New bank resolution regime as an engine of EU integration

On 1 June 2017 the European Commission and Italy reached an agreement ‘in principle’ on the recapitalization of Banca Monte dei Paschi di Siena (MPS). A mere week later, the Single Resolution Board (SRB) put Banco Popular Español (BPE) into resolution, and had its shares transferred to Banco Santander. Both cases must be understood in the context of the Bank Recovery and Resolution Directive (BRRD) and both can be considered as examples of how the new European bank resolution regime performs as an engine of European integration.

1. Bank resolution as part of the Banking Union  

First, the Banking Union as originally intended included, besides a new bank insolvency regime, also a common European deposit guarantee scheme (DSG) and a Single Supervisory Mechanism (SSM). The founders of the Banking Union believed that banking supervision would only be credible if it could allow banks to become insolvent. This would entail that the burden of bank insolvencies should be shared amongst Member States, because individual Member States might not wish or be able to carry the burden of a major bank insolvency in their jurisdictions. However, for political reasons, a common European deposit guarantee scheme has until now apparently been a step too far. Yet, in November 2015, a new initiative has been introduced that should bring about a ‘European Deposit Insurance Scheme’ (EDIS). Emmanuel Macron, who was elected president of France only a couple of weeks ago, seems to endorse it. Such an EDIS would mean an important step in the direction of further European (or at least: Eurozone) integration, not only economically, but also politically and morally.

2. Cross-border bank resolutions in court   

Second, the new pan-European bank resolution regime has been ‘consolidated’ by two relatively recent court decisions, although these cases paint a nuanced picture. In both court decisions, the central question was whether certain decisions by (national) government authorities would qualify as ‘resolution measures’. If they would, they would have to be recognized in all other Member States of the EU as per the BRRD. In both decisions, such recognition was challenged by creditors in another Member State, who would suffer damages as a consequence of an insolvency measure taken by a government body in the Member State where the failing bank was located. In the judgment of the Regional Court Munich I of 8 May 2015, the court held that a certain form of cancellation of debt by the Austrian resolution authority of Austrian bank Hypo Alpe Adria was not to qualify as a resolution measure. Consequently, there needed not be any recognition in Germany, and hence the creditor, Bayern LB, was not to suffer damages as a consequence.

In the Banco Espírito Santo (BES) case, on the other hand, it was contested before an English court whether the Portuguese Central Bank had transferred a facility agreement that had been concluded between Goldman Sachs International and BES to Novo Banco (NB). The Central Bank had incorporated NB to function as a bridge institution in the context of BES’s resolution, and BES was to be liquidated. Goldman Sachs contended that the facility agreement was effectively transferred, and the Central Bank said it was not. In its judgment of 4 November 2016, the Appeal Court held, in short, that whether the facility agreement was effectively transferred was first and foremost a matter of Portuguese law, and that resolution measures such as these should be recognized under the CIWUD. It also found support in the Kotnik case, in which the CJEU decided on 19 July 2016 that resolution measures that were taken by the Slovenia government pre-BRRD should nonetheless be recognized.

These two cases indicated at the least that measures taken by a resolution authority in the context of bank insolvency are not always recognized throughout the EU. But if they are recognized (and this seems increasingly to be the case), that has an integrational effect: it means measures taken in a Member State under that Member State’s law have effect in other Member States.

3. Harmonization of national insolvency laws   

Third, the new bank resolution regime has also led to harmonization of national insolvency laws. On the one hand, for many EU jurisdictions, the new bank resolution regime has meant a major shift in that crisis management for banks has been taken away from the bankruptcy courts (and ‘normal’, ie general, corporate insolvency law), and been put in the hands of government authorities, viz. resolution authorities.

On the other hand, national insolvency laws continue to play an important role in the new regime. Not only does the new regime rely, in several instances, on normal insolvency law (for instance because parts of a bank in resolution must be liquidated under normal insolvency law), but also as regards creditors and shareholders, the leading principle is that they must not be worse off than they would have been if the bank had been subjected to national insolvency laws. In order to retain a level playing field in the EU, this No-Creditor-Worse-Off (NCWO) rule has required the European legislator to harmonize, besides bank resolution law, also national insolvency laws.

Moreover, under a recent Commission draft Directive of 23 November 2016, Article 108 BRRD is to be amended. Pursuant to this draft Directive, Member States must amend their insolvency laws so that a new category of ordinary unsecured claims is inserted into the national priority order. These claims follow from a specific type of debt instruments, and are to have a lower priority ranking than that of ordinary unsecured, non-preferred claims , but higher than statutory or contractually subordinated claims. The proposal is currently being debated in the European Parliament. But it signifies a trend, viz. the trend that the common bank resolution regime will require more harmonization and even unification as regards the national priority order under general insolvency law.

4. Resolution regimes for non-banks

A fourth development concerns the initiatives of national as well as of European legislators to introduce resolution regimes, à la BRRD/SRMR, for financial institutions other than banks. Several weeks ago, for instance, the Dutch Council of State has advised on a draft bill that would create a resolution regime for insurers that is similar to the current bank resolution regime as established by the BRRD and SRMR.

Similarly, on 28 November 2016, the Commission published a draft resolution regime for Central Counter Parties (CCPs). Partly as a consequence of the 2012 European Market Infrastructure Regulation (EMIR), a ‘large proportion of the EUR 500 trillion of derivatives contracts that are outstanding globally are cleared by 17 CCPs across Europe’ (dixit the Commission). Thus, enormous risks have been centralised at CCPs, so that an appropriate resolution regime for these institutions seemed warranted.

5. Resolution in practice   

The above has shown that there are various reasons to believe that the new bank resolution regime will give further impetus to European integration. But, as many commentators have rightly noted, only a real-life case will show whether the new resolution regime actually works. More specifically, only then will it become clear whether the new regime will prevent governments from choosing the way of the least resistance by bailing-out failing banks. Thus, the costs of those bank failures would continue to be borne by all tax payers together, rather than by a specific group of investors. The recent cases of MPS and BPE are cases in point.

In December, the ECB required MPS to recapitalize EUR 8.8b and denied an extension of the period to raise extra capital. The Commission has also been involved, for any ‘precautionary measure’ must be approved under the State-aid rules by the Commission. On 1 June 2017, the Commission and Italy announced that an agreement was reached under which subordinated bonds will be wiped-out, although retail investors may be compensated on the grounds of miss-selling. MPS represents an instance where the workings of the SSM and the new resolution regime have been put to the test. It proves the reluctance of governments to trigger resolution, but it also has required the relevant EU authorities to investigate, together with the Member State concerned, the limits of the new regime. This was all the more true for BPE, where the SRB did take a resolution measure which had to be implemented by the national resolution authority. Quite different from the solution chosen for MPS, as of 7 June 2017, all shareholders of BPE have been wiped out. Moreover, subordinated debt were converted into shares and subsequently transferred to Banco Santander for the price of 1 EUR, which effectively meant a wipe-out and expropriation of both shareholders and subordinated debtholders.

Whilst it remains to be seen how the current plight of Banca Popolare di Vicenza and Veneto Banca will be handled, I think it is fair to conclude that the new EU bank resolution regime proves to be an engine of integration with respect to the institutions tasked with resolving bank insolvencies, but also regarding national insolvency laws, and also for financial institutions other than banks.

This post was originally posted on the Oxford Business Law Blog on 14 June 2017. This is a cross-post of the original article. 

Featured image credit: ‘Banca Monte dei Paschi di Siena, Siena, Italy’, by DV. CC BY-SA via Wikimedia Commons