Banking Reform Updater 11

In this Banking Reform updater we examine the single resolution mechanism (SRM), which together with the single supervisory mechanism (SSM) (Banking Reform updater 10) forms the key pillars of the EU Banking Union.

The Bank Recovery and Resolution Directive (BRRD) sets out rules as to how EU banks in difficulties are to be restructured, how vital functions for the real economy are maintained, and how losses and costs are allocated to the banks’ shareholders and creditors. Whilst the BRRD was thought to be a major step forward to minimising the different Member State national approaches to recovery and resolution, the European Council considered that in the EU Banking Union, bank supervision and resolution needed to be exercised by the same level of authority. If not, tensions could exist between the Member State national resolution authority and the European Central Bank (ECB). In addition, the financial crisis in Cyprus illustrated concerns regarding market expectations about Member States’ ability to deal with bank failure nationally which could reinforce negative feedback loops between sovereigns and banks.

Rather than create a network of Member State national resolution authorities the European Commission (the Commission) proposed the creation of a SRM following agreement on the SSM. The Regulation establishing the SRM (the SRM Regulation) was published in the Official Journal of the European Union (the OJ) on 30 July 2014.

The SRM provides an integrated decision-making structure aligning resolution under the SRM with supervision under the SSM. Resolution decisions will be prepared and monitored centrally by a single resolution board (SRB) to ensure a uniform approach to resolution rules. The SRB will be responsible for the resolution process of banks in participating Member States, with the BRRD governing the interaction between the SRB and national resolution authorities in non-participating Member States. As the framework for resolution under the SRM corresponds very closely to that of BRRD, this updater will focus primarily on the procedures for initiating resolution under the SRM. In addition, the SRM Regulation establishes a single resolution fund.

The SRM will apply to all banks established in Member States that participate in the SSM. Member States “participate” either automatically by virtue of being part of the Eurozone, or as a consequence of entering into a close co-operation agreement. The UK is not participating in either the SSM or SRM.

The SRM will apply to the resolution of the following entities in participating Member States:

• credit institutions (i.e. banks and certain other deposit-takers), as defined in the Capital Requirements Regulation (CRR);
• parent undertakings, including financial holding companies and mixed financial holding companies, subject to consolidated ECB supervision under the SSM; and
• investment firms and financial institutions, as defined in the CRR, when covered by consolidated ECB supervision of the parent undertaking under the SSM.

For non-participating Member States, such as the UK, the BRRD and the resolution process under it will govern the interaction between the SRB and Member State national resolution authorities, with the European Banking Authority potentially undertaking a mediation role.

If a resolution affects banks established only in participating Member States, the resolution process under the SRM will apply, whereas if a resolution affects banks established only in non-participating Member States, the resolution process under the BRRD will apply. In the scenario that a banking group in resolution includes banks established in both participating and non-participating Member States, the resolution process under the BRRD will apply with the SRB representing the national resolution authorities of participating Member States.

If a resolution affects a bank that operates in third countries as well as in the SSM, the resolution framework, as set out in the BRRD, will apply with adjustments. The BRRD provides that the Commission may submit proposals to the Council of the EU (the Council) for the negotiation of agreements with third countries on the means of co-operation between EU resolution authorities and the relevant third country authorities, in respect of resolutions affecting banks that operate in Member States as well as third countries. If such an agreement does not exist, the SRB will assess and issue a recommendation addressed to the national resolution authorities, on the recognition and enforcement of resolution proceedings conducted by third-country resolution authorities, in relation to banks located in participating Member States.

The SRM applies from 1 January 2016, although certain provisions in the SRM Regulation have already come into force. These include provisions relating to the:

• establishment of the SRM and the SRB;
• single resolution fund (SRF) (see below) giving the Council the power to adopt implementing acts and the Commission power to adopt delegated acts; and
• cooperation between the SRB and Member State national resolution authorities for the preparation of the resolution plans.

The SRB is the cornerstone of the SRM and is an EU institution based in Brussels.

The SRB is the EU resolution authority under the SRM. It will prepare resolution plans and carry out the resolution of those banks established in participating Member States that have failed or are likely to fail. The SRB will also be in charge of the SRF (see below).

On 19 December 2014, the Council of the EU formally appointed the SRB’s chair, vice-chair and the four other permanent members. The chair is Dr Elke König who has been President of the German Federal Financial Supervisory Authority since 2012.

Between now and 1 January 2016 the SRB will carry out work developing resolution plans for those firms that are within scope of the SRM and will be fully operational, with a complete set of resolution powers, from 1 January 2016.

The banking industry in participating Member States will need to pay contributions toward the SRB and the SRF.

The aim of the SRM is to make a bank’s shareholders and creditors responsible for the costs of its resolution. If however, additional capital is needed, the SRB will have the opportunity to utilise the SRF, which will be established to provide medium-term funding support for a bank’s resolution in participating Member States. In this sense, the SRF is intended to be a back-up, in the event that a bank’s shareholders and creditors cannot bear the costs of resolution, to ensure that funding is available during a bank restructuring. It is not intended to be a bail-out fund.

On 9 December 2014, the Council of the EU reached political agreement on the implementing Regulation that determines the contributions to be paid by banks to the SRF. The SRF will be built up over a period of eight years to reach a target level of at least 1% of the amount of covered deposits of all banks authorised in all participating Member States. Banks will have to make annual contributions to the SRF. These will be calculated on the basis of their liabilities, excluding own funds and covered deposits, and adjusted for risk.

For Member States participating in the EU Banking Union, the national resolution funds set up under the BRRD as of 1 January 2015 will be replaced by the SRF as of 1 January 2016.

Under the BRRD, the target level of the national resolution funds is set at the national level and calculated on the basis of covered deposits. Under the SRM the target level of the SRF is the sum of the covered deposits of all institutions of participating Member States. To mitigate any abrupt increase in fees for banks in some participating Member States when switching to the European target level, political agreement in the Council was reached. An implementing Regulation was agreed, which provides for an adjustment mechanism during the initial eight years when the SRF is being built up.

Between 2016 and 2023, annual contributions by banks will be calculated in a manner that is increasingly based on the SRM target level. In the first year 60% of banks’ contributions will still be calculated in accordance with national target levels, this share will decrease annually so that by the eighth year all banks’ contributions will be calculated on the basis of the SRM target level.

The SRB will also be funded by levy. On 11 December 2014 a Commission delegated Regulation was published in the OJ which will allow the SRB to collect contributions to cover its expenditure until a final system is adopted by the Commission. The contributions will be collected from those banks that are deemed to be significant for the purposes of supervision by the ECB under the SSM.

At the request of the Council, to reduce the risk of any legal challenges certain elements relating to the functioning of the SRF will be regulated by an Intergovernmental Agreement (IGA) entered into by participating Member States. The scope of the IGA is strictly limited and in particular it covers:

• the transfer of contributions raised by Member State national resolution authorities to national compartments (which will be merged after a transitional phase of 8 years) of the SRF;
• the mutualisation (60% over the first two years and 6.7% in each of the remaining six years) of the funds available in the national compartments;
• the replenishment of national compartments;
• the order in which financial resources are mobilised to cover resolution costs; and
• possible participation (and their contribution to the SRF) of the non-euro area Member States into the SRM.

The IGA was signed by all participating Member States on 21 May 2014. However, participating Member States must now ratify the IGA in accordance with their own respective constitutional requirements. The IGA will apply from 1 January 2016.

The resolution framework and tools under the SRM Regulation are intended to mirror those available to Member State national resolution authorities under the BRRD. The resolution framework includes:

• preparatory and preventative measures, such as recovery plans and resolution plans;
• early intervention measures; and
• resolution tools, including bail-in.

Before a bank established within a participating Member State can be placed under resolution, the following resolution conditions must be met:

1. the bank is failing or likely to fail. The SRM Regulation sets out the circumstances in which a bank should be deemed to be failing or likely to fail;
2. having regard to timing and other relevant circumstances, there is no reasonable prospect that any alternative private sector or supervisory action, taken in respect of the bank, would prevent its failure within a reasonable timeframe; and
3. resolution action is necessary in the public interest. Resolution action should be treated as in the public interest if it is necessary for the achievement of, and is proportionate to one or more of the resolution objectives specified in the SRM Regulation (i.e. to ensure the continuity of critical functions; to avoid significant adverse effects on financial stability, in particular by preventing contagion, including to market infrastructures, and by maintaining market discipline; to protect public funds by minimising reliance on extraordinary public financial support; to protect depositors covered by the Deposit Guarantee Schemes Directive and investors covered by the Investor Compensation Schemes Directive; to protect client funds and client assets) and winding up of the bank under normal insolvency proceedings would not meet those resolution objectives to the same extent.

The process for initiating a resolution for a particular bank under the SRM will commence once the ECB makes a notification to the SRB and the Commission, that it is satisfied that a particular bank has met the first resolution condition, although the SRB could also make this assessment on its own initiative. The SRB will then be responsible for conducting an assessment as to whether all the conditions for resolution are met. If the SRB has not made its own assessment with regards to the first condition, it will usually rely on the ECB’s assessment. If the SRB considers that all the conditions for resolution are met, it will adopt a resolution scheme and transmit it to the Commission. The resolution scheme will place the bank under resolution, determine which resolution tools should be deployed and determine how the SRF should be used to support the resolution action.

For its part, once receiving the resolution scheme, the Commission may take the following action(s):

• action 1. Within 12 hours after transmission, it may propose to the Council that it should (i) object to the resolution scheme on the ground that it does not fulfil the third resolution condition, or (ii) that it should approve or object to a material modification proposed by the Commission of the amount of the SRF provided for in the resolution scheme. If the Council objects to the resolution scheme on the grounds that it does not fulfil the third resolution condition, the bank will be wound up in accordance with the applicable national law; and/or
• action 2. Within 24 hours after transmission, it will either endorse the resolution scheme, or object to it with regard to the discretionary aspects of the resolution scheme in the cases not covered by the above.

The effect of this procedure is that the Council will only be involved in considering a resolution plan at the express request of the Commission.  If the Council and the Commission express no objections to the resolution scheme, the scheme will enter into force 24 hours after transmission to the Commission. On the other hand, if the Commission expresses an objection in accordance with the second action or the Council proposes a modification to the amount of the SRF proposed by the Commission in accordance with the first action, the SRB will modify the scheme within eight hours.

The execution of the resolution scheme will fall on the relevant Member State national resolution authority. The SRB will monitor the relevant bank’s resolution and may give instructions to the Member State national resolution authority on any aspects of the resolution. In the event that the Member State national resolution authority does not comply with the resolution scheme, the SRB will have the power to directly instruct the relevant bank in resolution.

As stated above the SRM will apply from 1 January 2016.

By 31 December 2018, the Commission is required to produce a report on the application of the SRM Regulation, with a new report following every five years.

It is worth noting that the SRB now has its own website.