financial support agreement
The SAG grants BaFin comprehensive powers of early intervention. These supplement its rights of early intervention which are already provided for in the German Banking Act (Kreditwesengesetz – KWG). For example, BaFin may now require an institution to implement recovery options detailed in its recovery plan or even to revise its business strategy. Should it become clear through ongoing supervision that an institution may find itself in difficulties, BaFin will rapidly urge it to implement corrective measures. If restructuring of the institution is necessary, BaFin will intensively supervise this process.
Under the SAG, cross-border groups may enter into intragroup agreements which require individual group entities to provide reciprocal financial support if the preconditions for early intervention by the supervisory authority are fulfilled. These agreements are intended to enable the group to resolve crises on its own. BaFin must approve the related arrangements in advance.
Resolution of institutions
A further key section of the SAG covers the resolution of institutions and financial groups. The financial crisis has shown that this requires specific arrangements. The limits of the universal insolvency rules for companies are particularly evident for large and interlinked institutions and financial groups. A normal market exit by such an institution due to its insolvency may have considerable negative effects on other institutions, other investors, such as insurance firms and depositors, and may ultimately jeopardise financial stability.
For this reason, in the past it was necessary to save large institutions which found themselves in difficulties through the use of public money. The new resolution measures – i.e. the resolution tools and powers – are intended to avoid this too-big-to-fail problem in the future.
Failing or being likely to fail as a condition for resolution
To implement resolution measures, the conditions for resolution specified in section 62 (1) of the SAG must be fulfilled. This includes that the institution must be failing or likely to fail. For example, this will be the case if the institution infringes supervisory requirements in a way that justifies the withdrawal of this institution’s authorisation by the competent authority.
An institution is also deemed to be failing or likely to fail in case of actual or imminent overindebtedness or actual or imminent inability to make payments. These two terms are based on those in the German Insolvency Code (Insolvenzordnung – InsO) but are not identical with them. This reflects the fact that a resolution order within the meaning of the SAG pursues goals which are different from liquidation under insolvency proceedings. For instance, the Insolvency Code distinguishes between insolvency due to inability to make payments and a temporary delay in payments. In principle, a temporary delay in payments will apply in case of a liquidity gap of less than 10 per cent and a delay in payments of up to three weeks. The concept of insolvency due to inability to make payments as defined in the Insolvency Code is not suitable for bank restructuring purposes. In the interests of financial stability, resolution measures must be implemented without delay in case of any inability to make payments.
Similar rules apply for the concept of overindebtedness within the meaning of the Insolvency Code. In particular, the valuation rules laid down in the SAG – particularly sections 69ff. of the SAG – rather than those specified in the Insolvency Code must be applied when determining whether the institution’s assets are worth less than its liabilities or if this will be the case in the near future.
Apart from this, an institution is also deemed to be failing or likely to fail if extraordinary financial support in the form of public funds is granted. However, this does not apply if these funds are provided on a precautionary basis in order to avoid serious economic disruption and to preserve financial stability. Such funds might be provided in the form of liquidity guarantees or precautionary recapitalisation.
Public interest as a condition for resolution
As a rule, resolution measures involve significant interference in the legal positions of owners, creditors and other third parties. For this reason, a resolution measure may only be implemented under the SAG if this is necessary and appropriate to avoid systemic threat, i.e. if this is in the public interest.
However, only institutions and financial groups which have a certain significance pose a potential systemic risk. Institutions which do not qualify for this status are subject to the normal insolvency proceedings.
Need for private-sector measures
A further condition for resolution is that failure of the institution cannot be equally well prevented by other means within the available period of time.
Here the legislator emphasises, in particular, the responsibility of owners and the management – but also an institution’s creditors – to cope with any difficulties themselves or to avoid them from the outset. All those involved – but the owners and the management in particular – must aim to avoid the need for any resolution measures arising in the first place.
If the conditions for resolution are fulfilled, principally four resolution tools are available: sale of business, transfer to a bridge institution, asset separation and bail-in. In addition, the SAG provides for further, as yet unspecified measures which may become necessary in a crisis. The resolution authority also has additional powers at its disposal which enable use of the above-mentioned resolution tools.
The sale of a business, asset separation and bail-in are entirely new resolution tools. The tool of transfer to a bridge institution, however, has been available in Germany since the German Restructuring Act (only available in German) came into force in 2011.
Bail-in of shareholders and creditors
The bail-in tool will be particularly important in future. In a crisis scenario, shareholders and creditors may now be required to participate in the institution’s losses and recapitalisation. The goal is for banking crises no longer to be resolved by means of taxpayers’ money.
The bail-in tool enables the resolution authority to write down liabilities of the institution in whole or in part and to convert liabilities into shares or other Common Equity Tier 1 instruments of the institution. However, certain types of liabilities, particularly covered deposits of up to EUR 100,000 and secured liabilities, are excluded from bail-in.
To ensure that sufficient liabilities are available in a crisis in order to use the bail-in tool, the SAG requires institutions to maintain a minimum amount of liabilities eligible for bail-in. The amount of such liabilities is determined individually for each institution.
Cross-border resolution of groups
In case of international financial groups, the competent national supervisory and resolution authorities must closely cooperate in planning and implementing resolution measures. To ensure the success of such measures, the SAG includes provisions on cooperation between authorities and on the setup of resolution colleges in particular.