Topic Recovery/resolution Recovery and restructuring
Article from the Annual Report 2016 of the BaFin
BaFin uses the term "restructuring" to encompass a number of initiatives with similar objectives that were introduced as a consequence of the financial crisis in 2007/2008. An important element of this is recovery planning, aimed at further improving the institutions' resilience. A new Regulation issued by the Federal Ministry of Finance contains Minimum requirements for the contents of recovery plans (Mindestanforderungen an die Ausgestaltung von Sanierungsplänen), which implement and/or add to the provisions of the German Recovery and Resolution Act (Sanierungs- und Abwicklungsgesetz) and of the European Banking Authority.
Additional focal points for BaFin during the year under review were the identification of financial institutions posing a potential systemic risk (potenziell systemgefährdende Institute – PSIs), the stipulation of higher capital requirements for global and national systemically important institutions and the implementation of the German Ringfencing Act (Abschirmungsgesetz).1 In addition, the EU Commission drafted provisions in 2016 specifically addressing the recovery and resolution planning of central counterparties (CCPs).
Recovery and resolution regime for CCPs
In 2012, European legislators introduced the European Market Infrastructure Regulation (EMIR), which requires standardised over-the-counter (OTC) derivatives transactions to be cleared through CCPs. Since these derivatives are now no longer cleared between banks, the risks of contagion in the event of a bank defaulting are reduced. This measure has made financial markets significantly more robust. At the same time, however, market participants' dependence on the CCPs has risen substantially, which entails higher risks for the stability of the financial markets in the event of default by a CCP.
In order to counter those risks, a recovery and resolution regime is required that at least ensures that the functions of CCPs that are critical for the financial markets are protected. The existing recovery and resolution regime of the BRRD – implemented in Germany mainly by the Recovery and Resolution Act – is in the first place only applicable to CCPs that are at the same time CRR credit institutions.2 In the second place, the Recovery and Resolution Act is designed for banks and is therefore not adapted to counter the specific risks arising from the business model of the CCPs. In particular, the resolution mechanisms set out in the Recovery and Resolution Act, such as writing down liabilities in consideration for the issue of shares (bail-in), are not sufficiently effective for CCPs.
Against this background, the EU Commission has developed rules for the recovery and resolution of CCPs. These were published in November 2016 as a draft regulation. The draft contains provisions enabling open positions to be closed and default losses arising from the default of clearing members, generally banks, to be settled. The draft is also intended to regulate the treatment of losses arising from the operating business of the CCPs themselves (non-default losses). The latter include losses from IT disruptions or errors in managing the collateral clearing members have to provide.
MaSan Regulation
The Recovery and Resolution Act imposes an obligation on all institutions to prepare a recovery plan. Prior to the entry into force of the Recovery and Resolution Act, this was only mandatory for PSIs. In addition to the Recovery and Resolution Act, requirements for the contents of recovery plans are derived from the EBA guidelines on recovery plan scenarios and indicators and Commission Delegated Regulation (EU) No 2016/1075. Furthermore, the Federal Ministry of Finance is authorised pursuant to section 21a (1) of the Recovery and Resolution Act to set out minimum requirements for the contents of recovery plans in a Regulation (MaSan Regulation).
The Federal Ministry of Finance will conduct a public consultation exercise on the draft Regulation beforehand. The Regulation deals with the recovery plans of the PSIs. The latter must satisfy all of the requirements at all times in view of their nature as institutions posing a potential systemic risk. The MaSan Regulation also stipulates simplified requirements for the recovery plans which non-PSIs are required to prepare. In addition, the MaSan Regulation specifies requirements for the recovery plans of institutional protection schemes (IPSs). The background to this is the possibility of exempting institutions from the obligation to prepare a recovery plan, if they belong to an institutional protection scheme and are not considered to pose a potential systemic risk. In this event, the IPS must prepare a recovery plan relating to the institutions exempted. Accordingly, the MaSan Regulation sets out the rules for the application for exemption, the necessary preconditions and the requirements for the contents of such recovery plans.
Guidance Notice on recovery planning
In addition, BaFin and the Deutsche Bundesbank are planning to publish a Guidance Notice on recovery planning. Prior to its issue, BaFin and the Bundesbank will launch a public consultation on the Guidance Notice. This is intended to take place at the same time as the public consultation on the MaSan Regulation. The Guidance Notice on recovery planning explains the provisions of Delegated Regulation (EU) No 2016/1075 and is intended to illustrate the interaction of the MaSan Regulation with Delegated Regulation (EU) No 2016/1075.
Systemically important institutions and institutions posing a potential systemic risk
BaFin reviews the classification of institutions as posing a potential systemic risk at least once a year in consultation with the Deutsche Bundesbank. An institution poses a potential systemic risk if it is either a global systemically important institution (G-SII) or another systemically important institution (O-SII), or if BaFin is unable to allow this institution to apply the simplified requirements for recovery planning (see info box "Institutions posing a potential systemic risk in 2016").
Institutions posing a potential systemic risk
In 2016, BaFin classified a total of 39 institutions as institutions posing a potential systemic risk (PSIs). The 39 institutions included 1 global systemically important institution (G-SII) and 14 other systemically important institutions (O-SIIs). The number of PSIs rose slightly from 37 institutions to 39 compared with the previous year. While the number of G-SIIs remained unchanged, the number of O-SIIs declined from 16 institutions to 14. This was due firstly to the merger of two O-SIIs and secondly to one institution being assessed as having lower systemic importance during the annual review. By contrast, the number of institutions which BaFin did not permit to apply the simplified requirements for recovery planning increased by 4 institutions compared with the previous year. They include 1 institution for which it was not possible to determine whether it qualified as a PSI in 2015. They also include 2 institutions that were not classified as PSIs in 2015. The reason for this is that the assessment method was revised and four indicators used by the scoring model for the quantitative analysis were changed. In keeping with the EBA guidelines on the assessment of O-SIIs, the method therefore now also records receivables from and liabilities to foreign central banks as part of receivables from and liabilities to foreign banks. Moreover, the number of legally independent domestic and foreign subsidiaries, used as an indicator, now includes only the legally independent domestic and foreign institutions of the superordinate entity for supervisory purposes, and no longer includes downstream financial undertakings as well.
Interpretive guidance on the Ringfencing Act
BaFin has developed interpretive guidance on the Ringfencing Act dated 7 August 2013 jointly with the Bundesbank. It references Article 2 of the Act. The Act prohibits deposit-taking credit institutions above a specified size from engaging in proprietary business. Lending and guarantee business with hedge funds and alternative investment funds (AIFs) is also not permitted. The prohibition also applies to high-frequency trading with the exception of market-making activities within the meaning of the EU Short Selling Regulation.3 For example, if a proprietary trader provides liquidity to the market on a regular and ongoing basis by posting firm, simultaneous two-way quotes for financial instruments, this market-making activity is excluded from the scope of the activities prohibited.
The interpretive guidance provides the credit institutions with guidelines on the provisions of the Ringfencing Act and so contributes to greater legal certainty on the implementation of the statutory requirements.
The interpretive guidelines make clear, for example, the extent of the prohibition on conducting proprietary business and the distinction from proprietary trading. They also explain the meaning of lending and guarantee business and the cases in which even indirect lending and guarantee business is prohibited. In addition, the interpretive guidance deals with the determination of the leverage of an AIF, which is relevant for the scope of the prohibited activities.
Implementation of the TLAC and MREL requirements
On 9 November 2015, the FSB published the global standard on total loss-absorbing capacity (TLAC).4 This also entailed an obligation on the part of the FSB member states to implement the standard in their national legal systems. The member states of the European Union implement the standard at EU level. For this purpose, on 23 November 2016, the EU Commission published proposed legislation as part of its reform package,5 with the objective of amending various directives and regulations – including the CRR and the BRRD. The EU Commission's proposed legislation also includes changes to the provisions on the minimum requirement for own funds and eligible liabilities (MREL)6 and integrates the MREL and TLAC into a single concept. BaFin was represented in the group of experts which advised the EU Commission on the drafting of the proposed legislation.
TLAC Standard
From 2019 onwards, the standard on total loss-absorbing capacity requires own funds and eligible liabilities equal to at least 16% of risk-weighted assets and 6% of the leverage exposure. These requirements will rise to 18% and 6.75%, respectively, at the start of 2022.
Under the proposed legislation, the minimum requirements for total loss-absorbing capacity in the form of liabilities and own funds prescribed by the TLAC Standard would now also become a statutory minimum for the MREL. To date, the resolution authority has set the MREL ratio individually for each institution depending on its business model, risk profile and resolution strategy. Under the Commission's proposal, the MREL can still be specified individually for global systemically important institutions, but it may not be less than the minimum prescribed by the TLAC.
The rules for setting the MREL for individual institutions will still be contained in the BRRD and/or the Single Resolution Mechanism (SRM) Regulation after the reform. But in order to create a uniform framework for Pillar 1 own funds and eligible liabilities requirements, the provisions relating to the statutory minimum (TLAC) will be set out in the CRR. The EU Commission's proposed legislation therefore prescribes corresponding amendments to the CRR. There remain differences of opinion between the member states on a number of points contained in the proposal, and these will need to be resolved in the further course of the legislative process.
Also in relation to the MREL, BaFin has published a liability cascade for the event of a bail-in.7 The MREL is highly significant for the effective implementation of a bail-in, since the latter involves writing down liabilities and converting them into equity in the event of a resolution. This enables losses to be covered and the institution to be provided with fresh capital, without the need to use taxpayers' funds for this purpose. In this process, the MREL ensures that sufficient suitable liabilities are in fact available. The critical factor for the resolution is then the order in which owners and creditors are liable and in which liabilities are written down or converted. This order is laid down by the liability cascade published by BaFin.
Footnotes:
- 1 Federal Law Gazette I 2013, page 3090.
- 2 Credit institutions which satisfy the criteria in Article 4(1)(1) of the CRR.
- 3 Regulation (EU) No 236/2012 of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps (OJ EU 86 dated 24 March 2012, page 1).
- 4 See 2015 Annual Report, pages 109 ff.
- 5 On the reform package, see European reform package.
- 6 See 2015 Annual Report, pages 109 ff.
- 7 See Overview of the liability cascade in bank resolution (as at 1 January 2017).
