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2 Resolution: Concepts, Requirements, and Tools

Jens-Hinrich Binder

From: Bank Resolution: The European Regime

Edited By: Jens-Hinrich Binder, Dalvinder Singh

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2022. All Rights Reserved. Subscriber: null; date: 10 August 2022

Banker-customer relationship — Deposit insurance schemes — Deposit protection schemes — Recovery and Resolution Plan (RRP) — Special Resolution Regime (SSR) — Regulation of banks — European Banking Authority (EBA)

(p. 25) Resolution

Concepts, Requirements, and Tools

A.  Introduction

2.01  With a total of fifty-five articles in the final version, Title IV on ‘resolution’ and corresponding powers for resolution authorities certainly constitutes a core part of the Bank Recovery and Resolution Directive (BRRD) in terms of both size and content. These provisions have also been the blueprint for the corresponding framework stipulated by the SRM Regulation,1 parts of which replicate the BRRD, while others make reference to provisions in the Directive. The fundamental objective of the Directive, in this regard, has been identified as to define ‘a credible set of tools to intervene sufficiently early and quickly in an unsound or failing institution so as to ensure the continuity of the institution’s critical financial and economic functions, while minimising the impact of an institution’s failure on the economy and financial system’.2 In other words, the Directive promises no less than mechanisms that could ‘minimize negative repercussions by preserving the systemically important functions of the institution concerned’, when a credit institution (or securities firm) comes close to insolvency.3

2.02  The functionality and reliability of the new regime will therefore certainly be crucial for the assessment of the entire Directive, its impact on long-term incentives for bank owners, managers, creditors, and, indeed, financial stability as a whole. In the light of the severe fiscal repercussions of public bailouts in most mature economies during the financial crisis since 2007,4 the avoidance of such responses in the (p. 26) future and their substitution by either existing insolvency regimes or functional alternatives instead has become a key policy objective of national and supranational responses to lessons learnt from the crisis. Against this background, whether or not the new regime, both within and outside the Banking Union, can be made operational even in the case of large, complex, highly interconnected banks and banking groups will thus provide the ultimate test for the concept underlying the BRRD as a whole. This is not merely a question of reliability ex post, that is, once insolvency has occurred, but also instrumental for the ex ante incentive structure that will be associated with the new regime: If—and only if—bank owners and other relevant stakeholder groups (i.e. managers and creditors) have to expect losses and/or other sanctions rather than tax-funded bailouts with a view to minimizing the economic impact of large-scale financial crisis, will they have an incentive to exercise their influence in a way that minimizes excessive risk-taking. In this light, a credible bank insolvency regime could help to remove one of the driving forces that have led up to the global crisis.

2.03  Against this backdrop, ‘making banking resolution credible’ has been rightly, and pointedly, identified as the core challenge for legislators and regulators when drafting new resolution regimes.5 Credibility in this sense crucially depends on technical issues. Special bank insolvency regimes can be credible only to the extent that they adequately address the specific problems associated with the insolvency of large, complex, internationally active banks and banking groups. Many of these problems have been illustrated throughout the financial crisis. In particular, the global liquidation of the Lehman Brothers group, administered in the course of traditional insolvency procedures, has demonstrated the fundamental inaptitude of such procedures in the context of bank insolvency, given their impact on basically all systemically relevant relationships with insolvent banks, their customers, and counterparties and providers of market infrastructure (stock exchanges, clearing houses, etc.).6

(p. 27) 2.04  This chapter undertakes to present an introduction to, and brief analysis of, the resolution toolbox and accompanying powers in the light of contemporary findings on the technical problems posed by large, complex, cross-border insolvencies in the banking sector. The remainder of the chapter is organized as follows: Following an account of the key trends in the design of modern bank insolvency regimes generally, the concept of resolution (as an alternative to traditional forms of insolvency procedures) as well as the key policy objectives of the BRRD will be analysed in some detail in section B below. Section C then examines the conditions for resolution and the general principles for resolution as set out by articles 32 and 33 and article 34, respectively. Section D finally turns to the core of the harmonized framework, that is, the four ‘resolution tools’ (articles 37–58) and the write down of capital instruments (articles 59–62). Procedural issues, as addressed by articles 81–85, will not be discussed in this chapter. As the technical implications, including with regard to group and cross-border resolution scenarios (whose specific problems will be the real challenge for the implementation of the new framework in future cases, and the real test for its viability), will be dealt with in other contributions to this volume, the main purpose is to conceptualize the various parts of the new toolbox in view of lessons learnt from past banking crisis, and to identify key issues for further discussion.

B.  The Concept of ‘Resolution’ and General Principles

1.  Requirements of an alternative insolvency regime for banks: BRRD and its background

a)  The lack of international harmonization prior to the global financial crisis

2.05  While special insolvency regimes for banks had been in place in a number of jurisdictions long before the global financial crisis of 2007–9,7 consensus as to their rationale and objectives had not, and established ‘best practice’ with regard to technical solutions could be found only to a very limited extent. In view of regional banking crises during the 1990s, both academic studies8 and studies commissioned by international standard setters, including the Basel Committee on Banking Supervision9 and, notably, the International Monetary Fund and the (p. 28) World Bank in their joint ‘Global Bank Insolvency Initiative’10 had, by the middle of the first decade of this century, collected a considerable amount of comparative expertise based on country-specific experiences with a multitude of concepts in a large number of jurisdictions. While most of these works advocated special approaches for the treatment of banks in distress, though, there was little agreement on whether the specific technical implications of bank failures required special technical solutions in all circumstances or only in the case of systemically important institutions, however these could be defined. Prior to the global financial crisis, alternatives to outright insolvency liquidation, such as the forced transfer of assets and liabilities of insolvent banks to third-party acquirers or bridge banks, had already been recommended as ‘best practice’, referring to their rather successful and indeed frequent application in the context of bank resolution under the auspices of the Federal Deposit Insurance Corporation (FDIC) in the US regulatory environment.11 Whether or not these instruments could be transplanted into different institutional frameworks, however, was debated theoretically, but with very few practical consequences.12

2.06  With hindsight, the lack of a global conceptual consensus may well have to be attributed to the rather limited amount of pre-crisis precedents that could be analysed in order to explore the merits and shortcomings of the different approaches available. To be sure, regional banking crises, such as the Asian crisis of the 1990s,13 the Latin American crisis of the 1980s and early 1990s,14 the Scandinavian crisis of (p. 29) the early 1990s,15 as well as sectoral national banking crises, for example, the US Savings and Loans crisis of the 1980s and 1990s,16 provided some evidence with regard to the viability of individual legal frameworks. However, such evidence was usually limited to the resolution of a large number of failing medium sized or small institutions operating in regional or national markets that were experiencing widespread systemic stress. By contrast, the technical and legal complexities associated with the coordinated unwinding of a globally active, highly interconnected complex institution, or group of institutions, in a global market environment already under stress had only rarely been experienced before, although some prominent failures in the past had cast some light on individual technical implications and challenges caused by the failure of a cross-border institution. To name but the most important examples: Bankhaus Herstatt, which failed as early as 1974, illustrated potential global repercussions of national insolvency regimes in the foreign exchange markets; Barings plc; Banco Ambrosiano; BCCI; etc.17

2.07  All in all, the technical expertise with regard to the legal treatment of large, complex, interconnected bank failures with cross-border bank failures available before the global financial crisis of 2007–9 was, at best, piecemeal and anecdotal, and certainly not based on broad, empirically sound comparative legal and economic research, which could easily be translated into specific legal frameworks at supra-national or national levels of legislation. The state of affairs before the global collapse of Lehman Brothers in 2008 was very aptly captured by former FDIC chairman William F. Seidman, who is reported to have concluded that ‘The bottom line is that nobody really knows what might happen if a major bank were allowed to default, and the opportunity to find out is not one likely to be appealing to those in authority or to the public’.18 In other words, evidence on the functional characteristics of both traditional insolvency law and alternative concepts in the event of a large multinational bank insolvency was scarce and, at best, anecdotal. As a result, the scope and size of problems likely to be encountered in such circumstances were rather ill-defined. From a political economy perspective, as illustrated by the (p. 30) remark quoted above, these uncertainties would have been sufficient so as to deter the application of general insolvency law except in extraordinary circumstances, for example, in the case of Lehman Brothers which, as an investment bank, did not fall within the established framework for bank resolution in the United States.

b)  Lessons learnt from Lehman and others: The shortcomings of traditional approaches to bank insolvency

2.08  With the repercussions from the Lehman Brothers insolvency felt globally in the aftermath of the initiation of Chapter 11 bankruptcy proceedings with regard to Lehman Brothers Holdings International, Inc. on 15 September 2008, which affected a total of 2,985 group legal entities worldwide,19 the understanding of the sources of systemic risk and the transmission of such risk across global markets has grown substantially. On the basis of a growing body of experience as to the immediate consequences of formal liquidation or reorganization proceedings on contractual relationships to counterparties, the immediate and medium-term effects of formal insolvency management on market prices, refinancing conditions, and existing market infrastructures have been analysed intensively. As a consequence, the understanding of what constitutes ‘systemic risk’ and ‘systemically important institutions’ has been developed significantly over the past few years.20

2.09  Against this backdrop, it has become widely accepted that traditional means for the resolution of failing credit institutions cannot work in the case of systemically important institutions. First and foremost, the reasons for this are to be found in the immediate consequences on on-going business activities that are usually triggered by the commencement and during the initial stages of such procedures. In many jurisdictions, bank insolvency laws before the crisis provided for safeguards in the early stages of resolution procedures in order to help prevent further losses for the period during which isolated corrective action measures or comprehensive restructuring plans are implemented. In some jurisdictions, such safeguards took the form of some sort of a moratorium over the relevant institution, usually including both a ban on all payments and a stay of proceedings and enforcements against it, which may or may not be formally linked to the payout of insured deposits by deposit insurance schemes.21 Such moratoria usually replicate similar mechanisms under general insolvency legislation, which frequently provides for the freeze of assets upon the petition for the opening of insolvency proceedings and prior to the insolvency (p. 31) court’s decision if, and to what end, such proceedings are to be initiated.22 In pre-crisis bank insolvency legislation, a moratorium was frequently followed by a liquidation process, either under general insolvency law or a special regime as part of the legal framework for banking supervision.23 To the extent that jurisdictions had established bank-restructuring procedures prior to the crisis, such procedures hardly ever facilitated the survival of the insolvent bank as a going concern.24

2.10  In view of the drastic consequences associated for on-going commercial relationship with third parties that are triggered by any sort of formal intervention, it is hardly surprising that these concepts failed during the crisis. The messy and systemically disastrous consequences of the Lehman Brothers bankruptcy proceedings were but the most visible example in this respect, with depositors queuing in the run on Northern Rock providing another drastic illustration. Little wonder then that such measures were widely substituted by various measures of open bank assistance, at least in the aftermath of the turmoil triggered by Lehman Brothers and in relation to institutions of a more than trivial size and market position.25 In the insolvency of a non-financial firm in ordinary market conditions, a moratorium can work well to facilitate a beneficial breathing space for renegotiations with creditors with a view to rescheduling the debts, and thus ultimately lead to a successful restructuring.26 This will not usually be feasible in the case of a financial institution, though, because the default on payments to other market participants will immediately trigger the complete breakdown of the institution’s relationships with those actors, and result in accelerated loss of value particularly in financial contracts. Close-out and/or netting provisions frequently used in standard master agreements for derivatives contracts and clearing try to protect the respective counterparties precisely against the fallout of forced interruptions in their contractual relationships against insolvent institutions, and therefore have long been (p. 32) recognized as insolvency-proof by international standards and national regulation as legitimate tools for the reduction of systemic risk in large and complex financial institutions (LCFI) insolvency.27 As moratoria or similar formalized infringements in the vicinity of insolvency, under the applicable master agreement, will usually trigger the right of counterparties to close-out pending contracts and claim their respective net position against the failing institution, they will thus abruptly end that institution’s trading activities and block liquid resources.

2.11  In sum, it is now almost undisputed both in scholarly writing and among policy makers that a moratorium in the context of the insolvency of financial institutions, be it part of a purely administrative approach or adopted under general insolvency law, can hardly ever serve as a restructuring tool; rather, it is confined to a purely conservatory function as part of the preparation of ensuing liquidation procedures.28 If at all feasible, restructuring efforts must therefore be implemented within a very short timeframe, preferably outside normal trading hours, and without disruption to the on-going business relationships with clients and professional counterparties and thus outside traditional formalized insolvency proceedings.29 Even if these conditions are fulfilled, however, it will be difficult enough to keep up access to sources of liquidity and to avoid runs among providers of short-term funding, a major problem in the run-up to the Lehman insolvency, where money market funds and other institutions refused to roll over short-term debt.30 As the crisis has evidenced, problems in this regard will occur out of a combination of reputational factors associated with bad news in relation to the relevant institution (p. 33) and an ensuing fear among investors that they will not be able to recover the money lent. Again, these factors, interconnected with the more technical implications of moratoria and other procedural solutions discussed above, call for immediate solutions once an institution has become known to face financial problems and once rumours to that effect have spread among market participants.

2.12  In principle, similar considerations apply to all sorts and dimensions of bank failures, and in this sense, the case of systemically important financial institutions does not differ fundamentally from ‘ordinary’ bank insolvencies, that is, cases where the size, interconnectedness, and/or complexity of the institution or group of institutions does not give rise to concerns for financial stability in the relevant markets. Although the consequences are more dramatic and difficult to contain in these cases—and indeed may justify higher efforts and cost in order to avoid them altogether—the technical challenges that have to be met are identical or at least similar to cases of less important institutions. Just as any other insolvent financial institution, an institution that is considered ‘too big to fail’ or ‘too connected to fail’ realistically has to be restructured within an extremely short timeframe and without taking resort to formalized measures such as a comprehensive moratorium, if it can be restructured at all. Again, any action taken in this regard must pay sufficient attention to the appropriate timing. In order to minimize the systemic impact, no formal action involving adjustments in the relevant firm’s contractual obligations to third parties should be taken within normal trading hours. The size and complexity of large international financial institutions and their trading activities will usually create significant obstacles to restructurings per se, nevertheless, since any restructuring efforts, regardless of their nature (e.g., through an assisted merger or by way of a recapitalization that may be facilitated by temporary financial support from a government agency), will be difficult both to plan and to execute within the required short timeframe. While the size of the bank’s positions in the inter-bank markets, especially in the markets for financial derivatives, will make it difficult to compensate counterparty losses in a way that avoids domino effects and/or a breakdown in global derivatives markets, the complexity of pending legal relationships will usually be extremely difficult to assess, let alone disentangle, in a reliable way within the very limited timeframe available.31

2.13  This explains why—even prior to the global financial crisis—the support of emergency financial assistance to LCFI had come to be accepted as probably inevitable in times of financial distress,32 notwithstanding the controversy over the justification (p. 34) of ‘too big to fail’ exemptions to insolvency liquidation more generally.33 At least, it indicates that successful restructurings of LCFI require the presence of a strong and capable actor (not necessarily the government or its agencies) that could provide temporary financial support to the transaction, and thus help to mitigate counterparty risk in systemically important contracts.

c)  Squaring the circle? The quest for alternative procedures and the emergence of the toolbox approach

2.14  Both at national and international levels, the search for alternatives has been driven not just by the drastic macroeconomic repercussions of the meltdown in global markets triggered by the Lehman failure, but also by the vast fiscal impact of public financial assistance in the form of equity injections, guarantees, or liquidity support to a large number of banking institutions, or even outright nationalization of some, especially in a number of EU jurisdictions.34 The need to avoid public financial support and to shift the losses associated with the failure of financial institutions from the taxpayer to shareholders, creditors, and, where appropriate (in cases of individual fault) to the senior management of the insolvent firms has since evolved as a key paradigm for the design of alternative concepts for bank resolution, in addition to the containment of systemic implications of individual defaults.35

2.15  This priority is mirrored by both major promulgations on bank resolution that were released by international standard-setters during the crisis, and has been stressed in the preparation of BRRD and its final text: Already the Basel Committee’s ‘Report and Recommendations of the Cross-border Bank Resolution Group’, which was published in March 2010 and marked the beginning of renewed efforts by international setters for the development of substantive global harmonization of bank insolvency regimes, emphasized the need to foster market discipline by effectuating the existing resolution regimes and removing the de facto reliance of major market participants on public financial support.36 Likewise, the Financial Stability Board (FSB)’s ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’, released in October 2011 and in many respects all but a blueprint for the later (p. 35) Commission proposal for the BRRD, ranks the allocation of losses to owners and creditors as well as the avoidance of public financial support amongst its key purposes.37 The Directive itself also expressly seeks to facilitate that ‘shareholders bear losses first and that creditors bear losses after shareholders’, and is confident that the new regime ‘should help avoid destabilizing financial markets and minimize the costs for taxpayers’.38

2.16  The quest thus was for an alternative to traditional forms of insolvency resolution, which serve broadly the same ends—permanent resolution of the failure, with losses borne by shareholders and creditors—while minimizing systemic and fiscal exposure. Ideally, this should come with an incentive structure that leads to improvements in the monitoring efforts of shareholders and (wholesale) creditors and in reduced risk-taking by the management of credit institutions. Both BRRD39 and international standards40 rightly emphasize that in order for these purposes to be accomplished, the regime must be ‘credible’, in the sense that market participants be made aware of the consequences of failure ex ante and that these expectations can be reconciled with their experience ex post failure: Only if banks, their owners, and stakeholders can realistically anticipate both the reaction of resolution authorities in the event of a failure as such and its possible implications on their respective positions, will markets be made to adjust their risk appetite in normal times.41 In other words, as formulated by the Basel Committee’s Cross-border Bank Resolution Group: ‘Discipline is enhanced if market participants clearly perceive that authorities are willing and able to effect a managed resolution of a financial institution.’ This, in turn, requires a precise understanding of the implications such resolution may have both on the individual institution and its shareholders as well as on the relevant markets more generally, or else political economy determinants, that is, the fear of unintended side-effects which could then be held against the responsible authorities and/or politicians, would still deter decisive action and favour bailouts in the future.

2.17  It is not difficult to see that these challenges amount to hardly less than squaring the circle. Size, complexity, and interconnectedness of financial institutions will, in all likelihood, render swift, effective responses ‘over a weekend’ highly difficult to accomplish for technical and logistical reasons, which will be explored further in other chapters of the present volume. At the same time, LCFI resolution, by (p. 36) definition, is about firms whose position and standing in usually more than one national financial system is capable of triggering systemic implications irrespective of existing contractual arrangements (e.g., close-out netting provisions in master agreements governing derivatives, or collateral granted as security to their creditors) and irrespective of resolution powers that do respect such arrangements. If, for example, a large number of derivatives are terminated, or if collateral is being caught up or sold at a large scale upon the initiation of resolution procedures, the result may cause logistical havoc either in the relevant market infrastructure (e.g., securities settlement systems, payment systems, and/or central counterparties) or indeed the market price of assets pledged as collateral to the respective operators of such institutions.42 In this sense, contagious effects of LCFI insolvency are attributable not just to gridlocks caused in the on-going exchange of money and securities, in effect liquidity problems, but also to the lack of substitutes for the position of a significant player in the relevant markets, which may be even more difficult to resolve. As they depend, to a large extent, on the market environment, which will be changing rapidly in particular during a general downturn in the financial markets, such consequences will be not just difficult to avoid, but also difficult to foresee. If transparency and predictability of the economic consequences is a prerequisite both for the adoption of resolution measures by the relevant authorities and for the desired incentive structure to become effective, it would follow that uncertainties in this respect could well turn out to be decisive for the fate of the entire reform.

2.18  In this light, it is hardly surprising that the ‘toolbox’ approach which was advocated both by the Basel Committee’s Cross-border Bank Resolution Group43 and the FSB44 relies to a considerable extent on instruments that had been in place in some jurisdictions long before the global financial crisis. Specifically, the set of harmonized instruments, which is made available for discretionary use in a variety of combinations, includes bridge bank mechanisms45 or the outright transfer of assets and liabilities to a private sector acquirer through purchase-and-assumptions transactions of the sort known under US banking laws for some time.46 While both instruments often did not work without at least some interim funding, they had at least become trusted as instruments that could reduce the adverse incentives (p. 37) inevitably associated with the traditional concept of implicit too-big-to-fail exemptions in more traditional bank insolvency regimes, which made them attractive as international ‘best practice’ with well-established technical features and requirements. Notwithstanding considerable experience with bridge banks and transfer mechanisms at national levels, however, whether or not such instruments can reliably be applied in the context of LCFI is an open question, which will be addressed later in this chapter (infra, para. 2.51). The uncertainties are even higher in the case of what became known as the ‘bail-in’ tool, an innovative instrument that was recommended first by the FSB’s Key Attributes and subsequently enacted as part of the BRRD (infra, paras 2.27–2.61).

2.19  To sum up: While the systemic implications associated with traditional, formalized means of bank resolution have become increasingly well understood since the crisis (although empirical research is still meagre), the potential implications that may follow the eventual application of the new toolbox clearly continue to be a source of uncertainty. The fundamental objective is clear in principle: To implement a harmonized set of resolution tools which simulates the economic outcome of ordinary liquidation procedures for shareholders and some creditors, but avoids the adverse implications of such procedures on markets and market infrastructure. The effective functioning of such a system, however, rests on a complex set of preconditions. These include ‘hard’, or technical, ones, such as the availability of relevant information to all involved authorities and the functionality of the technical solutions for transnational cooperation despite residual differences in terms of substantive contract, corporate and insolvency laws between the relevant jurisdictions, as well as ‘soft’ factors, such as perceptions by market participants or the readiness of authorities to cooperate and neutralize domestic biases especially in cross-border cases. It is certainly too early to evaluate whether or not the system of mutual cooperation in the implementation of a system of powers that, at least in this combination, has never been tested before in any jurisdiction will ever meet these challenges. In this light, the following sections, which will be complemented by more specific analysis of technical issues in the remaining contributions to this volume, should be understood as a preliminary assessment of merits and potential shortcomings, not as a definite verdict.

2.  The concept of ‘resolution’ under BRRD

2.20  The concept of resolution, as defined by article 2(1)(1) BRRD (and, similarly, by article 3(1)(10) SRM Reg) and developed further by the provisions of Title IV of the Directive, clearly reflects the challenges discussed above and is, as such, entirely in line with the relevant international standards in this regard. In rather technical terms, ‘resolution’, for the purposes of the Directive, is defined as

the application of a resolution tool or a tool referred to in article 37(9) BRRD [i.e. additional tools or powers imposed by member states under their domestic laws and regulations, see also the corresponding provision in article 22(2) SRM Reg] in order (p. 38) to achieve one or more of the resolution objectives referred to in article 31(2) BRRD (article 14(2) SRM Reg).

2.21  This definition must be read in conjunction with the requirement, under article 32(1)(c) and (5) BRRD (article 18(1)(c) and (5) SRM Reg), that all ‘resolution action’ be taken only where it is deemed necessary in the public interest and only as a last resort where winding up of the institution under normal insolvency proceedings would be insufficient to meet the resolution objectives set out by article 31 of the Directive (article 14(2) SRM Reg).47

2.22  In addition, article 34(1) of the Directive (and, correspondingly, article 15(1) SRM Reg) sets out a number of ‘general principles governing resolution’, including, to name but the most important, that

  • •  shareholders are to bear first losses (point (a)),

  • •  creditors are to ‘bear losses after the shareholders in accordance with the order of priority of their claims under normal insolvency proceedings, save as expressly provided otherwise’ (point (b)),

  • •  management body and senior management, as a rule, are to be replaced (point (c)),

  • •  those responsible for the failure are to be held liable (point (e)),

  • •  creditors of the same class, as a rule, are ‘to be treated in an equitable manner’ (point (f)),

  • •  no creditor is to incur greater losses as a result than he would have incurred if the institution had been wound up in normal insolvency proceedings (point (g)).

2.23  These provisions reflect an interpretation whereby ‘resolution’—contrary to earlier, much wider definitions of the term48—is designed as an innovative alternative to, and functional substitute of, traditional means of crisis management, which are summarized under the term ‘winding-up’,49 to be adopted in cases where such traditional means would trigger systemic implications. In this concept, resolution authorities are not free to apply this alternative but as an ultima ratio in specific circumstances, where the consequences of traditional forms of crisis management (p. 39) give rise to systemic concerns that could not otherwise be addressed effectively. As will be discussed later,50 this restrictive approach can be justified on the grounds that the application of the resolution tools will inevitably lead to higher risk of loss to the creditors of the failing institution, which can be tolerated only if public interests outweigh their positions.

2.24  While the technical interplay between the ‘resolution objectives’ and ‘conditions for resolution’ under BRRD will be examined in more detail below,51 the provisions cited above are also reflective of the policy underlying the new toolbox in more general terms. In this respect, they are critical for the understanding (and evaluation of) the entire Directive and its future role in financial crisis management: The definition of ‘resolution’ and the guiding principles define not just the micro-economic objectives which are to be pursued in all incidents of financial institutions’ insolvency in the future, but they also represent the benchmark against which the entire toolbox itself has to be measured. Consequently, all resolution action has to be evaluated not just as to its compliance with the technical requirements specified for the individual instruments, but also against the overall concept of ‘resolution’. All in all, the definition of ‘resolution’ in article 2(1) in conjunction with the provisions of Chapter 1, Title IV of the Directive envisages that, if an institution becomes insolvent or near-insolvent and if its failure gives rise to systemic concerns, action must be taken by resolution authorities—which rules out supervisory forbearance as an option—and that such action must pursue a set of specific policy objectives that is defined exclusively by the Directive itself and is, as a rule, not to be manipulated at the discretion of individual Member States.52

2.25  While this ideally should reduce the scope for supervisory forbearance in the event of individual failures, it is worth noting that the Directive still leaves considerable discretion with regard to, inter alia, the choice of instruments as such (articles 32(1), 37(4) BRRD, articles 18(1) and (6) as well as 22(4) SRM Reg), possible derogations from the ranking of claims upon in bail-ins (article 44(3) BRRD, article 27(5) SRM Reg), and irregular financial bank assistance by Member States in extraordinary circumstances (articles 56–58 BRRD, not replicated in the SRM Reg). Whereas alternative resolution along pre-defined lines is the standard policy under BRRD and the SRM Regulation, the wording thus deviates from a strict rules-based approach and provides for considerable flexibility. This may or may not have an impact on the overall policy objective to ensure swift and effective response to banking problems in the future. This flexibility comes with a downside, however. In addition to the technical difficulties associated with choosing and calibrating the course of action in view of the special circumstances, which has to be based on (p. 40) a highly complicated valuation of the relevant institution that may be difficult to accomplish in time,53 the high degree of discretion left to the relevant authorities certainly puts the public interest above the protection of individual depositors. The ‘no creditor worse off rule’, as prescribed by article 34(1)(g) of the Directive (article 15(1)(g) SRM Reg), could well turn out to offer little help in this regard.

C.  Defining the Key to the Toolbox: Objectives of and Conditions for Resolution

1.  ‘Resolution objectives’

2.26  In performing their choice of instruments within the toolbox available under BRRD, authorities are bound to a rather heterogeneous set of interrelated ‘resolution objectives’ defined by article 31(2) of the Directive (article 14(2) SRM Reg). These objectives serve not just as general guidelines for the design of technical reactions to cases of individual failure, but also, pursuant to article 32(5) BRRD (article 18(5) SRM Reg), as a technical benchmark against which the proportionality of any resolution action has to be assessed by way of a comparison to the outcome of a hypothetical winding-up of the relevant institution. In other words: Under the Directive, resolution actions are required to be in conformity with one or more of the objectives defined by article 31(2) BRRD (article 14(2) SRM Reg), which, as a consequence, restrict the resolution authorities’ discretion in planning and implementing such actions in each particular case.

2.27  This could be particularly important in cases where persons affected by resolution measures seek judicial review under article 85(3) and (4) of the Directive. Even though the conditions for appeals are defined rather restrictively so as to accomplish maximum protection against the disruption of resolution measures by litigation,54 it is at least conceivable that individuals could successfully challenge relevant measures if it could be established that the resolution authority had taken action without paying due regard to the restrictions on admissible ‘objectives’ as stipulated by article 31(2) BRRD (article 14(2) SRM Reg).55 That (p. 41) said, if and how the different objectives could ever be reconciled despite their heterogeneous nature in the course of practical applications of the new regime is open to scepticism, which could further increase legal uncertainty and, possibly, also litigation ex post. With good reasons, the catalogue of objectives has been criticized as ‘confusing’ and possibly even detrimental to swift action, in that it might ‘paralyse the resolution authority’.56 In this respect, much will depend on whether courts will come to accept that the objectives—contrary to what the wording of article 31(3) BRRD (article 14(3) SRM Reg) indicates—cannot, and should not, be construed as ranking equally in all circumstances, but any application of the regime will inevitably require the relevant resolution authorities to strike a reasonable, necessarily discretionary balance between them. If they insist on strict equality of the different objectives, these would inevitably become meaningless, as it would appear hardly possible to achieve all objectives to the same extent.

a)  Ensuring continuity of ‘critical functions’

2.28  In the light of the shockwaves throughout global financial markets that were triggered by the Lehman closure,57 it is hardly surprising that ensuring ‘the continuity of critical functions’ prominently has been identified as the first resolution objective in article 31(2)(a) of the Directive (article 14(2)(a) SRM Reg). As protecting the uninterrupted provision of those banking functions deemed essential in macroeconomic terms has inspired all incidents of tax-funded open bank assistance during the crisis, it is evident that the protection of such functions must have top priority in the design of alternative approaches to crisis management, or else public financial support would continue to be indispensable.

2.29  ‘Critical functions’ in turn are defined by article 2(35) BRRD as

activities, services or operations the discontinuance of which is likely in one or more Member States, to lead to the disruption of services that are essential to the real economy or to disrupt financial stability due to the size, market share, external and internal interconnectedness, complexity or cross-border activities of an institution or group, with particular regard to the substitutability of those activities, services or operations.

2.30  This definition, which is to be specified further in a Commission Delegated Act pursuant to article 2(2) BRRD, clearly reflects the insights gained into the determinants of ‘systemic importance’ of credit institutions during the crisis, as well as an international consensus that such functions are worthy of special protection even if this comes with privileges for relevant counterparties.58 It should not be (p. 42) overlooked, however, that despite such convergence there still remains room for controversies among different jurisdictions, for example, with regard to the qualification of activities in securities trading or client services other than deposit taking and payment services.

2.31  This is particularly important because the protection of ‘critical functions’ is not unlikely to play a major role among the motives for resolution measures in the future. As mentioned already,59 resolution authorities may only take action under BRRD if they determine that this would be proportionate in comparison to the implications that would have to be expected under outright winding-up. At the same time, if action under the Directive is permissible, this will, as a consequence, provide the resolution authorities with a much higher degree of discretion than they would enjoy in ordinary insolvency liquidation, while the influence of creditors would be reduced significantly. As a consequence, authorities may be biased towards relying on this objective even in situations where the real effect of a hypothetical winding-up actually could well be absorbed by other market participants and the market infrastructure. Especially in the case of idiosyncratic failures in otherwise sound market environments, the criteria for determining ‘critical functions’ could give room for politically motivated manoeuvre and open the door to a top-down re-engineering of market conditions that would otherwise be prohibited. This may have detrimental consequences for the relevant markets—non-critical functions could perhaps be reallocated more efficiently through outright liquidation—while creditors and other stakeholders would avoid the uncertainties that are inevitably associated with any form of resolution action under BRRD.

b)  Avoiding significant adverse effects on financial stability

2.32  The second objective identified as admissible by article 31(2)(b) BRRD (article 14(2)(a) SRM Reg) is certainly related to the first and, again, representative of the underlying policy. Pursuant to this provision, authorities shall

avoid a significant adverse effect on the financial system, in particular by preventing contagion, including to market infrastructures, and by maintaining market discipline.

2.33  There are, obviously, two aspects addressed here. The first, ‘preventing contagion’, clearly mirrors, and complements, the objective of protecting ‘critical functions’ discussed above, but takes the perspective of the relevant markets and market infrastructures. In this regard, similar considerations apply as have been developed above in relation to the first objective. The second aspect refers to the maintenance of market discipline and thus recognizes the need to establish a viable incentive structure for shareholders and stakeholders, including creditors and managers. This is entirely in line with the international standards that have inspired BRRD.60(p. 43) It is particularly noteworthy that it is mentioned in direct conjunction with concerns for the immediate contagion triggered by the default of financial firms, given that the primary government response to the crisis consisted of open bank assistance which accomplished protection against the latter at the expense of long-term market discipline.

c)  Protecting public funds

2.34  The third ‘resolution objective’, that is, ‘to protect public funds by minimising reliance on extraordinary public financial support’ (article 31(2)(c) BRRD, article 14(2)(c) SRM Reg), complements considerations of financial stability with the motive to avoid future bailouts in response to cases of individual failure. As mentioned before,61 this reflects a key driver of the development of alternative bank resolution regimes in recent years. Within the BRRD framework, article 31(2)(c) is only one example of many provisions aiming at preventing tax-funded bank assistance, which also include specific requirements for recovery plans and resolution plans62 along with corresponding powers of resolution authorities to enforce measures. It should be noted that the final wording of article 31(2) BRRD does not rule out extraordinary financial support a limine. Indeed, articles 37(10), 56–58 BRRD expressly set out conditions for ‘government financial stabilization tools’, ‘public equity support’, and ‘temporary public ownership’, respectively.

2.35  While this could be interpreted as contradicting the general objective of protecting public finances,63 the express recognition that the provision of such support could be unavoidable in extreme circumstances, in particular in cases of large and complex failures in volatile markets, is probably realistic, and a sufficient degree of flexibility should be accepted as desirable.64 As has been quite convincingly argued,

minimising costs to taxpayers (in that capacity) is a more or less pointless goal since taxpayers’ money should be used if that could reduce the cost to society. Expressed in another way: the goal of minimising costs to taxpayers is connected (p. 44) with a risk that costs are shifted to the same persons in different roles, namely as banks’ customers or counterparts, and also that the costs to society will be higher.65

2.36  Whether or not exceptions to the objective of ‘protecting public funds’ ought to have been made subject to stricter, pre-defined criteria and whether the Directive leaves too much discretion to national authorities in this regard is a different question, though. To be sure, the approach adopted in the final version of BRRD does leave room for misuse in this respect, and the original intention to rule out fiscal exposure in response to problems in the financial sector is compromised as a result. Irrespective of the fiscal implications, however, a decisive public intervention, involving substantial tax-payer funded financial resources, may be the only viable approach to avoid macroeconomic disaster, even if this requires the provision of support to banking institutions whose governance and risk culture would appear suboptimal in hindsight. If and to the extent that alternative resolution regimes, designed to deal with individual cases of insolvency, cannot deal with gridlocks in the provision of credit and liquidity to the economy as a whole, an appropriate response could thus inevitably necessitate a ‘relaxation of the supposed rigours of market discipline’.66 Such decisions are genuinely political in nature, and they should be treated and respected as such. The notion that clearer, bright-line rules as to the possible limits of such alternative approaches in the future would have been desirable is therefore, at best, disputable.

d)  Protecting insured depositors and investors, protecting client assets

2.37  Finally, the objectives include the protection of depositors and investors to the extent that their funds are covered by the Deposit Insurance and Investor Protection Directives, respectively67 (article 31(2)(d) BRRD, article 14(2)(d) SRM Reg), and the protection of client funds and client assets generally (article 31(2)(e) BRRD, article 14(2)(d) SRM Reg). While this may appear trivial, it should be noted that the lower rank among the objectives defined by article 31(2) BRRD (article 14(2) SRM Reg) is not accidental. The underlying decision to protect depositors and investors only up to specified ceilings, above which they may be subjected to bail-ins or otherwise exposed to losses, is not unproblematic, though. The interests of depositors and investors could certainly conflict with the public interest in avoiding systemic contagion and protect public finances. Authorities must be aware of a rather complex trade-off in this regard: Depositors’ and investors’ claims, from a public policy perspective, may indeed be deemed worthy of special protection only to a (p. 45) given extent, for example, up to the maximum levels of protection granted by the EU Deposit Insurance and Investor Protection Directives. The approach adopted by BRRD, whereby depositor and investor claims can, and usually will, be included in the distribution of losses to the extent that claims of lower ranks have been depleted,68 is certainly plausible in this respect. In practice, however, the decision to bail-in uncovered deposits will be a problematic one to take, especially in circumstances where depositor and investor confidence in the stability of the relevant financial system has already suffered. The case of Cyprus, where a drastic bail-in of deposits essentially wiped out this confidence, necessitating drastic restrictions on payouts of covered deposits and on cross-border payments in order to prevent a massive flight of capital, clearly provides a highly negative example in this regard.69 Against this backdrop, it is laudable that article 108 BRRD requires Member States to introduce insolvency priority for depositors ahead of the claims of ordinary unsecured, non-preferred creditors, which is to be respected by the terms of a bail-in pursuant to article 34(1)(b), 60(1) BRRD (article 15(1)(b), 17(1) BRRD).

2.  Conditions for resolution

a)  Overview

2.38  Pursuant to article 32(1) BRRD (and, similarly, article 18(1) SRM Reg), taking formal resolution action is permissible ‘only if the relevant resolution authority considers that all of the following conditions are met:

  1. (a)  the determination that the institution is failing or is likely to fail has been made by the competent authority, after consulting the resolution authority or, subject to the conditions laid down in paragraph 2, by the resolution authority after consulting the competent authority;

  2. (b)  having regard to timing and other relevant circumstances, there is no reasonable prospect that any alternative private sector measures, including measures by an IPS,70 or supervisory action, including early intervention measures or the write down or conversion of relevant capital instruments (…) taken in respect of the institution, would prevent the failure of the institution within a reasonable timeframe;

  3. (c)  a resolution action is necessary in the public interest (…).’

2.39  To an even greater extent than the definition of ‘resolution objectives’ discussed above, these triggers—complemented by European Banking Authority (EBA) (p. 46) guidelines pursuant to article 32(6) of the Directive71—are designed to restrict the relevant authorities’ powers to take resort to alternatives to winding-up. In this regard, they add to the set of resolution objectives prescribed by article 31 BRRD (article 14(2) SRM Reg) and in accordance with the underlying concept of ‘resolution’ as a functional substitute of traditional insolvency proceedings discussed above.72 Conceptually, the three ‘conditions for resolution’ should ensure that creditor rights, which are likely to be less effectively protected in alternative resolution regimes supervised by resolution authorities than they would be in a normal insolvency liquidation, are infringed only in cases where public interest considerations, that is, mainly concerns for the protection of financial stability, outweigh the interests of individual stakeholders.73 This protection is weakened by a considerable degree of discretion left to the relevant authorities especially with regard to the requirements under subparagraphs (b) and (c), however. Notwithstanding the right of affected parties to seek judicial review,74 it is hard to imagine a court that would declare a resolution action illegal merely because the relevant resolution authority had, in hindsight, overestimated these requirements. Moreover, it is unclear what consequence such a verdict could possibly have. It thus remains to be seen whether or not these objectives will provide a meaningful barrier between ‘systemically relevant’ cases, in which resolution action is permitted with potentially significant consequences for individual groups of creditors, and ‘the rest’, where only ordinary ‘winding-up’ procedures (in the terminology of the Directive75) may take place.

b)  Institution failing or likely to fail

2.40  Among the three requirements defined by article 32(1) BRRD (article 18(1) SRM Reg), the first is certainly the most uncontroversial in principle. The failure or likeliness to fail is defined further in article 32(4) (article 18(4) SRM Reg) by way of reference to the failure to meet prudential capital requirements (article 32(4)(a) BRRD, article 18(4)(a) SRM Reg), to traditional balance-sheet and liquidity insolvency thresholds (article 32(4)(b) and (c) BRRD, article 18(4)(b) and (c) SRM Reg), and, in rather complicated terms, to the need of

extraordinary financial support76 (…) except when, in order to remedy a serious disturbance in the economy of a Member State and preserve financial stability, the extraordinary public financial support takes any of the following forms:(p. 47)

  1. (i)  a State guarantee to back liquidity facilities provided by central banks according to the central banks’ conditions;

  2. (ii)  a State guarantee of newly issued liabilities; or

  3. (iii)  an injection of own funds or purchase of capital instruments at prices and on terms that do not confer an advantage upon the institution, where neither the circumstances referred to in point (a), (b) or (c) of this paragraph nor the circumstances referred to in Article 59(3)77 are present at the time the public support is granted

(article 32(4)(d) BRRD, article 18(4)(d) SRM Reg).

2.41  This provision illustrates, once again, that extraordinary public financial support under BRRD is not ruled out as a means for crisis resolution, especially in systemic financial crises. Somewhat awkwardly, it exempts ‘solvent’ recipients of public assistance from the application of resolution tools, in that state aid that is granted under the exceptions defined in points (i)–(iii) is not counted as indication of a failure or likeliness of failure within the meaning of paragraph 1(a).78 The underlying rationale is certainly defendable, although it may well prove difficult to evaluate within a short timeframe to which category a particular case actually belongs. It would appear at least unclear, however, whether the differentiation between ‘solvent’ and ‘other’ institutions with respect to the provision of extraordinary public support really adds further clarification to the requirements under article 32(4)(a)–(c), as it is difficult to imagine a case where neither of these requirements is met but nonetheless extraordinary public financial support is required.

2.42  Irrespective of these—rather technical—considerations, however, the definition of the triggers for resolution in article 32(1) broadly provides relevant authorities with a sufficiently flexible framework. It allows for swift responses already at a stage where the institution has not yet reached a state of outright (balance-sheet or liquidity) insolvency and, at the same time, should be sufficiently specific so as to prevent such action in the event of mere financial irregularities, which do not or not yet justify infringements of shareholder and creditor rights. One aspect should be noted, however: Pursuant to article 32(1)(a), and article 32(2) of the Directive, Member States are free to allocate the determination of actual or imminent failure to either the ‘competent’ authority, that is, the authority responsible for the (p. 48) on-going prudential supervision of banking institutions,79 or the resolution authority, but are required to ensure cooperation between these agencies in any case. This recognizes existing different institutional frameworks for the supervision and resolution authorities in the Member States, but also highlights a potential source of disagreement between these different players which could turn out to be detrimental to swift action in individual cases.

c)  No reasonable prospect of other successful solutions

2.43  With the second condition, the Directive requires the relevant resolution authority to conduct an assessment whether resolution could be avoided by alternative means (article 32(1)(b) BRRD, article 18(1)(b) SRM Reg). The requirement, again, reflects the aim to restrict the concept of ‘resolution’ under BRRD and the SRM Regulation in cases where public interest considerations outweigh the interests of creditors and other stakeholders, by ensuring that available alternatives must have been exhausted. Although it leaves considerable discretion to the resolution authorities, it is thus nonetheless part of a proportionality test, which is complemented by the third condition (discussed below). In this context, it is worth noting that the write down or conversion of relevant capital instruments in accordance with article 59(2) of the BRRD (cf. article 21 SRM Reg) are mentioned as examples of alternative ‘supervisory action’, although they are interrelated with the Directive’s provisions on the bail-in tool and although the relevant powers are allocated to the resolution authority, not the supervisory authority. This reflects the rather complicated position of the write down and conversion powers as a hybrid of the preliminary stages of resolution on the one hand and formal resolution proper on the other hand.80 As these powers, just as the ‘resolution tools’ themselves, are part of the Directive’s provisions on ‘resolution’ in Title IV, the wording of article 32(1)(b) is not entirely consistent with the overall structure and systematic concept, however. Conceptually, the corresponding provisions in Article 21 SRM Reg, which precede the Regulation’s provisions on resolution tools, have been drafted in a much more consistent way in this respect.

d)  Resolution necessary in the public interest

2.44  In practice, the requirement set out in article 32(1)(c) BRRD (article 18(1)(c) SRM Reg), whereby any resolution action must be ‘necessary in the public interest’, will probably turn out to be the crucial determinant for the relevant authorities’ (p. 49) decisions in each particular case, as it is in this respect that the arguments for and against taking resolution action must be balanced against the costs associated with that action for shareholders and, in particular, the different groups of creditors and other stakeholders. Against this backdrop, the provision could thus become the source of complex litigation too.81 Its wording indicates that public interest considerations are not, in themselves, sufficient to support the authorities’ decision to take resolution action under BRRD rather than submit the relevant institution to ordinary insolvency proceedings, but that resolution must in fact appear ‘necessary’ in view of the weight of such considerations in each particular case. Arguably, this ought to be interpreted as a procedural requirement, whereby the relevant authority must make a formalized assessment of the conflicting arguments in support of and against alternative resolution in each particular case, taking the hypothetical outcome of outright liquidation in ordinary insolvency proceedings as a counterfactual and benchmark. This interpretation is supported by article 32(5) BRRD (cf. article 18(5) SRM Reg), which specifies ‘necessity in the public interest’ by providing that

a resolution action shall 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 referred to in Article 31 and winding up of the institution under normal insolvency proceedings would not meet those resolution objectives to the same extent.

2.45  The complex nature of this assessment, and the dimension of legal uncertainty that could follow from it, can hardly be underestimated. While the wording of the provision indicates that it would be required, a fully fledged cost-benefit analysis in this respect will be impossible to accomplish in practice. Especially absent reliable experience with the application of the resolution tools provided by the Directive, the costs involved in alternative resolution can hardly be quantified. Likewise, especially in the case of large, complex failures, it will be hardly feasible to quantify the implications for creditors, other stakeholders and financial stability that would be associated with a hypothetical insolvency liquidation, given the extent to which these implications will depend not just on volatile market prices of assets and liabilities as such but also on the influence of the expectations of market participants as to the possible outcome, which in turn will have a bearing on the relevant market conditions.

2.46  To demand anything but an informed guess ex ante would therefore burden the relevant authorities with a task they cannot adequately handle. However, if interpreted as a procedural requirement rather than a bright-line substantive delineation of systemically important from ordinary cases, the ‘public interest’ condition could nonetheless work as a useful element to calibrate, and restrict, the relevant authority’s discretion: From this perspective, the relevant authorities would then (p. 50) be required to conduct a rational assessment of the situation (including an interim valuation in accordance with article 36 of the Directive), taking into account not just the authority’s own assessment, but also the positions of other public bodies (including the supervisory authority and central banks, benefiting from their long-standing relationships to the relevant institution), other market participants, and relevant providers of market infrastructure. The determination whether the individual case has the potential to trigger systemic implications or not in the given market circumstances, which forms the core of the considerations required by article 32(1)(c) and (5) of the Directive, could well benefit from established standards for a formalized assessment procedure in this respect.

D.  Resolution Tools and Write Down of Capital Instruments

1.  Sale of business and bridge institution

2.47  Together, the sale of business and bridge institutions, prescribed by articles 38–39 and articles 40–41 BRRD (articles 24 and 25 SRM Reg), respectively, represents a combination of powers that had become accepted as best practice in a number of jurisdictions already prior to the global financial crisis, notably in the United States and Canada,82 and has been adopted by others in the years since 2009—Britain,83 Denmark,84 and Germany85 being just a few examples. As mentioned above, these jurisdictions have also inspired the relevant parts of the FSB’s Key Attributes.86 The Directive and the SRM Regulation take up and refine those earlier models, while adding few, if any, original features.87

(p. 51) 2.48  Under both the Directive and the SRM Regulation, the sale of business tool may be exercised in the form of both share deals (article 38(1)(a) BRRD, article 24(1)(a) SRM Reg) and asset deals (article 38(1)(b) BRRD, article 24(1)(b) SRM Reg). In either form, the purpose is to divest the relevant credit institution of those parts of its business that are deemed systemically sensitive, and to transfer the relevant commercial relationships, including assets and liabilities pertaining to them, to a third-party purchaser (other than a bridge institution). The transaction shall be ‘made on commercial terms, having regard to the circumstances and in accordance with the Union State aid framework’ (article 38(2) BRRD, cf. article 24(2)(b) SRM Reg), with any consideration paid to benefit the institution itself or its owners, depending on the form of transaction (article 38(3) BRRD). The relevant institution itself can then be wound up under normal insolvency law, without any systemic repercussion.88 The selection of a purchaser, in this context, is subject to certain qualitative and procedural criteria pursuant to article 39(2) BRRD, to ensure the equal treatment of prospective purchasers and to avoid anticompetitive effects. These requirements may be waived in the interest of avoiding systemic implications in extraordinary circumstances, though, where immediate action may be necessary (article 39(3) BRRD).

2.49  All in all, these provisions appear to strike a reasonable balance between the interest of shareholders, potential purchasers, and the need to maintain financial stability by taking swift and effective action. However, whether a private purchaser will be available at all will depend on the commercial value of the relationships selected for transfer, on the availability of banks both ready and financially capable of assuming the associated risk, and, finally, on the availability of sufficient time to conduct due diligence assessments and agree on pricing. Where these conditions are not fulfilled and a transfer of systemic activities seems nonetheless desirable, shares or a combination of assets and liabilities may alternatively be transferred to a ‘bridge institution’ set up and organized by public authorities pursuant to article 40 of the Directive. The bridge institution may then, within a limited period of time,89 either wind down the business, sell it as a whole or in part to another institution, or merge with another institution (article 41(2) BRRD, cf. article 25(2)(b) SRM Reg). In exercising the sale of business and bridge institution tools, the resolution authorities shall be able to invoke a wide range of harmonized ‘resolution powers’, available in conjunction with all resolution tools pursuant to articles 63–72.

(p. 52) 2.50  All in all, the new framework replicates the arrangements for transfer orders and bridge bank solutions in existing legislation worldwide, and it should be possible to implement the new toolbox in a way that draws from such earlier experience.90 Available precedents also highlight some potential obstacles to an effective application, nevertheless. Transfer mechanisms and bridge banks have to date been applied only to smaller or medium-sized banks, with rather simple corporate structures and no major cross-border business. Faced with the task to apply the tool at a group basis or in relation to a single but large, highly interconnected institution with significant cross-border activities, the relevant resolution authorities may be unable to cope with the sheer complexity of orchestrating a consistent approach in the face of conflicting national interests, conflicting substantive and, possibly, also procedural rules (at least in their relationships with non-European authorities) within the required short timeframe. Moreover, neither the transfer of business to a private acquirer nor the transfer to a bridge institution is likely to facilitate no-cost solutions in all circumstances. Private acquirers may seek some sort of indemnification against risks associated with the portfolio that cannot be discovered in time before the transaction, and bridge banks need both liquidity and own funds in order to be able to operate the transferred business for the time being. This again will be very difficult to accomplish at least in the context of LCFIs and groups. In short, both instruments are probably to be dismissed as ill suited for application in LCFI insolvency—and thus of little help as instruments for ending ‘too big to fail’ approaches to bank insolvency altogether.91

2.  Asset separation tool

2.51  In the political debate on alternative approaches to bank resolution in response to lessons learnt from the global financial crisis, the transfer of distressed debt to asset management companies set up specifically for the purpose of managing and restructuring distressed debt under public surveillance outside the banking sector has played a comparatively small role. In the Basel Committee’s report on cross-border bank resolution,92 asset management companies are not even mentioned, while the FSB’s recommendations only briefly refer to them as one of the instruments that should be available to resolution authorities as part of their toolbox of powers in crises.93 Nonetheless, asset management vehicles of different designs, ranging from solutions designed for individual institutions to companies designed for the acquisition of distressed debt from entire banking sections, have been used, and discussed, in a variety of regional banking crises in the past.94

(p. 53) 2.52  Against this backdrop, it is hardly surprising that both the BRRD and the SRM Regulation have introduced asset management companies, named the ‘asset separation tool’, as part of the harmonized toolbox. Pursuant to article 42 BRRD (cf. article 26 SRM Reg), resolution authorities may implement a transfer of assets, rights, or liabilities from banking institutions or bridge banks to asset management companies which are wholly or partly owned by public authorities, in order for the management company to ‘manage the assets transferred to it with a view to maximizing their value through eventual sale or orderly wind down’ (article 42(1), (2) and (3) BRRD). Removing these positions from the failing institution’s balance sheet can thus remove uncertainty in the valuation of the institution’s books and free up capital, which may facilitate the recovery of the institution’s capital base and/or new lending to more profitable ends. As such benefits may come with anti-competitive externalities the Directive prescribes restrictive conditions for the use of the instrument. As a rule, it may only be invoked together with another resolution tool (article 37(5) BRRD, article 22(4) SRM Reg), which is intended to offset ‘undue competitive advantage[s]‌’.95 Even then, the application of the tool is permissible only if an ordinary liquidation of the relevant assets could have adverse effects on market stability, only if the transfer is necessary to ensure the ‘proper functioning’ of the relevant institution or bridge institution, and only if it is ‘necessary to maximize liquidation proceeds’ (article 42(5) BRRD). These conditions have been specified further by EBA guidelines pursuant to article 42(14) of the Directive.96

2.53  It is difficult to foresee whether and to which extent resolution authorities will make use of asset management companies under BRRD. While the Directive appears to envisage a rather limited role of the instrument, it could nonetheless prove to be a useful instrument to be deployed not least in the restructuring of regional banking systems within Europe, as the true dimension of structural problems unfolds in the wake of the European Banking Union. Lessons learnt from the (p. 54) Scandinavian banking crisis of the early 1990s could possibly be informative also in this respect.97

3.  Bail-in and write down of capital instruments

2.54  The provisions on the ‘bail-in tool’ (articles 43–55 BRRD, see article 27 SRM Reg) and the write down of capital instruments (articles 59–62 BRRD, see article 21 SRM Reg) are by far the most complex part of the harmonized toolbox. In some sense, they are also the most ambitious one: Not least cases where neither the transfer of assets and/or liabilities to private purchasers or bridge institutions nor the asset separation tool is likely to work, that is, especially in the case of large, complex, internationally active institutions, a combination of the bail-in tool and the complementing powers to write down capital instruments is hoped to provide resolution authorities with the means to accomplish results that would be broadly similar to the outcome of ordinary insolvency winding-up for shareholders and stakeholders, but avoid the systemic fallout that would otherwise follow. Mandatory bail-in imposed by resolution authorities (as opposed to contractual bail-in) in the form prescribed by both the Directive and the SRM Regulation is a relatively new concept. The relevant provisions in the Directive build on the FSB’s Key Attributes,98 whereas the Basel Committee’s cross-border bank resolution group, in its 2010 report, did not mention the concept at all.

2.55  Compared with the rather crude approach taken by the FSB and the early drafts of the Directive, the final version of the BRRD has been refined considerably, however. Pursuant to article 43(2) BRRD (article 27(1) SRM Reg), the bail-in tool may now be used alternatively to

  1. (a)  recapitalize an institution [or other relevant entity] that meets the conditions for resolution to the extent sufficient to restore its ability to comply with the conditions for authorization (to the extent that those conditions apply to the entity) and to continue to carry out the activities for which it is authorized (…), and to sustain sufficient market confidence in the institution or entity; [or]

  2. (b)  to convert to equity or reduce the principal amount of claims or debt instruments that are transferred:

    1. (i)  to a bridge institution with a view to providing capital for that bridge institution; or

    2. (ii)  under the sale of business tool or the asset separation tool.

2.56  Unlike in earlier versions of the draft Directive, articles 47 and 48 of the BRRD now expressly require the resolution authorities to write down and/or convert to equity relevant capital instruments pursuant to articles 59–62 prior to bailing-in creditors. The same applies within the SRM framework pursuant to articles 21, 27 (p. 55) SRM Reg. These provisions seek to ensure that losses are distributed in accordance with the general hierarchy of claims set out in article 34(1)(a) and (b) BRRD (article 17 SRM Reg), discussed above.99 Pursuant to article 48 BRRD (articles 21(10), 28(13), and 17 SRM Reg), losses are to be borne (a) first, by holders of Common Equity Tier 1 instruments, that is, shares, and subsequently by (b) holders of Additional Tier 1 instruments, (c) holders of Tier 2 instruments, (d) holders of other subordinated debt and, finally, (e) holders of other ‘eligible liabilities’, that is, all other liabilities except those excluded from the scope of the bail-in tool by article 44(2) of the Directive (article 27(3) SRM Reg).100 Pursuant to articles 45, 46, 48, and 50 BRRD, the relevant amounts and conversion rates will be determined by the resolution authority on the basis of a valuation of the insolvent institution, details on which are set out in article 36 of the Directive (cf. article 20 SRM Reg). If applied in an ‘open bank scenario’, where the bail-in instrument is used in order to recapitalize a failing bank, this must be accompanied by recovery and resolution measures, including the development of a business reorganization plan, within a predefined timeframe (articles 43(3), 51, and 52 of the Directive). As in the case of other resolution actions, an ex post valuation will be carried out later pursuant to article 74 of the Directive, in order to determine whether shareholders and creditors would have received better treatment if the institution had undergone ordinary insolvency liquidation.

2.57  Under the final version of BRRD, the bail-in of creditors has thus become a multi-purpose instrument designed to ensure that creditors realize losses on their claims as they would do in ordinary insolvency proceedings, and, possibly, to facilitate a (re-)capitalization of the failing institution or a bridge institution, as the case may be. As a result, the implementation of the tool is likely to be fraught with complex policy decisions and intricate problems of technical design with regard to both the (p. 56) calibration of the relevant amounts and the combination with other instruments. Given the lack of reliable precedents, this could prove a serious obstacle to swift resolution from the start. Against this backdrop, whether, and in which form, bail-in should be expected to substitute other means of resolution in LCFI insolvency under the BRRD is, at best, not free from doubt. From a theoretical point of view, the concept undeniably offers substantial advantages compared with any other alternative. If the framework could be applied smoothly in practice, that is, without causing contagion in the derivatives and Credit Default Swaps (CDS) markets, payment and securities settlement systems, and hopefully in the market for refinancing instruments, it could thus be a viable option especially in relation to large and complex institutions, where sale of business and/or bridge institution solutions may not be feasible. Effectively, a bail-in would thus be the very ideal response to the quest for alternatives to traditional forms of insolvency resolution, inasmuch as it leaves intact the incentive structure associated with general insolvency law and avoids systemic repercussions. While recommended, for these and other reasons, by many,101 some significant unresolved issues and uncertainties nonetheless remain, including the following:

2.58  First, the smooth implementation of bail-ins in practice clearly rests on a number of highly ambitious preconditions, including, to start with, the feasibility of a proper valuation of the insolvent institution’s financial position, which may be difficult to achieve within a short period of time.102 While the desire to keep bail-ins in line with the hierarchy of claims under normal insolvency proceedings is, in itself, laudable and fully consistent with the Directive’s underlying policy objectives,103 the calibration of the instrument in a way that conforms with the doctrine that no creditor shall be worse off than in ordinary insolvency104 will be particularly difficult to accomplish.105 In this regard, the interplay between bail-in instrument, the ‘conditions for resolution’ (which, as discussed above, presuppose that the relevant institution has already reached the proximity of insolvency106), and the no creditor worse off principle could deter effective recapitalization until a very late stage, which could undermine the availability of the tool to assist in ‘open bank’ (p. 57) restructurings.107 Particularly in the context of a bail-in, the result could be protracted and complex litigation, which could, in turn, threaten the orderly implementation.108 This could turn out to be particularly problematic in cross-border cases, where the courts in countries other than the home country of a resolution action could effectively block the execution by refusing recognition.109

2.59  Secondly, despite growing international convergence with regard to the treatment of close-out-netting and termination rights in the insolvency of financial institutions, it is not entirely clear if foreign jurisdictions would respect the Directive’s provisions on the treatment of such rights in resolution in general and within a ‘bail-in’ in particular.110 While articles 49 and 76–78 BRRD do recognize the need for special treatment in view of established market practice, it remains to be seen whether these provisions and safeguards are sufficient to contain the risk of ‘technical’ contagion that could arise out of the application of the tool in this respect.

2.60  Thirdly, even if technically feasible, a bail-in could trigger serious implications for the funding channels of banks, both retail and wholesale, and thereby give rise to systemic repercussions not too different from the contagious effects of more traditional forms of insolvency resolution:111 As has been mentioned already, bailing-in retail creditors could substantially weaken confidence in the safety of deposits and assets held not just with the relevant institution itself but possibly also by other institutions in a similar position, which might trigger a system-wide run. Resolution authorities could therefore be well advised to exclude such liabilities, exercising their limited discretion under article 44(3) of the Directive (article 27(5) SRM Reg).112 Bailing-in wholesale creditors could lead to similar results among professional investors in bank debt, however, which could weaken the relevant bank’s funding base and thus reduce rather than improve the prospects of recovery.113

(p. 58) 2.61  In short, the ad hoc implementation of a bail-in in crisis scenarios, in whatever form, involves a drastic reorganization of the entire passive side of an institution’s balance sheet. In this context, the resolution authority will have to make extremely far-reaching decisions with tremendous consequences not just for the individual firm’s capital base but for the system as a whole. Essentially, the authority performs a task that would, in normal insolvency proceedings, fall to the insolvency administrators, to the creditors, and to the insolvency court jointly. As there are no precedents for forced debt-to-equity swaps at this scale and as the relevant information gathering and valuations will have to be carried out within a restrictive timeframe in practice, it is certainly ambitious to trust the authorities to deliver sustainable results without triggering contagion among creditors and the market for bank equity. These implications make the instrument particularly problematic for application in systemic financial crises.114 It is perhaps telling that former US Secretary of the Treasury Timothy Geithner, in his account of the US approach to the management of the bank failures during the global financial crisis, ruled out ‘haircuts’ on creditors, that is, the participation of creditors and investors in losses caused by individual failures, as absolutely counterproducting during systemic crisis.115 This is, at least, indicative of strong incentives for public officeholders which may, even after full implementation of BRRD across Europe, deter the implementation of the bail-in instrument in cases of LCFI insolvency.

E.  Conclusion

2.62  To sum up: irrespective of all the different problematic aspects identified above, the harmonized toolbox prescribed by Title IV of the BRRD should be welcomed as a significant step forward. More traditional forms of insolvency procedures (both in the form of outright liquidation and of Chapter 11-style reorganization procedures) have proved inadequate in view of the contagion risk triggered by their implementation, Lehman Brothers being the most drastic example of that so far. The overarching aim to replace this dysfunctional approach with an innovative set of powers that simulate the economic outcome of traditional insolvency for owners, management, and stakeholders certainly appears laudable. To some extent, these powers, in particular the sale of business and bridge institution tools, build on well-established practices that have been tested in a number of jurisdictions. Using such past precedents as a source of reference, they stand a chance to prove of value (p. 59) especially in the event of idiosyncratic insolvencies of medium-sized institutions, whose failure could nonetheless give rise to systemic implications. Even with regard to cases involving large, complex, internationally active institutions, the innovative bail-in tool, along with the power to write down or to convert capital instruments issued by the relevant institution, could well become a valuable substitute for more traditional responses. Leaving aside the only partly resolved technical details, it looks like a fascinating alternative.

2.63  Nevertheless, it may turn out to be the case that the devil is precisely in those details—which may explain why there are no meaningful precedents in the history of bank insolvency management so far. While it significantly expands the range of policy options available for the resolution of systemically relevant bank insolvencies, the Directive does not succeed in removing the many uncertainties as to the technical design of resolution action and as to the possible implications of systemic stability. From a political economy perspective, this could well turn out to discourage the use of the harmonized toolbox especially in cases involving very large institutions, where failure on the part of the relevant authorities and flaws in the technical design of the chosen course of action could jeopardize not just the failing institution but also market stability—and public budgets—more generally. Where resolution action along the lines envisaged by the BRRD is taken nonetheless, it is hard to escape the conclusion that the many uncertainties associated with this course of action will, almost inevitably, be burdened not least on the institution’s creditors and other stakeholders, possibly with serious consequences for depositor and investor confidence. For reasons discussed above, neither the ‘no creditor worse off rule’ as such nor ex post valuation and compensation claims are likely to offset the ensuing risk. In this light, it is laudable that the Directive restricts the scope of the resolution tools to cases where the public interest, in view of potential systemic implications of the failure, outweighs the interests of shareholders and stakeholders, which may well be better served in ordinary insolvency liquidation.(p. 60)


1  SRM Regulation (SRM Reg), Part II, Title I, Chapter 3.

2  Bank Recovery Resolution Directive (BRRD), preamble, recital 5.

3  Ibid., recital 1.

4  See, e.g., EU Commission, ‘Commission Staff Working Paper: The Effects of Temporary State Aid Rules Adopted in the Context of the Financial and Economic Crisis’, SEC (2011) 1126 final, 20 November 2012; EU Commission, ‘Commission Staff Working Paper: Facts and figures on state aid in the EU Member States’, SEC (2011) 1487 final, 1 December 2011; SM Stolz and M Wedow, ‘Extraordinary measures in extraordinary times: Public measures in support of the financial sector in the EU and the USA’, (2010) ECB Occasional Paper Series No. 117.

5  J Armour, ‘Making Bank Resolution Credible’ in E Ferran, N Moloney, and J Payne (eds), Oxford Handbook of Financial Regulation (OUP 2014), p. 453; see also BRRD, preamble, recital 5, above n 1.

6  For in-depth analysis of this case, see M Fleming and A Sarkar, ‘The Failure Resolution of Lehman Brothers’ (2014) Special Issue: Large and Complex Banks, FRBNY Econ. Pol’y Rev. 20; SJ Lubben and S Pei Woo, ‘Reconceptualising Lehman’ (2014) 49 Texas International Law Journal 297; R Kulms, ‘Lehman’s Spill-over Effects’ (2012) 3 Peking University Journal of Legal Studies 3; see also, analysing the case from a policy perspective, Basel Committee on Banking Regulation, ‘Report and Recommendations of the Cross-border Bank Resolution Group’ (March 2010), <www.bis.org/publ/bcbs169.pdf> accessed 17 September 2014, paras 49–50; Centre for Economic Policy Research, A Safer World Financial System: Improving the Resolution of Systemic Institutions, Geneva Reports on the World Economy No. 12 (London: CEPR 2012) <www.cepr.org/active/publications/books_reports/viewreport.php?cvno=P210> 42–6.

7  For comparative overviews, see, e.g., M Giovanoli and G Heinrich (eds), International Bank Insolvencies: A Central Bank Perspective (The Hague: Kluwer 1999); HG Hüpkes, The Legal Aspect of Bank Insolvency (The Hague: Kluwer 2000) 49–106.

8  See, e.g., A Campbell and P Cartwright, Banks in Crisis (Aldershot: Ashgate 2002); Hüpkes, The Legal Aspect, above n 7; DG Mayes and A Liuksila (eds), Who Pays for Bank Insolvency? (Houndmills: Palgrave Macmillan 2004); finally, in German (comparing the German and UK approaches to bank insolvency management at the time) JH Binder, Bankeninsolvenzen im Spannungsfeld zwischen Bankaufsichts- und Insolvenzrecht (Berlin: Duncker & Humblot 2005).

9  See Basel Committee on Banking Supervision, ‘Supervisory Guidance on Dealing with Weak Banks’ (March 2002) <www.bis.org/publ/bcbs88.pdf> esp 30–8. The focus of this document was on general problems associated with bank failure, however, and specific problems associated with groups (38–9) and cross-border issues (39–40) were addressed only very briefly.

10  See International Monetary Fund and the World Bank, ‘An Overview of the Legal, Institutional, and Regulatory Framework for Bank Insolvency’, final report (17 April 2009) <www.imf.org/external/np/pp/eng/2009/041709.pdf>; see also R Leckow, ‘The IMF/World Bank Global Insolvency Initiative—Its Purpose and Principal Features’, in DS Hoelscher (ed.), Bank Restructuring and Resolution (Basingstoke: Palgrave Macmillan 2006) 185–95. And see TMC Asser, Legal Aspects of Regulatory Treatment of Banks in Distress (Washington D.C.: International Monetary Fund 2001).

11  See, e.g., Asser, Legal Aspects, above n 10, 144–7; for a comparison of bridge bank solutions adopted in a variety of jurisdictions, see JR LaBrosse, ‘International Experience and Policy Issues in the Growing Use of Bridge Banks’, in JR LaBrosse, R Olivares-Caminal, and D Singh (eds), Financial Crisis Management and Bank Resolution (London: Informa 2009) 217.

12  See, e.g., SA Seelig, ‘Techniques of Bank Resolution’, in Hoelscher (ed.), Bank Restructuring, above n 9, 97, 106–13; see also (discussing whether such regimes might be commendable also for the German market), e.g., Binder, Bankeninsolvenzen, above n 8, 733–5.

13  On which, see, e.g., M Yokoi-Arai, Financial Stability Issues: The Case of East Asia (London: Kluwer 2002) 83–183; CP Chandrasekhar and J Ghosh, ‘The Asian Financial Crisis, Financial Restructuring, and the Problem of Contagion’, in MH Wolfson and GA Epstein (eds), The Handbook of the Political Economy of Financial Crises (New York: Oxford University Press 2013) 311.

14  See, e.g., M Damill, R Frenkel, and M Rapetti, ‘Financial and Currency Crises in Latin America’, in Wolfson and Epstein (eds), Handbook, above n 13, 296; Liliana Rojas-Suarez and Steven R. Weisbrod, ‘Financial Market Fragilities in Latin America: From Banking Crisis Resolution to Current Policy Challenges’ IMF Working Paper (October 1994) <http://ssrn.com/abstract=883859>; L Rojas-Suarez and SR Weisbrod, ‘Banking Crises in Latin America: Experience and Issues’ IDB Working Paper No. 265 (February 1996) <http://ssrn.com/abstract=1815951>.

15  See, e.g., DG Mayes, L Halme and A Liuksila, Improving Banking Supervision (Houndmills: Palgrave Macmillan (2001)) 11–48; specifically on Norway: TG Moe, JA Solheim, and B Vale (eds), The Norwegian Banking Crisis, Norges Bank Occasional Paper no. 33/2004 <http://www.norges-bank.no/en/Published/Papers/Occasional-Papers/33-The-Norwegian-banking-crisis>; on the crisis in Finland: P Nyberg and V Vihriälä, ‘The Finnish Banking Crisis and Its Handling’, Bank of Finland Discussion Papers no. 8/93 (1993) <www.suomenpankki.fi/pdf/SP_DP_1993_08.pdf>.

16  For an account of events and review of the academic literature see, e.g., Federal Deposit Insurance Corporation (FDIC), ‘The Savings and Loans Crisis and its Relationship to Banking’, in FDIC (ed.), History of the Eighties—Lessons for the Future (1997) <https://www.fdic.gov/bank/historical/history/index.html>, ch. 4.

17  For a comparative account of past banking crises and resulting policy implications, see, e.g., B Gup, Bank Failures in the Major Trading Countries of the World (Westport, US: Quorum Books 1998) 17–67.

18  Quoted after GG Kaufman, ‘Are Some Banks Too Large to Fail? Myth and Reality’ (1990) 1 Contemporary Policy Issues 2.

19  See references above in n 6.

20  See Basel Committee on Banking Supervision, ‘Global Systemically Important Banks: Updated Assessment Methodology and the Higher Loss Absorbency Requirement’ (July 2013), <www.bis.org/publ/bcbs255.pdf>; M Dijkman, ‘A Framework for Assessing Systemic Risk’ (2010) World Bank Policy Research Working Paper5282; for a review of the recent economic literature see O De Bandt, P Hartmann, and JL Peydró, ‘Systemic Risk in Banking. An Update’, in AN Berger, P Molyneux, and JOS Wilson (eds), The Oxford Handbook of Banking (Oxford: Oxford University Press 2010) 633; from a legal perspective, SL Schwarcz, ‘Systemic Risk’ (2008) 97 Georgetown Law Journal 193.

21  See, e.g., Asser, Legal Aspects, above n 10, 94–101.

22  E.g., World Bank, ‘Revised Insolvency and Creditor Rights Systems Principles’ (2011) <http://siteresources.worldbank.org/EXTGILD/Resources/5807554-1357753926066/ICRPrinciples-Jan2011%5BFINAL%5D.pdf> para 94: ‘Principle C.53: ‘A stay of actions by secured creditors also should be imposed in liquidation proceedings to enable higher recovery of assets by sale of the entire business or its productive units, and in reorganization proceedings where the collateral is needed for the reorganization. The stay should be of limited, specified duration, strike a proper balance between creditor protection and insolvency proceeding objectives, and provide for relief from the stay by application to the court based on clearly established grounds when the insolvency proceeding objectives or the protection of the secured creditor’s interests in its collateral are not achieved. Exceptions to the general rule on a stay of enforcement actions should be limited and clearly defined’. For detailed recommendations on preliminary stays upon commencement of insolvency proceedings, see UNCITRAL, ‘Legislative Guide on Insolvency Law, Parts One and Two’ (2004) <www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf> paras 26–69.

23  For discussions of the different national models, see, again, references above in n 7.

24  For discussion, see Binder, Bankeninsolvenzen, above n 8, 562–6 (with focus on Germany and England); JH Binder, ‘An den Leistungsgrenzen des Insolvenzrechts: Systemische Bankeninsolvenz und verfahrensförmige Sanierung’ (2013) 73 KTS Zeitschrift für Insolvenzrecht 277, 300.

25  See above text and n 4.

26  E.g., UNCITRAL, ‘Legislative Guide’, above n 22, paras 28–9.

27  Cf., e.g., Basel Committee on Banking Supervision, Report and Recommendations, above n 5, paras 105–14; Bank for International Settlements, ‘OTC Derivatives: Settlement Procedures and Counterparty Risk Management’ (1998) <www.bis.org/publ/cpss27.pdf>, and, within the EU, the protective provisions in Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements, OJ L 168 of 27 June 2002, 43. And see, for controversial discussions, RR Bliss and GG Kaufman, ‘Derivatives and Systemic Risk: Netting, Collateral, and Closeout’ (2006) 2 Journal of Financial Stability 55; P Paech, ‘Close-Out Netting, Insolvency Law and Conflict of Laws’, LSE Legal Studies Working Paper No. 14/2014, <http://ssrn.com/abstract=2414400>.

28  See Asser, Legal Aspects, above n 10, 95 (disputing the merits of moratoria as part of restructuring solutions); Binder, Bankeninsolvenzen, above n 8, 532–5 (evaluating critically the benefits of the German solution and reaching the same conclusion); C Hadjiemmanuil, ‘Bank Resolution Policy and the Organization of Bank Insolvency Proceedings’, in Mayes and Liuksila, Who Pays?, above n 7, 296; see also C Hadjiemmanuil, ‘Special Resolution Regimes for Banking Institutions: Objectives and Limitations’, in W Ringe and PM Huber (eds), Legal Challenges in the Global Financial Crisis: Bail-outs, the Euro and Regulation (Oxford: Hart 2014) 209, 210–13; R Guynn, ‘Are Bailouts Inevitable?’(2012) 29 Yale Journal on Regulation 121, 137–40; SJ Lubben, ‘Systemic Risk & Chapter 11’ (2009) 82 Temple Law Review 433; E Morrison, ‘Is the Bankruptcy Code an Adequate Mechanism for Resolving the Distress of Systemically Important Institutions?’ (2009) 82 Temple Law Review 449. But see also K Ayotte and DA Skeel, Jr., ‘Bankruptcy or Bailouts?’ (2010) 35 Journal of Corporation Law 469, 488–93 (arguing in support of the application of general bankruptcy law to LCFI insolvency).

29  See Binder, Bankeninsolvenzen, above n 8, 543–4, 564 (discussing the German and British experiences); see also Hadjiemmanuil, ‘Bank Resolution Policy’, above n 28, 296 (reaching a similar conclusion).

30  See references cited above n 6.

31  Cf., for a vivid description of the practical problems involved in the administration of Barings Bank plc, the account of Maggie Mills, administrator in that case, in Group of Thirty (ed.), International Insolvencies in the Financial Sector. A Study Group Report (1998) 78.

32  See, e.g., DG Mayes, ‘A More Market Based Approach to Maintaining Systemic Stability’ (2004) Financial Services Authority Occasional Paper Series 10, 10–11 <www.fsa.gov.uk/pubs/occpapers/OP10.pdf>. For a critical assessment of the legal implications, see Asser, Legal Aspects, above n 10, 18–99, 90 (discussing the consequences of the ‘too big to fail’ doctrine on crisis resolution concepts); Binder, Bankeninsolvenzen, above n 8, 121–6, 721–37 (arguing against open bank assistance except in cases of systemic risk); Gup, Bank Failures, above n 17, 69.

33  Contrast, e.g., CA Goodhart, ‘Myths about the Lender of Last Resort’, in CA Goodhart and G Illing (eds), Financial Crises, Contagion, and the Lender of Last Resort (Oxford: Oxford University Press 2002) 227, 241 (arguing that in such circumstances, exceptional state support to ailing institutions is absolutely unavoidable), with GG Kaufman, ‘Are Some Banks Too Large to Fail?’ (1990) 8 Contemporary Policy Issues 1 (disputing the legitimacy of the ‘too big to fail’ policy); see generally GH Stern and RJ Feldman, Too Big to Fail. The Hazards of Bank Bailouts (Washington: Brookings Institution 2004); DG Mayes, An Overview of the Issues, in D Mayes and A Liuksila, Who Pays?, above n 8, 27, 31–2 (discussing various circumstances where financial institutions could be considered too important to fail).

34  See references above n 4.

35  See above n 4.

36  Basel Committee, Report and Recommendations, above n 6, paras 2–16, 120–1.

37  Financial Stability Board, ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’ (2011) <www.financialstabilityboard.org/publications/r_111104cc.pdf> Preamble, 3. An updated version was released in October 2014, <www.fsb.org/wp-content/uploads/r_141015.pdf>. As the following analysis traces the origins of the BRRD, however, all references are to the original version of 2011.

38  Bank Recovery Resolution Directive (BRRD), Preamble, recital 5.

39  See above n 1.

40  Cf. Basel Committee, Report and Recommendations, above n 6, para. 2.

41  See also Armour, ‘Bank Resolution’, above n 5, 458–9.

42  The implications triggered by the Lehman failure are representative for this, see references above n 6. And see, drawing policy conclusions, Basel Committee, Report and Recommendations, above n 6, paras 105–14.

43  Basel Committee, Report and Recommendations, above n 5, paras 74–6 and Recommendation 1.

44  Financial Stability Board, ‘Key Attributes’, above n 37, para. 3.2.

45  See, again, Asser, Legal Aspects, above n 10, 144–7; LaBrosse, ‘International Experience’, above n 10; and see GN Olson, ‘Government Intervention: The Inadequacy of Bank Insolvency Resolution—Lessons from the American Experience’, in RM Lastra and HN Schiffman, Bank Failures and Bank Insolvency Law in Economies in Transition (London: Kluwer 1999) 107, 147–8.

46  12 U.S.C. 1823(c)(2). See generally, e.g., Olson, above n 45, 145–7.

47  See further below, paras 2.26–2.37.

48  Cf. Hadjiemmanuil, ‘Special Resolution Regimes’, above n 28, 218–19 (reviewing the pre-crisis understanding of the concept).

49  As has been rightly observed by C Thole, this is not free from irony from the perspective of modern insolvency law doctrine, given the considerable effort dedicated to the development of insolvency procedures geared towards restructuring rather than liquidation in many jurisdictions in recent years (see C Thole, ‘Bank Crisis Management and Resolution—Core Features of the Bank Recovery and Resolution Directive’, Working Paper (2014) <http://ssrn.com/abstract=2469807> 6). For the reasons explained above, however, such procedures, inasmuch as their economic consequences trigger the breakdown of on-going relationships with clients and professional counterparties effectively in the same way as formalized liquidation procedures, are ill-suited to the specific needs of bank insolvencies. Using ‘winding-up’, i.e. the forced liquidation, rather than insolvency restructuring as a counterfactual in this regard is, therefore, only realistic.

50  See below, para. 2.27.

51  Below, paras 2.26, 2.39.

52  But see further below, paras 2.26–2.38, for further discussion of the discretion left in this regard.

53  On the Directive’s requirements for the valuation of failing institutions by resolution authorities, see BRRD, art. 36 and SRM Reg, art. 20.

54  Pursuant to art. 85(4) BRRD, the right to appeal of persons affected by decisions to take crisis management measures (i.e. a ‘resolution action’ or the appointment of a special manager under art. 35 or a person under arts 51(2) or 72(1), see art. 2(102) BRRD) is restricted to ex post reviews of relevant measures. In this context, notwithstanding an appeal, ‘the decision of the resolution authority shall be immediately enforceable and it shall give rise to a rebuttable presumption that a suspension of its enforcement would be against the public interest’ (art. 85(4)(b)).

55  See, for further discussion in this regard, JH Binder, ‘The Position of Creditors Under the BRRD’ (2 December 2015) in Bank of Greece’s Center for Culture, Research and Documentation (ed), Commemorative Volume in Memory of Professor Dr. Leonidas Georgakopoulos (2016), forthcoming. Preprint available at <http://ssrn.com/abstract=2698086>:

56  G Sjöberg, ‘Banking Special Resolution Regimes as a Governance Tool’, in Ringe and Huber (eds), Legal Challenges, above n 28, 187, 196.

57  See references, above n 6.

58  See above n 20 and accompanying text.

59  And see further below, paras 2.38–2.47.

60  See above, para. 2.15.

61  Above n 34.

62  See arts 5(3) and 10(3)(a) BRRD (and, within the Banking Union, art. 8(6) SRM Reg), pursuant to which such plans shall not ‘assume any access to or receipt of extraordinary public financial support’, or ‘assume any extraordinary public financial support besides the use of the financing arrangements established in accordance with Article 100’, respectively.

63  But note BRRD, Preamble, recital 58, pursuant to which ‘[t]‌he application if government stabilization tools should be fiscally neutral in the medium term’ (which is but a weak restriction, however, and not reflected as such in the corresponding provisions of arts 58–61 of the Directive). Significantly, within the Banking Union framework, this option has not been replicated in the SRM Regulation (which triggers the question—outside the scope of this chapter—if participating Member States are entitled to resort to extraordinary tax-payer funded support in cases where the SRM arrangements, including the Single Resolution Fund, could turn out to be inadequate in view of the size of the individual case).

64  See, reaching the same conclusion, Sjöberg, ‘Banking Special Resolution Regimes’, above n 56, 204.

65  Ibid., 195 (citing lessons from the Scandinavian banking crisis of the 1990s).

66  Cf., reaching a similar conclusion, Hadjiemmanuil, ‘Special Resolution Regimes’, above n 28, 226.

67  Council Directive 2014/49/EU on deposit guarantee schemes (recast), OJ L 173 of 12 June 2014, 149, and Council Directive 97/9/EC on investor-compensation schemes, OJ L 84 of 26 March 1997, 22.

68  Cf., for bail-ins, arts 48(1)(e), 44 BRRD (art. 17(1) SRM Reg).

69  The statutory framework is <www.centralbank.gov.cy/nqcontent.cfm?a_id=12727&lang=en>. For a critical evaluation, see, e.g., SA Zenios, ‘Fairness and Reflexivity in the Cyprus Bail-In’, The Wharton Financial Institutions Center Working Paper No. 14-04, <http://ssrn.com/abstract=2409284>. See also J Giotaki, ‘The Cypriot “Bail-in Litigation”: A First Assessment of The Ruling of the Supreme Court of Cyprus’ (2013) Butterworth’s Journal of International Banking and Financial Law 485.

70  ‘Institutional Protection Scheme’ within the meaning of art. 113(7) of Regulation (EU) No. 575/2013, cf. art. 2(1)(8) BRRD.

71  EBA, ‘Guidelines on the interpretation of the different circumstances when an institution shall be considered as failing or likely to fail under Article 32(6) of Directive 2014/59/EU (EBA/GL/2015/07)’ (6 August 2015), <https://www.eba.europa.eu/documents/10180/1156219/EBA-GL-2015-07_EN_GL+on+failing+or+likely+to+fail.pdf/9c8ac238-4882-4a08-a940-7bc6d76397b6>.

72  See above, para. 2.23.

73  Cf., in this regard, Preamble, recitals 49 and 50.

74  See, again, arts 85(3) and (4) BRRD and see above, text and n 54.

75  As to which, see above, text and n 48.

76  Defined in turn by art. 2(1)(28) as

State aid within the meaning of Article 107(1) TFEU, or any other public financial support at supra-national level, which, if provided for at national level, would constitute State aid, that is provided in order to preserve or restore the viability, liquidity or solvency of an institution or entity referred to in point (b), (c) or (d) of Article 1(1) or of a group of which such an institution or entity forms part.

77  I.e. the conditions for a write down of capital instruments specified by that provision (as to which see below, paras 2.40–2.42).

78  The conditions laid down in art. 31(d)(i)-(iii) are specified further in the remaining sentences of that subparagraph as follows:

In each of the cases mentioned in points (d)(i), (ii) and (iii) of the first subparagraph, the guarantee or equivalent measures referred to therein shall be confined to solvent institutions and shall be conditional on final approval under the Union State aid framework. Those measures shall be of a precautionary and temporary nature and shall be proportionate to remedy the consequences of the serious disturbance and shall not be used to offset losses that the institution has incurred or is likely to incur in the near future.

79  See art. 2(1)(21) BRRD, referring to point (40) of art. 4(1) of Regulation (EU) No. 575/2013.

80  Art. 48 BRRD expressly requires that a bail-in be implemented only after capital instruments have been written-down in accordance with the provisions of arts 59 and 60. However, art. 59(1)(a) recognizes that the power to write down or convert relevant capital instruments can also be exercised independently of resolution action. For further discussion of both the bail-in tool and the write down powers, see below, paras 2.25–2.61.

81  See, again, Binder, above n 55.

82  See above n 45.

83  Banking (Special Provisions) Act 2008 (c. 2), ss 3–5 (‘transfer of securities’), 6–7 (‘transfer of property etc.’); Banking Act 2009 (c. 1), esp. ss 11 (‘private sector purchaser’) and 12 (‘bridge bank’). See, e.g., D Singh, ‘U.K. Approach to Financial Crisis Management’, (2011) 19 Transnational Law and Contemporary Problems 872.

84  The complex statutory framework is available at <www.finansielstabilitet.dk/Default.aspx?ID=766>.

85  Law on the restructuring and orderly resolution of credit institutions, on the creation of a Restructuring Fund, and on the prolongation of the limitation period for directors’ and officers’ liability [Gesetz zur Restrukturierung und geordneten Abwicklung von Kreditinstituten, zur Errichtung eines Restrukturierungsfonds für Kreditinstitute und zur Verlängerung der Verjährungsfrist der aktienrechtlichen Organhaftung (Restrukturierungsgesetz)] of 9 December 2010, Bundesgesetzblatt Teil 1, 1900. For an introduction, see, e.g., JH Binder, ‘Too-big-to-fail’—Can Alternative Resolution Regimes Really Remedy Systemic Risk in Large Financial Institutions’ Insolvency?’, in JR LaBrosse, R Olivares-Caminal, and D Singh (eds), Managing Risk in the Financial System (Cheltenham: Edward Elgar 2011) 233, 240–4; CG Paulus, ‘The New German System of Rescuing Banks’ (2011) 6 Brooklyn Journal of Corporate, Financial & Commercial Law 171.

86  Financial Stability Board, ‘Key Attributes’, above n 36, para. 3.3.

87  See, e.g., (comparing the Directive’s provisions against the UK and German legal frameworks developed during the crisis), M Schillig, ‘Bank Resolution Regimes in Europe–Part II: Resolution Tools and Powers’ (2014) European Business Law Review 67.

88  See BRRD, Preamble, recital 60:

Where the resolution tools have been used to transfer the systemically important services or viable business of an institution to a sound entity such as a private sector purchaser or bridge institution, the residual part of the institution should be liquidated within an appropriate time frame having regard to any need for the failing institution to provide services or support to enable the purchaser or bridge institution to carry out the activities or services acquired by virtue of that transfer.

89  Two years with possible extensions, cf. art. 41(5), (6) BRRD.

90  See above n 44 and accompanying text.

91  See also Armour, ‘Bank Resolution’, above n 5, 455; Sjöberg, ‘Banking Special Resolution Regimes’, above n 57, 191.

92  Above n 6.

93  Financial Stability Board, ‘Key Attributes’, above n 37, 8.

94  See, e.g., CW Calomiris, D Klingebiel, and L Laeven, ‘Seven Ways to Deal with a Financial Crisis: Cross-Country Experience and Policy Implications’ (2012) 24 Journal of Applied Corporate Finance 8. See also, discussing the potential of asset management companies in the global financial crisis, WF Stutts and WC Watts, ‘Of Herring and Sausage: Nordic Responses to Banking Crises as Examples for the United States’ (2008) 44 Texas International Law Journal 577; JB Thomson, ‘Cleaning up the Refuse from a Financial Crisis: The Case for a Resolution Management Corporation’ (2011) 10 Florida State University Business Review 1; specifically on the use of asset management companies in transition regions R De Haas and S Knobloch, ‘In the Wake of the Crisis: Dealing with Distressed Debt Across the Transition Region’ (2010) European Bank for Reconstruction and Development (EBRD) Working Paper No. 112, <http://dx.doi.org/10.2139/ssrn.1742286>. On the design of asset management companies, see also D He, S Ingves, and SA Seelig, ‘Issues in the Establishment of Asset Management Companies’ in Hoelscher (ed.), ‘Bank Restructuring’, above n 10, 212.

95  BRRD, Preamble, recital 66.

96  EBA, ‘Guidelines on the determination of when the liquidation of assets under normal insolvency proceedings could have an adverse effect on one or more financial markets under Article 42(14) of Directive 2014/59/EU (EBA/GL/2015/05), available at <https://www.eba.europa.eu/documents/10180/1156565/EBA-GL-2015-05_EN_+Guidelines+on+the+asset+separation+tool.pdf/8cf69d01-3e3f-4768-9ea7-00013b97b1f4.>

97  See above n 15; see also JH Binder, ‘Institutionalisierte Krisenbewältigung bei Kreditinstituten’ (2009) 19 ZBB Zeitschrift für Bankrecht und Bankwirtschaft 27–8.

98  See Financial Stability Board, ‘Key Attributes’, above n 37, paras 3.2 (ix), 3.5–3.6.

99  Above, para. 2.22. For further discussions of possible scenarios, see DH Bliesener, ‘Legal Problems of Bail-Ins under the EU’s Proposed Recovery and Resolution Directive’, in A Dombret and PS Kenadjian (eds), The Bank Recovery and Resolution Directive—Europe’s Solution for ‘Too Big To Fail’? (Berlin: de Gruyter 2013) 189, 212–17. And see, generally, A Gardella, ‘Bail-in and the Financing of Resolution Within the SRM Framework’, in D Busch and G Ferrarini (eds), European Banking Union (Oxford: OUP 2015), Ch. 11; A Gardella, ‘Bail-in and the Two Dimensions of Burden-Sharing’, in European Central Bank (ECB), ECB Legal Conference 2015: From Monetary Union to Banking Union, on the way to Capital Markets Union—New Opportunities for European Integration (Frankfurt: ECB 2015), 205; C Hadjiemmanuil, ‘Bank Stakeholders’ Mandatory Contribution to Resolution Financing: Principle and Ambiguities of Bail-in’, in ECB, ibid., 225; KP Wojcik, ‘Bail-In in the Banking Union’, (2016) 53 CMLR 91.

100  See BRRD, art. 2(1)(71). Pursuant to art. 44(2), a number of liabilities are exempt from bail-in and thus enjoy special protection, including, inter alia, covered deposits (art. 44(2)(a)), ‘secured liabilities including covered bonds and liabilities in the form of financial instruments used for hedging purposes which form an integral part of the cover pool and which according to national law are secured in a way similar to covered bonds’ (art. 44(2)(b)), liabilities with short maturities to other institutions and certain providers of market infrastructure (art. 44(2)(e) and (f)), liabilities to employees, tax, and social securities (art. 44(2)(g)(i) and (iii)). The same applies pursuant to art. 27(3) SRM Reg.

101  See, e.g., S Gleeson, ‘Legal Aspects of Bank Bail-Ins’ (2012) LSE Financial Markets Group Special Paper No. 205, <http://financial-stability.org/fileadmin/research/themen/stability/auf%20frsn_2012/LSE_leg%20aspects%20bank%20bail-ins_1-2012.pdf>; TF Huertas, ‘The Case for Bail-ins’, in Dombret and Kenadjian (eds), Bank Recovery and Resolution Directive, above n 99, 167; JH Sommer, ‘Why Bail-in? And How?’, in Federal Reserve Bank of New York Economic Policy Review Special Issue: Large and Complex Banks (2014); see also, modelling potential effects in the light of recent bank failures in Europe, T Conlon and J Cotter, ‘Anatomy of a Bail-In’ (2014), <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2294100>.

102  Cf., again, the highly complex requirements on valuations laid down in art. 36 BRRD.

103  On which, see above, paras 2.26–2.37.

104  See art. 34(1)(g) of the Directive.

105  Cf., again, Gardella, ‘Bail-in and the Financing of Resolution’, above n 99, paras 11.24–11.32; Wojcik, above n 99, 120–1, 124–6.

106  Above, paras 2.40–2.42.

107  See Schillig, above n 87, 91. Note again, in this context, that art. 43(3) of the Directive restricts the recapitalization of banks by way of a bail-in to cases where ‘there is a reasonable prospect that the application of the tool (…) will, in addition to achieving relevant resolution objectives, restore the institution (…) to financial soundness and long-term viability’.

108  See E Avgouleas and CA Goodhart, ‘A Critical Evaluation of Bail-In as a Bank Recapitalisation Mechanism’ (2014), CEPR Discussion Paper No. 10065, 14. See also above n 68.

109  See, for further discussion and an analysis of the underlying cross-border arrangements, JH Binder, ‘Cross‐Border Coordination of Bank Resolution in the EU: All Problems Resolved?’ (11 September 2015), available at <http://ssrn.com/abstract=2659158 or http://dx.doi.org/10.2139/ssrn.2659158>.

110  See also Avgouleas and Goodhart, ‘Critical Evaluation’, above n 108, 18–19; Bliesener, ‘Legal Problems’, above n 99, 222–4, on problems of cross-border coordination of bail-ins generally.

111  See also Wojcik, above n 99, 129–30.

112  Pursuant to art. 44(3)(c) BRRD (article 27(5)(b) SRM Reg), exemptions are admissible where ‘the exclusion is strictly necessary and proportionate to avoid giving rise to widespread contagion, in particular as regards eligible deposits held by natural persons and micro, small and medium sized enterprises, which would severely disrupt the functioning of financial markets, including of financial market infrastructures, in a manner that could cause a serious disturbance to the economy of a Member State or of the Union’.

113  See, for further discussion, e.g., Avgouleas and Goodhart, ‘Critical Evaluation’, above n 108, 15–18; see also S Micossi, G Bruzzone, and M Cassella, ‘Bail-In Provisions in State Aid and Resolution Procedures: Are They Consistent With Systemic Stability?’, CEPS Policy Brief No. 318 (21 May 2014), and see, discussing the cyclical effects of bail-ins, A Aviram, ‘Bail-Ins: Cyclical Effects of a Common Response to Financial Crises’ (2011) University of Illinois Law Review 1633.

114  See, reaching a similar conclusion, Avgouleas and Goodhart, ‘Critical Evaluation’, above n 108; Sjöberg, ‘Banking Special Resolution Regimes’, above n 56, 198.

115  Cf. TF Geithner, Stress Test. Reflections on Financial Crises (New York: Crown Publishers) 215, 429.