In the first of our regular primer articles, IFLR explains the BRRD basics, Italian and Spanish cases and how the directive could be improved.
What is the Bank Recovery and Resolution Directive (BRRD)?
It’s a European-wide law that aims to protect taxpayers from having to bail out banks by forcing creditors, including senior bondholders, liable for losses. It marks a huge departure from past practice, establishing the bail-in tool for dealing with failing banks that no longer calls upon the public purse in the form of the taxpayer, but writes down the value of a failing bank’s liabilities to match its losses.
Why does it exist?
Lehman Brothers, basically. Europe wanted to avoid a re-run of the US bank’s 2008 insolvency which showed that when a large or interconnected financial institution fails the result tends to be a full-blown meltdown of the entire industry.
But during the financial crisis, a lack of appropriate tools for the resolution of banks resulted in the need to resort to public funds to maintain financial stability. Anger grew over the bailing out of large banks using public money considered too-big-to-fail. It quickly became apparent that existing national insolvency regimes were not well-suited to big banks.
The G20 acted in 2011, endorsing the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions. The EU picked up the baton and a new framework, The Bank Recovery and Resolution Directive (BRRD) was born in 2014. It was implemented nationally in 2015.
How does it work?
“[The BRRD] lifts banks out of insolvency law as we know it,” says Tim Skeet, senior adviser at the International Capital Market Association (ICMA) in London.
It regulates the different stages of a problem bank’s recovery and resolution process, relying on six key things:
- Recovery and resolution planning;
- a stronger set of early intervention measures;
- a harmonised set of resolution tools and powers;
- the limitation of government support;
- resolution funding sourced from bank contributions to ensure resolution when preconditions are met;
- better cooperation between member states.
According to Patrizio Messina, partner at Orrick in London, in order to begin the BRRD procedure, the competent authorities have to confirm existence of three requirements: the entity must be failing or likely to fail; there must be no reasonable prospect that any alternative private sector measures or supervisory action would prevent the bank’s failure within a reasonable timeframe, and a resolution action must be necessary to pursue the public interest - a sticking point in the recent Italian troubles.
Why does it matter now?
Despite being over two years old, the BRRD was only truly tested for the first time last month, when European regulators took control of Spain’s Banco Popular, wiping out the lender’s shareholders and junior bondholders, and selling it for €1 ($1.1) to Banco Santander.
The action taken by the Single Resolution Board (SRB) finally offered a first glimpse of how the new bail-in regime might work in practice.
Not everyone was happy with the result. Holders of subordinated lower tier 2 notes found themselves treated as harshly as the far higher yielding and deeply subordinated contingent convertible notes. And questions still surround the quantum of the write-down, its calculation and timing. But the case of Banco Popular did seem to demonstrate that the European Central Bank (ECB) and the SRB were able to implement the BRRD.
What about Italy?
Whatever reassurance Banco Popular offered was severely undermined only weeks later, when the resolution of two Italian regional banks, Veneto Banca and Banca Popolare di Vicenza (BPVi), appeared to be rather more retrograde. Both looked like classic bailouts using €17 billion of public funds.
On June 23 2017, the ECB declared the two Venetian Banks failing, or likely to fail. But after the ECB evaluation, the SRB stated that the BRRD procedure could not begin because the banks’ crisis could not be qualified of public interest. So on June 25, the Italian government, ECB, European Commission and the Italian Central Bank (ICB), applied the forced administrative liquidation of the Venetian banks. Nevertheless, questions surround why both banks underwent a precautionary recapitalisation last year, especially if the SRB’s analysis led to the conclusion they were not systemic.
The Italian decree authorising the Venetian banks’ liquidation stresses the need to ‘avoid a serious disturbance in the economy of the areas where they operate’. The European Central Bank also announced on June 23 that both banks were ‘failing or likely to fail’.
According to IFLR editor Amelie Labbe’s piece on June 30, this would seem to hint that Banco Veneta and BPVi are indeed systemic and would therefore fall under the scope of the BRRD.
“There is a credibility issue,” said Cleary Gottlieb partner Amelie Champsaur at the time. “BRRD is designed to protect taxpayers while safeguarding due process and, as applied in this latest situation, fails on both counts.”
And the other Italian banks?
There have been a few. Dense negotiation has been going on between the Italian government and the European institutions over the case of Monte dei Paschi di Siena, which has been in the news for much of the past year. The aim has been to begin a precautionary recapitalisation procedure, as provided from the BRRD, in order to restore financial stability.
There are others too. For Banca Etruria, Banca Marche, Cassa di Risparmio di Ferrara and Cassa di Risparmio di Chieti, the resolution mechanism has been activated as a result of the evaluation made by the Bank of Italy which asserted the presence of all the necessary requirements.
Is the market happy with this summer’s test cases?
Not really. A feeling of vague uneasiness seems to linger around the BRRD as it stands. Though the directive’s aims are noble, the Spanish and Italian examples have only served to highlight the scope for national discretion.
On top of that there are legacy issues that continue to colour the directive’s application. The ICMA’s bail-in working group has long warned of investors’ inability to measure the true likelihood of a bank failing and gauge the degree of write-down faced when a bank fails.
What this means in practice, say the ICMA, is that investors may need to apply more stringent valuation criteria when pricing risk of bank securities and also evaluate the risk that lower yielding and higher-ranking tiers of debt may end up as risky as the more obviously subordinated securities.
What’s the point? (of non-viability)
Much of this hand-wringing boils down to the regulators’ opacity in setting the point of non-viability (ponv) – the stage at which they deem the bank in question to be past the point of saving. “As Banco Popular demonstrated, [the ponv] was clearly not where the market had anticipated,” say the ICMA.
Banco Popular was a Spanish solution to a Spanish problem, where a large, well-capitalised and larger rival could step in quickly. That might not be the case in future examples.
What future examples?
The Venetian banks and Banco Popular are thought to be the beginning rather than the end of BRRD test cases. In the UK, the Co-operative Bank is seeking to raise £750 million ($980 million) by issuing new shares and imposing losses on bondholders, without which the regulator could put it into resolution.
In Portugal, meanwhile, the central bank has agreed a deal to sell control of Novo Banco, the lender rescued two years ago from the ashes of Banco Espirito Santo, to US private equity investor Lone Star. But the deal requires its senior bondholders to suffer more losses on top of those stemming from a previous restructuring. According to the FT, they are now trying to block the deal, which could leave Novo Banco needing a resolution by European authorities.
And back in Spain, Liberbank, a smaller Spanish lender saw its stock price fall around 20% following Popular’s rescue, as investors hunted for banks that could go the same way.
How can it be improved?
A few ways. Relevant regulators could be more transparent in how and when they determine that a bank is in trouble. European authorities are privy to certain information that investors are not, which is rational when attempting to prevent contagion. But considering Banco Popular passed its stress tests in 2016 and was posting relatively good capital, the intervention surprised some. More disclosure would add comfort here.
On the investor side, other moves are already afoot. A new category of senior non-preferred debt has emerged in the past 18 months, following Credit Agricole’s December 2016 issuance. The instrument will apply to all banks, not just G-Sibs and will be bailed-in in the case of BRRD intervention.
But one key problem lingers: intervention comes down to the subjective judgement of national authorities and the ECB, with little transparency over how the decision was taken. “They are trying to redefine insolvency practices for banks and put it into words for people to understand, while leaving enough wiggle room for regulators to make up their minds and make a decision on the day,” says Skeet. “There is the conundrum.”
Venetian banks’ bailout undermines BRRD credibility
Banco Popular restructuring proves SRB can work