European Banking Union [2 ed.] 0198827512, 9780198827511

Part of the Oxford EU Financial Regulation Series, this work analyses the implications of the Single Supervisory Mechani

274 15 6MB

English Pages 736 [730] Year 2020

Table of contents :
Preface
Contents
Table of Cases
Table of Legislation
List of Abbreviations
Author Biographies
List of Contributors
I GENERAL ASPECTS
1. The Economic Consequences of Europe’s Banking Union • Nicolas Véron
2. European Banking Union: Effectiveness, Impact, and Future Challenges • Kern Alexander
3. Judicial Protection of Supervised Credit Institutions in the European Banking Union • Tomas M C Arons
II SINGLE SUPERVISION AND CRD IV
4. The Single Supervisory Mechanism for Banking Supervision: Institutional Aspects • Eddy Wymeersch
5. The Single Rulebook and the SSM: Regulatory Polycentrism vs. Supervisory Centralization • Guido Ferrarini and Fabio Recine
6. CRD IV Framework for Banks’ Corporate Governance • Peter O Mülbert and Alexander Wilhelm
7. Fit and Proper Assessments within the Single Supervisory Mechanism • Danny Busch and Annick Teubner
8. The EU Framework Dealing with Non- Performing Exposures: Legal and Economic Analysis • Emilios Avgouleas
III SINGLE RESOLUTION AND THE BRRD
9. Governance of the Single Resolution Mechanism • Danny Busch
10. Recovery and Resolution Plans of Banks in the Context of the BRRD and the SRM: Fundamental Issues • Victor de Serière
11. Bail-in: Preparedness and Execution • Anna Gardella
12. Bank Resolution in Practice: Analysis of Early European Cases • Guido Ferrarini and Alberto Musso Piantelli
13. The Architecture of the BRRD—A UK Perspective • Simon Gleeson
14. European Deposit Insurance System (EDIS): Cornerstone of the Banking Union or Dead End? • Veerle Colaert and Gilian Bens
15. Doom Loop or Incomplete Union? Sovereign and Banking Risk • Giorgio Barba Navaretti, Giacomo Calzolari, José Manuel Mansilla-Fernández, and Alberto Franco Pozzolo
16. Bank Resolution in Europe: The Unfinished Agenda of Structural Reform • Jeffrey N Gordon and Wolf-Georg Ringe
17. Financial Conglomerates in the European Banking Union • Arthur van den Hurk and Michele Siri
Index

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i

EUROPEAN BANKING UNION

ii

OXFORD EU FINANCIAL REGULATION SERIES The Oxford EU Financial Regulation Series provides rigorous analysis of all aspects of EU

Financial Regulation and covers the regulation of banks, capital markets, insurance undertakings, asset managers, payment institutions and financial infrastructures. The aim of the series is to provide high-quality dissection of and comment on EU Regulations and Directives, and the EU financial regulation framework as a whole. Titles in the series consider the elements of both theory and practice necessary for proper understanding, analysing the legal framework in the context of its practical, political and economic background, and offering a sound basis for interpretation.

Series Editors: Danny Busch

Professor of Financial Law and founding Director of the Institute for Financial Law, Radboud University Nijmegen; Research Fellow of Harris Manchester College and Fellow of the Commercial Law Centre, University of Oxford; Visiting Professor at Università Cattolica del Sacro Cuore di Milano; Visiting Professor at Università degli Studi di Genova; Visiting Professor at Université de Nice Côte d’Azur; Member of the Dutch Banking Disciplinary Committee (Tuchtcommissie Banken); Member of the Appeal Committee of the Dutch Complaint Institute Financial Services (Klachteninstituut Financiële Dienstverlening or KiFiD).

Guido Ferrarini

Emeritus Professor of Business Law, University of Genoa; Visiting Professor, Radboud University Nijmegen; Founder and fellow of the European Corporate Governance Institute (ECGI), Brussels; Former member of the Board of Trustees, International Accounting Standards Committee (IASC), London. Previous volumes published in the series: Governance of Financial Institutions, Edited by Danny Busch, Guido Ferrarini, and Gerard van Solinge, January 2019, 9780198799979 Capital Markets Union, Edited by Danny Busch, Emilios Avgouleas, and Guido Ferrarini, March 2018, 9780198813392 Regulation of the EU Financial Markets –MiFID II and MiFIR, Edited by Danny Busch and Guido Ferrarini, January 2017, 9780198767671 European Banking Union, First Edition, Edited by Danny Busch and Guido Ferrarini, July 2015, 9780198727309 Alternative Investment Funds in Europe –Law and Practice, Edited by Lodewijk van Setten and Danny Busch, May 2014, 9780199657728

iii

EUROPEAN BANKING UNION SECOND EDITION Edited by

Danny Busch Guido Ferrarini

1

iv

1 Great Clarendon Street, Oxford, OX2 6DP, United Kingdom Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries © The editors and several contributors 2020 The moral rights of the authors have been asserted First Edition published in 2015 Second Edition published in 2020 Impression: 1 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, by licence or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above You must not circulate this work in any other form and you must impose this same condition on any acquirer Crown copyright material is reproduced under Class Licence Number C01P0000148 with the permission of OPSI and the Queen’s Printer for Scotland Published in the United States of America by Oxford University Press 198 Madison Avenue, New York, NY 10016, United States of America British Library Cataloguing in Publication Data Data available Library of Congress Control Number: 2019947218 ISBN 978–0–19–882751–1 Printed and bound by CPI Group (UK) Ltd, Croydon, CR0 4YY Links to third party websites are provided by Oxford in good faith and for information only. Oxford disclaims any responsibility for the materials contained in any third party website referenced in this work.

v

PREFACE

This second edition of European Banking Union offers a thorough revision and expansion of the first edition of this work. The book chapters are grouped in a thematic way, covering the following areas: (i) general aspects; (ii) single supervision and the Capital Requirements Directive (CRD IV); (iii) single resolution and the Bank Recovery and Resolution Directive (BRRD); and (iv) the European Deposit Insurance System (EDIS) and policy perspectives. Part I discusses the economic consequences of the European Banking Union (EBU), its effectiveness, impact and future challenges, as well as judicial protection in the context of EBU’s Single Supervisory Mechanism (SSM) and Single Resolution Mechanism (SRM). Part II considers the SSM’s institutional aspects, the interplay between the Single Rulebook and the SSM, the CRD IV framework for bank’s corporate governance, fit and proper assessments within the SSM, and the EU framework dealing with non-performing exposures. Part III analyses the governance structure of the SRM, particularly with respect to financing of the Single Resolution Fund and adoption of resolution schemes. Moreover, it discusses the function of existing recovery and resolution plans in the context of a bank restructuring under the BRRD and the SRM Regulation, and then provides an in-depth analysis of the bail-in instrument. This part also features a critical discussion of the recent bank resolution cases in Europe, as well as an analysis of the architecture of the BRRD from a UK perspective including Brexit Part IV discusses the envisaged EDIS, followed by a treatment of the so-called ‘doom loop’ between sovereign and banking risk. In this part, it is also argued that the work of EBU remains incomplete in one important respect, the structural re-organization of large European financial firms that would make ‘resolution’ of a systemically important financial firm a credible alternative to bail-out or some other sort of taxpayer assistance. The book ends with a treatment of the complex topic of supervision of financial conglomerates in the context of EBU. The volume was preceded by a meeting on 20 October 2017 of the International Working Group on the European Banking Union, established as a joint initiative of the Institute for Financial Law within the Business & Law Research Centre of Radboud University, Nijmegen, the Netherlands and the Genoa Centre for Law v

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Preface and Finance, University of Genoa, Italy. We thank the Business & Law Research Centre of Radboud University, Nijmegen and the European Banking Institute (EBI), Frankfurt, Germany, for their sponsorship and support. We also thank Università Cattolica del Sacro Cuore di Milano and its Vice-Rector Professor Antonella Sciarrone Alibrandi for hosting the meeting. We are grateful to the distinguished members of the Working Group for their dedication to the project and, in particular, for their contributions to this book as authors. We also thank the invitees to the meeting for providing the members of the Working Group with invaluable comments on their draft chapters. Last but not least, we acknowledge our gratitude to the editorial team at Oxford University Press, who successfully brought a lengthy and complex project to completion. The law is stated as of 1 May 2019. Danny Busch, Nijmegen, The Netherlands Guido Ferrarini, Genoa, Italy

vi

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CONTENTS

Table of Cases Table of Legislation List of Abbreviations Author Biographies List of Contributors

xiii xvii xli xlv xlvii I GENERAL ASPECTS

1. The Economic Consequences of Europe’s Banking Union Nicolas Véron

I. The Impact so Far: A Shift of Expectations II. Six Developments to Watch

1.03 1.20

III. Conclusion

1.64

2. European Banking Union: Effectiveness, Impact, and Future Challenges Kern Alexander

I. Introduction

2.01

II. Single Supervisory Mechanism—Setting the Context

2.05

III. SSM and EU Agencies and Institutions

2.31

IV. Bank Resolution, the SSM, and the Single Resolution Board (SRB)

2.49

V. SSM, Macroprudential Tools, and National Competent Authorities VI. Member State Perspectives on the SSM VII. Banking Union and the Banking Industry

VIII. Conclusion

2.67 2.114 2.121 2.136

3. Judicial Protection of Supervised Credit Institutions in the European Banking Union Tomas M C Arons

I. Introduction

3.01

II. Judicial Protection for Credit Institutions under the SSM vii

3.07

vi

Contents

III. Judicial Protection for Credit Institutions under the SRM

3.37

IV. Substantive Review by the CJEU

3.66

V. Liability of the ECB and the SRB

3.86

VI. Conclusion

3.94

II SINGLE SUPERVISION AND CRD IV 4. The Single Supervisory Mechanism for Banking Supervision: Institutional Aspects Eddy Wymeersch

I. Historical Introduction

4.01

II. The New Regulatory Framework: The Banking Union

4.09

III. Applicable Bodies of Law in Banking Supervision

4.15

IV. The Choice of the ECB as the Prudential Supervisor

4.31

V. Application to the Euro Area or Beyond? VI. The Single Supervisory Mechanism VII. Legal Position of the Supervisory Board in the ECB VIII. Independence and Accountability IX. Review of SSM Decisions

4.38 4.46 4.104 4.114 4.136

X. Conclusion

4.143

5. The Single Rulebook and the SSM: Regulatory Polycentrism vs. Supervisory Centralization Guido Ferrarini and Fabio Recine

I. Introduction

5.01

II. A Short History of the EU Regulatory Framework

5.04

III. The Allocation of Regulatory and Supervisory Powers

5.17

IV. The Decoupling of Regulatory and Supervisory Powers in the SSM

5.28

V. Evolutionary Dynamics of the EU Institutional Regulatory Framework VI. Conclusion

5.53 5.68

6. CRD IV Framework for Banks’ Corporate Governance Peter O Mülbert and Alexander Wilhelm

I. Introduction

6.01

II. Banking Structures in the European Union viii

6.03

ix

Contents

III. Historical Development

6.05

IV. CRD IV Corporate Governance Standards

6.10

V. Conceptual Concerns

6.46

VI. Functional Concerns

6.87

VII. Conclusion and Outlook

6.106

7. Fit and Proper Assessments within the Single Supervisory Mechanism Danny Busch and Annick Teubner

I. Introduction

7.01

II. Key Terms and Definitions

7.02

III. Fit and Proper Assessments as an Element of Corporate Governance

7.06

IV. Division of Responsibilities Between the Banks, the ECB, and the NCAs

7.11

V. Relevant Sources of Substantive Requirements VI. Convergence

7.23 7.28

VII. National Variations and Limits VIII. Concluding Observations

7.78 7.96

8. The EU Framework Dealing with Non-Performing Exposures: Legal and Economic Analysis Emilios Avgouleas

I. Introduction

8.01

II. Causes and Consequences of NPL Accumulations

8.14

III. Structural Measures

8.21

IV. Market-based Solutions: Asset Management Companies and NPL Platforms

8.31

V. Prudential and Supervisory Policies for Tackling NPLs

8.38

VI. Conclusion

8.57

III SINGLE RESOLUTION AND THE BRRD 9. Governance of the Single Resolution Mechanism Danny Busch

I. Introduction

9.01

II. General Aspects

9.04

III. Financing of the Fund

9.46 ix

x

Contents

IV. Resolution

9.75

V. Conclusion

9.121

10. Recovery and Resolution Plans of Banks in the Context of the BRRD and the SRM: Fundamental Issues Victor de Serière

I. Introduction

10.01

II. The Making of Recovery and Resolution Plans: A Theoretical Exercise?

10.03

III. Experience with Some Bank Failures

10.17

IV. Some Intermediate Conclusions

10.27

V. The Authority to Impose Ex Ante Measures

10.29

VI. Remedies Against Imposed Ex Ante Measures

10.35

VII. A Difficult Debate on the Need for Ex Ante Measures VIII. The Wider Context in which Ex Ante Measures Are Imposed IX. Bottlenecks

10.39 10.49 10.65

X. Some Concluding Comments

10.98

11. Bail-in: Preparedness and Execution Anna Gardella

I. Introduction

11.01

II. Bail-in: Main Features

11.06

III. Building-up Bail-in Preparedness: TLAC/MREL

11.12

IV. Bail-in Execution

11.49

12. Bank Resolution in Practice: Analysis of Early European Cases Guido Ferrarini and Alberto Musso Piantelli

I. Introduction

12.01

II. Crisis Management Pre-BRRD

12.13

III. Crisis Management in the Transition to the New EU Regime

12.20

IV. The New Regime: Crisis Management in Italy

12.30

V. The New Regime: The Resolution-like Liquidation of Venetian Banks VI. The New Regime: Crisis Management in Spain VII. Conclusions

12.40 12.64 12.81

x

xi

Contents 13. The Architecture of the BRRD—A UK Perspective Simon Gleeson

I. Introduction

13.01

II. Scope of the Legislation

13.04

III. Approach

13.15

IV. Tools

13.24

V. Other Powers

13.37

VI. MREL & TLAC

13.72

VII. Brexit and Bank Resolution

13.77

VIII. Conclusion

13.82

IV THE EUROPEAN DEPOSIT INSURANCE SYSTEM AND POLICY PERSPECTIVES 14. European Deposit Insurance System (EDIS): Cornerstone of the Banking Union or Dead End? Veerle Colaert and Gilian Bens

I. Introduction

14.01

II. Why Is There a Need for a Fully-fledged Third Pillar in the Banking Union?

14.04

III. Legislative Proposals for EDIS

14.20

IV. Main Features of the EDIS Proposals

14.33

V. Conclusion

14.69

15. Doom Loop or Incomplete Union? Sovereign and Banking Risk Giorgio Barba Navaretti, Giacomo Calzolari, José Manuel Mansilla-Fernández, and Alberto Franco Pozzolo

I. Introduction

15.01

II. Are Sovereigns Risky?

15.13

III. What Was Done and Should Have Been Done? Banks and Sovereigns during the Crisis and the Specificities of a Monetary Union

15.22

IV. The Long Run Equilibrium: Sovereign Exposures under ‘Normal Conditions’

15.46

V. Summing-up, Transition, and Notes of Caution

xi

15.77

xi

Contents 16. Bank Resolution in Europe: The Unfinished Agenda of Structural Reform Jeffrey N Gordon and Wolf-Georg Ringe

I. Introduction

16.01

II. The Regulatory Aftermath of 2007–2008 and the Emergence of EU Bank Resolution

16.08

III. The Path to Single Point of Entry Resolution in the US

16.25

IV. The US Path to Holding Companies

16.35

V. SPE for Europe: The Structural Reform Project VI. Conclusion

16.38 16.49

17. Financial Conglomerates in the European Banking Union Arthur van den Hurk and Michele Siri

I. Introduction

17.01

II. Consolidated Supervision in the Banking Sector

17.05

III. Group Supervision in the Insurance Sector

17.09

IV. Consolidated Supervision vs Group Supervision

17.15

V. Background of Financial Conglomerate Supervision VI. Institutional Framework for Conglomerate Supervision VII. Purpose, Content, and Design of Conglomerate Supervision VIII. Evolution of Financial Conglomerate Supervision IX. Recovery and Resolution of Financial Conglomerates

X. Conclusion

17.24 17.29 17.34 17.63 17.74 17.89

Index

665

xii

xi

TABLE OF CASES

GENERAL COURT (GC) ABLV Bank v ECB, Action brought on 3 May 2018, FOLTF (CI, T-281/18)��9.106 AIUFASS and AKT v Commission [1996] ECR II-2169 (Case T-380/94)��3.61 Antillean Rice Mills NV v Commission [1995] ECR II-2941 (Case T-480/93)��3.84 Asociación Española de Banca v Commission [2012] ECR (Case T-236/10)��3.61 Associazione Italiana delle Società Concessionarie per la Costruzione e l’esercizio di Autostrade e Trafori Stradali (Aiscat) v Commission, ECLI:EU:T:2013:9 (Case T-182/10)��3.61 Banco Cooperativo Español v SRB (Case T-323/16) ��9.54 Banque Postale v ECB [2018] (Case T-733/16)��3.66 BNP Paribas v ECB [2018] (Case T-768/16)��3.66 BPCE v ECB [2018] (Case T-745/16)��3.66 Caisse régionale de credit agricole mutuel Alpes Provence, Caisse régionale de credit agricole mutuel Nord Midi-Pyrénées, Caisse régionale de credit agricole mutuel Charente-Maritime Deux Sèvres, and Caisse régionale de credit agricole mutuel Brie Picardie v ECB [2018] (Cases T-133/16 to T-136/16), 24 April 2018, ECJ��3.66, 4.15, 4.136, 4.146 Comprojecto-Projectos e Construções, Lda and Others v ECB [2017] (Case T-22/16) ��3.60 Confédération Nationale du Crédit Mutuel v ECB [2018] (Case T-751/16) ��3.66 Crédit Agricole v ECB [2018] (Case T-758/16)��3.66 Crédit Mutuel Arkéa v ECB [2017] (Case T-712/15 and T-52/16)��3.24, 3.66, 4.16, 4.65 Credito Fondiario v CRU (Case T-661/16) ��9.54 Diputación Foral de Álava and Others v Commission [2009] ECR II-3029 (Joined Cases T-227/01 to T-229/01, T-265/01, T-266/01 and T-270/01)��3.61 Freistaat Sachsen and others v Commission [1999] ECR II-3663 (Cases T-132 and 143/96) ��3.32 Goldman Sachs a.o. (T-419/14) 12 July 2018 ��4.65 Komercbanka and others v ECB [2017] (Case T-247/16)��3.66 Land Oberösterreich and Austria v Commission [2005] ECR-4005 (Cases T-366/03 and 235/04)��3.32 Landesbank Baden Württemberg v SRB (Case T-14/17) ��9.54 Landeskreditbank Baden-Württemberg–Förderbank v ECB [2017] (Case T-122/15) ECJ, 16 May 2017��3.66, 4.16, 4.49, 4.51, 4.81, 4.84, 4.104 NRW Bank v SRB (Case T-466/16)��9.54 Portigon v SRB (Case T-365/16) ��9.54 Société générale v ECB [2018] (Case T-757/16)��3.66, 4.16, 4.57 Trasta Komercbanka and others v ECB [2017] (Case T-247/16) ��3.58 United Kingdom v ECB [2015] 3 CMLR 8 (Case T-496/11) ��2.110 EUROPEAN COURT OF JUSTICE (ECJ)/C OURT OF JUSTICE OF THE EUROPEAN UNION (CJEU) AKZO Chemie v Commission [1986] ECR 1965 (Case 53/85)��3.84 AKZO Nobel a.o., 10 September 2009(C-97/08) ��4.65 Alcan Aluminium Raeren v Commission [1970] ECR 385 (Case 69/69)��3.32 Altmann et al/Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) (Case 140/13)��3.74

xiii

xvi

Table of Cases Apesco v Commission [1988] ECR 2151 (Case 207/86)��3.32, 3.84 Atzeni et al v Scalas and Lilliu [2006] ECR I-1875 (Cases C-346/03 and C-529/03)��3.34 Bock v Commission [1971] ECR 897 (Case 62/70)��3.32 BPC Lux 2 Sàrl v Commission [2018] (Case C-544/17 P)��3.24, 10.64 Brasserie du Pêcheur/Factortame III [1996] ECR I-1029 (ECJ Cases C-46/93 and C-48/93)��3.87 British Aggregate Association v Commission [2008] ECR I-10515 (Case 487/06 P)��3.61 Commission v Assisi Domän Kraft Products AB [1999] ECR I-5363 (Case C-310/97P)��3.84 Commission v Hansestadt Lübeck (Case C-524/14 P)��3.61 Crédit Mutuel Arkéa v ECB [2017] (Case C-152/18 P) ECJ��4.65 Fininvest/Banca d’Italia [2018] (Case C-219/17)��3.25, 3.26 Foto-Frost v Hauptzollamt Lübeck-Ost [1987] ECR 4199 (Case 314/85)��3.34 Front national v Parliament (Case C-486/01 P)��3.61 Gauleiter (C-62/14) ECLI:EU:C:2015:400 of 16 June 2015��4.05 Gemeente Differdange/Commission [1984] ECR 2889 (Case 222/83) ��3.32 Germany v Parliament and Council [2000] ECR I-8419 (Case C-376/98) ��2.57 Glencore Grain v Commission (Case C-404/96 P)��3.61 Inuit Tapiriit Kanatami et al v European Parliament, Council, Netherlands and Commission, ECLI:EU:C:2013:625 (Case C-583/11 P) ��3.34, 3.61 Kotnik (Case C-526/14) of 19 July 2016��11.03 Landeskreditbank Baden-Württemberg–Förderbank v ECBECLI:EU:C:2019:372 (Case C-450/17 P��3.66 Marshall v Southampton and South-West Hampshire Area Health Authority ECLI:EU:C:1986:84; [1986] ECR 723 (Case 152/84)��2.95 Meroni v High Authority [1957/1958] ECR 133 (Cases C-9/56 and 10/56)��2.57, 2.58, 2.59, 4.36, 4.112, 5.25, 9.108, 9.112, 9.131 Mory v Commission [2015] (Case C-33/14 P) ��3.24 NV International Fruit Company v Commission [1971] ECR 411 (ECJ Cases 41-44/70) ��3.32 Peter Paul et al./Germany [2004] ECR I-09425 (ECJ Case 220/02) ��3.88 Romanelli (C-366/97) ECJ, 11 February 1999 ��4.57 Simmenthal v Commission [1979] ECR 777 (Case 92/78)��3.84 Stichting Woonlinie et al v Commission, ECLI:EU:C:2014:105 (Case C-133/12 P)��3.31, 3.61 Sveriges Betodlares and Henrikson v Commission [1997] ECR I-7531 (Case 409/96 P)��3.61 Telefónica SA v Commission, ECLI:EU:C:2013:852 (Case C-274/12 P)��3.34 Trasta Komercbanka v ECB (ECLI:EU:C:2019:323), A-G Kokott, 11 April 2019 (Case C-669/17P)��3.24, 3.58, 3.61 UK v Parliament and Council (ENISA) [2006] ECR I-3771 (Case C-217/04) (ENISA)��2.57 UK v Parliament and Council (Smoke Flavourings) [2005] ECR I-10553 (Case C-66/04) ��2.57 UK v Parliament and Council, 20 September 2013 (Case C507/13), 20 September 2013, ECJ ��6.26 United Kingdom v European Parliament and Council [2014] ECR I-2014, 22 January 2014, (Case C-270/12)��2.57, 3.69, 4.112, 5.25, 9.112 Universität Hamburg v Hauptzollamt Hamburg-Kehrwieder [1983] ECR-2771 (Case 216/82)��3.34 Van Landewyck/Commission [1980] ECR 3125 (ECJ Cases 209-215 and 218/78)��3.74 Weiss (C-493/17) ECJ, 11December 2018 ��4.05 FRANCE Rozenblum case, Criminal Court of Cassation, 4 February 1985, Rev Soc (1985) 665��6.66 6.68, 13.49 GERMANY Federal Court of Justice (Bundesgerichtshof ) Decision of 5 June 1975, BGHZ 65, 15—ITT��6.64 Decision of 1 February 1988, BGHZ 103, 184—Linotype��6.64

xiv

xv

Table of Cases Decision of 30 September 1991 (1992) 45 Neue Juristische Wochenschrift (NJW) 368, 369��6.64 Decision of 19 September 1994, BGHZ 127, 107, 111��6.64 Decision of 20 March 1995, BGHZ 129, 136—Girmes ��6.64 NETHERLANDS SNS Reaal NV: VEB et al Dutch Minister of Finance, Administrative Court Division of the Council of State, 25 February 2013, JOR 2013/140��3.61 UNITED STATES Inv. Co. Instit. v Camp, 401 US 617 (1971) ��16.35

xv

xvi

xvi

TABLE OF LEGISLATION

TREATIES AND INTERNATIONAL INSTRUMENTS Basel II Accord��6.05, 15.56, 16.09 Pillar II��6.05 Basel II plus (Basel 2.5) ��6.06, 16.09 Basel III Accord��2.08, 2.23, 2.25, 2.50, 2.137, 5.08, 5.14, 6.06, 6.09, 6.92, 6.107, 15.56, 16.03, 16.09, 16.16, 16.38 Basel IV Accord��2.08, 2.23, 6.107 Basel Accord 2017��2.30 EU Charter of Fundamental Rights [2010] OJ C 83/2��3.73, 3.76, 3.77 Art 17��3.77 Art 41(1) ��3.77 Art 41(2) ��3.72, 3.77 Art 41(2)(a) ��10.75 Art 47��3.62 Art 47(1) ��3.77 Art 47(2) ��3.77 Art 48(1) ��3.77 Art 48(2) ��3.77 Art 49(3) ��3.77 Art 50��3.77 European Convention on Human Rights and Fundamental Freedoms (ECHR)��3.76 Intergovernmental Agreement on the Single Resolution Fund, Council Document 8457/14 ��1.43 Intergovernmental Agreement on the Transfer and Mutualization of Contributions to the Fund among the participating Member States (IGA)��9.46, 9.58, 9.59, 9.60, 9.63, 9.93 Recital 7��9.58, 9.60 Recital 9��9.58, 9.60 Recital 13��9.70 Recital 16��9.42 Recital 17��9.96 Art 3��9.58, 9.60 Art 4��9.58, 9.60 Art 4(1) ��9.61 Art 4(2) ��9.61 Art 5��9.58, 9.60

Art 5(1)(b) in fine��9.61 Art 7(1) ��9.62 Art 7(2) ��9.62 Art 7(3) ��9.63 Art 7(4) ��9.63 Art 7(6) ��9.63 Art 11(2) ��9.59 Art 12(4) ��9.59 Protocol No 4 on the Statute of the European System of Central Banks and the European Central Bank [2012] OJ L326/230 (ESCB/ECB Statute) Art 3.1��2.109, 2.110 Art 3.3��2.110 Art 9.3��4.105, 4.113 Art 14(3) ��3.3.94 Art 22��2.109, 2.110, 4.90 Art 35(2) ��3.92 Art 35(3) ��3.87 Art 37��3.74, 4.117 Treaty of Lisbon Art 290��5.13 Art 291��5.13 Treaty on the European Community (TEC) Art 85��3.69 Art 95��3.37 Art 105(2) ��3.94 Art 110(1) ��3.94 Art 205(1) ��3.69 Art 205(2) ��3.69 Art 225a��3.99 Art 230��3.24 Art 251��3.69 Treaty on the European Union (TEU) ��2.18, 3.67, 3.76 Art 13��3.60 Art 13(1) ��3.24 Art 16(3) ��3.69 Art 19(1) ��3.03 Art 127(6) ��15.01, 17.04 Art 282��5.33 Protocol 36��9.59 Treaty on the Functioning of the European Union (TFEU)��3.07, 3.35, 3.67, 3.69, 3.76 Art 20 e.s��4.40

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Table of Legislation Art 50��3.37 Art 107(3)(b)��10.61 Art 114��1.43, 2.57, 3.37, 3.69, 8.05 Art 114(1) ��3.69 Art 123(1) ��12.35 Art 127(1) ��2.20 Art 127(2) ��2.110, 3.94 Art 127(2), 1st indent��2.110 Art 127(2), 4th indent��2.109, 2.110 Art 127(6) ��1.07, 1.10, 2.73, 2.110, 3.07, 4.33, 4.61, 5.03, 5.62, 8.05, 17.55, 17.56, 17.57, 17.76 Art 129(1) ��4.105, 4.113 Art 132��5.35 Art 132(1) ��3.94 Art 136(2) ��9.45, 9.51, 9.52, 9.54, 9.57, 9.109, 9.113, 9.114, 9.116 Art 139��4.39 Art 238��3.69 Art 250��9.45, 9.51, 9.108, 9.109, 9.114, 9.115, 9.116 Arts 251–253��3.25 Art 253(5) ��3.22 Arts 254–256��3.25 Art 257��3.99 Art 257(1) ��3.99 Art 257(2) ��3.99 Art 263��3.03, 3.04, 3.24, 3.25, 3.27, 3.29, 3.34, 3.36, 3.60, 3.61, 3.65, 3.66, 10.37 Art 263(1) ��3.24, 3.66 Art 263(2) ��3.24, 3.27, 3.66 Art 263(4) ��3.24, 3.26, 3.27, 3.32, 3.66 Art 263(5) ��3.28 Art 263(6) ��3.34 Art 265��3.60 Art 265, subpara 2��3.60 Art 266��3.84, 3.95 Art 267��3.35 Art 267(b) ��3.34, 3.95 Art 282(3) ��3.87 Art 288��4.52 Art 289��5.18 Art 290��5.13, 5.18, 5.36 Art 290(2) ��4.23, 9.45, 9.51, 9.52, 9.54, 9.57 Art 291��4.23, 5.13, 5.18, 5.36, 9.112 Art 294��3.69 Art 339��3.74 Art 340(2) ��3.93 Art 340(3) ��3.77 Protocol 36��9.59

EUROPEAN SECONDARY LEGISLATION Directives 77/91/EEC Directive of 13 December 1976 (Second Company Law Directive) [1976] OJ L 26/1��6.68 89/646/EEC Directive of 15 December 1989 on the coordination of laws, regulations and administrative provisions relating to the taking up and pursuit of the business of credit institutions and amending Directive 77/780/EEC [1989] OJ L 386/1 ��5.05 Art 3��4.57 1994/19/EU Directive of the European Parliament and of the Council of 30 May 1994 on deposit guarantee schemes [1994] OJ L 135��9.76, 14.06, 14.07, 14.12 Recital 5��14.06 Art 7(1) ��14.06 Art 10��14.06 97/9/EC Directive of the European Parliament and of the Council of 3 March 1997 on investor-compensation schemes [1997] OJ L 84��3.44, 12.48, 9.76 98/26/EC Directive of 19 May 1998 on settlement finality in payment and securities settlement systems [1998] OJ L 166/45 (Finality Directive)��4.19, 9.88 2000/12/EC Directive of the European Parliament and of the Council of 20 March 2000 relating to the taking up and pursuit of the business of credit institutions [2000] OJ L 126/1��3.49 Recital 9��3.49 Art 2, subpara 1��3.49 Art 9(1) ��3.49 Art 10(1) ��3.49 2000/46/EC Directive of 18 September 2000 on the taking up, pursuit and prudential supervision of e-money [2000] OJ L 275/39��4.19, 10.21 2001/23/EC Council Directive of 12 March 2001 on the approximation of the laws of the Member States relating to the safeguarding of employees' rights in the event of transfers ofundertakings, businesses or parts of undertakings or businesses [2001] OJ L 82 ��9.77 Art 5(1) ��9.77

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Table of Legislation 2001/24/EC Directive of 4 April 2001 on the reorganisation and winding-up of credit institutions [2001] OJ L 125/5��3.49, 4.19 2002/47/EC Directive of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements [2002] OJ L 168 (Financial Collateral Directive (FCD)) ��13.56 2002/87/EC Directive of the European Parliament and of the Council of 16 December 2002 on the supplementary supervision of credit institutions, insurance undertakings and investment firms ina financial conglomerate and amending Council Directives 73/239/EEC, 79/267/EEC, 92/49/EEC, 92/96/EEC, 93/6/EEC and 93/22/EEC and Directives 98/78/EC and 2000/12/EC of the European Parliament and of the Council [2003] OJ L 35/1 (Financial Conglomerates Directive)��4.19, 4.61, 10.21, 17.18, 17.19, 17.24, 17.32, 17.34, 17.36, 17.39, 17.40, 17.41, 17.42, 17.43, 17.48, 17.49, 17.50, 17.52, 17.53, 17.55, 17.59, 17.60, 17.63, 17.64, 17.65, 17.66, 17.67, 17.68, 17.69, 17.72, 17.74, 17.90, 17.91, 17.92, 17.93, 17.95 Recital 2��17.24, 17.36 Recital 3��17.24 Recital 4��17.34 Art 2(4) ��17.72 Art 2(14) ��17.72 Art 3(2) ��17.72 Art 3(3) ��17.72 Art 6��17.44 Art 6(2) ��17.41 Art 6(2), 2nd para��17.41 Art 7(2) ��17.42 Art 7(4) ��17.42 Art 8(2) ��17.42 Art 8(4) ��17.42 Art 9(1) ��17.43 Art 9(2) ��17.44 Art 9(2)(d)��17.74 Art 9(3) ��17.44 Art 9(4) ��17.46 Art 9(4), 1st para��17.45 Art 9b��17.48, 17.53 Art 9b(2) ��17.48 Art 10ff ��17.52 Art 11��17.54 Art 11(1) ��17.52

Art 11 (1), 2nd para��17.53 Art 13��17.47 Art 18(1a)��17.53 Art 18(3) ��17.53 Art 21a(1)(b) ��17.53 Art 21a(2b)��17.42 Art 21a(2c)��17.42 Annex I ��17.32, 17.41, 17.44 Annex II��17.42 2003/71/EC Directive of the European Parliament and of the Council Art 53(2) ��11.57 2004/39/ECDirectiveof the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC (Markets in Financial Instruments Directive (MiFID I)) [2004] OJ L 145/1) ��3.74, 6.11, 12.07 Art 4(1)(1)��6.11 Art 13(2) ��6.32 Art 54(1) ��3.74 Art 54(2) ��3.74 Art 64��3.74 2006/43/EC Directive of 17 May 2006 on statuary audits of annual accounts andconsolidated accounts [2006] OJ L 157/87��6.13 Art 39��6.13 2006/48/EC Directive of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions (recast) [2006] OJ L 177/1 (one part of CRD I)��6.05, 6.06 Art 11��6.07 Art 22��6.07 Art 22(1) ��6.05, 6.06, 6.09 Annex V��6.06 2006/48/EC and 2006/49/EC together constitute CRD I��6.05 2006/49/EC Capital Adequacy Directive of 14 June 2006 [2006] OJ L 177/1 and [2006] OJ L 177/201 (one part of CRD I)��6.05, 10.21 Art 34��6.05 2006/73/EC MiFID Implementing Directive of 10 August 2006 [2006] OJ L 241/26��6.32 Art 6(2) ��6.32 2007/36/EC Directive on Shareholder rights ��6.37

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Table of Legislation 2007/44/EC Directive of the European Parliament and of the Council of 5 September 2007 amending Council Directive 92/49/EEC and Directives 2002/83/EC, 2004/39/EC, 2005/68/EC and 2006/48/EC as regards procedural rules and evaluation criteria for the prudential assessment of acquisitions and increase of holdings in the financial sector [2007] OJ L 247/1 (Antonveneta Directive)��10.21 Art 5��10.21 2009/14/EC Directive��14.07 Recital 1��14.07 Art 7��14.07 Art 10��14.07 2009/65/EC Directive of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS)��4.29 2009/111/EC Directive of the European Parliament and of the Council of 16 September 2009 amending Directives 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certain own funds items, large exposures, supervisory arrangements, and crisis management (CRD2)��15.75 Art 493��15.75 2009/138/EC Directive of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II Directive) ��17.13, 17.14, 17.59, 17.65, 17.84, 17.85, 17.86, 17.95 Art 136��17.84 Art 138(1)–(4)��17.84 Art 148��17.55 Art 212(1)(g)��17.13 Art 213(2)(d)��17.14 Art 213(3)–(6)��17.59, 17.63 Art 213(3) ��17.61 Art 213(5) ��17.60 Art 213(6) ��17.62 Art 228��17.22 Art 242(2) ��17.12, 17.84, 17.85 Art 265��17.13 Art 265(2) ��17.13 2010/76/EU Directive of the European Parliament and of the Council of

24 November 2010 Amending Directives 2006/48/EC and 2006/49/EC as Regards Capital Requirements for the Trading Book and for Re-Securitisations, and the Supervisory Review of Remuneration Policies [2010] OJ L 329/3 (CRD III)��6.06, 6.07, 6.23, 6.26, 6.28, 6.89 Recitals 1–4 ��6.89 2011/89/EU Directive of the European Parliament and of the Council 16 November 2011 amending Directives 98/78/EC, 2002/87/EC, 2006/48/EC and 2009/138/EC as regards the supplementary supervision of financial entities in a financial conglomerate[2011] L326/113��17.48, 17.59, 17.63, 17.92 Art 5��17.65 2012/30/EU Directive of the European Parliament and of the Council of 25 October 2012 on coordination of safeguards which, for the protection of the interests of members and others, are required by Member States of companies within the meaning of the second paragraph of Article 54 of the Treaty on the Functioning of the European Union, in respect of the formation of public limited liability companies and the maintenance and alteration of their capital, with a view to making such safeguards equivalent [2012] OJ L 315/74��6.68, 14.53 Recital 5��6.68 Art 17��6.68 2013/34/EU Directive of the European Parliament and of the Council of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC��4.79 2013/36/EU Directive of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives

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Table of Legislation 2006/48/EC and 2006/49/EC [2014] OJ L 176/338 (Capital Requirements Directive IV (CRD IV))��2.08, 2.11, 2.25, 2.26, 2.29, 2.43, 2.87, 2.92, 2.95, 2.100, 2.104, 2.107, 2.108, 2.111, 2.137, 3.01, 3.07, 3.11, 3.43, 3.66, 4.15, 4.19, 4.69, 4.71, 5.01, 5.08, 5.14, 5.16, 5.29, 5.30, 6.01, 6.02, 6.09, 6.11, 6.18, 6.23, 6.24, 6.26, 6.32, 6.33, 6.34, 6.36, 6.37, 6.38, 6.39, 6.40, 6.41, 6.42, 6.43, 6.44, 6.47, 6.49, 6.56, 6.58, 6.59, 6.60, 6.61, 6.62, 6.64, 6.65, 6.67, 6.77, 6.82, 6.84, 6.87, 6.90, 6.91, 6.92, 6.94, 6.98, 6.99, 6.100, 6.101, 6.102, 6.103, 6.105, 6.106, 6.107, 6.108, 7.02, 7.03, 7.04, 7.07, 7.10, 7.23, 7.28, 7.29, 7.31, 7.33, 7.62, 7.65, 7.78, 7.79, 7.80, 7.81, 7.82, 7.83, 7.84, 7.86, 7.87, 7.88, 7.89, 7.92, 7.94, 7.95, 7.96, 8.46, 9.05, 9.75, 9.87, 10.21, 11.13, 13.07, 15.75, 16.03, 16.38, 17.05, 17.06, 17.07, 17.08, 17.65, 17.71 Chap 3��17.06 Recital 9��3.01 Recital 10��6.39 Recital 11��6.39 Recital 13��6.39 Recital 39��6.17 Recital 41��6.43 Recital 47��6.70 Recital 49��6.70, 6.74 Recital 50��6.70 Recital 52��6.70, 6.74 Recital 54��6.34, 6.70 Recital 55��6.34, 6.35, 6.55, 6.56, 6.88, 7.03 Recital 56��6.48, 6.49, 6.51, 6.56 Recital 60��6.21 Recital 62��6.70 Recital 63��6.23, 6.97 Recital 65��6.26 Recital 66��6.26 Recital 67��6.24, 6.70 Art 2(5) ��4.57, 14.36 Art 2(8) ��14.36 Art 2(14) ��14.36 Art 3(1) ��6.35, 6.56 Art 3(1)(3)��6.11 Art 3(1)(7)��6.35, 6.48, 6.49, 7.02 Art 3(1)(7)–(9)��6.46 Art 3(1)(8)��6.35, 6.51, 7.02 Art 3(1)(9)��6.35, 6.49, 6.51, 7.04 Art 3(1)(15)��6.65 Art 3(2) ��6.47, 6.48, 6.51, 6.54, 6.57, 6.62, 7.03

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Art 4(1)(3)��6.11 Art 8(2)–(4)��6.39 Art 12(3) ��3.10 Art 12(4) ��3.10 Art 13(1), subpara 2��6.43 Art 17��4.68 Art 18(c)��6.43 Art 22–27��6.36, 6.54 Art 22��3.25 Art 22(9) ��6.39 Art 23��3.25 Art 23(1) ��6.54 Art 23(1)(b)��6.51 Art 29��13.07 Art 29(3) ��3.10 Art 32(1) ��3.10 Art 35��4.70 Art 35(5)–(7)��6.39 Art 36(5)–(7)��6.39 Art 39(4)–(6)��6.39 Art 40��3.10 Art 50(6)–(8)��6.39 Art 51(4)–(6)��6.39 Arts 64–72��6.42 Art 66(1) ��6.42 Art 66(1)(c)–(d)��6.43 Art 66(2) ��6.42, 6.43 Art 67(1) ��6.42 Art 67(1)(b)–(c)��6.43 Art 67(1)(d)��6.43 Art 67(1)(p)��6.43 Art 67(2) ��6.42, 6.43 Art 67(2)(e) ��6.43 Art 67(2)(f ) ��6.43 Art 68��6.42 Art 69��6.17 Art 71(3) ��6.32 Art 73��6.28, 6.31 Art 74��6.22, 6.43, 7.10 Art 74(1) ��6.09 Art 74(2) ��6.09, 6.13, 6.105 Art 74(3) ��6.39, 6.40 Art 74(4) ��9.75 Art 75(2) ��6.39, 6.40 Art 76–95��6.09 Art 76(1) ��6.28 Art 76(3) ��6.11, 6.12, 6.13 Art 76(3)(1)��6.13, 6.29 Art 76(3)(2)��6.29, 6.50 Art 76(3)(4)��6.13 Art 76(4) ��6.29 Art 76(4)–(5)��6.47 Art 76(5) ��6.30, 6.105 Art 76(5)(3)��6.50 Art 76(5)(4)��6.30, 6.52

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Table of Legislation Art 76(5)(5)��6.30 Art 77(4) ��6.39 Art 78(6) ��6.39 Art 78(7)–(9)��6.39 Art 88��6.11, 6.14, 6.58 Art 88(1) ��6.22, 7.07, 7.55 Art 88(1)(a) ��6.61 Art 88(1)(e) ��6.11, 6.46, 6.47, 6.50 Art 88(2) ��6.11, 6.57 Art 88(2)(a) ��6.74 Art 88(2)(a)–(d)��6.12 Art 88(2), subpara 4��6.79 Art 91��4.17, 6.11, 6.14, 6.36, 6.40, 6.43, 6.44, 6.51, 6.54, 6.58, 6.81, 6.94, 6.101, 7.23 Art 91(1) ��6.15, 6.17, 6.43, 6.51, 6.54, 7.29, 7.33 Art 91(2)–(8)��7.29 Art 91(2) ��6.20, 7.29, 7.61 Art 91(3)–(6)��6.20, 7.29 Art 91(3) ��6.20, 6.96, 6.105, 7.61, 7.62, 7.65, 7.94 Art 91(4)–(5)��6.20 Art 91(4) ��7.63 Art 91(5) ��7.64 Art 91(6) ��6.20, 7.62, 7.94 Art 91(7) ��6.16, 7.29, 7.68 Art 91(8) ��6.17, 6.50, 6.79, 6.81, 6.86, 6.94, 7.29, 7.52 Art 91(9) ��6.19, 7.48 Art 91(10) ��6.21, 7.41 Art 91(12) ��6.39, 6.40, 6.81, 7.31 Art 92–95��6.23 Art 92(1) ��6.23, 6.60, 6.62, 6.103, 6.105 Art 92(2) ��6.24 Art 92(2)(a) ��6.24 Art 92(2)(c) ��6.24 Art 92(2)(f ) ��6.27, 6.32, 6.47, 6.52 Art 94(1) ��6.25 Art 94(1)(a) ��6.25 Art 94(1)(b)��6.25 Art 94(1)(f ) ��6.24 Art 94(1)(g)��3.10, 6.26, 6.108 Art 94(1)(g)(i) ��6.26 Art 94(1)(g)(ii)��6.26 Art 94(1)(g)(iii), subpara 2��6.39 Art 94(1)(k)��6.25 Art 94(1)(l)(i)��6.103 Art 94(1)(l)–(m)��6.103 Art 94(1)(l)��6.25 Art 94(1)(m) ��6.25 Art 94(1)(n)��6.25 Art 94(2) ��6.24, 6.39 Art 95��6.73

Art 95(1) ��6.11, 6.73, 6.74 Art 95(2) ��6.12, 6.27, 6.71, 6.72, 6.74, 6.76, 6.78, 6.98 Art 97(4) ��6.105 Art 100(2) ��6.39 Art 101(5) ��6.39 Art 103(2) ��6.39 Art 104��3.11, 3.43, 9.75 Art 107(3) ��6.39 Art 108(2)–(3)��6.31, 6.61 Art 109(3) ��6.62 Art 113(5) ��6.39 Art 115��17.06 Art 116��17.06, 17.55 Art 116(4)–(5)��6.39 Art 117��17.06 Art 120��17.59, 17.63 Art 121��7.15 Art 123(1) ��17.08 Art 131��2.108 Art 131(18) ��6.39 Art 133(18) ��3.10 Art 136(1) ��2.99 Art 140(7) ��6.39 Art 143(3) ��6.39 Art 160(6) ��3.10 2014/49/EU Directive of the European Parliament and of the Council of 16 April 2014 on Deposit Guarantee Schemes [2014] OJ L 173/149 (DGS Directive)��3.01, 3.44, 4.19, 6.01, 9.88, 12.48, 14.08, 14.11, 14.14, 14.15, 14.16, 14.21, 14.22, 14.33, 14.34, 14.35, 14.36, 14.37, 14.38, 14.39, 14.41, 14.43, 14.44, 14.48, 14.54, 14.58, 14.62 Recital 6��14.08 Recital 26��14.08 Art 1(2) ��14.35 Art 2(1) ��14.08, 14.62 Art 2(1)(18)��14.26 Art 2(9) ��14.35 Art 4��3.01 Art 5��14.15 Art 6��14.04, 14.15 Art 6(2) ��14.08, 14.16 Art 8��14.53 Art 8(1) ��14.08 Art 8(2) ��14.08, 14.16 Art 10(2) ��14.15, 14.37, 14.38, 14.58 Art 10(3) ��14.43 Art 10(6) ��14.38 Art 10(8) ��14.37 Art 10(9) ��14.37 Art 11(1)–(2)��14.48

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Table of Legislation Art 11(2) ��14.13 Art 11(6) ��12.48 Art 12(1) ��14.37 Art 12(2)(a) ��14.58 Art 12(3) ��14.58 Art 13��14.41 Art 14(2) ��14.12 Art 15(1) ��14.36 Art 41(j)��14.39 2014/59/EU Directive of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations 1093/2010/EU and 648/2012/EU, of the European Parliament and of the Council [2014] OJ L 173/190 (Bank Recovery and Resolution Directive (BRRD))�� 1.18, 1.32, 1.37, 1.38, 2.08, 2.50, 2.52, 2.54, 2.56, 2.62, 2.63, 3.04, 3.37, 3.46, 3.48, 3.49, 3.51, 3.53, 3.62, 3.63, 4.26, 6.01, 6.103, 8.05, 8.06, 8.07, 8.30, 9.04, 9.06, 9.07, 9.23, 9.43, 9.51, 9.70, 9.75, 9.93, 9.94, 9.126, 10.01, 10.02, 10.08, 10.11, 10.12, 10.14, 10.16, 10.21, 10.25, 10.34, 10.36, 10.45, 10.47, 10.48, 10.56, 10.67, 10.69, 10.71, 10.72, 10.75, 10.79, 10.86, 10.97, 10.98, 11.01, 11.03, 11.04, 11.08, 11.13, 11.16, 11.25, 11.48, 11.52, 11.57, 11.58, 12.01, 12.02, 12.10, 12.15, 12.20, 12.26, 12.33, 12.35, 12.60, 12.62, 12.81, 12.82, 13.01, 13.03, 13.07, 13.10, 13.13, 13.14, 13.15, 13.17, 13.18, 13.21, 13.23, 13.24, 13.26, 13.28, 13.29, 13.30, 13.31, 13.32, 13.35, 13.36, 13.37, 13.39, 13.41, 13.43, 13.45, 13.49, 13.51, 13.53, 13.55, 13.56, 13.60, 13.61, 13.62, 13.63, 13.64, 13.67, 13.69, 13.70, 13.74, 13.79, 13.80, 13.82, 14.13, 14.54, 14.64, 16.03, 16.16, 16.18, 16.38, 17.75, 17.76, 17.79, 17.84, 17.87, 17.88, 17.89 Chap IV��13.35 Chap V��13.35 Title III ��2.62 Recital 10��3.37 Recital 21��10.04 Recital 25��10.04 Recital 38��113.51

xxiii

Recital 45��12.10 Recital 67��12.04 Recital 70��16.18 Recital 95��13.18 Recital 110��14.13 Art 1(1) ��13.06 Art 1(1)(a) ��9.88 Art 1(1)(b)��9.88 Art 1(1)(c) ��9.88 Art 1(c)��17.75 Art 2(1)(21)��3.09 Art 2(1)(30)��12.32 Art 2(1)(47)��12.10 Art 2(1)(55)��9.86 Art 2(1)(56)��9.86 Art 2(1)(57)��9.87 Art 2(1)(58)��9.85 Art 2(1)(59)��9.85 Art 2(1)(60)��9.85 Art 2(1)(102)��3.62 Art 4–16��9.75 Art 4–26��9.75 Art 5��6.22, 10.16 Art 5(1), sentence 2 ��6.22 Art 5(3) ��10.97 Art 5(6) ��10.29 Art 6��10.29 Art 6–9��3.51 Art 6(5) ��3.09 Art 6(6) ��3.09 Art 6(6), subpara 3(c)��3.09 Art 6(6), subpara 3(e)��3.09 Art 10(2) ��3.51 Art 10(3) ��10.97 Art 10(7)(j)��3.51 Art 11��9.16 Art 12(1) ��17.78 Art 13(1) ��9.16 Art 15��2.64 Art 16��2.64, 5.35 Art 16(1) ��10.32 Art 16a��9.75 Art 17��10.29, 10.33, 13.48 Art 17(4), 2nd para��10.45 Art 17(5) ��2.64, 2.66 Art 17(5)(a) ��13.48 Art 17(5)(b)��13.48 Art 17(5)(c) ��13.48 Art 17(5)(d)–(f )��13.48 Art 17(5)(g)��13.48 Art 17(5)(h)��13.48 Art 17(5)(i)��13.48 Art 17(5)(j)��13.48 Art 17(5)(k)��13.48

xvi

Table of Legislation Art 17(6)(c) ��10.36 Art 17(7) ��10.34 Art 19��13.52 Art 19(4) ��13.50 Art 26(2) ��3.53 Art 27��9.75, 13.52 Art 27(1) ��3.43, 9.75 Art 27(1)(a) ��10.16 Art 27(1)(d)��10.15 Art 27(1)(e) ��10.16 Art 27ff ��10.16 Art 28��3.43, 3.51, 9.75, 10.15 Art 29��3.43, 3.51, 9.75, 10.15, 13.55 Art 30��10.15 Art 31–92��9.75 Art 31(2) ��12.02 Art 32��8.06, 9.106, 12.23, 13.10, 13.53 Art 32b��9.106 Art 32(1)(c) ��10.02 Art 32(4)(d)(iii)��10.64, 10.86 Art 32(5) ��10.02 Art 33(3) ��13.06 Art 34��12.03, 13.19, 13.22 Art 34(1) ��10.75, 13.18 Art 34(1)(a) ��12.26 Art 34(1)(c) ��10.15 Art 34(1)(g)��10.74, 13.18 Art 35��9.81, 13.55 Art 36��13.21 Art 36(4)(d)��13.21 Art 37��12.04 Art 37(3) ��2.50, 3.48 Art 37(4) ��2.50 Art 37(10) ��8.06 Art 37ff ��10.70 Art 38��9.85 Art 39��12.73 Art 39(2) ��3.47, 3.51 Art 40��9.85 Art 40(9) ��10.93 Art 40(10) ��10.93 Art 41(1) in fine��10.93 Art 42��9.86 Art 42(3) ��9.86 Art 43��9.06, 9.87 Art 43(1) ��14.62 Art 44��9.06 Art 44(2) ��9.06, 16.18 Art 44(5) ��11.08 Art 44(11) ��9.115 Art 44a��9.06 Art 45 �� 11.12, 11.25, 11.28, 13.40, 13.74 Art 45(5) ��13.81 Art 45(8) ��13.74 Art 50��11.55

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Art 55��10.71, 10.72, 13.81 Art 56–58��13.31 Art 59–62��9.75 Art 59(3) ��13.39 Art 59(6) ��17.17 Art 59(7) ��13.39 Art 63–72��3.50 Art 63(1) ��3.50 Art 63(1)(d)��3.50 Art 63(1)(e)–(h)��3.50 Art 63(1)(i)��3.50 Art 63(1)(j)��3.50 Art 63(1)(k)��3.50 Art 63(1)(l)��3.50 Art 64(1)(b)��3.50 Art 64(1)(c) ��3.50 Art 65��3.50 Art 66��3.50, 10.93 Art 67��3.50 Art 68��3.50, 13.43 Art 68ff ��10.68 Art 69��3.50 Art 70��3.50 Art 71��3.50 Art 72(1)(a) ��3.50 Art 72(1)(b)��3.50 Art 73��13.19, 13.22 Art 73–75��10.74, 13.18 Art 73(a)��13.19 Art 73(b) ��13.19 Art 74��13.21, 13.22 Art 74(2)(a) ��13.21 Art 74(2)(b)��13.21 Art 74(3)(c) ��10.75 Art 74ff ��10.87 Art 76��10.87 Art 82��13.19 Art 85(2) ��3.04, 10.36 Art 85(3) ��3.62, 3.63, 10.36 Art 85(4) ��10.36 Art 85(4), subpara 2��3.63, 3.85 Art 85(4)(a) ��3.63 Art 85(4)(b)��3.63 Art 93–98��13.58 Art 94��13.80 Art 95��13.80 Art 96��13.58 Art 99ff ��10.75 Art 100��9.06, 10.97 Art 100(6) ��13.61 Art 103(7) ��9.49, 9.51 Art 104��13.66 Art 106(3) ��9.73 Art 106(4) ��9.74 Art 106(5) ��9.74

xv

Table of Legislation Art 107(2)–(5)��9.94 Art 109��13.69, 13.70, 14.13, 14.69 Art 118��13.56 Art 130(1), 3rd para ��9.06 2014/65/EU Directive of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU [2014] OJ L 173/349 (Markets in Financial Instruments Directive II (MiFID II))��2.83, 3.76, 4.19, 6.01, 6.11, 6.81, 7.04, 7.86, 9.87, 11.29, 11.45, 11.46, 12.07, 14.22 Recital 37��6.70 Recital 53��6.11 Recital 55��6.35, 6.56, 6.88 Art 1(3)(a) ��6.11, 6.22 Art 1(4)(a) ��6.11, 6.22 Art 9(1) ��6.11, 6.14 Art 9(1), sub-para 2��6.40 Art 9(3) ��6.22 Art 9(3)(a)–(c)��6.22 Art 9(4) ��6.14 Art 9(6)(2)��6.14 Art 16��6.32 Art 16(2) ��6.32 Art 76��3.74 Art 94(2) ��6.11 Annex IV��6.11 2015/2366/EU Directive of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation 1093/2010/EU, and repealing Directive 2007/64/EC (Payments Services Directive (PSD 2))��4.26 2017/828/EU Directive of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement [2017] OJ L132/1 ��6.37, 6.95 Ch 1b��6.95 Art 2(1) ��6.37 Art 3j��6.95 Art 9a��6.37 2017/1132/EU Directive of 14 June 2017 [2017] OJ L169/46 Recital 40��6.68 Art 56��6.68 2019/878/EU Directive of the European Parliament and of the Council of

20 May 2019 amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures [2019] OJ L150/253 (Capital Requirements Directive V (CRD V))��2.04, 2.24, 2.25, 2.26, 2.28, 2.29, 2.30, 2.107, 2.108, 4.19, 6.102, 6.103, 6.105, 7.02, 7.10, 7.29, 7.52, 7.68, 8.46, 9.05, 9.75, 11.17, 11.18, 11.19, 11.26, 17.71 Art 21a��17.71 Art 141a(1)(a)–(c) ��3.43 2019/879/EU Directive of the European Parliament and of the Council of 20 May 2019 amending Directive 2014/ 59/EU as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296 (BRRD2)��9.04, 9.06, 9.75, 11.19, 11.25, 11.26, 11.28, 11.31, 11.32, 11.33, 11.37, 11.39, 11.41, 11.42, 11.43, 11.46, 12.06 Preamble, Recital 6��11.29 Preamble, Recital 15��11.45, 11.48, 12.06, 12.07 Preamble, Recital 16��12.07 Preamble, Recital 27��3.48 Art 3(1) ��11.43 Art 33a��3.48 Art 44a��11.45, 11.46, 11.48 Art 44a(1)��11.46 Art 44a(2)��11.46 Art 45a–45i ��11.28 Art 45b(4) ��11.32 Art 45c��11.30 Art 45c(3)��11.30 Art 45c(5)��11.30, 11.31 Art 45c(6)��11.31 Art 45e��11.29 Art 45f��11.29 Art 45f(3)��11.40 Art 45f(4)��11.40 Art 45f(5)��11.40 Art 45h��11.39 Art 45i(3)��11.43 Art 45(2) ��11.29 Proposal for a Commission Directive of the European Parliament and of the Council amending Directive 2014/59/EU on loss-absorbing and

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Table of Legislation recapitalisation capacity of credit institutions and investment firms, COM (2016) 852 (23 November 2016) ��16.47 Proposal for a Commission Directive amending Directive 2017/1132/EU as regards cross-border conversions, mergers and divisions��6.66 Proposal for a Commission Directive amending Directive 2017/1132/EU as regards the use of digital tools and processes incompany law, COM(2018) 239 final of 25 April 2018 ��6.66 Proposal for a Directive of the European Parliament and of the Council on the prudential supervision of investment firms and amending Directives 2013/36/EU and 2014/65/EU, 4 January 2019, 5021/19, 4 January 2019, 5022/19��4.60 Proposal for a Directive on credit servicers, credit purchasers and the recovery of collateral COM/2018/0135 final—2018/063 (COD) ��8.19 Regulations 259/68/EEC, Euratom, ECSC Council Regulation of 29 February 1968 [1968] OJ L 56��9.30 Art 110��9.30 1346/2000/EC Council Regulation of 29 May 2000 on insolvency proceedings [2000] OJ L160/1 (Insolvency Regulation) Art 1(2) ��3.49 44/2001/EC Council Regulation of 22 December 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters [2001] OJ L 12/1 (Brussels I Regulation)��3.92 1606/2002/EC Regulation on the application of international accounting standards Recital 11��4.36 1092/2010/EU Regulation of the European Parliament and of the Council of 24 November 2010 on European Union macro-prudential oversight of the financial system and establishing a European Systemic Risk Board [2010] OJ L 331/1 (ESRB Regulation)��2.31 Art 1, 6th sentence ��4.63

1093/2010/EU Regulation of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority) amending Decision 716/2009/EC and repealing Commission Decision 2009/78/EC (European Banking Authority Regulation (EBA Regulation 2010) COM(2013) 520��2.08, 2.31, 2.33, 2.38, 4.69, 5.37, 5.38, 5.40, 5.53, 9.06, 9.07, 11.13 Recitals 21–23��5.25 Recital 26��7.24 Art 1–2��2.08 Art 1(2) ��2.33 Art 2(2)(f ) ��2.33 Art 3(2) ��2.33 Art 8��2.32 Art 8(1) ��2.32 Art 8(1), para 1(a) ��5.12 Art 9��2.32 Art 10–15��4.43, 5.36 Art 10–16��2.32 Art 10–21��2.32 Art 10��2.08, 11.13 Art 10(1) ��5.13 Art 14–16��2.08 Art 15, para 1��5.13 Art 16��2.35, 4.69, 5.36, 7.24 Art 16(1) ��5.13, 7.31 Art 16(3) ��5.13, 6.18, 6.45 Art 17��4.54, 7.24 Art 29��2.32 Art 34��2.32 Art 44��5.37 1094/2010/EU Regulation of 24 November 2010 establishing a European Supervisory Authority (European Insurance and Occupational Pensions Authority) amending Decision 716/2009/EC and repealing Commission Decision 2009/79/EC��2.31, 2.41, 5.53 1095/2010/EU Regulation of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority) amending Decision716/2009/EC and repealing Commission Decision 2009/77/EC (ESMA Regulation) [2010] OJ L 311/84��2.31, 2.41, 5.53 1096/2010/EU Council Regulation conferring specific tasks upon the ECB concerning the functioning

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Table of Legislation of the European Systemic Risk Board [2010] OJ L331/162 ��2.31 513/2011/EU Regulation of the European Parliament and of the Council of 11 May 2011 amending Regulation 1060/2009/EC on credit rating agencies [2011] OJ L 145/30 (CRA Regulation II)��4.29 236/2012/EU Regulation of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps [2012] OJ L 86/1 (Short Selling Regulation) Art 28��3.69, 5.25 648/2012/EU Regulation of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (European Market Infrastructure Regulation (EMIR))��2.110, 4.19, 4.61, 7.01 Art 1, 2nd sentence��4.61 Art 14��9.88 Art 25��9.88 1215/2012/EU Regulation of the European Parliament and of the Council of 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters [2012] OJ L 351/1��3.92 345/2013/EU Regulation on European venture capital funds��2.41 346/2013/EU Regulation on European social entrepreneurship funds��2.41 575/2013/EU Regulation of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation 648/2012/EU [2014] OJ L 176/1 (Capital Requirements Regulation (CRR))��1.34, 2.08, 2.11, 2.25, 2.87, 2.98, 2.102, 2.104, 2.110, 2.111, 3.01, 3.07, 3.10, 4.19, 4.26, 4.65, 4.69, 4.71, 5.01, 5.14, 5.15, 5.16, 5.49, 5.50, 5.69, 6.02, 6.11, 6.22, 6.61, 6.103, 7.01, 8.46, 8.47, 9.05, 9.75, 9.104, 11.13, 11.41, 13.10, 15.75, 16.03, 16.38, 17.05, 17.06, 17.08, 17.17, 17.18, 17.19, 17.20, 17.22, 17.23, 17.65, 17.71, 17.76, 17.89, 17.95 Pt 1, Title II, Chap 2 ��17.17 Pt 1, Title II, Chap 2, Section 2��6.31, 6.61 Pt 1, Title II, Chap 2, Section 3��6.31, 6.61

Art 4(1) ��4.57 Art 4(1)(1)��2.106, 6.11, 7.01, 14.35 Art 4(1)(2)��6.11 Art 4(1)(2)(a)–(c)��6.11 Art 4(1)(3)��6.11 Art 4(1)(4)��6.11 Art 4(1)(15)(b)��4.65 Art 4(1)(16)(b)��6.65 Art 4(22) ��17.07 Art 4(1)(47)��17.17 Art 5(4) ��2.99 Art 5(5) ��2.99 Art 8��10.79 Art 10��4.65 Art 10(1) ��4.65 Art 18��4.79, 17.17 Art 25ff ��6.22 Art 49(1) ��17.18, 17.20 Art 49(1)(a)–(e)��17.18 Art 49(1)(b)��17.18 Art 92a��13.75 Art 92ff ��6.22 Art 99��6.102 Art 113(7) ��9.104 Art 362–369��6.92 Art 429��3.42 Art 429(14) ��3.66 Art 429a��3.42 Art 430��6.102 Art 458��2.99 Art 458(1) ��2.99 Art 458(2) ��2.99 Art 458(4) ��2.99 Art 469a��8.46 Art 471��17.18, 17.20 Art 471(1) ��17.20 1022/2013/EU Regulation of 22 October 2013 amending Regulation 1093/2010/EU [2013] OJ L 287/5 (Amending Regulation) [2013] OJ L 287/5 ��2.02. 2.33, 2.41, 5.37, 5.38 Recital 14��5.37 Art 1(2) ��2.33 Art 1(5) ��5.37 Art 1(8) ��5.37 Art 1(21) ��5.38 Art 1(24) ��5.38 Art 2��5.37 Art 3(24) ��5.37 1024/2013/EU Council Regulation of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2014] OJ L287/63

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Table of Legislation (Single Supervisory Mechanism Regulation (SSM Regulation))��1.27, 1.30, 1.32, 1.58, 2.02, 2.07, 2.11, 2.33, 2.34, 2.35, 2.36, 2.53, 2.62, 2.68, 2.72, 2.91, 2.95, 2.98, 2.99, 2.102, 2.110, 2.130, 2.136, 3.02, 3.04, 3.05, 3.07, 3.11, 3.20, 3.21, 3.22, 3.25, 3.26, 3.58, 3.66, 3.69, 3.72, 3.73, 3.74, 3.87, 3.90, 3.91, 3.92, 3.93, 4.01, 4.02, 4.13, 4.15, 4.18, 4.34, 4.37, 4.37, 4.39, 4.40, 4.41, 4.44, 4.46, 4.48, 4.49, 4.58, 4.61, 4.64, 4.72, 4.74, 4.100, 4.101, 4.104, 4.106, 4.107, 4.115, 4.132, 4.133, 5.34, 5.35, 5.37, 5.51, 5.52, 7.96, 9.04, 9.05, 9.20, 9.75, 10.22, 10.98, 14.01, 17.58, 17.76 Chap III, Section 1��3.11 Chap III, Section 2��3.11 Preamble ��3.90 Recital 2��5.51 Recital 12��2.72 Recital 14��2.09, 4.87, 9.07 Recital 15��4.51 Recital 28��3.09, 4.58, 14.36 Recital 31��2.33, 2.34 Recital 32��2.35, 5.36 Recital 34��3.10 Recital 37��3.89 Recital 60��3.27 Recital 61��3.87 Recital 73��4.115 Recital 83��2.72 Recital 85��2.52 Art 1��2.08, 3.07, 4.61 Art 1(2) ��4.58 Art 2��9.07 Art 2(1) ��2.16, 9.05 Art 2(3) ��3.08, 4.57 Art 2(9) ��3.08 Art 3��2.33, 17.58 Art 3(1) ��4.43, 17.58 Art 3(1), 1st subpara��2.33 Art 3(6) ��2.09, 4.43 Art 4–6��2.73 Art 4��2.07, 2.11, 2.67, 2.80, 2.91, 2.98, 4.52, 4.100, 4.101, 4.104 Art 4(1) ��2.11, 2.72, 3.07, 3.08, 4.48, 4.49, 5.52, 13.08 Art 4(1)(a) ��2.07, 3.12, 7.15, 9.05 Art 4(1)(c) ��2.07, 3.12, 3.25, 7.15, 9.05, 10.22 Art 4(1)(d)��2.11 Art 4(1)(e) ��2.11, 3.09, 6.45, 7.12, 7.15, 7.16 Art 4(1)(g)��2.11, 3.39, 9.08, 17.75

xxviii

Art 4(1)(h)��2.11, 4.61, 17.56 Art 4(1)(i)��3.09, 3.51, 9.08 Art 4(2) ��4.85 Art 4(3) ��2.11, 2.87, 3.10, 4.24, 4.52, 4.89, 4.101, 4.106, 5.19, 5.35, 5.40, 5.52, 7.88 Art 4(3), 1st para��3.09, 3.11, 7.23 Art 4(3), 2nd sentence��4.27, 5.51, 6.45 Art 4(4) ��4.119, 5.19 Art 4(5)(b)��4.16 Art 5��2.67, 2.91, 2.98, 2.99, 2.106, 3.87 Art 5(b) ��2.72 Art 5(1) ��2.98, 2.101 Art 5(2) ��2.94, 2.98, 2.99, 2.100, 2.101 Art 5(4) ��2.98, 2.104 Art 5(5) ��2.98 Art 6��2.67, 4.49, 4.51, 4.52, 5.51, 7.15 Art 6(1) ��2.67, 3.09, 4.02 Art 6(2) ��4.50, 4.88,7.16 Art 6(4) ��2.07, 3.08, 3.09, 3.12, 4.49, 4.67, 4.77, 6.45, 7.12, 7.15, 9.05, 9.10 Art 6(4), 2nd para��4.84 Art 6(5)(a) ��4.24 Art 6(5)(b)��2.07, 2.68, 3.12, 4.49, 4.53, 4.76, 4.80, 7.16, 9.05, 9.10 Art 6(5)(c) ��4.50, 4.51, 4.52 Art 6(5)(d)��4.66 Art 6(5)(e) ��4.51, 4.66 Art 6(6) ��3.09, 3.12, 4.49, 4.51, 4.99 Art 6(6), subpara 2��3.08 Art 6(7) ��4.89 Art 6(7)(a)–(c)��2.68 Art 6(7)(b)��2.74 Art 6(8) ��3.14 Art 7��3.08, 4.49, 4.99, 9.05 Art 7(1) ��2.09 Art 7(2) ��4.41, 4.87 Art 7(2)(a)–(c)��2.09 Art 7(7) ��4.41 Art 9(1) ��2.74, 2.91, 4.101, 5.34, 5.51, 5.52 Art 9(1), 2nd sentence��3.02, 5.51 Art 9(1), 2ndsubpara��3.11, 5.51 Art 9(1), 3rdsubpara ��2.91, 3.02, 3.12 Art 9(2) ��2.100, 2.101, 3.13 Art 9(3) ��3.08 Art 10��3.11, 4.101 Art 10(2) ��4.99 Art 11��3.11 Art 12��3.11 Art 13��3.11, 4.138 Art 14��3.11, 4.102, 6.45, 7.15 Art 14(5) ��3.24, 3.61 Art 15��3.11, 3.25, 4.103,

xi

Table of Legislation 6.45, 7.15, 10.22 Art 16��3.11, 3.43, 9.75 Art 16(1) ��4.100 Art 16(2) ��4.100 Art 16(2)(a) ��5.47, 5.48 Art 16(2)(c) ��5.48 Art 16(2)(m) ��7.92 Art 17(2) ��4.67 Art 17(3) ��4.69 Art 18��3.11, 3.17 Art 18(1) ��3.02 Art 18(5) ��3.02 Art 19��4.34 Art 19(1) ��4.115, 4.117 Art 19(2) ��4.117 Art 20(3) ��4.125 Art 20(8) ��4.126 Art 21��4.131 Art 21(4) ��4.132 Art 22��2.101, 3.16, 4.96, 7.19 Art 22(1) ��3.16, 3.72, 4.96 Art 22(1), subpara 1, 1st sentence��3.16 Art 22(1), subpara 1, 2nd sentence ��3.16 Art 22(1), subpara 2��3.16 Art 22(2), subpara 1��3.17 Art 22(2), subpara 2��3.18 Art 24��3.20, 4.119, 4.136 Art 24(1) ��3.21 Art 24(1), 2nd sentence��3.22 Art 24(5) ��3.26, 4.136 Art 24(6) ��3.22 Art 24(7) ��3.23 Art 24(8) ��3.23 Art 24(9) ��3.23 Art 24(11) ��3.24 Art 25��2.17, 4.34 Art 25(5) ��4.140, 4.141 Art 26��2.16, 4.105, 4.115 Art 26(5) ��4.24 Art 26(8) ��2.68, 4.107, 4.127 Art 27��4.34, 4.122 Art 27(1) ��4.117 Art 27(1), subpara 1��3.74 Art 27(1), subpara 2��3.74 Art 27(8) ��4.34 Art 31(3) ��4.122 Art 33(2) ��2.72, 4.24, 4.52 Art 34��4.107 468/2014/EU Regulation of the European Central Bank of 16 April 2014 establishing the framework for cooperation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and

xxix

with national designated authorities [2014] OJ L 141/1 (ECB/2014/17) (SSM Framework Regulation) ��2.81, 2.100, 2.102, 2.103, 3.03, 3.14, 3.15, 4.24, 4.26, 4.44, 4.52, 4.54, 4.65, 4.72, 4.79, 4.89, 4.98, 4.99 Recital 4��4.105, 4.113 Title 2 ��2.102 Pt III ��4.96 Art 2(20) ��4.58, 4.61, 4.64 Art 2(21) ��4.65 Art 2(21)(b)��4.64 Art 5��4.52 Art 7��4.52 Art 8(1) ��2.81 Art 8(2) ��2.81 Art 9(2) ��2.74 Art 10��2.75 Art 10(c)��2.75 Art 11��4.68 Art 11(2) ��4.68 Art 13��4.70 Art 14��2.82, 4.66, 4.70 Art 14(2) ��2.82 Art 15��2.82 Art 16(1) ��2.83 Art 17(1) ��2.84, 4.68, 4.69 Art 19��4.96 Art 21��4.99 Art 22(1) ��3.12 Art 27–33��7.19 Art 33��4.107 Art 39(5) ��4.53 Art 40ff ��4.85 Art 47��4.85 Art 50��4.79 Art 52��4.79 Art 53��4.79 Art 57��4.79 Art 62��4.80 Art 70��2.72, 4.75, 4.79, 4.81 Art 70(1) ��3.66 Art 73��4.102 Art 78��7.17 Art 78(5) ��4.102 Art 85–87��3.25 Art 86��17 Art 90��4.50 Art 91��4.91 Art 93��7.17 Art 93(1) ��7.18 Art 93(2) ��7.18 Art 94��7.17 Art 94(1) ��7.20 Art 94(2) ��7.20

x

Table of Legislation Art 95��2.90 Art 96��4.98 Art 97–100��4.52 Art 97��4.51 Art 99(4) ��4.54 Art 101��2.100, 2.101 Art 101(1) ��2.101 Art 101(2) ��2.101 Art 102��2.101 Art 103��2.102 Art 104(1) ��2.103 Art 104(3) ��2.103 Art 105(1) ��2.104 Art 105(2) ��2.104 Art 106–199��4.44 Art 115 e.s��4.41 Art 126(1) ��3.17 Art 126(2) ��3.17 596/2014/EU Regulation of the European Parliament and of the Council of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC OJ L 173/1 (Market Abuse Regulation) (MAR)��10.89, 10.92 Art 12(1)(c) ��10.92 Art 17��10.89 Art 17(4) ��10.89, 10.90, 10.91 Art 17(5) ��10.90, 10.91 Art 17(6) ��10.90 600/2014/EU Regulation of 15 May 2014 on markets in financial instruments and amending Regulation 648/2012/EU [2014] OJ L173/84 (Markets in Financial Instruments Regulation (MiFIR))�� 2.41, 4.19, 17.95 604/2014/EU Commission Delegated Regulation of 4 March 2014 supplementing Directive 2013/36/EU of the European Parliament and of the Council with regard to regulatory technical standards with respect to qualitative and appropriate quantitative criteria to identify categories of staff whose professional activities have a material impact on an institution’s risk profile [2014] OJ L 167/30��6.24 673/2014/EU Regulation of the European Central Bank of 2 June 2014 concerning the establishment of a Mediation Panel and its Rules

of Procedure (ECB/2014/26) Art 8��4.141 806/2014/EU Regulation of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation 1093/2010/EU [2014] OJ L225/1 (SRM Regulation) ��1.43, 2.02, 2.53, 2.54, 2.56, 2.64, 2.65, 2.66, 3.04, 3.09, 3.12, 3.38, 3.39, 3.40, 3.46, 3.57, 3.58, 3.69, 3.72, 3.73, 3.74, 3.85, 3.91, 3.92, 4.79, 8.30, 9.01, 9.07, 9.11, 9.12, 9.13, 9.14, 9.16, 9.18, 9.20, 9.27, 9.30, 9.33, 9.39, 9.40, 9.43, 9.44, 9.58, 9.67, 9.68, 9.75, 9.77, 9.78, 9.93, 9.107, 9.118, 9.128, 9.132, 10.01, 10.02, 10.08, 10.11, 10.12, 10.14, 10.15, 10.17, 10.25, 10.26, 10.34, 10.45, 10.48, 10.67, 10.75, 10.79, 10.97, 10.98, 11.13, 12.01, 12.02, 12.10, 12.12, 12.15, 12.20, 12.26, 12.30, 12.62, 12.81, 12.82, 14.01, 14.22, 14.33, 17.75, 17.76, 17.79, 17.87, 17.88 Preamble, Art 90(2)��3.39 Pt II, Title I ��9.41 Pt II, Chap 5 ��9.16 Chap 1��2.54 Chap 2��2.56 Recital 6��3.37 Recital 10��3.37 Recital 11��3.38 Recital 12��2.52, 3.38 Recital 15��9.08 Recital 19��3.37, 3.28 Recital 21–22��3.39 Recital 22��9.08 Recital 24��9.112, 9.131, 10.04 Recital 26��9.111 Recital 26, 1st para��9.112 Recital 26, 2nd para��9.109 Recital 28��3.40, 3.52 Recital 33��9.98, 9.100 Recital 34��9.24 Recital 35��9.23 Recital 55��2.54 Recital 58��12.10 Recital 59��12.10 Recital 60��10.15 Recital 73��12.04, 14.10 Recital 75��10.15

xxx

xxi

Table of Legislation Recital 80��3.42 Recital 87��3.52, 3.54 Recital 95��3.52 Recital 104��9.43 Recital 105��9.43 Recital 114��2.56 Art 1(1)(b)–(d)��3.39 Art 2 �� 2.52, 3.39, 3.74, 9.07, 9.08, 13.08 Art 3(1)(21)��9.104 Art 3(1)(21a) ��9.104 Art 3(1)(24a) ��9.104 Art 3(1)(24b)��9.104 Art 3(1)(28)��9.104 Art 3(2) ��9.85, 9.86, 9.87 Art 4��3.39 Art 4(1) ��9.07 Art 4(1)(h)��2.54 Art 5��2.138 Art 5(1) ��3.51, 3.63, 3.85 Art 5(2) ��9.12 Art 6(1)–(7)��2.52 Art 6(4) ��2.59 Art 6(5) ��9.12 Art 6(6) ��9.67 Art 6(7) ��10.37 Art 6(10), 2nd para��10.45 Art 7��2.138, 10.34 Art 7(1) ��3.39, 9.10 Art 7(2) ��9.10 Art 7(2)(a) ��3.53 Art 7(2)(a)(i) ��3.08 Art 7(3) ��3.08, 9.12, 9.14, 9.16 Art 7(3), 2nd para��9.10, 9.97 Art 7(3), 4th para ��9.12, 9.81, 9.82, 9.83, 9.97, 9.103, 9.105, 9.108, 9.119 Art 7(3), 4th para, in fine��9.12 Art 7(3), 5th para ��9.12 Art 7(3), 6th para ��9.12 Art 7(3)(a) ��9.11 Art 7(3)(b)��9.11 Art 7(3)(c) ��9.11 Art 7(3)(d)��9.11 Art 7(3)(e) ��9.11 Art 7(3)(f ) ��9.11 Art 7(4) ��9.14 Art 7(4)(a) ��9.13 Art 7(4)(b)��9.13 Art 7(5) ��9.14 Art 8��9.11, 10.29 Art 8–12��9.75 Art 8(1) ��2.54, 3.41, 3.51 Art 8(2) ��13.41 Art 8(3) ��10.32 Art 8(5) ��3.41 Art 8(6) ��3.41, 9.12, 10.97

xxxi

Art 8(8) ��9.12 Art 8(9) ��10.33 Art 8(12) ��9.12 Art 8(13) ��9.12 Art 9��9.11, 9.12, 9.14, 10.29 Art 10��9.12 Art 10(1)–(10)��9.12 Art 10(10) ��10.37 Art 10(11) ��2.65, 2.65 Art 10(11)(a)–(j) ��2.65 Art 11–14��9.12 Art 11��9.11 Art 12��9.11, 9.75 Art 12(2) ��9.14 Art 12a–12k��9.75 Art 13��9.75 Art 13(1) ��3.43, 9.75 Art 13(1)(f ) ��10.74 Art 13(2), subpara 2��3.43 Art 13(3) ��9.11 Art 13(3), subpara 1��3.47, 3.51 Art 13(3), subpara 2��3.51 Art 14��2.61, 12.11, 9.41, 9.79, 9.106 Art 14–28��9.75 Art 14(1) ��3.44 Art 14(2) ��3.44, 9.76, 12.02, 12.12, 12.48, 12.72 Art 14(2)(a)–(c)��2.60 Art 14(2)(b)��2.60 Art 15��9.41, 12.03 Art 15(1)–(3)��9.12 Art 15(1)(a) ��9.77 Art 15(1)(b)��9.77 Art 15(1)(c) ��9.78, 10.15 Art 15(1)(d)��9.78 Art 15(1)(e) ��9.78 Art 15(1)(f ) ��9.77 Art 15(1)(g)��9.77, 9.90 Art 15(1)(h)��9.77 Art 15(1)(i)��9.78 Art 15(2) ��9.79 Art 15(3) ��9.77 Art 15(4) ��9.80 Art 16��10.79, 9.12 Art 16(1) ��3.45, 9.97 Art 16(6) ��9.97 Art 16(7), 4th para ��9.116 Art 16a��10.79 Art 17��9.77 Art 17(18)(c) ��10.75 Art 18��9.119, 12.47, 12.48 Art 18(1) ��3.45, 9.97, 9.101 Art 18(1), 1st subpara��3.48, 9.12 Art 18(1), 2nd para��9.103 Art 18(1), 3rd para ��9.103, 9.105, 9.107

xxxi

Table of Legislation Art 18(1), 4th para ��9.105 Art 18(1)(a) ��9.102, 9.104 Art 18(1)(b)��3.48, 9.104 Art 18(1)(c) ��9.106, 10.02, 12.11, 12.48, 12.72 Art 18(2) ��9.12 Art 18(4) ��3.48, 9.102 Art 18(4)(a) ��9.102 Art 18(4)(b)��9.102 Art 18(4)(c) ��9.102, 12.71 Art 18(4)(d)��9.102 Art 18(4)(d)(iii)��12.38 Art 18(5) ��2.60, 9.106, 10.02, 12.11, 12.12, 12.48, 12.59, 12.72 Art 18(6) ��4.36, 9.12, 9.97 Art 18(6), subpara 2(b)��3.49 Art 18(6), subpara 7��3.49 Art 18(6)(a) ��3.48, 3.61, 9.81 Art 18(6)(b)��3.48, 3.61, 9.81, 9.84 Art 18(6)(c) ��3.48, 9.81 Art 18(7) ��4.36, 9.27, 9.108 Art 18(7), 1st subpara��3.49 Art 18(7), 2nd subpara ��3.49, 9.108 Art 18(7), 3rd para ��9.108, 9.109 Art 18(7), 4th para ��9.109, 9.113, 9.114 Art 18(7), 5th subpara��3.49, 9.116 Art 18(7), 6th para ��9.110 Art 18(7), 7th para ��9.114 Art 18(7), 8th subpara��3.49, 9.115 Art 18(8) ��9.113 Art 18(9) ��3.50, 3.62, 9.120 Art 18(9) subpara 1 ��3.62 Art 19��9.81, 12.03, 9.120 Art 19(1) ��3.49, 9.118 Art 19(3) ��9.118 Art 19(10) ��9.118 Art 20��9.12, 9.82, 12.73 Art 20(1) ��9.82, 10.09 Art 20(3) ��9.82 Art 20(5) ��9.92 Art 20(16) ��9.92, 10.09 Art 21��9.11, 9.75 Art 21(1) ��3.48, 3.53, 9.102 Art 21(1)–(7)��9.12 Art 21(8), 2nd para��9.12 Art 21(9) ��9.12 Art 21(10) ��9.12 Art 22��12.04 Art 22(1) ��9.12, 9.83 Art 22(2) ��3.48, 9.81, 9.84 Art 22(3) ��9.12, 9.92 Art 22(4) ��9.86 Art 22(5) ��9.85 Art 22(6) ��9.12

xxxii

Art 23��9.12, 9.81 Art 23, 1st para��3.63 Art 23, 4th para��9.119 Art 23, 5th para��9.81 Art 24��9.12, 9.85 Art 24–27��9.11 Art 24(2) ��3.63 Art 25(3) ��9.12 Art 26��9.86 Art 27��2.54, 9.85, 9.87, 12.60, 9.115 Art 27(1)–(15)��9.12 Art 27(1)(a) ��9.87, 10.14, 12.79 Art 27(1)(b)��9.87 Art 27(2) ��9.87 Art 27(3) ��9.88 Art 27(3)(f ) ��9.88 Art 27(3)(h)��9.88 Art 27(5) ��3.42, 3.48, 9.81, 9.92, 12.50 Art 27(5), 1st para��9.89 Art 27(5), 2nd para��9.90 Art 27(5)(c) ��12.60 Art 27(5)(a)–(d)��2.61 Art 27(6) ��9.95, 12.60 Art 27(6)(a) ��12.60 Art 27(6)(b)��12.60 Art 27(7) ��9.96 Art 27(7)(a) ��9.42 Art 27(7)(b)��9.42 Art 27(9) ��9.42, 9.96 Art 27(12) ��9.91 Art 27(14) ��3.48, 9.81, 9.89 Art 27(16), 2nd sentence of the 2nd subpara��9.12 Art 27(16), 2nd sentence of the 3rd subpara��9.12 Art 27(16), 1st sentence of the 4th subpara��9.12 Art 27(16), 3rd sentence of the 4th subpara��9.12 Art 27(16), 4th sentence of the 4th subpara��9.12 Art 28��3.50 Art 28(1) ��9.120 Art 28(1) in fine��9.120 Art 28(1)(a) ��9.120 Art 28(1)(b)(vi) ��3.50 Art 29��3.52, 3.57, 3.60, 3.62, 9.77, 9.120, 12.74 Art 29(1), subpara 1��3.51 Art 29(1), subpara 2 in fine��3.51 Art 29(2)–(4)��9.120 Art 29(2) ��3.53 Art 29(2)(a) ��3.53 Art 29(2)(b)��3.53 Art 29(2)(c) ��3.53, 3.65

xxxii

Table of Legislation Art 29(2), subpara 2��3.51, 3.53 Art 29(2), subpara 3��3.54 Art 29(2), subpara 4��3.54 Art 29(3) ��3.54, 3.65 Art 29(4) ��3.54 Art 31��9.11, 9.15 Art 31(1) ��9.14, 9.30 Art 31(1)(a) ��9.13, 9.16 Art 31(1)(b)��9.13, 9.16 Art 31(1)(c) ��9.16 Art 31(1)(d)��9.16 Art 31(1), 1st para��9.15 Art 31(1) in fine��9.16 Art 32��9.12 Art 34��3.52 Art 34–37��9.16 Art 35��3.52 Art 36��3.52 Art 36(1) ��10.09 Art 36(5) ��3.52 Art 37��3.52 Art 37(2) ��3.52 Art 38��3.52 Art 39��3.52 Art 39(1)(c) ��9.20 Art 39(1)(d)��9.20 Art 40��3.72 Art 40(1) ��3.55 Art 40(2) ��3.55, 9.85 Art 42(1) ��9.17 Art 42(1), 3rd sentence��3.60, 3.87 Art 42(2), 2nd sentence��9.17 Art 42(3) ��9.17 Art 43(1)(a) ��9.18 Art 43(1)(b)��9.18, 9.22, 9.31, 9.32, 9.98, 9.103, 9.105, 9.107 Art 43(1)(c) ��9.19 Art 43(2) ��9.19 Art 43(3) ��9.20, 9.23 Art 43(4) ��9.19 Art 45��9.30 Art 45(1) ��9.39 Art 45(2) ��9.39 Art 47(1) ��9.25 Art 47(2) ��9.18, 9.25 Art 47(3) ��9.18, 9.25 Art 48��9.17 Art 49��9.21 Art 50(1)(a) ��9.30 Art 50(1)(b)��9.30 Art 50(1)(c)�� 9.30, 9.36, 9.37, 9.99, 9.100 Art 50(1)(d)��9.30, 9.36 Art 50(1)(e) ��9.30, 9.36, 9.37, 9.56, 9.66, 9.72 Art 50(1)(f ) ��9.30

xxxiii

Art 50(1)(g)��9.30 Art 50(1)(h)��9.30 Art 50(1)(i)��9.30 Art 50(1)(j)��9.30 Art 50(1)(k)��9.30 Art 50(1)(l)��9.30 Art 50(1)(m) ��9.30 Art 50(1)(n)��9.30 Art 50(1)(o)��9.30 Art 50(1)(p)��9.30 Art 50(1)(q)��9.30 Art 50(2) ��9.30 Art 50(2), 2nd para��9.99 Art 50(3) ��9.30 Art 52(1) ��9.35, 9.56, 9.63, 9.99 Art 52(2) ��9.36, 9.99 Art 52(3) ��9.37, 9.56, 9.66, 9.72 Art 52(4) ��9.38 Art 53(1) ��14.63 Art 53(1), 1st para��9.18, 9.22, 9.31, 9.32, 9.98, 9.103, 9.105, 9.107 Art 53(1), 3rd para ��9.23, 9.24 Art 53(3) ��9.22, 9.31, 9.98, 9.103, 9.105, 9.107 Art 53(4)�� 9.32, 9.98, 9.103, 9.105, 9.107 Art 53(5) ��9.24 Art 54(1) ��9.48 Art 54(1)(a) ��9.27 Art 54(1)(b)��9.27, 9.44, 9.48 Art 54(2)(a) ��9.27 Art 54(2)(b)��9.27 Art 54(2)(c) ��9.27 Art 54(2)(d)��9.27, 9.98, 9.100 Art 54(2)(e) ��9.27, 9.33 Art 54(3) ��9.28 Art 54(4) ��9.29 Art 55(1)�� 9.31, 9.98, 9.103, 9.105, 9.107 Art 55(2)�� 9.32, 9.98, 9.103, 9.105, 9.107 Art 55(3)�� 9.34, 9.44, 9.48, 9.98, 9.103, 9.105, 9.107 Art 56(3) ��9.18 Art 56(3), 2nd sentence��9.18 Art 56(4) ��9.18 Art 60(1) ��9.27 Art 60(2) ��9.27 Art 61(2) ��9.30 Art 63(4) ��9.30 Art 63(8) ��9.30 Art 64��9.30 Art 67–79��2.56 Art 67(2), 1st sentence ��9.41 Art 67(2), 2nd sentence��9.41 Art 67(3) ��9.41 Art 67(4) ��10.75 Art 69��9.55

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Table of Legislation Art 69(1) ��9.43, 9.47, 9.52 Art 69(2) ��9.52 Art 69(3) ��9.44 Art 69(4) ��9.53 Art 69(5)(a) ��9.52 Art 69(5)(b)��9.45 Art 69(5)(c) ��9.54 Art 70��9.55 Art 70(1) ��9.47 Art 70(2), 1st para��9.48 Art 70(2), 2nd para��9.50 Art 70(2), 3rd para ��9.50 Art 70(2)(b)��2.56 Art 70(3) ��9.50 Art 70(6) ��9.51 Art 70(7) ��9.51 Art 71��3.48, 9.30, 9.37 Art 71(1) ��9.55 Art 71(2) ��9.57 Art 71(3) ��9.57 Art 72��9.30, 9.37 Art 72(1) ��9.71 Art 72(2) ��9.73, 9.74 Art 73��9.30, 9.37, 9.66, 9.68 Art 73(1) ��9.64 Art 73(2) ��9.64 Art 74��9.30, 9.37, 9.65, 9.66, 9.67 Art 74(1) ��10.09 Art 75��9.30 Art 76��9.41, 9.81 Art 76(1) ��9.92 Art 76(1)(e) ��10.75 Art 76(2)–(4)��9.92 Art 77��9.41 Art 77, 1st para��9.93 Art 77, 2nd para ��9.93 Art 78��9.30, 9.36, 9.37, 9.41, 9.94 Art 78(3) ��3.87 Art 79��9.11 Art 79ff ��10.87 Art 82(3) ��9.52, 9.54, 9.57 Art 82(5) ��9.52, 9.54, 9.57 Art 85(1) ��3.57 Art 85(3) ��3.57, 3.58, 3.61, 10.37 Art 85(3), subpara 1��3.57 Art 85(3), subpara 2��3.58 Art 85(4) ��3.58 Art 85(6) ��3.58 Art 85(7) ��3.58 Art 85(8) ��3.59 Art 85(9) ��3.59 Art 85(10) ��3.59 Art 86��10.37 Art 86(1) ��3.60 Art 86(2) ��3.60

Art 86(3) ��3.60 Art 86(4) ��3.60 Art 87��9.40 Art 87(1) ��9.40 Art 87(2) ��9.40 Art 87(4) ��3.91, 9.40 Art 87(5) ��3.92, 9.40 Art 87(6) ��9.40 Art 87��3.87 Art 88��3.47, 3.51 Art 88(1), subpara 1, 1st sentence��3.74 Art 88(1), subpara 1, 2nd sentence ��3.74 Art 88(1), subpara 2��3.74 Art 88(2) ��3.74 Art 93��9.45, 9.52, 9.54 Art 93(4) ��9.45 Art 93(6) ��9.45 Art 94(1)(a)(i) ��9.132 Art 94(1)(a)(v)��9.132 Art 94(1)(a)(vi)��9.43 Art 94(1)(a)(vii)��9.43 Art 97(4) ��3.91 Art 98(1) ��9.17 Art 99��9.07 Art 99(3) ��3.01 909/2014/EU Regulation of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories and amending Directives 98/26/EC and 2014/65/EU and Regulation 236/2012/EU [2014] OJ L 257/1 (Central Securities Depositories Regulation (CSD Regulation))��4.19 Art 54(3) ��4.62 1163/2014/EU Regulation of the European Central Bank of 22 October 2014 on supervisory fees (ECB/2014/41)��4.150 2015/35/EU Commission Delegated Regulation (Solvency II) Art 235��17.22 Art 236��17.22 Art 335(1)(e) ��17.22 2015/63/EU Commission Delegated Regulation of 21 October 2014 supplementing Directive 2014/59/ EU of the European Parliament and of the Council with regard to ex ante contributions to resolution financing arrangements [2015] OJ L 11/44��9.51 2015/81/EU Council Implementing Regulation of 19 December 2014 specifying uniform conditions of application of Regulation 806/2014/

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Table of Legislation EU of the European Parliament and of the Council with regard to ex ante contributions to the Single Resolution Fund [2015] OJ L 15/1 ��6.103, 9.51 2015/760/EU Regulation on European long-term investment funds ��2.41 2015/848/EU Regulation of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings [2015] OJ L141/19 Art 84��3.49 2015/2450/EU Implementing Regulation ��17.61 2016/98/EU Commission Delegated Regulation of 16 October 2015 supplementing Directive 2013/36/EU of the European Parliament and of the Council with regard to regulatory technical standards for specifying the general conditions for the functioning of colleges of supervisors��17.06 2016/99/EU Commission Implementing Regulation of 16 October 2015 laying downimplementing technical standards with regard to determining the operational functioning of the colleges of supervisors according to Directive 2013/36/EU of the European Parliament and of the Council ��17.06 2016/445/EU ECB Regulation of the European Central Bank of 14 March 2016 on the exercise of options and discretions available in Union law (ECB/016/4) (ECB Regulation)��4.17, 5.50 Preamble ��5.52 Recital 8��5.52 Recital 9��5.52 2016/778 Commission Delegated Regulation Art 6��12.56, 12.72 2016/1011/EU Regulation on indices used as benchmarks in financialinstruments and financial contracts or to measure the performance of investment funds��2.41 2016/1075/EU Commission Delegated Regulation of 23 March 2016 giving technical standards on the content of recovery and resolution plans ��10.16, 10.34, 10.76, 11.48 Art 23ff ��10.34 Art 44��10.71 2016/1450/EU European Commission Delegated Regulation��11.25

2017/1129/EU Regulation on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market ��2.41 2018/344/EU Commission Delegated Regulation ��11.52 2018/345/EU Commission Delegated Regulation ��11.52 2018/1624/EU Implementing Regulation dated 23 October 2018��10.07 2019/876/EU Regulation of the European Parliament and of the Council of 20 May 2019 amending Regulation 575/2013/EU as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation 648/2012/EU [2019] OJ L150/1 (CRR2) ��3.10, 7.01, 9.05, 11.19, 11.20, 11.21, 11.22, 11.41, 11.42, 11.43, 13.75, 15.75 Recital 16��11.17 Recital 56��11.23 Art 72a��11.21, 11.22 Art 72b��11.21 Art 72b(3) ��11.22 Art 72b(4) ��11.22 Art 72e��11.21 Art 92a��11.20, 11.22 Art 92b��11.24 Art 412(5) ��3.10 Art 413(4) ��3.10 Art 434a��11.22, 11.23 Art 437a��11.22 Art 447(h) ��11.22 Art 458��3.10 Art 493(3) ��3.10 Art 494b��11.21 2019/877/EU Regulation of the European Parliament and of the Council of 20 May 2019 amending Regulation 806/2014/EU as regards the loss- absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L 150/226 ��9.01, 9.11, 9.75, 9.82, 9.88, 9.90, 9.104, 17.18 Art 3(1)(24a) ��3.42 Art 10a��3.43

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Table of Legislation Art 12(1) ��3.42 Art 12a��3.42 Art 12a(1)��3.42 Art 12c(4)��3.42 Art 12d(1)(a)��3.42 Art 12d(1)(b)��3.42 Art 12d(1)(c)��3.42 Art 12d(1)(e) ��3.42 Art 18(1)(b)��3.48 Proposal from the European Commission for a Regulation of the European Parliament and of the Council on sovereign bond-backed securities (COM(2018) 339 final, 24 May 2018 ��14.32 Proposal for a Regulation of the European Parliament and of the Counsel on structural measures improving the resilience of EU credit institutions COM/2014/043 Final—2014/0020 (COD) (Structural Regulation Proposal; Commission Proposal and the ‘draft Regulation’) ��10.58, 10.59, 16.03, 16.42 Art 18��10.58 Proposal for a Regulation of the European Parliament and of the Council amending Regulation 1092/2010/EU on European Union macroprudential oversight of the financial system and establishing a European Systemic Risk Board’ COM(2017) 538 final ��2.105 Proposal for a Regulation of the European Parliament and of the Council amending Regulation 1093/2010/EU establishing a European Supervisory Authority (European Banking Authority), 27 November 2012 (CON/ 2012/96) (ECB Opinion SSM Regulation) ��2.41 Proposal for a Regulation of the European Parliament and of the Council amending Regulation 806/2014/EU in order to establish a European Deposit Insurance Scheme (COM(2015) 586 final, 24 November 2015) (Commission Proposal)��14.02, 14.22 Recital 11��14.65 Recital 22��14.38 Recital 39��14.64 Art 2(2) ��14.35 Art 41a(2)��14.49 Art 41a(3)��14.53 Art 41b(1) ��14.49

Art 41c(1)��14.53 Art 41c(2)��14.53 Art 41e��14.50, 14.54 Art 41f(1)��14.50 Art 41f(2)��14.50 Art 41g(1) ��14.54 Art 41g(2) ��14.54 Art 41h(1) ��14.50 Art 41h(3) ��14.54 Art 41i(l) ��14.67 Art 41j(l) ��14.39 Art 41o(2) ��14.59 Art 41o(3) ��14.59 Art 41q(1) ��14.59 Art 41q(2) ��14.59 Art 43a��14.62 Art 43c��14.64 Art 49��14.63 Art 49a��14.63 Art 49b(1) ��14.63 Art 50��14.63 Art 50a��14.63 Art 52��14.63 Art 52(2)–(4)��14.63 Art 54a��14.63 Art 54b��14.63 Art 74a(1), last para��14.42 Art 74a(3)��14.65 Art 74b(1) ��14.39 Art 74b(2) ��14.39 Art 74c(1)��14.42 Art 74c(2)��14.42 Art 74c(5)��14.42 Art 74d(1) ��14.45 Art 74d(2) ��14.45 Art 74e(3)��14.67 Art 74f(1)��14.45 Art 74g(1) ��14.45 Capital Requirements Regulation V (CRR V)��2.107, 2.108 CRD IV Package��6.01 CRD V Package (CRR/CRD V Regulation and Directive)��2.107 Proposal for a Regulation of the European Parliament and of the Council on the prudential requirements of investment firms and amending Regulation 575/2013/EU, 600/2014/EU and 1093/2010/EU, Brussels 20.12.2017, COM(2017) 790 final, 3–4 ��2.107 Proposal for a Regulation of the European Parliament and of the Council on the prudential requirements of investment firms and amending Regulations 575/2013/EU, 600/2014/EU and

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Table of Legislation 1093/2010/EU, 4 January 2019, 5021/19��4.60 Proposal for a Regulation on amending Regulation 575/2013/EU as regards minimum loss coverage for non- performing exposures: (39604), 7407/18 + ADDs 1–2, COM(18) 134 (CRR II)��8.46, 8.53, 11.17, 11.19 Recital 16��11.17 Art 2��11.17 Proposal for a Regulation on amending Regulation 575/2013/EU as regards as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending Regulation 648/2012/EU, Brussels, 23.11.2016 COM(2016) 850 final ��8.46, 11.13

TABLE OF NATIONAL LEGISLATION France Monetary and Financial Code (Code Monétaire et Financier)��3.66 Art L613–18 ��2.51 Art L613–22 ��2.51 Art L613–25 ��2.51 Germany Act on the Recovery and Resolution of Credit Institutions ��12.14 Bank Restructuring Act ��12.14 s 2 ��12.14 s 3 ��12.14 Banking Act s 46(1)��2.51 Civil Code (Bürgerliches Gesetzbuch) s 31 ��6.44 Code on Regulatory Offences (Ordnungswidrigkeitengesetz) s 30(1)��6.44 Commercial Code (Handelgesetzbuch (HGB))��6.36, 6.53, 6.59 Companies Act of 6 September (Aktiengesetz) 1965��13.49 CRD IV Transposition Act (CRD IV- Umsetzungsgesetz), BT-Drucksache 17/10974, 88��6.59, 6.62

Financial Market Stabilisation Amendment Act of April 2009��12.14 Financial Market Stabilisation Development Act (‘Bad Bank Act’) of July 2009��12.14 Limited Liability Companies Act (GmbH-Gesetz)��6.53, 6.58 Stock Corporation Act (AktiengesetzAktG) �� 6.52 s 93(1)��6.83 s 311 ��6.66 Greece Cabinet Act No 36 of 2 November 2015�� 12.23 Law 3864/2010 with the objective to safeguard the stability of the Greek banking system��12.21 Law 4051/2012 amending Law 3864/2010, Law 3601/2007, and Law 3746/2009, in conjunction with provisions of Law 4021/2011 on the enhanced measures for the supervision and resolution of credit institutions Art 9–11��12.21 Law 4335/2015��12.22 Art 2��12.22 Ireland Central Bank and Credit Institutions (Resolution) Act 2011 ��12.18 s 10ff ��12.18 s 17ff ��12.18 s 20ff ��12.18 Credit Institutions (Stabilization) Act 2010��12.18 Italy Banking Law 1936��12.33 Consolidated Banking Law (CBA)��12.33 Art 72(6) ��2.51 Art 80(1) ��12.34 Art 80(2) ��12.34 Art 80(5) ��12.34 Art 81��12.34 Art 84��12.34 Art 84(2) ��12.34 Art 84(3) ��12.34 Art 90(2) ��12.34, 12.35 Constitution Art 47��11.10 Law Decree No 183/2015 ��12.49 Law Decree No 237/2016 ��12.44 Art 7��12.38 Law Decree No 17/2017 ��12.49 Law Decree No 99/2017 ��12.49 Recital 15��12.54 Art 4(1)(a)(i) ��12.49

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Table of Legislation Art 4(1)(a)(ii)��12.49 Art 4(1)(b)–(d)��12.49 Art 5(2) ��12.49 Legislative Decree 385/1993 (Testo Unico Bancario, TUB)��12.33 Legislative Decrees 180–181/2015��12.33 Ministerial Decree of 27 September 1974 ��12.35 Netherlands Bankruptcy Act Art 128��10.75 Civil Code Art 3:305a ��3.61 Art 6:162(2), in fine��10.92 Financial Supervision Act��10.25 Art 3:159aff��10.25 Art 3:296(1)��13.41 Art 6:1ff��10.11, 10.25 Art 96��4.17 General Administrative Act (Algemene wet Bestuursrecht) ��3.21 Intervention Act 2011 ��10.18, 10.25 Norway Act on Guarantee Schemes for Banks and Public Administration etc, of Financial Institutions (Guarantee Schemes Act) of 6 December 1996 (as amended per 1 July 2004) ss 3–5��2.51 Portugal Decree-Law No 298/92, as emended by Decree-Law 31-A/2012 Art 145.º-E��12.28 Art 153-Bff��12.28 Decree-Law 31-A/2012 amending the Legal Framework of Credit Institutions and Financial Companies adopted with Decree-Law No 298/92 of 31 December 1992��12.28 Law 23-A/2015 of 26 March 2015 transposing the BRRD��12.29 Spain Law 11/2015��12.74 Royal Decree-Law 9/2009 ��12.64, 12.65 Royal Decree-Law 24/2012 ��12.64, 12.65 Art 25–27��12.65 Art 28–34��12.65 Switzerland Banking Act Art 23quater��2.51 Art 29, s 3 ��2.51

United Kingdom Statutes Banking Act 2009 (BA 2009)��12.13, 13.03, 13.10, 13.12, 13.13, 13.15, 13.16, 13.24, 13.32, 13.36, 13.37, 13.39, 13.43, 13.45, 13.46, 13.53, 13.56, 13.58, 13.80, 13.82 s 5 ��13.27 s 6A(2)(c)��13.42 ss 11–13��12.13 s 12AA��13.40 s 14 ��13.38 s 17 ��13.38 s 19 ��13.38 s 39 ��13.44 s 81A ��13.54 s 81B ��13.54 s 83A ��13.08 s 89A ��13.07 ss 89H–89J��13.80 s 137K��13.46 Special Resolution Regime��12.13 Special Resolution RegimeCode of Practice��13.12 Banking (Special Provisions) Act 2008��12.13 Companies Act 2006��13.05 s 172 ��6.72 European Union (Withdrawal) Act 2018 (Withdrawal Act)��13.78 Finance Act 2011��12.13 s 73 ��12.13 Sch 19 ��12.13, 13.65 Financial Service Act 2012��13.07 s 101(1)��13.07 Financial Services and Markets Act 2000 (FSMA)��13.14, 13.77 s 55L ��13.09 s 55M��13.09 Sch 6 ��13.10 Sch 6, Pt 1E, para 5D��13.10 Financial Services (Banking Reform) Act 2013��12.13, 13.24, 13.70 s 17 ��12.13 Sch II��12.13 Statutory Instruments Bank Recovery and Resolution and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018 (SI 2018/1394)��10.72, 13.79 Banking Act 2009 (Exclusion of Insurers) Order 2010 (SI No 2010/35)��13.05

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Table of Legislation EEA Passport Rights (Amendment, etc and Transitional Provisions) (EU Exit) Regulations 2018 (SI 2018/1149)��13.77 European Union (Bank Recovery and Resolution) Regulations 2015 (SI 2015/289) Art 1(3) ��12.18 Financial Services and Markets Act 2000 (PRA Regulated Activities) Order 2013 (SI 2013/556) para 3(4)��13.08 United States 12 USC § 23(7)��16.35 § 24 (Seventh) ��16.35, 16.36 § 361��6.35 § 78��16.35 § 377��16.35 § 378��16.35 § 843(k)(4)(H)��16.36 § 843(k)(4)(I)��16.36 § 1841��16.36 Banking Act 1933 §16��16.35 §20��16.35 §21��16.35

§32��16.35 Bank Holding Company Act 1956��16.36 Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 ��10.05, 10.51, 10.52,10.54, 16.02, 16.10, 16.25, 16.27, 16.28, 16.31, 16.34, 17.88 Title II��16.26 § 165(d)��16.10 § 210(a)(1)(E)(i)��16.28 § 210(c)(4)��16.27 § 210(c)(8)��16.27 § 210(c)(9)��16.27 § 210(c)(13)��16.27 § 210(n)(9)��16.27 § 210(o)��16.27 § 616��16.31 § 619��16.39 § 1101��16.31 Volcker rule ��10.51, 10.53, 10.54, 10.60, 16.03, 16.39, 16.42 Federal Reserve Act 1913 § 23A��16.36 § 23B��16.36 Glass-Steagall Act��16.35, 16.26, 16.39 Gramm-Leach-Bliley Act 1999��16.36 McFadden Act 1933��16.35

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LIST OF ABBREVIATIONS

ABI AFME AIFMD AktG AQR AT 1 BA 2009 BCBS BHC BRRD CA 2006 CCP CDGS CDS CEA CEBS CEO CESR CET 1 CJEU CMD IV CME CMU CoCos COSO CRA CRO CRR CRD I CRD IV CSD CSD Reg DGS DG COMP DGD DRI EBA EBU ECB ECGI

Association of British Insurers Association for Financial Markets in Europe Alternative Investment Funds Managers Directive Aktiengeesetz Asset Quality Review Additional Tier 1 Banking Act 2009 Basel Committee on Banking Supervision Bank Holding Company Bank Recovery and Resolution Directive Companies Act 2006 Central Clearing Counterparty Common Deposit Guarantee System Credit Default Swap Critical Economic Activity Committee of European Banking Supervisors Chief Executive Officer Committee of European Securities Regulators Common Equity Tier 1 Court of Justice of the European Union Capital Markets Directive IV Co-ordinated Market Economy Capital Markets Union Contingent Convertible Securities Committee of Sponsoring Organizations Credit Rating Agency Chief Risk Officer Capital Requirements Regulation Capital Requirements Directive I Capital Requirements Directive IV Central Securities Depository Central Securities Depositories Regulation Deposit Guarantee Scheme Directorate-General for Competition Directive on Deposit Guarantees Direct Recapitalization Instrument European Banking Authority European Banking Union European Central Bank European Corporate Governance Institute

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List of Abbreviations ECHR ECJ ECMI ECtHR EEA EFAMA EIOPA ELA EMIR ESA ESFS ESMA ESM ESRB EP EU FCA FCD FDIC FESCO FSA FSAP FSB FSMA 2000 FTT GFST GHOS GLAC G-SIB HNWI IBGYBG ICAAP ICLEG ICSD IFRS IGA IMF IPS JST KA LBIE LME MAD MAHC MAR MiFID MiFIR MoA

European Convention on Human Rights European Court of Justice European Capital Markets Institute European Court of Human Rights European Economic Area European Fund and Asset Management Association European Insurance and Occupational Pensions Authority Emergency Liquidity Arrangements European Market Infrastructure Regulation European Supervisory Authority European System of Financial Supervisors European Securities and Markets Authority European Stability Mechanism European Systemic Risk Board European Parliament European Union Financial Conduct Authority Financial Collateral Directive Federal Deposit Insurance Corporation Federation of European Securities Commissions Financial Services Authority Financial Sector Action Plan Financial Stability Board Financial Services and Markets Act 2000 Financial Transactions Tax Government Financial Stabilization Tool Group of Governors and Heads of Supervision Gone-concern Loss-Absorbing Capacity Globally Systemically Important Bank High-Net-Worth Individual ‘I’ll Be Gone You’ll Be Gone’ Internal Capital Adequacy Assessment Process Informal Company Law Experts Group International Central Securities Depository International Financial Reporting Standards Inter-Governmental Agreement International Monetary Fund Institutional Protection Scheme Joint Supervisory Team Key Attributes Lehman Brothers International (Europe) Liberal Market Economy Market Abuse Directive Mixed Activity Holding Company Market Abuse Regulation Markets in Financial Instruments Directive Markets in Financial Instruments Regulation Memorandum of Understanding

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List of Abbreviations MPE MREL NCA NCWO NRFB OLAF OMT PCAOB PONV PPT PRA PSP RAS RCAP RFB RTS RWA SIFI SMEs SOX 2002 SPE SRB SREP SRF SRM SRP SSM T 2 TBTF TEU TFEU TLAC US VaR VoC

Multiple Points of Entry Minimum Requirements and Eligible Liabilities National Competent Authority ‘No Creditor Worse Off’ Non-Ring-Fenced  Bank European Anti-Fraud Office Outright Monetary Transaction Public Company Auditing Oversight Board Point of Non-Viability Partial Property Transfer Prudential Regulation Authority Private Sector Purchaser Risk Assessment System Regulatory Consistency Assessment Programme Ring-Fenced  Bank Regulatory Technical Standards Risk-Weighted  Asset Systematically Important Financial Institution Small-and Medium-Sized Enterprises Sarbanes-Oxley Act 2002 Single Point of Entry Single Resolution Board Supervisory Review and Evaluation Process Single Resolution Fund Single Resolution Mechanism Supervisory Review Process Single Supervisory Mechanism Tier 2 ‘Too Big To Fail’ Treaty on European Union Treaty on the Functioning of the European Union Total Loss-Absorbing Capital United States Value at Risk Varieties of Capitalism

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AUTHOR BIOGRAPHIES

Editors Danny Busch is full Professor (Chair) of Financial Law and the founding Director of the Institute for Financial Law, at Radboud University Nijmegen. He is a Research Fellow of Harris Manchester College and a Fellow of the Commercial Law Centre, University of Oxford. He is also visiting professor at Université de Nice Côte d’Azur, Università Cattolica del Sacro Cuore di Milano and Università degli Studi di Genova, Member of the Dutch Banking Disciplinary Committee (Tuchtcommissie Banken), and Member of the Appeal Committee of the Dutch Complaint Institute Financial Services (Klachteninstituut Financiële Dienstverlening or KiFiD). He sits on the Editorial Board of the Capital Markets Law Journal and some other journals. He is author of many articles in the field of financial and commercial law, and author and editor of several books, including Systemic Risk in the Financial Sector (with D W Arner, E Avgouleas, and S L Schwarcz), CIGI 2019; Capital Markets Union in Europe (with E Avgouleas and G Ferrarini), OUP 2018; Regulation of the EU Financial Markets –MiFID II and MiFIR (with G Ferrarini), OUP 2017; A Bank’s Duty of Care (with C C van Dam), Hart/Bloomsbury 2017; Agency Law in Commercial Practice (with L J Macgregor and P Watts), OUP 2016; Alternative Investment Funds in Europe (with L D van Setten), OUP 2014; Liability of Asset Managers (with D A DeMott), OUP 2012; The Unauthorised Agent (with L J Macgregor), CUP 2009. After having graduated with highest honours in Dutch law from Utrecht University in 1997, he was awarded the degree of Magister Juris in European and Comparative Law by the University of Oxford (St John’s College) in 1998. From 1998 until 2001 he held the position of lecturer and researcher at the Molengraaff Institute of Private Law in Utrecht. In 2002 he defended his PhD in Utrecht (Indirect Representation in European Contract Law (Kluwer Law International, 2005)). From 2002 until 2010 he was an attorney-at-law (advocaat) with the leading Dutch international law firm De Brauw Blackstone Westbroek in Amsterdam where he practised banking and securities law (both the private law and regulatory aspects). He is extensively engaged in the provision of training to attorneys-at-law, financial regulators, and financial professionals in the Netherlands. Guido Ferrarini is Emeritus Professor of Business Law and Capital Markets Law at the University of Genoa, Department of Law; former Director of the Genoa Centre for Law and Finance; Visiting Professor at Radboud University Nijmegen. xlv

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Author Biographies He is also an advocate admitted to the Italian Court of Cassation; chair of the board of an investment firm and board member of a private bank. He holds a J. D. (University of Genoa, 1972), an LL.M. (Yale Law School, 1978), and a Dr. jur. (h.c., Ghent University, 2009). He is founder and fellow of the European Corporate Governance Institute (ECGI), Brussels; member of the Academic Board of EBI (European Banking Institute); and member of ECLE (European Company Law Experts). He was a member of the Board of Trustees, International Accounting Standards Committee (IASC) and an independent director at several Italian blue-chip companies. He was an advisor to the Draghi Commission on Financial Markets Law Reform, to Consob (the Italian Securities Commission) and to the Corporate Governance Committee of the Italian Stock Exchange. He has held Visiting Professor positions at several universities in Europe (Bonn, Frankfurt, Ghent, Hamburg, LSE, UCL, Tilburg, and Duisenberg) and the US (Columbia, NYU, and Stanford), teaching courses on comparative corporate governance and financial regulation. He is author of many articles in the fields of financial law, corporate law, and business law, and editor of several books.

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LIST OF CONTRIBUTORS

Kern Alexander is Professor of Banking Regulation and Chair for Commercial and Financial Law at the University of Zurich. Tomas M C Arons holds the Financial Law Chair at Utrecht University, the Netherlands. Emilios Avgouleas holds the International Banking Law and Finance Chair, and is a senior research fellow at the Blockchain Technology Laboratory at the University of Edinburgh. Gilian Bens is a former PhD researcher at KU Leuven University. Giacomo Calzolari is Professor of Economics at the European University Institute, and Research Fellow at the Centre for Economic Policy Research (CEPR). Veerle Colaert holds the Financial Law Chair at KU Leuven University since 2011, is co-director of the KU Leuven Jan Ronse Institute for Company and Financial Law and is Chair of the ESMA Stakeholder Group. Anna Gardella is a Senior Legal Expert at the European Banking Authority and a member of the Advisory Board of the European Banking Institute. Simon Gleeson is a partner at Clifford Chance, London. Jeffrey N Gordon is the Richard Paul Richman Professor of Law at Columbia Law School and Co-Director of the Richman Center for Business, Law, and Public Policy; of the Millstein Center for Global Markets and Corporate Ownership; and of the ECGI. José Manuel Mansilla-Fernández is Assistant Professor at Department of Business Management of the Public University of Navarra. Peter O Mülbert is Professor of Law at Faculty of Law and Economics and Director of the Center for German and International Law of Financial Services at University of Mainz. Alberto Musso Piantelli is a graduate of the Genoa Law School, and Ph.D. student at the Radboud University of Nijmegen. Giorgio Barba Navaretti is Professor of Economics at the University of Milan and Scientific Director of the Centro Studi Luca d’Agliano. xlvii

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List of Contributors Alberto Franco Pozzolo is Professor of Political Economy at the University of Molise. Fabio Recine is Director, Head of the External Relations Division, Supervisory Department, of Banca d’Italia. Wolf-Georg Ringe is Professor of Law and Economics at the University of Hamburg and a Visiting Professor at University of Oxford, Faculty of Law. Victor de Serière is Professor of Securities Law at University Nijmegen, the Netherlands, and solicitor with Allen & Overy in Amsterdam. He has been involved as a solicitor giving Dutch regulatory law advice on the bank interventions that took place in the Netherlands in 2008 and subsequent years. He has also advised on living wills of Dutch financial institutions. Michele Siri is Professor of Business Law and holds the Jean Monnet Chair of European Union Financial and Insurance Markets Regulation at the Department of Law of the University of Genoa, Italy. He is also a member of the Joint Board of Appeal of the European Supervisory Authorities and an Academic Fellow at the European Banking Institute in Frankfurt. Annick Teubner is Principal Supervisor in the Authorisation Division at European Central Bank, Chair of the Subgroup on Governance and Remuneration of the European Banking Authority and Chair of the Governance Working Group of the IAI. Arthur van den Hurk is a fellow of the Institute of Financial Law at Radboud University Nijmegen and a senior regulatory counsel at Aegon N.V. in the Hague, the Netherlands. Nicolas Véron is a Co-founder and Senior Fellow at Bruegel and a Senior Fellow at Peterson Institute for International Economics, Washington DC. Alexander Wilhelm is a Researcher at the Faculty of Law and Economics, University of Mainz and the author of several journal articles in the area of financial regulation and corporate governance. Eddy Wymeersch is Professor Emeritus at University of Gent. He has been Chairman of the Committee of European Securities Regulators and of the European Regional Committee of IOSCO. He was Chairman of the CBFA (Chief Executive 2001–07 and Chairman of the Supervisory Board 2007–10).

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Part 1 GENERAL ASPECTS

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1 THE ECONOMIC CONSEQUENCES OF EUROPE’S BANKING UNION Nicolas Véron

I. The Impact so Far: A Shift of Expectations

3. Bank Resolution Funding and Market Discipline in Bank Credit Markets 4. The Transformation of Europe’s Banking Landscape 5. Diversification of Europe’s Financial System Away from Banks 6. A New Institutional Order for the Elaboration of European and Global Financial Sector Policies

1.03

1. Banking Union and Positive Contagion 1.07 2. Banking Union and Moral Hazard in Banking 1.14

II. Six Developments to Watch

1. Supervisory Quality and the Repair of Banks’ Balance Sheets 2. Reversing Financial Fragmentation in the Euro Area

1.20 1.23

III. Conclusion

1.36 1.44 1.50 1.56 1.64

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Banking union, even in the incomplete form of the legislative package adopted 1.01 by the EU in 2013–2014, represents a structural inflection for EU financial services policy. The planned transition towards the new regime is protracted, with some provisions not fully effective until as late as 2024. Its economic impact will unfold over a long period of time. Even at the current early stage, however, uncertainties have been reduced to a sufficient extent that an analysis of its economic consequences can be started. This chapter proposes both a tentative assessment of banking union’s initial eco- 1.02 nomic impact and a discussion of possible further consequences over a medium- term horizon. It does not provide a quantitative assessment: its subject matter does not easily lend itself to economic modelling, let alone forecasting. But it does attempt to map areas in which banking union has led, or may lead, to observable economic consequences, depending on policy decisions still to be made by the numerous authorities involved. In this, it aims to complement the legal assessment of banking union provided in other chapters in this volume with a 3

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Nicolas Véron consideration of its actual consequences on the European financial system and the broader European economy.

I. The Impact so Far: A Shift of Expectations 1.03 The inception of banking union was the declaration of the euro area heads of state

and government at the end of their summit meeting in Brussels on 28–29 June 2012, which started with the declaration of intent: ‘[w]‌e affirm that it is imperative to break the vicious circle between banks and sovereigns’.1 This summit, and the developments that followed, resulted in a gradual shift of expectations from investors on both sides of that ‘vicious circle’.

1.04 From a sovereign standpoint, the summit in late June 2012 amounted to a com-

mitment of support by euro area Member States to each other. It also signaled support from them all for the European Central Bank (ECB). This was the basis which the ECB used to act. The resulting announcement of the ECB’s Outright Monetary Transactions (OMTs) programme in turn triggered the almost uninterrupted trend of decrease in the sovereign debt spreads of the more fragile periphery country over the stronger core ones, or ‘positive contagion’, during the following two-and-a-half  years.

1.05 From a banking standpoint, the shift of key components of the banking policy

framework from the national to the European level gave initial credibility to the claims by European policy-makers that bank creditors would share at least part of the losses in future cases of bank crisis resolution, contrary to what had been an almost universal practice of bank creditor bail-outs in the first half-decade of crisis from mid-2007 to mid-2012.

1.06 The combination of these two interrelated shifts has markedly improved the sta-

bility of financial conditions in the euro area, even though it is not sufficient to revive the region’s current anaemic growth. The rest of this section examines them in more detail. 1. Banking Union and Positive Contagion

1.07 The leaders’ declaration of 29 June 2012 represented a significant, and arguably

unprecedented, commitment by euro area Member States to support each other at a time when their willingness to do so had come under increasing doubt. Beyond the rhetorical aspiration to break the bank-sovereign vicious circle, it included two specific policy commitments. The first commitment was the creation of a

1 Euro Area Summit Statement, Brussels, 29 June 2012 (available at ).

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The Economic Consequences of Europe’s Banking Union Single Supervisory Mechanism (SSM), understood as the pooling by euro area Member States of their sovereign responsibility over banking supervision, which would be entrusted to the ECB in application of Article 127(6) of the Treaty on the Functioning of the European Union (TFEU). The second commitment was the pledge to introduce a mechanism allowing the direct recapitalization of a country’s banks by the European Stability Mechanism (ESM), the common euro area fund whose creation had been enshrined in a treaty signed by all euro area Member States a few months earlier, on 2 February 2012, and which was then in the course of being ratified. During the summit, leaders had agreed that such direct recapitalization of banks 1.08 by the ESM may be applied retroactively, at least in the cases of Spain and Ireland. This meant that the ESM would take over capital instruments in the banks from Member States some time after the initial recapitalization of these banks by their home country’s government. However, this agreement was not made explicit in the public statement, as negotiations on Spanish banks were still ongoing. The declaration also included language that could be interpreted as making it easier for the ESM to buy Italian and Spanish sovereign bonds, with the ECB acting as its agent.2 With the summit’s decisions, euro area leaders signalled that they were ready to go 1.09 much farther in tying together their financial systems and supporting each other through joint financial instruments than had been the case until then. This was particularly significant, as doubts about the future integrity of the euro area had been rising fast in the previous few weeks, exacerbated by the drama of Greece’s two successive general elections of 6 May and 17 June 2012 and by increasingly pressing problems in the Spanish banking sector. How far the commitment really went, however, was a matter of interpretation, given the vagueness and ambiguity of the content of the public declaration. In the days and weeks that followed the summit, the German government was seen as backtracking on the commitment about direct recapitalization by the ESM. Senior German government officials argued that the financial risks associated with the capital instruments thus transferred should remain the responsibility of the Member State in which the banks were headquartered, which defeated the whole risk-pooling purpose of the policy proposal. The initial market reaction immediately after the summit had been positive, but was rapidly reversed and gave way to new peaks of market volatility and uncertainty in July 2012. The pledge of mutual support in late June was thus not sufficient to alter market 1.10 perceptions directly. However, it had that effect indirectly by broadening the scope of possible initiative by the ECB. Significantly, the signal of political cohesion of

2 See, eg Stephen Fidler, Gabriele Steinhauser, and Marcus Walker, ‘Investor Cheer Europe Deal’, wsj.com, 29 June 2012.

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Nicolas Véron the summit was further reinforced by a vote of confidence by the political leaders in the ECB itself. The choice of Article 127(6) of the TFEU as the legal basis of the future SSM meant that the ECB would become the central authority of the euro area’s future banking supervision. This new context enabled the ECB to take action, first with the statement on 26 July by its president, Mario Draghi, in London3 that ‘[w]‌ithin [its] mandate, the ECB is ready to do whatever it takes to preserve the euro’ and the subsequent announcement by the ECB of a new OMTs programme, first in general terms on 2 August and then in more technical detail on 6 September. 1.11 From a market perspective, it was Mr Draghi’s London speech of 26 July 2012,

rather than the Brussels summit of 28–29 June, that reversed the earlier trend of rising volatility and marked the beginning of the long phase of ‘positive contagion’ that has continued almost uninterrupted in the following two-and-a-half years. Nevertheless, there are strong indications of a causal link between the summit and the OMT programme. When presenting the OMT programme at the European Parliament a few weeks later, Mr Draghi called it a ‘bridge’ to a destination towards which ‘the establishment of the SSM is a key step’.4 Almost exactly a year after the June 2012 summit, in a speech in Berlin, he singled out that moment’s unique importance in providing ‘a clear vision of what is necessary’.5 More explicitly, other leaders have asserted that the ECB’s action would not have been possible without the decision to initiate banking union. In a speech in Brussels, the President of the European Council who had chaired the June 2012 summit declared: the [European] Central Bank was only able to take this [OMT] decision because of the preliminary political decision, by the EU’s Heads of State and Government to build a banking union. This was the famous European Council of June 2012, so just weeks before [Mr] Draghi’s statement [in London]; he himself said to me, during that Council, that this was exactly the game-changer he needed.6

Similarly, Mario Monti was quoted in 2014 as arguing that ‘Mr Draghi had been able to say it [the London speech] because he had received the political support of the leaders’ during the summit, in which Mr Monti had participated as Prime Minister of Italy.7

3 Verbatim of the remarks made by Mario Draghi at the Global Investment Conference, London, 26 July 2012 (available online at ). 4 Mario Draghi, Hearing at the Committee on Economic and Monetary Affairs of the European Parliament, 9 October 2012 (available online at ). 5 Mario Draghi, ‘Stable Euro, Strong Europe’, speech at the Wirtschaftstag 2013, Berlin, 25 June 2013. 6 Herman Van Rompuy, speech at the Brussels Economic Forum 2014, 4th Annual Tommaso Padoa-Schioppa Lecture, 10 June 2014. 7 Interview with Mario Monti, de Volkskrant, 13 April 2014.

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The Economic Consequences of Europe’s Banking Union Somewhat ironically, the decrease in market pressure that followed the announce- 1.12 ment of OMT may have encouraged the governments of Germany and other Member States to keep backtracking on their initial commitment of 29 June about the ESM direct recapitalization programme. On 25 September 2012, the finance ministers of Finland, Germany, and the Netherlands issued a joint declaration according to which ‘the ESM can take direct responsibility of problems that occur under the new supervision [once the SSM is in place], but legacy assets should be under the responsibility of national authorities’. This cemented the position according to which direct bank recapitalization by the ESM would not be applied retroactively, contrary to the agreement made (but not publicized) on 28–29 June. A few weeks later, German Chancellor Angela Merkel confirmed that ‘there will be no retroactive direct recapitalization’,8 a reversal of position that was met with incredulity in the countries that felt they had been given assurances in June, particularly Ireland.9 This reversal, however, was not enough to alter the improvement of sovereign debt market conditions that had been started by the ECB’s announcements. To be sure, the definitive history of developments in the summer of 2012 re- 1.13 mains to be written. The sequence of events during those weeks was dense and convoluted. Even so, the available indications suggest that the decision to create a banking union on 29 June 2012, even though it was not an explicit promise of financial support to struggling Member States, was the central political turning point that enabled the subsequent ECB initiatives and decrease in periphery countries’ sovereign debt spreads. 2. Banking Union and Moral Hazard in Banking The other key consequence of the announcement of banking union in late June 1.14 2012 was to give initial credibility to the proposition that European policy would move away from the earlier preference for bailing-out the creditors of failing banks and would instead establish a regime in which moral hazard among banks and investors is mitigated by the prospect of financial participation of creditors in future bank restructurings, or ‘bail-in’. The link between banking union and the mitigation of moral hazard in banking 1.15 stems from the unique political economy of banking supervision in Europe under the previous regime, when banking supervision remained a national competency while other EU policies (single market, competition policy, and (in the euro area) economic and monetary union) introduced an increasingly binding framework

8 ‘Merkel: No Retroactive Direct Bank Recapitalization by ESM’, Market News International, 19 October 2012. 9 ‘Michael Noonan Admits Mixed Messages from Germany over Bank Recapitalisation’, RTE News, 19 October 2012.

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Nicolas Véron of cross-border financial integration. This combination created powerful tensions between each national banking supervisor’s prudential mandate, on the one hand, and the concern to protect and promote the domestic banking industry in the increasingly open cross-border competition, on the other hand. The latter objective tended to prevail, especially in countries where elites share a belief that the national interest is somehow aligned with the interest of iconic companies or ‘national champions’, a group that typically includes banks. 1.16 Such ‘banking nationalism’—by analogy with the broader phenomenon of eco-

nomic nationalism—predated the crisis. For example, the avowed objective of the governor of the Bank of Italy in 2005, Antonio Fazio, had been to use the central banks’ supervisory authority in order to preserve the ‘italianity’ of two banks that were the targets of takeover bids by companies headquartered in Spain and the Netherlands respectively and ensure that they would remain in domestic hands. (The ensuing developments were complex. Governor Fazio resigned after the wire-tapping of his phone conversations with Italian financiers revealed blatant favouritism. One of the two banks, Antonveneta, was purchased by ABN AMRO of the Netherlands, then taken over by Banco Santander as part of a separate acquisition of ABN AMRO, and subsequently sold to Banca Monte dei Paschi di Siena, contributing in no small part to that Italian bank’s current difficulties. The other, Banca Nazionale del Lavoro, escaped the initial bid from Spain’s BBVA, but was eventually purchased by France’s BNP Paribas.)

1.17 During the first five years of financial crisis in Europe from mid-2007 to mid-

2012, banking nationalism prevented national public authorities from adequately addressing the systemic problem of weak bank balance sheets and led them to an almost universal preference for regulatory forbearance in order not to put ‘their’ champions at a competitive disadvantage.10 When a bank became obviously too weak for authorities to pretend it was sound, banking nationalism led to an almost universal preference for bail-out of all creditors no matter how subordinated (and no matter how small the bank), sometimes even extending to shareholders, ostensibly to preserve financial stability but often also motivated by the desire to bolster financing conditions for the country’s other banks.11

1.18 Thus, the structure of banking supervision in Europe and its division across na-

tional borders encouraged moral hazard and excessive risk-taking by the banks, in spite of various forms of political backlash against government -funded bank bail-outs that gathered steam after the first few years of crisis. Conversely, the shift towards banking union in mid-2012 suddenly made the participation of bank See Nicolas Véron, ‘Banking Nationalism and the European Crisis’, speech at the European Private Equity and Venture Capital Association Symposium, Istanbul, June 2013 (available online at ). 11 Morris Goldstein and Nicolas Véron, ‘Too Big to Fail: The Transatlantic Debate’, Peterson Institute Working Paper No 11–2, January 2011. 10

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The Economic Consequences of Europe’s Banking Union creditors in future bank restructurings a more credible proposition. Indeed, the first instance in which the European Commission’s competition policy arm was able to impose shareholder wipe-out and junior creditor bail-in on a large scale was on Spanish banks in the assistance programme that was negotiated at the same time as the banking union decision. This is also when the European Commission published its first proposal of a Bank Recovery and Resolution Directive (BRRD) that would enshrine in EU law the hierarchy of creditors in future cases of bank restructuring and the bailing-in not only of junior creditors but also of senior ones as a precondition for the use of public funds beyond 2018 (that date was later changed to 2016). In the summer of 2013, the European Commission’s competition policy arm enacted new rules that made state aid to banks conditional on junior creditor bail-in and the BRRD was eventually finalized in May 2014 after a protracted negotiation. The management by public authorities of the collapse of Dutch bank SNS Reaal in early 2013, of Cypriot banks in March of that year, and of Portugal’s Banco Espirito Santo in the summer of 2014, confirmed that the imposition of losses on junior creditors has become the ‘new normal’ in European bank restructuring, in contrast to the pre-banking union era. The leading credit rating agencies have also factored in a decrease in future government support in their expectations about future banking crises, even though only to a partial extent that differs across EU Member States. In sum, there appears to be a strong case that the inception of banking union in 1.19 mid-2012 enabled both the de-escalation of sovereign debt spreads in the euro area and the shift of European preferences in bank crisis resolution from almost systematic bail-out towards an approach that emphasizes creditor loss-sharing and market discipline. These two developments have appeared robust, at least in the two-and-a-half years following the critical euro area summit of 28–29 June 2012. Whether they are durable over the long-term remains of course to be seen.

II. Six Developments to Watch There are many possible scenarios on the future implementation of existing 1.20 banking union legislation in the EU and the emergence of new EU banking legislation, in interaction with other financial and economic policy developments as well as political and institutional shifts. There is nothing deterministic in how the economic consequences may unfold. Looking ahead, key economic implications of the transition towards banking 1.21 union may be grouped alongside six broad directions, each of them significant. It can be expected that: (1) the ECB becomes a strong supervisor and gradually brings the euro area banking sector back to soundness; 9

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Nicolas Véron (2) the fragmentation of the euro area’s financial system is reversed; (3) future banking crises are addressed with limited recourse to public money and in a consistent manner across Member States; (4) the euro area banking system becomes more integrated, with pan-European banks coexisting with local credit institutions on a broadly level playing field across countries; (5) banks become a relatively smaller part of a more diverse euro area financial system, with more balance between bank and non-bank funding; and (6) the institutions of banking union become authoritative players in the European and global policy environment. 1.22 The early implementation of the banking union legislation of 2013–14, and leg-

islation enacted since, suggests that all these expectations will eventually be fulfilled, albeit at differentiated paces. But the early development path of banking union has been protracted and complex, and future evolutions will not be linear either. Transitional challenges will be significant and reversals cannot be ruled out. The rest of this section provides a summary overview of possible trends and challenges on each of these six dimensions. 1. Supervisory Quality and the Repair of Banks’ Balance Sheets

1.23 The first and most basic test of success of banking union is about the effectiveness

of the ECB as a bank supervisor and its ability to restore the euro area banking system back to soundness. The SSM was largely born from the failure of the previous national supervisory regimes to fulfil their prudential mandate. Its initial challenge has been to steer the repair of euro area banks’ balance sheet, so that trust could gradually return to the entire system.

1.24 The initial basis for this was the ‘comprehensive assessment’ of the euro area’s

130 largest banks that was carried out in late 2013 and most of 2014 and whose results were published on 26 October 2014. This massive undertaking was co-ordinated by the ECB with the help of external consultants (Oliver Wyman). It included an Asset Quality Review (AQR), for which the ECB was assisted by national supervisors and thousands of auditors (mostly from the big four audit networks of Deloitte, EY, KPMG, and PwC) hired for the occasion; and a stress test, co-ordinated by the European Banking Authority (EBA) and also including banks from EU Member States outside of the euro area. The AQR resulted in the identification of €136 billion in non-performing exposures that had not been adequately acknowledged so far. Combining the findings from the AQR with the stress testing, the ECB identified actual capital shortfalls (at the time of announcement of results) in 13 of the 130 banks examined.12 European Central Bank, ‘Aggregate Report on the Comprehensive Assessment’, October 2014. 12

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The Economic Consequences of Europe’s Banking Union The ECB subsequently built on the insight it had gained through the AQR pro- 1.25 cess to apply a gradually more consistent and demanding definition of capital to all banks under its direct supervisory authority. This could not be fully achieved in 2014, given the constraints of the comprehensive assessment in terms of time and resources, as well as the lack of prior supervisory experience at the ECB itself. The ECB has rolled out a single methodology and toolkit for its yearly Supervisory Review and Evaluation Process (SREP) which forms the backbone of its interaction with supervised banks. It has demonstrated an ability to ‘pull the trigger’ on banks it deems failing or likely to fail, in the cases of Banco Popular Español (June 2017), Banca Popolare di Vicenza (June 2017), Veneto Banca (June 2017), and Latvia’s ABLV (February 2018). Nevertheless, as of 2019, pockets of fragility linger in several countries, particularly Italy, Greece and Cyprus where levels of non-performing loans remain elevated. The ECB’s ability to achieve credibility and effectiveness as a bank supervisor 1.26 has been bolstered by the build-up of its own supervisory capacity in terms of governance, resources, operations, and practice. This process started in 2013–14 with the initial recruitment of nearly 1,000 supervisory staff in Frankfurt, most from national supervisory authorities but many also from the broader financial industry (and some, mostly on support functions, from the ECB itself ). On the basis of its own communication and of anecdotal observation, the ECB appears to have had access to a wide pool of talent and to have managed to attract experienced candidates with a high level of initial motivation. The governance framework of the SSM, in which representatives from national 1.27 supervisory authorities hold a majority of votes in the ECB’s Supervisory Board, is not necessarily conducive to consistently impartial decisions on matters of general policy and on individual banks. This is a different set of challenges from, say, monetary policy decisions within the ECB’s Governing Council. While deliberations of the Supervisory Board are not public, there is reason to expect tensions between the objective that individual Supervisory Board members act in the common European interest, as is their mandate under the SSM Regulation, and the potential for coalitions of special national interests that could be at odds with the SSM’s common objectives. Secondly, and related to the previous point, the ECB has to foster a common su- 1.28 pervisory culture across the participating national supervisors, a process that can only be gradual given the vast differences of practices and operating principles among them at the outset of the SSM. Personnel policies are important to achieve such cultural convergence. As noted earlier, most of the ECB’s initial supervisory staff comes from the national supervisory authorities and have helped to contribute to an effective communication between the ECB ‘hub’ and the national supervisory ‘spokes’ within the SSM. Conversely, over the medium-term, it is possible that the ECB would encourage its own supervisory staff to work outside 11

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Nicolas Véron of Frankfurt in the national supervisory authorities, on short-term secondment or for more extended time periods. The ECB has also gained from learning from the experience of other large supervisory systems, such as the US Federal Reserve system, as well as from other European networks of regulatory authorities, in particular the network of European competition authorities on which the SSM’s design was partly modelled. 1.29 Thirdly, the ECB has created information and data systems to support the vision

of a well-functioning SSM. The ongoing operation of the SSM involves the collection and analysis of data from the supervised banks and the broader economic and financial system on a regular basis, with a requirement of cross-border consistency among all participating Member States. This applies to a range of data categories. Looking ahead, banks’ financial information will need to be further standardized, an aim that is likely to require new EU legislation. Many banks, including all those that are publicly listed, publish consolidated financial statements using International Financial Reporting Standards (IFRS), but others, for example German local banks, only use national accounting standards. Auditing practices and standards also vary widely and are subject to national supervisory frameworks, with only limited European harmonization and co-ordination. At the outset of the SSM, definitions of capital (as well as risk-weighting practices) were still far from uniform across the euro area, and while their harmonization has been an early area of focus for the ECB, not all differences may have been eliminated yet. One may expect that the ECB will be increasingly compared to its US equivalents and thus be fostered to increase supervisory transparency, even though this does not appear to have been an ECB priority during the early years of the banking union.13

1.30 Fourthly, the ECB faces the challenge of achieving consistent supervisory

outcomes for, on the one hand, the banks which it supervises directly on the basis of their size or systemic significance (116 as of October 2019) and on the other hand, all the other ‘less significant’ banks which are supervised by national authorities on a day-to-day basis, but for the soundness of which the ECB retains ultimate responsibility according to the SSM Regulation (nearly 3,000 banks in 2019, most of which are in Austria, Italy, and Germany). A specific challenge is posed by those smaller banks that guarantee each other in regional or national systems, such as the German savings banks’ ‘institutional protection’ schemes. These banks are not independent from each other in terms of systemic risk analysis, even though their operational management is decentralized. The ECB has signalled attention to their specificity at an early stage of the SSM.14 However, enforcing their

13 Christopher Gandrud, Mark Hallerberg and Nicolas Véron, ‘The European Union Continues to Lag on Banking Supervisory Transparency, PIIE RealTime Economic Issues Watch, 10 May 2016. 14 Sabine Lautenschläger, ‘National Supervision in a European System: What is the New Balance?’, speech at the Fifth FMA Supervisory Conference, Vienna, 30 September 2014.

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The Economic Consequences of Europe’s Banking Union effective oversight from the European level may lead to contention, particularly in Germany where local savings banks (and to an extent also co-operative banks) retain unique features in terms of the regulatory and supervisory framework that applies to them. 2. Reversing Financial Fragmentation in the Euro Area The imperative to break the bank-sovereign vicious circle in the euro area was 1.31 the primary driver of the mid-2012 decision to initiate European banking union. Consistent supervision and repair of the banks’ balance sheets will help reassure financial market participants that banks are held to identical regulatory standards, irrespective of their location within the euro area. However, regulatory and supervisory differences have not been the only cause of ‘financial fragmentation’, or the divergence of financing conditions across euro area countries as has been observed since 2010–2011, especially as regards access of small-and medium-sized enterprises (SMEs) to bank credit. As of early 2019, the bank-sovereign vicious circle remains largely intact, and further legislative action will be needed to address other factors that have contributed to financial fragmentation. Firstly, banks should be allowed to manage their operations without regard to in- 1.32 ternal national borders within the euro area. During the crisis, national supervisory authorities imposed various constraints on the circulation of capital and liquidity inside cross-border banks. Motivations included, for financially weaker countries, the concern to retain scarce liquidity within national borders or, for financially stronger ones, the fear that banks might be exposed to the weaker countries’ risks. Legitimate though these actions may have been from a national standpoint, they contribute to European financial fragmentation and to the bank-sovereign vicious circle. Such ‘geographical ring-fencing’ cannot be eliminated by the ECB alone. In some countries, national legislation empowered national authorities (for example BaFin in Germany) to impose geographical ring-fencing or upper limits to intragroup exposures as an instrument to protect national deposit insurance systems. In such cases, the SSM Regulation does not directly deprive the national authority of its ability to create intra-euro-area barriers to the freedom of banks to manage their capital and liquidity across borders. As Supervisory Board Chair Danièle Nouy has put it, ‘the fences should be removed; they are out of place within a banking union’.15 But this will require new EU legislation, for which no political consensus has emerged yet. Secondly, initiatives are needed to force an erosion of the high home bias that 1.33 exists in many banks’ sovereign bond portfolios. It is not unusual for euro area

15 Danièle Nouy, ‘Risk Reduction and Risk Sharing—Two Sides of the Same Coin’, speech at the Berlin Financial Stability Conference, 31 October 2018

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Nicolas Véron banks, including many medium-sized ones in Southern European Member States, to hold sovereign bonds issued by their home country’s government in amounts that vastly exceed their regulatory capital. These banks’ sovereign bonds portfolios typically display a high home bias, with much lower exposures to other euro area countries than the one in which the bank is headquartered. Such home bias is not directly the result of regulation, since EU capital requirements do not grant any specific capital privilege for holding home country bonds. Its causes may include the anticipation of differentiated treatment in euro area breakup scenarios (however small the corresponding probability), as well as ‘moral suasion’ from national authorities to help the national government finance itself. Irrespective of its reasons, however, this home bias is a key component of the bank-sovereign vicious circle, since the banks’ balance sheet strength is directly reduced when the government’s creditworthiness deteriorates. 1.34 The Capital Requirements Regulation (CRR) of 2013 gives the ECB the option

to impose a maximum ratio on banks’ exposure to their home country government as a proportion of capital. While such pillar-2 measures are not publicized, there are indications that the ECB has used this option to reduce the home bias and force banks to diversify their sovereign debt portfolios, but only to a limited extent. But the political salience of sovereign exposures suggests that this issue can only be fully addressed through pillar-1 requirements enshrined in new EU legislation amending CRR. In any case, exposure limits to address concentration risk should be preferred to the imposition of positive risk weights on banks’ sovereign exposures in regulatory capital calculations, which could be more destabilizing in the absence of a sustainable European fiscal union.16

1.35 Thirdly, the diversity of bank insolvency arrangements across the banking union

area also contributes to the fragmentation of the banking market, and may be addressed with EU legislation over the medium to long term. Bank resolution regimes are defined by the BRRD as alternatives to insolvency, with the principle that no creditor should be worse off as a result of the resolution process than in a court-ordered insolvency. As a consequence, differences between different countries’ insolvency laws will result in differences in resolution outcomes, in spite of the labelling of the SRM as a ‘single’ European mechanism. How much of a market distortion these differences will create is difficult to predict, but their perceived impact can be expected to become more significant over time. A first wake-up call was the liquidation in June 2017 of Banca Popolare di Vicenza and Veneto Banca, through an idiosyncratic administrative process in Italian law that allowed the authorities to protect many creditors (including all senior ones) from having to incur losses. This greatly raised awareness in the EU policy community

16 See Nicolas Véron, ‘Sovereign Concentration Charges: A Regime Change for Banks’ Sovereign Exposures’, European Parliament, November 2017

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The Economic Consequences of Europe’s Banking Union about the need for bank insolvency law harmonization to ensure that the SRM would fully deserve its name. 3. Bank Resolution Funding and Market Discipline in Bank Credit Markets The expectation that banks will receive financial support from their home country 1.36 government in a crisis, and that this support will be dependent on the home country’s own sovereign creditworthiness, has arguably been the biggest of all drivers of the bank-sovereign vicious circle. As described earlier, the mid-2012 decision on European banking union has contributed to the erosion of this expectation, but is far from having eliminated it entirely. Indeed, for all the claims that taxpayers’ money will no longer be used to address financial crises, most market participants believe that some form of public support will be provided at least in severe crisis scenarios. As emphasized earlier, the transition to the SRM has lagged the SSM by more 1.37 than a year. The Single Resolution Board (SRB) was established as a new agency in Brussels on 1 January 2015. The Single Resolution Fund (SRF) was created on 1 January 2016, which is also the date when the SRB acquired the authority to handle resolution procedures at the European level and when both the SRB and national resolution authorities were empowered to impose the bail-in of bank creditors under the conditions defined by the BRRD. The SRF belongs to the SRB but retains ‘national compartments’ under the complex arrangements of an intergovernmental agreement signed on 14 May 2014, until these compartments are fully ‘mutualized’ in 2024. As a consequence, the framework for future crisis management and resolution in the euro area, and in particular for the possible use of public money, is affected by a number of important uncertainties. Firstly, the mechanism and instruments for the bail-in of bank creditors (and 1.38 possibly also of uninsured depositors) in a future resolution process are set by the BRRD in principle, but it remains to be seen how the directive’s arrangements will work in practice. The much longer experience with special bank resolution regimes in the US suggests a protracted process of adjustment before market participants gain a degree of predictability on how bail-in may work in isolated bank failures, let alone in future systemic bank crises. The pace of such adjustment will of course depend on the frequency and features of future cases of bank resolution in the EU, especially the first few ones which can be expected to establish significant precedents. At the time of writing, there has been only one case of SRB-led resolution, that of Spain’s Banco Popular in June 2017, which is not enough to answer all the corresponding questions. Secondly, as mentioned earlier, euro area leaders agreed on 28–29 June 2012 that 1.39 the ESM would be able to recapitalize banks directly in the future, even though they later backtracked from their initial decision to use this option retroactively in the cases of Ireland and Spain. While the ESM has no bank supervisory powers 15

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Nicolas Véron of its own, it has built up a permanent team of banking experts that may manage this recapitalization instrument in future crisis situations. The specific conditions set by euro area countries in 2014 for ESM direct recapitalization were so restrictive as to practically prevent its use, and the decision was made in 2018 to phase it out. Nevertheless, the need for an ESM direct recapitalization instrument might come back in some future crisis. 1.40 Thirdly, future decision-making by the SRB, on resolution processes and on the

use of the SRF, is also untested with the only exception of Banco Popular in June 2017. The SRB’s decision-making arrangements have been widely criticized for their complexity, which makes it more difficult to predict how they will play out in future situations. The SRF remains relatively small, at €33 billion in mid- 2019, with the expectation that it will eventually reach a total size of about €60 billion, an amount which itself is rather small compared to what could be future funding needs in many systemic crisis scenarios. Whether the SRF could be allowed to borrow from other sources, possibly including the ESM, is also still to be determined.17

1.41 Fourthly, the exact status of the public guarantee that applies to national deposit

insurance schemes is also untested, in future crisis scenarios that involve the loss of a euro area government’s creditworthiness. The Cyprus crisis episode of March 2013 has powerfully contributed to uncertainty. Representatives from all euro area countries, as well as from the ECB and the International Monetary Fund (IMF), initially decided to link their financial assistance to a breach of the national guarantee of bank deposits, including all those under the guarantee threshold of €100,000. But after this plan was rejected in the Cypriot parliament, they shifted to a different approach and made the guarantee of deposits up to €100,000 an integral part of the assistance package that was eventually approved (even though uninsured deposits in failing banks were subjected to a harsh bail-in and capital controls had to be introduced). In November 2015, the European Commission published a legislative proposal to address this challenge through the creation of a European Deposit Insurance Scheme (EDIS), but subsequent negotiations have stalled even though many EU policymakers, not least at the ECB, have called for EDIS to be implemented.

1.42 Fifthly, and probably most importantly, there remains a general uncertainty re-

garding the balance between national and European sources of funding in future cases of bank crisis resolution. On the one hand, the argument that bank failures should be seen as the ‘legacy’ of past national supervisory failures, and that any public money to address them should therefore come from the corresponding

17 Maria Demertzis, Inês Gonçalves Raposo, Pia Hüttl, and Guntram Wolff, ‘How to Provide Liquidity to Banks after Resolution in Europe’s Banking Union’, European Parliament, November 2018.

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The Economic Consequences of Europe’s Banking Union national budgets, has proven very powerful politically since 2012. The broader prevention against any mutualization of the financial burden from crisis management remains strong in most of the Northern half of the euro area. On the other hand, the establishment of banking union was entirely predicated on the ‘imperative to break the vicious circle between banks and sovereigns’ as formulated in the leaders’ statement of 29 June 2012. Furthermore, the legacy argument is set to gradually lose its potency over time. Increasingly, future problems in banks supervised by the ECB are likely to be seen as linked to supervisory failures of the ECB itself rather than of any national authority. In this context, a call for public support to come from a national government’s budget may be far from straightforward. In other words, the German view of bank crisis resolution in the transition towards banking union has focused on Altlasten (legacy assets) but future problem assets will be Neulasten (new burdens) that will have arisen under the ECB’s watch. How the tension between the two narratives, about Altlasten and Neulasten respectively, is resolved in the future will depend in no small part on the actual sequence of future bank problems in the euro area, where they will materialize first, and how large they will be. This is inherently unpredictable. In addition, the legal uncertainties associated with the new framework should not 1.43 be underestimated. The legal robustness of both the SRM Regulation and the intergovernmental agreement on the SRF remains to be tested: the former invokes the Internal Market framework (Article 114 of the TFEU), but its geographical scope is restricted to a subset of Member States; the latter is awkwardly set outside the Treaty framework even though it is about a policy instrument created under EU law. Decisions by the SRB are subject to both national and European judicial review. The state aid control framework is also likely to evolve over time. Finally, the institutional strength of the SRB is a crucial question mark. It is possible that it would evolve into a strong and autonomous institution, somewhat akin to the US Federal Deposit Insurance Corporation, with full effective authority over national resolution agencies. But this will depend on its leadership and political support from Member States, and on future cases of weak banks on which its effectiveness will be practically tested. 4. The Transformation of Europe’s Banking Landscape Banking union will have significant consequences in terms of the structure of 1.44 the banking industry in the euro area. As suggested above, earlier banking nationalism had motivated many national authorities in the euro area to prevent inward acquisitions of domestic banks by foreign ones (even those from fellow euro area Member States). By contrast, the ECB has an incentive to favour cross- border bank acquisitions as a way to reduce the fragmentation of the euro area financial space, and has explicitly called for such cross-border consolidation. This may prove significant over the medium-term, but has not much materialized in the banking union’s early years. While some euro area Member States (such as the 17

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Nicolas Véron Baltic countries, Belgium, Finland, and Slovakia) have high rates of penetration of foreign groups into their domestic banking sector, most others (including all five largest ones: France, Germany, Italy, the Netherlands, and Spain) still have more than 80% of national banking assets in the hands of domestically headquartered groups. 1.45 While the ECB (and the SRB) can be expected to be more sanguine about intra-

euro area cross-border bank combinations than national prudential authorities have been until now, it also remains to be seen whether the potential scope of acquirers will be enlarged beyond euro area banks. There is a strong case that private equity investors and non-EU banks could contribute positively to the repair of the euro area banking sector in the years ahead, as has been the case in various contexts following past systemic banking crises in Mexico, Japan, South Korea, and Indonesia, to name only a few. Such actors have already played a role in a few cases in Europe, such as private equity investments in BAWAG (Austria) in 2006, IKB (Germany) in 2008, and Bank of Ireland in 2011, as well as the purchase of NCG Banco in Spain (formerly NovaCaixaGalicia, now renamed Abanca) by Banesco, a Venezuelan banking group, in 2014, as exits from these banks’ nationalization by their respective governments. The ECB has allowed several further partial or full acquisitions by private equity groups, in Greek banks (late 2015), Portugal’s Novo Banco (2017) or Germany’s HSH Nordbank (2018).

1.46 One possible objection to cross-border acquisitions in the euro area is that they

might lead to large increases in the size of already significant banking groups and thus exacerbate the problem of ‘too big to fail’ (TBTF) financial institutions and the corresponding moral hazard. On the one hand, as compared with intra- country combinations, cross-border bank acquisitions tend to lead to more complex groups and complexity tends to exacerbate the TBTF problem. But on the other hand, genuine banking market integration could make it possible to consider the TBTF effect on a European rather than national level in the future, which might significantly mitigate it. The aggregate value of a large European bank’s assets represents a much smaller share of euro area GDP than its share of the bank’s home country national GDP. The ECB has indicated that it would take into consideration these advantages of market integration as regards the TBTF issue when considering future combinations of euro area banks, including among the larger ones.

1.47 Several structural consequences may emerge from the constitution of a broader set

of pan-European banking groups, which would have an impact on the political economy of the European banking sector. Genuine cross-border banks can be expected to call from more European banking policy integration, as this may help to reduce costs and maximize synergies among their operations in different euro area countries. This could help cement and reinforce the banking union policy framework with the support of an influential interest group. It will also call for checks 18

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The Economic Consequences of Europe’s Banking Union and vigilance to ensure that the ECB and other European-level authorities are not unduly captured by powerful pan-European banking interests. Cross-border banking integration may also lead to further differentiation across 1.48 euro area Member States, because the pan-European banks’ headquarters can be expected to cluster in a limited number of financial centres. As a consequence, an increasing number of Member States may be left without any significant ‘domestic’ banks of their own. This is already the case in several Central and Eastern European countries. At the national level, it could create political incentives to penalize the foreign-controlled banking sector as a whole, for example through significant increases in sector-specific taxation, as was done in Hungary in the early 2010s. At the European level, it will affect the dynamics of intergovernmental decision-making, including voting patterns in bodies such as the EBA, the ECB’s Supervisory Board, and the SRB’s plenary sessions, since a growing number of participants in such processes will no longer be motivated by the promotion or protection of national banking ‘champions’. At the other end of the spectrum, banking union could also result in a more 1.49 favourable environment for the creation of new (or ‘de novo’) banks that would not be linked to long-established financial groups. There have been remarkably few de novo banks in Europe in the past century: almost all significant European banks trace their roots back to the 19th century, if not earlier, as do most small banks as well. By contrast, there has been a near-constant flow of creation of de novo banks in the US: while the largest American banks all have old roots, many active local banks are of relatively recent origin. This feature of the current European banking landscape has many causes, one of which may be the protection of incumbent banks by national public authorities under the influence of banking nationalism. The combination of a more assertive EU competition policy framework, reduction of banking nationalism within the SSM, and post-crisis restructuring of overbanked countries and market segments18 could create an environment that may be more favourable to the emergence of European de novo banks in the future than has been the case in the past. 5. Diversification of Europe’s Financial System Away from Banks Banking union is likely to have further structural impact beyond the banking 1.50 sector itself, and to contribute to a reshaping of the broader European financial system, which until the crisis has been notable for its overwhelming dependency on banking intermediation. This transformation, however, is unlikely to be rapid and will only be observed over the longer term.

18 See European Systemic Risk Board, ‘Is Europe Overbanked?’, Report of the Advisory Scientific Committee No 4, June 2014.

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Nicolas Véron 1.51 An early indication of a shift away from the current dominance of banking in

European finance was the decision by Jean-Claude Juncker, at the time of his confirmation by the European Parliament as newly elected President of the European Commission in July 2014, to announce the creation of a Capital Markets Union (CMU), in other terms a renewed agenda of development of capital markets and other non-bank financial channels to help reinvigorate the European economy.19 This initiative, however, has not resulted in major legislation in the subsequent years of the Juncker Commission, partly as a result of the disruption brought by the 2016 British referendum on leaving the European Union (‘Brexit’).

1.52 There is a direct link between banking union and CMU. The same crisis experi-

ence that led to banking union underlies the policy momentum behind the CMU agenda, as the prior financial sector policy framework is largely considered to have failed to provide either stability or efficiency, at least in euro area countries. Furthermore, the perceived early successes of implementation of banking union may have contributed to the European Commission’s impulse to increase the ambition of its reform agenda on other parts of the financial system.

1.53 The primary motivation of CMU is the observation that Europe’s near-exclusive

reliance on banks for the financing of its economy has been shown by the crisis experience to be more of a vulnerability than a strength. In the US, the phase of significant bank restructuring and deleveraging in 2008–2009 did not generally result in credit scarcity, in large part because alternative channels of financing, largely based on capital markets activity, could still provide credit to economic actors even as banks were retrenching. By contrast, in the EU, bank deleverage has an essentially unavoidable contractionary impact on the economy, which is one of the reasons why it has proven so difficult to address the continent’s systemic banking fragility through adequate restructuring since the inception of financial crisis in 2007.

1.54 The ECB itself has expressed support for the prospect of a more diverse European

financial system that would rely less exclusively on banks in the future. In comparison to national prudential authorities, the ECB may be more supportive of the CMU agenda, and of more European capital markets development, for a number of reasons. Some national authorities may have been driven by banking nationalism to repress non-bank finance, as alternative credit channels may create additional competition that could have eroded the market position of their national banking champions. Moreover, the underdevelopment of capital markets in the euro area has created challenges to the ECB’s monetary policy, as the transmission of monetary policy signals to the broader economy has been impaired by the fragility of the banking system in a number of Member States since 2010–2011.

19 Jean-Claude Juncker, ‘A New Start for Europe: Political Guidelines for the Next European Commission’, Opening Statement in the European Parliament Plenary Session, 15 July 2014.

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The Economic Consequences of Europe’s Banking Union It has been very hard for the ECB to emulate the US Federal Reserve’s success with programmes of large-scale purchases of securities other than government bonds. In principle, the CMU agenda could include a number of significant items, 1.55 namely: reforms of EU securities regulation to unlock the potential of some underdeveloped market segments; changes to prudential rules, particularly those that apply to insurance companies and pension funds, to better take into account the long-term horizon of their investments and consequences in terms of risk management; integration of policy frameworks on accounting, auditing, credit information, and other forms of financial information, whose inconsistency across Member States until now has limited the potential for investment in the corporate sector on a pan-European basis; an overhaul of national insolvency frameworks to make them friendlier to creditor interests and the preservation of employment, and to reduce differences among them in order to facilitate the emergence of pan-European credit market segments; a partial harmonization of certain aspects of the taxation of savings and investments, perhaps limited to a subgroup of Member States; and a supervisory and resolution framework for financial infrastructure firms (such as central counterparties) that would be better aligned with the objective of an integrated marketplace across national borders.20 The lack of a similar pressure of emergency as existed in June 2012 when banking union was initiated, however, suggests that many of these dimensions of CMU will only unfold gradually in the future, if at all. 6. A New Institutional Order for the Elaboration of European and Global Financial Sector Policies Lastly, the advent of banking union is bound to modify the balance of institutions 1.56 at the national, European, and global levels and thus to affect the elaboration of banking policies. The central development is the emergence of the ECB as a uniquely influential institution at the EU level, given the relative deficit of executive capacity of other European institutions including the European Commission. The strengthening of the ECB’s comparative position in the balance of European institutions predated banking union, but has been significantly reinforced by it. At the national level, the activity of bank supervisory authorities is increasingly 1.57 determined by their participation in the SSM, which now binds them on most of their policy scope. This evolution has taken different forms in different countries, depending on idiosyncratic features that include whether the supervisory function is under the aegis of the national central bank (as in Belgium, Cyprus, France, Greece, Ireland, Italy, Lithuania, the Netherlands, Portugal, Slovakia, Slovenia, and Spain) or at least partly lodged in a separate institution (as in Austria, Estonia,

20 See Nicolas Véron, ‘Defining Europe’s Capital Markets Union’, Bruegel Policy Contribution, Issue 2014/12, November 2014.

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Nicolas Véron Finland, Germany, Latvia, Luxembourg, and Malta). On the one hand, being part of the SSM has helped national supervisors to gain more independence from their national political environments and related pressures, including in terms of banking nationalism; on the other hand, the loss of autonomy in formal decision- making has often been resented as a form of institutional downgrading. The balance of these effects depends strongly on country-specific institutional legacies. 1.58 The ECB appears to have been rather adept at managing such tensions during the

early years of banking union, but at the price of delaying some of the more controversial issues in its relationship with national supervisory authorities. Time is on the side of the ECB, however, as the SSM Regulation provides a firm basis for its centralization of policy authority on most aspects of banking supervision. Furthermore, a common culture is gradually emerging within the SSM, through the harmonization of supervisory definitions and processes, the operation of joint supervisory teams, joint on-site inspections, the fact that most ECB supervisory staff come from national authorities, and occasional secondments of ECB staff to those authorities.

1.59 At the European level, the new reality created by the crisis is one of multiple new

agencies that play a role in banking policy and more generally in the oversight of the financial system, with a corresponding proliferation of inelegant acronyms. These include the ECB as a bank supervisor (operational since late 2014), the EBA and its siblings the European Insurance and Occupational Pensions Authority (EIOPA) and European Securities and Markets Authority (ESMA) (all three created in 2011), the European Systemic Risk Board (ESRB) (also started in 2011 and hosted by the ECB) and the SRB (started in 2015 and fully operational since 2016). To these may be added the above-mentioned possible role of the ESM in bank recapitalization or in backstopping the SRF, which is supported by a permanent banking team at the ESM.

1.60 This sudden surge of institutional complexity stemmed partly from the ad hoc

nature of the EU’s policy response to the crisis and partly from the fact that not all EU Member States participate in monetary or banking union which creates some need for institutional duplication.21 It inevitably results in tensions among these agencies and rivalry for turf and resources, which will take time and leadership to fully settle.

1.61 Before the crisis, the European Commission was the undisputed hub of finan-

cial services policy at the EU level, but the new situation is markedly different. Indeed, maintaining working relationships with all the new agencies is one of the key challenges faced by the Commission in the new environment.22 This

21 Jenny Anderson, ‘A Fragmented, Confused Scramble to Fix Europe’s Banking Structure’, New York Times DealBook, 2 December 2014. 22 Silvia Merler and Nicolas Véron, ‘Memo to the Commissioner for Financial Services’, EU To Do in 2014–2019: Memos to the New EU Leadership, Bruegel, September 2014.

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The Economic Consequences of Europe’s Banking Union particularly applies to the Commissioner for Financial Stability, Financial Services, and Capital Markets Union, and the Commission’s Directorate-General (known as DG FISMA) that reports to him, but also to other parts of the Commission. Specifically, the Commission’s competition policy arm (Directorate-General for Competition (DG COMP)) has acquired a prominent role in financial sector policy through its scrutiny of state aid to banks, which generate potential overlap with the new functions of the ECB and SRB. Furthermore, the current institutional order at the EU level should not be seen 1.62 as static. The Capital Markets Union agenda may result in new bodies being created at the EU level, to handle areas such as IFRS enforcement, oversight of audit firms, or supervision and resolution of systemically important financial infrastructure firms such as international central counterparties (even though some of these functions may also be located within existing agencies, such as ESMA). The balance between the supervisory and monetary policy functions of the ECB may also evolve over time. The current system, in which the ECB’s Supervisory Board is formally subordinated to the central bank’s Governing Council but practically has wide autonomy, has overall rather well stood the test of its first few years, but is criticized by some analysts as potentially generating conflicts of interest. Looking ahead, the baseline scenario is one of lasting institutional complexity, similar to the US where past attempts to reduce the number of federal financial bodies, for example by merging the Commodities Futures Trading Commission and the Securities and Exchange Commission, have repeatedly failed. From an international perspective, banking union established the euro area as the 1.63 largest single jurisdiction in terms of the aggregate balance sheet of the banking sector, a status that had earlier belonged unambiguously to the US—even though, in the meantime, rapid bank balance-sheet expansion in China has relegated the euro area to second position, and the US to third. One measure of this shift is to look at the list of the world’s most systemically important banks, as maintained on a yearly basis by the Financial Stability Board (FSB). On the basis of the latest list of 29 institutions, eight of these are headquartered in the US, four in France, four in China, three in the UK, three in Japan, two in Switzerland, and one in each of Canada, Germany, Italy, the Netherlands, and Spain.23 But on an aggregate basis following banking union, the euro area reaches equal status with the US with eight banks. This inevitably gives the ECB more clout in global banking policy bodies. In the Basel Committee on Banking Supervision (BCBS), both the ECB and the SSM (in practice, the ECB’s supervisory board) became full members in October 2014 and it is probably only a matter of time before the current full membership of supervisory authorities in Belgium, France, Germany, Italy, 23 Financial Stability Board, ‘2018 List of Global Systemically Important Banks (G-SIBs)’, November 2018 (available online at ).

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Nicolas Véron the Netherlands, and Spain are downgraded to a less prominent status. A similar dynamic may apply to the FSB itself, in which representatives from the central banks of France, Germany, Italy, the Netherlands, and Spain are present in both the Plenary and the slightly more compact Steering Committee. Beyond issues of formal membership, banking union enhances the global status of EU-level bodies such as the ECB, European Commission, and SRB in global financial standard- setters and policy bodies, partly to the detriment of national authorities from euro area countries.

III. Conclusion 1.64 This summary review of possible economic consequences of banking union

illustrates how widespread these consequences might be and also the complexity and interrelations between various aspects of such economic impact. Furthermore, the European context remains marked by major uncertainties that will further affect the future of banking union and of the European economy more generally.

1.65 The future of the UK relationship with the EU is one source of such uncertainty.

The UK voted to exit the EU in June 2016, but at the time of writing, the modalities of that exit remain highly uncertain. Even an eventual return of the UK to the EU following its exit cannot be entirely ruled out, which over the long-term could entail future participation in banking union, even if the UK remains outside of the euro area.24 Aside from the UK, other non-euro Member States, such as Denmark, may choose the option offered by the banking union framework to join the SSM and SRM on a voluntary basis. Bulgaria is scheduled to do so in 2019 in anticipation of its expected future membership of the euro area. This may add additional complexity to what is already an intricate set of institutional arrangements, but would also make banking union a stronger framework by enlarging its base of support among EU Member States.

1.66 Continued economic and political fragility in the euro area, of course, is another

very significant uncertainty factor. The current environment is of growing popular distrust in established elites and political systems and it is unclear whether a path out of this predicament can be found with incremental reform only. Should further deterioration lead to more radical developments, such as renewed consideration of treaty change, there would surely be implications for the banking union framework. The possibility of separating the SSM from the ECB, as mentioned earlier, is only one of many options that would open up in such a context.

24 House of Lords, ‘ “Genuine Economic and Monetary Union” and the Implications for the UK’, European Union Committee 8th Report of Session 2013–2014, London, February 2014.

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The Economic Consequences of Europe’s Banking Union Banking union has itself been a radical step, made possible by the unique polit- 1.67 ical context of mid-2012. Even in its current incomplete form, it has had a major stabilizing impact and has mitigated the bank-sovereign vicious circle in its first few years of existence. Its future development and impact are subject to numerous question marks, but there is no prospect of return to the policy status quo that existed before the turning point of 28–29 June 2012. Banking union in its current incomplete form has been insufficient to put the euro area back on a sustainable trajectory. Even so, it has been one of the most constructive and promising developments in the EU since the start of the crisis in 2007, and even arguably since its creation. The early successes of its implementation could serve as inspiration for policy initiatives in other areas, such as energy and digital services, as well as for the Capital Markets Union agenda. The economic consequences of Europe’s banking union cannot be forecast with any precision at this early stage, but it is already sure that they will be significant.

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2 EUROPEAN BANKING UNION Effectiveness, Impact, and Future Challenges Kern Alexander

I. Introduction II. Single Supervisory Mechanism— Setting the Context

2.01

2.05 1. Supervisory Convergence and Harmonization 2.11 2. Governance of the SSM 2.16 3. SSM and International Bodies 2.22 4. CRD Reform Package (CRD V) 2.25

V. SSM, Macroprudential Tools, and National Competent Authorities

2.67 1. The SSM, NCAs, Supervisory Colleges, and Joint Supervisory Teams 2.72 2. Regulating Home-Host Responsibilities 2.80 3. Supervisory Review and Legal Uncertainty 2.87 4. SSM, NCAs/NDAs, and Macroprudential Tools 2.97 5. Financial Market Infrastructure 2.109

III. SSM and EU Agencies and Institutions

2.31 1. European Banking Authority 2.31 2. The SSM and ESMA, EIOPA, and ESRB 2.44 3. European Court of Auditors 2.46

VI. Member State Perspectives on the SSM VII. Banking Union and the Banking Industry

IV. Bank Resolution, the SSM, and the Single Resolution Board (SRB)

2.114

2.121 1. Banking Industry Reaction 2.122 2. Mergers, Market Structures, and Integration 2.126

2.49 1. Single Resolution Mechanism 2.52 2. SRB and Meroni 2.57 3. SRB’s Broad Powers and Legal Uncertainty 2.60 4. SSM Co-ordination with SRB 2.62

VIII. Conclusion

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I. Introduction The European Banking Union was designed to restore the financial health and 2.01 stability of the European banking system and to sever the link between weak banking systems and fragile sovereign debt finances. The Banking Union consists of three pillars: the Single Supervisory Mechanism (SSM), Single Resolution

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Kern Alexander Mechanism (SRM), and the European Deposit Insurance System (EDIS). The SSM was implemented first, taking effect in 2014 to enhance supervision of the European banking sector and to promote banking stability following the financial crisis of 2007–2009 and the euro area sovereign debt crisis of 2010–2012. The SSM provides the supervisory pillar of the European Banking Union and empowers the European Central Bank to carry out prudential supervision of credit institutions and certain financial holding companies that are established in participating Member States and to allocate supervisory responsibilities to the national competent authorities of participating Member States for less significant institutions. The other two pillars of the Banking Union consist of the Single Resolution Mechanism (SRM) and the European Deposit Insurance System (EDIS). The SRM took effect in 2016 and operates through the Single Resolution Board, which has authority to take a bank or systemically important investment firm into resolution and to utilize resolution tools to restructure or recapitalize the institution if necessary to prevent a crisis and to avoid a taxpayer funded bailout. The SRB can draw on a Single Resolution Fund, which can be tapped to help wind down a systemically important institution.1 The third pillar, known as EDIS, represents a common scheme to insure bank deposits across the Banking Union, but is still under negotiation as it faces strong political opposition in Germany and other countries.2 2.02 Political factors played a great role in the SSM’s creation in June 2012 because of

the economic threat to the single currency attributed to the Eurozone sovereign debt crisis and the Spanish banking crisis of May 2012.3 The centralization of supervisory powers in the European Central Bank was considered to be a necessary condition for the creation of an ‘effective single supervisory mechanism’ for banks in the Eurozone that could serve as a pre-condition for the recapitalization of individual banks through the European Stability Mechanism.4 The Commission’s

1 See Danny Busch, ‘Governance of the Single Resolution Mechanism’ Ch 9.46–9.64 (this volume) in Danny Busch and Guido Ferrarini (eds), European Baking Union (2nd edn, Oxford University Press 2019). 2 The EDIS would eventually mean customer bank deposits up to €100,000 would be guaranteed by Eurozone taxpayer money. See European Commission, Communication To The European Parliament, The Council, The European Central Bank, The European Economic and Social Committee and the Committee of the Regions on completing the Banking Union, COM(2017) 592 final, Brussels, 11.10.2017. 3 See Hermann van Rompuy, ‘Towards a Genuine Economic and Monetary Union’ (Report by President of the European Council, EUCO 120/12, 26 June 2012), available online at accessed 11 December 2018. See also, Euro Summit, ‘Euro Area Summit Statement’ (European Council 29 June 2012), available online at

accessed 11 December 2018. Several Eurozone governments were experiencing sovereign debt and banking crises in 2012, including Greece and Portugal (excessive sovereign debt), and Spain, Cyprus, Ireland (bank-driven crises), and both fiscal and banking fragility in Italy. 4 European Council, ‘ESM direct recapitalisation instrument—Main features of the operational framework and way forward’ (European Council 20 June 2013), available online at accessed 7 December 2018, establishing conditions for a recapitalization of individual banks. 5 Commission, ‘Proposal for a Council Regulation conferring specific tasks on the European Central Bank concerning policies relating policies relating to the prudential supervision of credit institutions’ COM(2012) 511 final. 6 Council Regulation (EU) 1024/ 2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2013] OJ L287/63 (SSM Regulation); Regulation (EU) 1022/2013 of the European Parliament and of the Council of 22 October 2013 amending Regulation (EU) 1093/2010 establishing a European Supervisory Authority (European Banking Authority) as regards the conferral of specific tasks on the European Central Bank pursuant to Council Regulation (EU) 1024/ 2013 [2013] OJ L287/5. 7 See European Central Bank, ‘Note: Comprehensive Assessment October 2013’ (October 2013) 5–8, available online at accessed 7 December 2018, discussing specific objectives of asset quality review; European Central Bank, ‘ECB to disclose final results of comprehensive assessment’ (ECB Press Release, 10 October 2014), available online at accessed 7 December 2018. 8 Regulation (EU) 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) 1093/2010 [2014] OJ L225/1 (SRM Regulation). 9 See Jean-Claude Juncker, ‘Completing Europe’s Economic and Monetary Union’ (European Commission, 22 June 2015), available online at accessed 7 December 2018.

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Kern Alexander and the effectiveness of the relationship between the SSM and the SRM’s Single Resolution Board. Part IV discusses the impact of the SSM on Member States and national competent authorities and some of the institutional and legal challenges to improving the effectiveness of the SSM-NCA relationship. Part V considers the effect of the SSM on the Eurozone banking sector and how it has impacted banking performance, organizational structures and related business practices. 2.04 The chapter concludes the Banking Union has achieved a considerable degree of

effectiveness in banking supervision by engaging effectively with other EU authorities, such as the European Banking Authority, in adopting regulatory and technical standards and guidelines that have enhanced the SSM’s supervisory practices. The chapter also considers how the SSM has co-ordinated with the other operational pillar of the Banking Union—the Single Resolution Mechanism— and will review how it has co-ordinated with the SRB in making determinations of the financial viability of institutions and when necessary supporting the SRB in taking institutions into resolution. Nevertheless, considerable challenges remain regarding further development of the Banking Union and whether the recently enacted Capital Requirements Directive V legislative package adequately expanded the ECB’s competence to supervise systemically important investment firms and to ensure that banks are managing the governance risks associated with financial crime, terrorist financing and related areas of market misconduct.10

II. Single Supervisory Mechanism—Setting the Context 2.05 The SSM represents the first legally binding transnational system for banking

supervision. The SSM institutional framework ties together the bank supervisory authorities of the nineteen Euro Area states to promote a more harmonized application and enforcement of EU bank prudential regulatory law. A growing literature in economics, policy science and law has analysed the viability and effectiveness of transnational bank supervisory arrangements.11 Generally, stricter 10 See Eddy Wymeersch, ‘The Single Supervisory Mechanism for Banking Supervision Institutional Aspects’ Ch 4 (this volume) in Danny Busch and Guido Ferrarini (eds), The European Banking Union (2nd edn, Oxford University Press 2019). See also Joined Cases T-133/16 to T-136/ 16, para, 81, in which CJEU upholds ECB’s interpretation of Directive 2013/36 as ‘lay[ing] down specific rules concerning good governance of credit institutions, which preclude, in principle, the chairman of the management body in its supervisory function from being also responsible for the effective direction of the business of the credit institution’. See also Judgment of the Court (Grand Chamber) (19 December 2019), Case C-219/17, para 58, upholding the ECB’s ‘exclusive competence to decide whether or not to approve the acquisition of a qualifying holding in a credit institution’ to prevent Silvio Berlusconi from acquiring a qualifying holding in an Italian credit institution because of his conviction for tax fraud. 11 See John Eatwell and Lance Taylor, Global Finance at Risk: The Case for International Regulation (Polity Press 2010), discussing the institutional model for a World Financial Authority to control systemic risk; Rosa Lastra, International Monetary and Financial Law (2nd edn, Oxford University Press 2015), discussing the legal norms that bind international financial regulation; Kern Alexander,

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Effectiveness, Impact, and Future Challenges supervisory standards that are jointly co-ordinated between states can improve banking sector stability and overall performance. Acharya et al have argued that risk spillovers from banks in weakly supervised jurisdictions into other strictly supervised jurisdictions leads to regulatory forbearance in the strictly supervised jurisdictions.12 Joint harmonization of supervision and regulation across jurisdictions however inhibits this race to the bottom.13 Agarwal et al empirically find that a centralized supervisor with responsibility over multiple jurisdictions can be stricter in applying and enforcing regulatory law than local supervisors.14 By analysing US banks, they show that, compared to state authorities, the federal supervisory agencies have adopted stricter prudential standards and are more proactive in enforcing them.15 This growing literature supports the idea that a transnational financial supervisor 2.06 can be effective in achieving its objectives if it is supported by an adequate institutional and legal framework.16 In the case of European Banking Union, it has been recognized that a fundamental rearrangement of the bank prudential regulatory, supervisory, and resolution frameworks has been achieved, with the exception of a deposit guarantee scheme, resulting in the creation of a ‘financial safety net’ in the Euro Area.17 The effectiveness of the SSM—and indeed the overall Banking Union—could be measured in part by the level of financial integration in the Euro Area and in particular to what extent ‘prudential legal obstacles and impediments’ still obstruct ‘the establishment of a single supervisory jurisdiction’ and whether or not home bias, financial fragmentation, and retrenchment largely along national lines, which can result in uneven and asymmetric funding and

Rahul Dhumale, and John Eatwell, Global Governance of Financial Systems: International Regulation of Systemic Risk (Oxford University Press 2006), arguing for an international framework treaty to delegate authority to international standard setting bodies to develop binding norms of international financial regulation to be implemented flexibly by states. 12 Viral V Acharya, ‘Is the International Convergence of Capital Adequacy Regulation Desirable?’ (2003) 58 The Journal of Finance 2745. 13 Ibid, 2780. 14 Sumit Agarwal et al, ‘Inconsistent Regulators: Evidence from Banking’ (2014) 129 The Quarterly Journal of Economics 889. 15 Ibid. 16 See Eddy Wymeersch, ‘The Single Supervisory Mechanism: Institutional Aspects’ in Danny Busch and Guido Ferrarini (eds), European Banking Union (Oxford University Press 2015) 93–4, citing an extensive academic and policy-based literature considering the need to adopt a European institutional framework for the supervision of financial markets. 17 See Asli Demirguc-Kunt and Harry Huizenga, ‘Market Discipline and Financial Safety Net Design’, (Policy Research Working Paper No 2183, World Bank 1999) 14, available online at

accessed 7 December 2018, arguing for prudential regulation, supervision and resolution and lender of last resort as main elements of financial safety net. See also Christos Gortsos, Fundamentals of Public International Financial Law (Nomos 2012) 90–104, arguing for these elements as well and discussing the absence of an effective regime for Emergency Liquidity Assistance by the European Central Bank in the Banking Union. See also Jens-Hinrich Binder and Christos Gortsos, The European Banking Union—A Compendium (Nomos 2016) 2–5.

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Kern Alexander risk sharing across the banking and financial sector, have been reversed.18 Other commentators emphasize the power of EU legal and institutional factors to shape the development of banking markets while influencing the organizational structure and strategy of banking groups.19 And others have analysed the effectiveness of the SSM in terms of whether the right balance has been struck in determining whether the ECB should have more influence over prudential rule-making.20 2.07 The SSM’s establishment has resulted in a historic shift of legal supervisory

competences from Member States to an EU institution. Under the SSM, the European Central Bank (ECB) has been empowered to exercise direct prudential supervision with respect to ‘significant’ credit institutions, banking groups and certain mixed financial conglomerates that are based in Eurozone states.21 For example, the ECB’s supervisory powers include the granting and withdrawal of banking licences, assessing the suitability of bank directors and senior management, and approving mergers and acquisitions.22 Although the ECB has the competence and responsibility for prudential supervision of these institutions regardless of size or systemic significance, the SSM Regulation authorizes the ECB to allocate direct supervisory tasks for ‘less significant’ banks and financial groups to the relevant national competent authority.23 However, the ECB can always ‘call up’ direct supervision for such other Eurozone banks when necessary to ensure consistent application of high supervisory standards. The SSM system therefore consists of both the ECB and the NCAs operating within a decentralised framework of supervision in which the ECB is exclusively competent in a legal sense and responsible for ensuring the effective discharge of the supervisory tasks enumerated in Article 4 of the SSM Regulation.24

18 See Giovanni Bassani, ‘The Legal Framework Applicable to the Single Supervisory Mechanism’ –Tapestry or Patchwork’ (Wolters Kluwer, 2019) 43- 44. See also Eilis Ferran, ‘European Banking Union: Imperfect, But It Can Work’ in Danny Busch and Guido Ferrarini (eds), European Banking Union (Oxford University Press 2015) 56–90, 60–1. Ferran observes that to achieve the Banking Union’s objectives of enhancing the internal market for banking and financial services while maintaining banking stability, it will be necessary to overcome ‘the legal complexities’ in building an institutional structure of banking regulation, supervision, and resolution that ‘touch the boundaries of what is permissible under EU law without a Treaty change’: ibid 86. 19 See Wymeersch, ‘SSM’ (n 16) 93–117, 111–12. 20 See Guido Ferrarini and Fabio Recine, ‘The Single Rulebook and the SSM: Should the ECB Have More Say in Prudential Rulemaking?’ in Danny Busch and Guido Ferrarini (eds), European Banking Union (Oxford University Press 2015) 118–54, 143–51. See also, Christos Gortsos, The Single Supervisory Mechanism (SSM) (Nomiki Bibliothiki 2015), provides comprehensive legal analysis of the SSM Framework. 21 SSM Regulation (n 6), arts 4(1)(a), (c) and 6(4). See for the list of significant and less significant entities as of 1 September 2018: European Central Bank, ‘List of supervised entities’ (ECB 2018), available online at accessed 7 December 2018. 22 See SSM Regulation (n 6), art 6(5)(b). 23 Ibid, art 6(4). 24 Judgment of the Court (First Chamber) (8 May 2019), Landeskreditbank Baden-Wurtttemberg Forderbank v European Central Bank, Case C-450/17P, upholding the General Court’s finding that ‘the Council conferred on the ECB exclusive competence, the decentralised implementation of

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Effectiveness, Impact, and Future Challenges The SSM’s overriding objectives are to ensure safety and soundness of the European 2.08 banking system and to ensure the unity and integrity of the EU internal market.25 To achieve these objectives, the ECB/SSM and Member State competent authorities apply the European Single Rulebook,26 which consists of EU prudential bank legislation and regulatory and technical implementing standards and guidelines adopted by the European Banking Authority.27 All euro area Member States are automatically SSM members, while non-euro area 2.09 members can decide to participate in the SSM through a procedure involving the national competent authority entering into a ‘close co-operation’ with the ECB.28 For the other non-participating Member States, the ECB is authorized to adopt a Memorandum of Understanding with the relevant national competent authority that explains how the ECB will co-operate with the competent authority in performing their respective supervisory tasks.29 As discussed in part V, five years after the creation of the SSM, a view has devel- 2.10 oped amongst some regulators and market participants that the SSM has proven itself to be an effective supervisory network that has functioned smoothly and has

which by the national authorities is enabled by Article 6 of that [SSM] regulation, under the SSM and under the control of the ECB, in relation to less significant credit institutions’. 25 Ibid, art 1. 26 The so-called ‘Single Rulebook’ in banking refers to the EU directives, regulations, technical standards, and guidance that apply to the 28 EU states’ domestic banking regulatory regimes. The EU legislation includes the Capital Requirements Directive IV, Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms; Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) 648/2012 [2013] OJ L176/1 (CRR); Directive 2014/59 EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directives 77/91/EEC and 82/891/EC, Directives 2001/ 24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/35/EC; and Directive 2014/59, OJ L173/ 190 (BRRD); Directive 2014/49/EU (deposit guarantees). The CRD IV and CRR implement the Basel Capital Accord (now Basel III & IV) into EU law, while the BRRD provides a minimum harmonization framework requiring Member States to adopt recovery and resolution laws for banks and certain investment firms. 27 Regulation (EU) 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC [2010] OJ L331/ 12, arts 1–2, 10, and 14–16. The Single Rulebook is analysed in depth in this volume. See Guido Ferrarini and Fabio Recine, ‘The Single Rulebook and the SSM: Regulatory Polycentrism vs Supervisory Centralization’ in Danny Busch and Guido Ferrarini (eds), The European Banking Union ( 2nd edn, Oxford University Press 2019), 5.01–5.03.. 28 SSM Regulation (n 5), art 7(1) and (2)(a)–(c), providing the legal requirements for ECB co-operation with national competent authorities that enter ‘close co-operation’ with the SSM, including rules that apply directly to banks established in participating countries. 29 Ibid, Recital 14 and art 3(6). The SSM Regulation reserves the term ‘NCA’ for authorities participating in the SSM. Non-SSM authorities are ‘competent authorities’ on equal footing with the ECB.

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Kern Alexander supported the stability and resilience of the European banking system.30 For instance, the German Federal Financial Supervisory Authority (the ‘BaFin’) has observed that ‘[i]‌t now plays an important role in safeguarding long-term financial stability and advancing financial market integration’.31 Another view, however, asserts that the SSM has limited the flexibility that national competent authorities previously had to address risks in local banking markets and has increased the operational costs for NCAs to ensure that they comply with the SSM regime, and furthermore increased compliance costs for banks, thereby hindering their capacity to support the Eurozone economy. 1. Supervisory Convergence and Harmonization 2.11 The SSM Regulation sets forth the ECB’s supervisory tasks in Article 4(1)32 that

the ECB shall have the powers to supervise credit institutions and banking groups by applying and enforcing the relevant provisions of EU banking law, such as the Capital Requirements Directive IV and the Capital Requirements Regulation33 as well as national law implementing related areas of EU banking law.34 The subject matter or areas of competence for the ECB are enumerated in Article 4 of the SSM Regulation35 that empowers the ECB to monitor capital adequacy, liquidity buffers and leverage limits, bank corporate governance (including remuneration and board appointments), approve bank mergers and acquisitions, recovery plans and asset transfers between affiliates within banking groups or mixed financial conglomerates.36

2.12 The SSM has created a regulatory and legal framework that has made it possible to

harmonize supervisory practices through the creation of the EU single rulebook, which has supported a more unified bank regulatory policy on an EU-wide basis, and has significantly enhanced the stability of the banking sector.37 Despite the goal of a more unified banking market based on harmonized prudential supervisory

30 Federal Ministry of Finance, ‘The Single Supervisory Mechanism: Lessons learned after the first three years’ (German Federal Ministry of Finance’s Monthly Report, Bundesfinanzministerium January 2018), available online at accessed 12 August 2019. 31 Ibid. 32 SSM Regulation (n 6), art 4(1). 33 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87 EC and repealing Directives 2006/48/EC and 2006/ 49/EC [2013] OJ L176/338 (‘CRD IV’); Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms [2013] OJ L176/1 (‘CRR’). 34 SSM Regulation (n 6), art 4(3). 35 Ibid, art 4(1)–(3), especially art 4(1)(d) and (e). 36 Ibid, art 4(1)(g) and (h) mention ‘mixed financial holding companies’ and ‘financial conglomerate’, respectively, over which the ECB has certain supervisory powers. 37 Federal Ministry of Finance (n 30).

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Effectiveness, Impact, and Future Challenges standards, it has been argued that European banking regulation and supervision is far from integrated and harmonized.38 Some of the barriers to a more integrated and harmonized supervisory framework include cultural differences, such as language and local customs, but also civil and commercial law differences. For instance, the financial industry operates largely on the basis of legal contracts that are essentially governed by Member State law. Financial products such as loans, deposits or mortgage-backed securities are contracts, which terms and conditions depend on local legislation and judicial decisions. Moreover, differences in corporate and personal insolvency laws, and collateral enforcement regimes, are considered a primary barrier to the creation of pan-European bank business models and financial products.39 In addition, harmonized supervisory practices under the SSM have been hindered by the unfinished business of creating a Eurozone Banking Union and an EU-wide Capital Market Union (CMU). Essentially, the group of countries that constitute the Banking Union have harmonized some bank rules, but many areas remain fragmented including tax, bankruptcy law and rules on treatment of collateral.40 For example, the lack of a common Eurozone deposit insurance scheme has hindered the integration of the cross-border retail banking business. EU legislation to promote a CMU across the twenty eight EU states attempts to ad- 2.13 dress similar challenges that include, among others, the heavy reliance of EU-based firms on bank finance, significantly different financing terms for firms across EU states, inadequate access to capital markets for many small and medium-sized firms, segmented national markets for shareholders and buyers of corporate debt, and differing rules and market practices between EU states for products like securitized instruments and private placements.41 The CMU’s objectives include establishing a genuine single capital market in 2.14 the EU where investors are able to invest their funds without hindrance across borders, and businesses can raise capital from a diverse range of sources, irrespective of their location.42 It aims to develop a more diversified financial

38 Oliver Wyman, ‘Cross-border Bank M&A? Europe Is Not Ready’ (Oliver Wyman Insights, 8 November 2017), available online at accessed 14 November 2018. 39 Ibid. 40 Martin Arnold, Patrick Jenkins, and Laura Noonan, ‘Banking M&A: the quest to create a European champion’ Financial Times (London, 11 July 2018), available online at accessed 14 November 2018. See also Commission, ‘Communication from the Commission to the European Parliament, the European Council, the Council, the European Economic and Social Committee and the Committee of the regions, Completing the Capital Markets Union by 2019—time to accelerate delivery’ COM(2018) 114 final, 5–6. 41 Commission, ‘Completing the Capital Markets Union by 2019’ (n 40), 5–6. 42 Commission, ‘Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions,

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Kern Alexander system complementing bank financing with deeper and more developed capital markets that facilitate the cross-border flow of capital to its most productive use. 2.15 Similarly, revisions to EU insolvency law that make it easier for companies to

restructure their debts and operations and EU legislation to adopt a common consolidated corporate tax base will improve incentives for firms to increase their cross-border operations in Europe and to raise more capital from investors in other EU states.43 These legislative initiatives are intended to reverse the fragmentation of European banking and capital markets that has occurred post-crisis by eliminating or reducing some of the main institutional and legal barriers that have hindered savers, investors and businesses from having greater investment choices and lower funding costs. This is particularly relevant to cross-border banking in Europe because pan-European combinations of banking groups across the Eurozone and EU states can only make sense if institutions can move capital and liquidity more freely across the bloc—something that is hindered due to different regulatory standards, private law frameworks, capital financing practices, and taxation. 2. Governance of the SSM

2.16 The SSM provides the ECB with supervisory powers to be exercised through a

Supervisory Board (‘SB’).44 The SB is responsible for supervising the euro area’s largest cross-border banks and the top three banks by size in each participating Member State. The SB is also responsible for the supervisory actions of national competent authorities responsible for supervising over 3,500 small and medium sized credit institutions in participating Member States.45 The SB has ultimate discretionary authority to decide whether to intervene and to take supervisory decisions that could supersede the decisions of national competent authorities with respect to less significant credit institutions which the SSM does not directly supervise.

Action Plan on Building Capital Markets Union’ COM(2015) 468 final, providing short overview of CMU initiatives. 43 See Commission, ‘Proposal for a Directive of the Parliament and of the Council on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU’ COM(2016) 723 final, Parliament and Council will decide in early 2019. See European Commission; ‘Proposal for a Council Directive on a Common Corporate Tax Base’ COM(2016) 685 final, still in the legislative process. 44 SSM Regulation (n 6), art 26 (‘planning and execution of the tasks conferred on the ECB shall be fully undertaken by an internal body composed of its Chair and Vice Chair’). 45 Ibid, art 2(1), defining ‘participating Member State’ as ‘a Member State whose currency is the euro or a Member State whose currency is not the euro which has established a close co-operation in accordance with Article 7’ [Close co-operation with the competent authorities of participating Member States whose currency is not the euro].

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Effectiveness, Impact, and Future Challenges Moreover, Article 25 of the SSM Regulation requires a separation between SB 2.17 and its prudential supervision function and monetary policy to address the moral hazard concern that central bankers might use monetary policy to increase the supply of credit to weak banks during times of market distress.46 However, the so- called ‘Chinese wall’ separating the monetary policy and prudential supervision functions has raised important questions about whether the pursuit of monetary and financial stability should be linked and co-ordinated or strictly separated.47 Aspects of the SSM governance structure have been criticized and improvements 2.18 have been recommended by some national competent authority regulators certain areas.48 In particular the German Federal Ministry of Finance has called for more safeguards to mitigate the potential conflict of interest between monetary policy and banking supervision. This should involve organizational changes that allow the SB more autonomy and to be subject to less detailed oversight from the Governing Council in making day-to-day supervisory decisions. However, it is recognized that any change that would diminish the Council’s final decision- making authority over supervisory decisions would require amendment of the EU Treaty. In lieu of Treaty change, it is recommended that the Mediation Panel that mediates disputes between the Council and Board plays a more proactive role in facilitating a more efficient allocation of functions between the Council and the SB. The potential for disputes between the Council and the SB raises an important 2.19 concern regarding the SSM’s governance. Good governance involves clear lines of accountability between those who take decisions and those who are subject to the decisions and also requires a certain amount of transparency in how decision- making is conducted and whether it is perceived as legitimate by those subject to the decisions. If governance of a regulatory body is not administered properly— for example, because decision- making procedures are unnecessarily cumbersome and complex or because decision-makers do not have the incentives to act in the interest of those who are affected by their decisions and do not explain

46 Ibid, art 25. The monetary policy and prudential supervision tasks of the ECB are separated. 47 See Kern Alexander, ‘European Banking Union: A Legal and Institutional Analysis of the Single Supervisory Mechanism and Single Resolution Mechanism’, 40:2 (April 2015) (Sweet & Maxwell, Andover, UK) 154–87, 170–71 48 Federal Ministry of Finance (n 30). See also Fernando Restoy, ‘European banking sector: situation and challenges’ (Speech for the APIE Association of Economics Journalists, Bank for International Settlements 18 Oct 2018), available online at accessed 10 August 2019. See also Riksbank, ‘Consequences for financial stability of Nordea’s relocation to Finland’ (Financial Stability Report 2018:1, Sweden’s central bank Riksbank 2018) 37– 8, available online at accessed 7 December 2018, discussing SSM’s effectiveness in the context of Nordea’s relocation of its parent office from Sweden to Finland and the consequences for applying high standards for prudential supervision.

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Kern Alexander adequately the rationale of their decisions—then it is more likely that regulators and supervisors will not perform their functions effectively. Addressing governance concerns in EU institutions inevitably raises the issue of how EU Member States are affected by the decisions of EU institutions and what role they can play to influence decision-making. 2.20 As mentioned above, the governance structure of the SSM reflects several

considerations, in particular the objective of separating the ECB’s prudential supervisory role from its primary monetary policy role of maintaining price stability and the value of the euro. The primacy of the ECB’s price stability mandate in Article 127(1)49 of the Treaty explains why the Governing Council is empowered to make all final ECB decisions, including approval by action or non-action of SB decisions. This has implications for the potential role of SSM-participating non-Euro Member States in ECB decision-making. Although non-euro Member States which participate in the SSM would be able to participate in the governance of the SB, such as in the day-to-day preparation of SB decisions, they would not have representatives on the Governing Council and therefore would not be able to vote on final decisions, particularly those that involve approving (or not) SB decisions that could directly affect banks operating in their local jurisdictions. This concern is not only theoretical: two non-Euro area member states –Bulgaria and Croatia -have applied for close cooperation with the SSM with their banks undergoing ECB comprehensive assessments of their balance sheets in 2019 with a view to joining the SSM in the near future. Over time, as more EU states apply for close cooperation with the SSM, governance concerns could arise potentially weakening its legitimacy and effectiveness, as non-euro Member States that participate in the SSM would not have any direct representation on the ECB Governing Council to influence final decisions relating to banking supervision. In fact, the only formal remedy that would be available to a participating non-euro state that objects to a Governing Council decision is to refuse to adhere to the decision and to withdraw from the SSM.

2.21 In addition, it has been noted that the objective of increased harmonization of

supervisory practices should not lose sight of the fact that effective banking supervision requires a supportive institutional structure in which the Governing Council and SB can delegate day-to-day supervisory tasks to joint supervisory teams with discretion to issue directives or to order institutions to take certain measures to comply with prudential requirements.50 The role of JSTs and how they have evolved into the main players in SSM supervision will be discussed in Part IV.

49 Consolidated Version of the Treaty on the Functioning of the European Union 2008 OJ C115/47 (‘TFEU’), art 127(1) (stating ‘the primary objective of the European System of Central Banks . . . shall be to maintain price stability’). 50 Federal Ministry of Finance (n 30).

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Effectiveness, Impact, and Future Challenges 3. SSM and International Bodies Since assuming its bank supervision responsibilities, the ECB has taken on full 2.22 member status in international financial standard setting bodies, most significantly on the Financial Stability Board and the Basel Committee on Banking Supervision (BCBS).51 This involves the ECB directly in the development of international financial standards for banking supervision, such as the FSB’s Key Attributes for Effective Resolution Regimes of Systemically Important Financial Institutions and the Basel Committee’s Capital Accord and the Core Principles for Banking Supervision. In contrast, the European Banking Authority only has observer status in these international bodies. In co-operation with the EBA, the ECB contributes to co-ordination of the positions among EU/SSM members of the Basel Committee and FSB with regard to key developments and reforms currently deliberated by these bodies. The ECB’s membership of the FSB and the Basel Committee provides it with the opportunity to influence directly international bank standard setting while offering the perspectives of Banking Union Member States as well as all EU members states in co-ordination with the EBA. The ECB’s membership in the Basel Committee contributes indirectly to the de- 2.23 velopment of EU bank regulatory law because the Commission practice has been to propose most parts of the Basel Accord and its amendments into EU law. The ECB played an important role in the Basel Committee’s deliberations in 2016– 2017 over the adoption of amendments to Basel III (so-called ‘Basel IV’), which were agreed in December 2017. Basel IV tightens the prudential regime in several ways, including stricter credit valuation adjustment standards between wholesale counterparty institutions, increased leverage ratios for systemically important institutions, and most controversially limitations on the use of bank internal risk models to lower the riskiness of assets in order to reduce capital requirements.52 Basel Committee members, including the ECB, are required to implement these 2.24 amendments by 2022. Before then, the European Commission will need to conduct an impact assessment for implementing these amendments, before proposing legislation to transpose them into EU law. The ECB will have to balance this initiative with its involvement in other EU banking regulation reforms, such as the 2016 CRD V legislation, the 2017 draft Regulation for reducing prudential requirements for investment firms, and the Commission’s Action Plan for sustainable finance and regulation, which would include sustainability measures in prudential risk assessments. As a member of the Basel Committee, the ECB should play a facilitative role in working with the Commission to ensure that 51 Commission, ‘Commission Staff Working Document—Report from the Commission to the European Parliament and the Council on the Single Supervisory Mechanism established pursuant to Regulation (EU) No 1024/13’ COM(2017) 591 final, 54. 52 Basel Committee on Banking Supervision, Basel III: finalising post-crisis reforms (December 2017),  1–2.

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Kern Alexander these various initiatives are implemented in a complementary way into supervisory practice. 4. CRD Reform Package (CRD V) 2.25 The European Parliament and Council adopted the Capital Requirements Directive

V reform package entitled ‘Amending Capital Requirements’ (also known as CRD V) into law in 2019.53 The CRD V amends the Capital Requirements Regulation (CRR) and Capital requirements Directive IV (CRD IV) by making certain regulatory adjustments to implement most of the Basel III requirements into EU law and by making bank prudential regulation more proportional in achieving regulatory objectives.54 In doing so, the legislation adjusts the pillar 1 capital calculation standards for standardized approach lending to small and medium-sized institutions; adopts a harmonized binding net stable funding ratio (NSFR)55 rules in relation to repurchase agreements (repos) and reverse repos;56 more risk sensitive capital requirements for market risk (trading books);57 large exposures prudential treatment (eg exposure to a single client); streamlines the Pillar 2 capital requirements to interact more effectively with Pillar 1) and allows supervisors to require the additional ‘add-on’ capital for pillar 2 to be Tier 2, rather than Tier 1, capital.58

2.26 Other aims in the legislation include reducing unnecessary compliance costs by

reducing the scope of reporting and disclosure requirements for non-complex banks and adjusting the remuneration restrictions in CRD IV so that a certain percentage of variable pay can be made in ordinary shares or other share-linked financial instruments of the company and can be deferred over a period of years

53 Commission, ‘Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending Regulation (EU) No 648/2012’ COM(2016) 0850 final. See also Commission, ‘Proposal for a Directive of the European Parliament and of the Council amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures’ COM(2016) 0854 final 3. See also, Carla Stamegna, ‘Amending capital requirements: The “CRD V Package” ’ (EU Legislation in Progress briefing, European Parliament September 2018), available online at accessed 5 December 2018. 54 COM(2016) 0854 final (n 51) 3; COM draft Regulation (2016) 0850 final (n 49) 5. 55 COM draft Regulation (2016) 0850 final (n 51) 20–1, 209–28. 56 COM draft Regulation (2016) 0850 final (n 51) 31–2, 142. 57 COM draft Regulation (2016) 0850 final (n 51) 9–10, 15–19. For the exact calculation of own funds for trading book and market risk, see 127–33 and 134–66 for the standardized approach, 167–93 for the internal model approach, and 193–208 for the simplified internal approach. The simplified standardized approach remains unchanged, while the simplified internal approach will not be permitted to be used after the proposed Regulation comes into effect. See p 17. 58 COM(2016) 0854 final (n 51) 10–11, 27–31.

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Effectiveness, Impact, and Future Challenges to meet the variable remuneration requirements.59 The CRD V package also addresses bank lending to small and medium-sized enterprises and infrastructure projects.60 Under the current EU capital regime, banks now receive a capital charge reduction of 23.81% for SME lending under €1.5 million. In the proposed legislation, the ‘SME supporting factor’ is maintained, but would be extended to all SME loans over €1.5 million. For the loans above the €1.5 million limit, a 15% reduction for the remaining part of the exposure would apply.61 The CRD V would create less stringent capital and liquidity requirements for 2.27 trading book risks of banks and investment firms that have relatively low trading book risk exposures. It would divide these institutions into two categories: (1) institutions with a smaller trading book of €50 million or less and the value of their trading book is less than 5% of the institution’s total assets; and (2) medium sized institutions with less than €300 million in trading book assets that are less than 10% of the institution’s total assets. These institutions will qualify for waivers from certain capital and liquidity requirements for trading book risk.62 Moreover, there will be exemption regimes from stricter capital, liquidity and gov- 2.28 ernance requirements for public development banks and credit unions.63 The proposal includes additional exemptions for institutions that are organizationally and functionally similar to these institutions.64 Despite the focus on more flexible and proportionate application of regulatory rules, CRD V failed to provide for the possibility of cross-border banking groups obtaining waivers from certain prudential requirements at individual subsidiary level, which would have permitted them to qualify for reduced capital and liquidity requirements in their cross-border EU subsidiaries, thereby allowing them to manage their capital and liquidity centrally and thereby gain the benefits of a common internal market. A shortcoming of the CRD V package could be that it does not adequately ad- 2.29 dress the risks posed by ‘shadow banks’—financial firms which engage in maturity transformation (borrow short and lend long) and which potentially pose financial stability risks, but which are not subject to the CRD IV capital, liquidity and governance requirements because they are not defined as ‘credit institutions’, as that term is defined under the Capital Requirements Regulation. Also, the CRD V package does not propose that the ECB and NCAs have competence to supervise non-bank finance companies in the shadow banking sector and entities involved in financial market infrastructure, such as clearing houses/central counter parties, and central securities depositories. However, CRD V package observes

59 COM(2016) 0854 final (n 51) 12–13, 25–6. 60 COM(2016) 0854 final (n 51) 3. 61 COM(2016) 0854 final (n 51) 22, 268–71. 62 COM(2016) 0854 final (n 51) 15, 69–71. 63 COM(2016) 0854 final (n 51) 10, 18–20. 64 Ibid.

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Kern Alexander that ‘[c]‌urrently, the Parliament proposed that, when carrying out the SREP, competent authorities shall monitor institutions’ exposures towards shadow banking and financial transactions potentially leading to tax benefits, and notify the Commission.’65 2.30 The CRD V package is likely to make a great deal of further regulatory adjustment

necessary including renewed reform of capital and liquidity requirements under the Basel Accord 2017 reforms that allow banks to rely less on internal ratings-based models by limiting the reduction in risk-based assets to not less than 70% of the standardized approach and stricter counter-party margining requirements. These proposals, among others, are contained in the draft CRR III and will apply the proportionality principle further to take into account the specificities of Member State markets as well as the European market.

III. SSM and EU Agencies and Institutions 1. European Banking Authority 2.31 The European Banking Authority (EBA) was created as one of the three European

Supervisory Authorities based on the recommendations of the EU High Level Group on Financial Supervision, chaired by former IMF Managing Director and French central banker Jacques De Laroisere, which submitted its Report on 25 February 2009 proposing the creation of a European System of Financial Supervision (ESFS).66 Reflecting the views in the De Larosiere Report, the Commission proposed the ESFS67 to consist of a European Banking Authority, a European Securities and Markets Authority, and a European Insurance and Occupational Pension Authority.68 The three ESAs would, with support from a

65 Stamegna (n 53), 10. See also COM(2016) 0854 final (n 51) 36, 196–7. 66 European Commission, ‘Report of the High-level Expert Group on financial supervision in the EU’ (Chaired by Jacques de Larosière, European Commission 25 February 2009) (‘De Larosière report’) paras 194–214, available online at accessed 6 December 2018. 67 The ESFS entered into force on 1 January 2011 and applies to all EU Member States requiring their participation in and co-ordination with other EU states in adopting regulatory and technical implementing standards in the three European Supervisory Authorities. In principle, Member States retained micro-prudential supervisory powers but are required to co-ordinate their adoption of regulatory technical standards with other EU states within the three ESA bodies along sectoral lines—banking, securities and insurance. Kern Alexander, ‘Reforming European Financial Supervision: Adapting EU Institutions to Market Structures’ (2011) 12 Journal of the Academy of European Law 229. 68 Regulation (EU) 1093/2010 (n 27); Regulation (EU) 1094/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Insurance and Occupational Pensions Authority), amending Decision No 716/ 2009/ EC and repealing Commission Decision 2009/79/EC [2010] OJ L331/48; Regulation (EU) 1095/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European

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Effectiveness, Impact, and Future Challenges European Systemic Risk Board,69 promote more effective micro-prudential and macroprudential regulation and supervision of European financial markets and a more efficient functioning of the EU internal market.70 The ESAs’ responsibilities include developing single rulebooks consisting of regulatory implementing standards and technical implementing standards and guidelines for Member States to apply in their respective financial sectors. The EBA’s main specific tasks and responsibilities are set forth in article 8 of the 2.32 EBA Regulation to contribute to the ‘establishment of high quality common regulatory and supervisory standards and practices’.71 The EBA has competence to contribute to the ‘consistent application of legally binding EU acts’,72 as well as to monitor and assess market developments in the areas of its competence, and to co-ordinate and co-operate with the ESRB and other the ESAs in conducting EU- wide assessments of financial institutions’ resilience to adverse market conditions (ie stress tests).73 A. EBA and SSM Interaction The Single Supervisory Mechanism Regulation and the Regulation (EU) 1022/ 2.33 2013 amending the EBA Regulation both aim to incorporate the SSM into the ESFS with regard to tasks conferred on it by the SSM Regulation.74 Article 3 of the SSM Regulation requires the ECB to co-operate closely with EU bodies and national authorities, particularly the three European Supervisory Authorities: the European Banking Authority (EBA), the European Supervisory and Markets Authority (ESMA), the European Insurance and Occupational Pension Authority (EIOPA), and the European Systemic Risk Board and other ESFS authorities

Supervisory Authority (European Securities and Markets Authority), amending Decision No 716/ 2009/EC and repealing Commission Decision 2009/77/EC [2010] OJ L331/84. 69 Regulation (EU) 1092/2010 on European Union macroprudential oversight of the financial system and establishing a European Systemic Risk Board [2010] OJ L331/1. In connection to the functioning of the ESRB, specific tasks were conferred on the ECB concerning macroprudential oversight of the financial system. See Council Regulation (EU) 1096/2010 conferring specific tasks upon the ECB concerning the functioning of the European Systemic Risk Board [2010] OJ L331/162. See discussion Eilis Ferran and Kern Alexander, ‘Can Soft Law Bodies be Effective? Soft Systemic Risk Oversight Bodies and the Special Case of the European Systemic Risk Board’ (2010) 6 European Law Review 751. 70 See Jean-Victor Louis, ‘The implementation of the Larosiere Report: a progress report’ in Mario Giovanoli and Diego Devos (eds), International Monetary and Financial Law: the Global Crisis (Oxford University Press 2010) 154. 71 Regulation (EU) 1093/2010 (n 27), art 8, para 1 providing an exhaustive list (without prejudice to art 9) of the tasks conferred upon the EBA. These regulatory and supervisory standards and practices are further specified in arts 10–16 and 34. 72 Regulation (EU) 1093/2010 (n 27), arts 10–21, 29, and 34. 73 See ibid, art 8 para 1, containing an exhaustive list of the tasks conferred upon the EBA, while para 2 features an exhaustive list of all regulatory and other powers conferred on it in order to fulfil its tasks. 74 Regulation (EU) 1093/2010 (n 27), art 2(2)(f ), amended by Regulation (EU) 1022/2013 (n 6), art 1(2).

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Kern Alexander to ensure an adequate level of regulation and supervision.75 This would involve co-operation with the competent or supervisory authorities, as specified in the EU legal acts referred to in Article 1, paragraph 2 of the EBA Regulation.76 Significantly, specific co-operation principles have been laid down for the ECB in Article 3 of the SSM Regulation on the basis of considerations in Recital 31 as follows: The conferral of supervisory tasks on the ECB should be consistent with the framework of the ESFS and its underlying objective to develop the single rulebook and enhance convergence of supervisory practices across the whole Union. Cooperation between banking supervisors and the supervisors of insurance and securities markets is important to deal with the issues of joint interest and to ensure proper supervision of credit institutions operating also in the insurance and securities sectors. 2.34 Recital 31 further reinforces the principle of co-operation with the ESFS by re-

quiring the ECB ‘to co-operate closely with EBA, ESMA and EIOPA and the European Systemic Risk Board, and the other authorities which form part of the ESFS.’ And the ECB should also ‘carry out its tasks’ in accordance with the SSM Regulation and ‘without prejudice to the competence and the tasks of the other participants within the ESFS’, and in co-operation with the relevant resolution authorities and facilities that provide direct or indirect public financial assistance to the financial sectors.

2.35 Despite the strong language requiring ECB co-operation with the ESFS, there

have been difficulties and tensions in the EBA-ECB relationship.77 The position is set forth in the SSM Regulation that states that the EBA is ‘entrusted with the development of the Single Rulebook for the banking sector’, and also states that the SSM ‘should not replace the exercise of those tasks by the EBA’.78 Moreover, Article 16 of the EBA Regulation provides that the SSM ‘has to follow the Guidelines and Recommendations developed by the EBA, or explain why it chooses not to follow them’.79

2.36 Yet whilst the functions of the EBA and ECB appear to be differentiated in the

SSM Regulation, the actual discharge of their respective regulatory and supervisory tasks has not been so straightforward. For instance, unlike national competent authorities, the ECB’s supervisory rulebook applies to all credit institutions based in the 19 euro area states. The ECB’s much broader competence to supervise directly all systemically important credit institutions across the euro area and to co-ordinate the supervisory activities of the participating Member States places its relationship with the EBA in a quite different context than the relationship of a

SSM Regulation (n 5), art 3(1) first subpara. 76 Regulation (EU) 1093/2010 (n 27), art 3(2). 77 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51). 78 SSM Regulation (n 6), Recital 32. 79 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 50. 75

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Effectiveness, Impact, and Future Challenges Member State competent authority with the EBA. Therefore, whenever the ECB exercises its supervisory competence by adopting guidelines and rules, this clearly affects and potentially overlaps with the EBA’s delegated competence under EU legislation to adopt guidelines and technical standards for Member States to implement. This overlap in supervisory competence has been recognized in the situation where an ECB supervisory initiative predates the final adoption of a technical standard or regulatory decision taken by the EBA.80 The SSM SB has implemented a process by which it can report its compliance 2.37 with EBA Guidelines and Recommendations involving the direct supervision of significant institutions. However, the SB has stated that its compliance with EBA guidelines and recommendations is based on a comply or explain basis. In its 2017 review of the SSM, the European Commission observed that this compliance approach does not create more transparency for ‘end-users’ such as credit institutions, as there is uncertainty regarding the hierarchy of legal and regulatory norms that apply to their cross-border business models.81 For instance, the ECB may use directly applicable Regulations or other binding domestic legal instruments that implement Directives to specify regulatory rules, even if that means departing from applicable EBA Guidelines and Recommendations.82 However, the Commission has noted that the ECB has demonstrated that it aims to comply with all the Guidelines that fall within its area of competence. Nevertheless, different views have been taken by the ECB and EBA regarding how to comply with the specific provisions of EBA guidelines. These different views could potentially undermine the development of harmonised supervisory practices between ‘in’ and ‘out’ Member States. B. EBA-ECB/SSM Governance Regarding the governance dimension of EBA and ECB/SSM interaction, the 2.38 Commission has proposed closer co-operation,83 including that the EBA should participate more often in SSM SB meetings, as this would promote further supervisory convergence. Moreover, the EBA Regulation grants the SSM observer status in the EBA Board of Supervisors (BoS),84 while allowing the BoS members representing the SSM countries to retain their independent membership status. This may appear unusual because the ECB is ultimately the competent supervisory authority responsible for ensuring that these same SSM member countries are complying with EU banking law, including EBA technical standards and guidelines. The Commission has attempted to promote more coherence in EBA/ SSM

Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 50–1. 81 Ibid, 51. 82 Ibid, 51. 83 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51). 84 Regulation (EU) 1093/2010 (n 27). 80

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Kern Alexander decision-making by proposing, at a minimum, that the ECB should have an equal voice with other SSM countries within the EBA Board of Supervisors.85 2.39 The EBA has observed that the creation of the SSM has significantly changed

its governance and decision-making processes. To ensure equivalent influence between ‘in’ Member States and ‘out’ Member States, the EBA regulation was amended to require double simple majority voting for the adoption of all technical standards and guidelines.86 At a more general level, the European Commission has observed that ‘the creation of the SSM has implied for the EBA a loss of visibility of supervisory processes that were previously conducted in supervisory colleges and are now internalised in the decision making of the SSM and the Single Resolution Board’.87 The Commission raised the concern that these institutional arrangements might generate an ‘artificial disconnect’ between the EBA’s regulatory and the SSM’s supervisory functions, which could be addressed by providing meaningful and systematic participation of the EBA in the SSM and SRB.88

2.40 It is suggested that the ECB/SSM should participate more in EBA activities, in-

cluding a more active role in developing binding technical standards, guidelines and recommendations. Although the EBA appreciates the ECB/SSM involvement in certain areas of standard setting and deliberations, it points out that the ECB’s involvement is not equally forthcoming across most areas of EBA activity. Sometimes, the ECB plays an important role in leading regulatory and supervisory discussions; on other occasions, it is less active. The Commission has stated that it would be ‘welcome if the ECB would ensure responsiveness and pro-active participation consistently, especially where the EBA calls for intervention’.89 The SSM already participates in EBA technical groups and expresses views on the BoS and Management Board.90 Building on this, a recent ECB paper91 recommends greater ECB/SSM involvement in the EBA with the ECB granted

Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 51. 86 European Banking Authority, ‘Opinion of the European Banking Authority on the public consultation on the operation of the European Supervisory Authorities’ (EBA/Op/2017/08, EBA 31 May 2017), available online at accessed 7 December 2018. 87 Ibid, 3. 88 European Commission, ‘Feedback Statement on the Public Consultation on the Operations of the ESAs having taken place 21 March to 16 May 2017’ (consultation document, 20 June 2017) 16, available online at accessed 5 December 2018. 89 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 52. 90 Ibid,  51–2. 91 European Central Bank, ‘ECB contribution to the European Commission’s consultation on the operations of the European Supervisory Authorities’ (consultation on the operations of the European Supervisory Authorities, ECB 2017), available online at accessed 5 December 2018. 85

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Effectiveness, Impact, and Future Challenges voting rights both as a member of the EBA BoS and as a permanent member of the Management Board.92 The implications of Brexit are also discussed in the context of voting reforms 2.41 in the EBA and the other European Supervisory Authorities (ESAs).93 The Commission’s 2017 consultation on the ESAs and ESRB includes a response that post-Brexit voting shares in the EBA/ESAs should be calculated based on the size of a Member State’s financial sector.94 Also, Banking Union countries suggested the elimination of double-majority voting, while Member States outside the Banking Union argue that double-voting should be maintained.95 The Commission proposed a draft Regulation96 in 2017 that the voting arrangements in the EBA should be amended to include voting status of the SSM and SRB on the EBA supervisory board in order to help bridge the current institutional divide between regulatory, supervisory, and resolution functions. The Commission also proposed to keep the double majority voting system for measures and decisions adopted by the EBA Board of Supervisors,97 but that voting rules should be modified to ensure that votes would not have to be postponed if a quorum on the BoS is not met. The draft Regulation amendment therefore clarifies that a decision would need to be supported by a simple majority of NCAs from non-participating Member States present at the vote and of national competent authorities from participating Member States present at the vote.98

Ibid, 2. 93 ECB/SSM and other ESAs: for EBA see Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 15. See also Commission, ‘Proposal for a Regulation of the European Parliament and of the Council Amending Regulation (EU) 1093/2010 establishing a European Supervisory Authority (European Banking Authority); Regulation (EU) 1094/2010 establishing a European Supervisory Authority (European Insurance and Occupational Pensions Authority); Regulation (EU) 1095/2010 establishing a European Supervisory Authority (European Securities and Markets Authority); Regulation (EU) 345/2013 on European venture capital funds; Regulation (EU) 346/2013 on European social entrepreneurship funds; Regulation (EU) 600/2014 on markets in financial instruments; Regulation (EU) 2015/760 on European long-term investment funds; Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds; and Regulation (EU) 2017/1129 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market’ COM(2017) 536 final, 13, 23. 94 European Commission, Feedback Statement 16: See Commission, ‘Proposal for a Regulation of the European Parliament and of the Council (to extend powers of the ESAs)’ (n 93), 23–4. See also Commission, ‘Communication from the Commission to the European Parliament, the Council, the European Central Bank, The European Economic and Social Committee and the Committee of the Regions reinforcing integrated supervision to strengthen Capital Markets Union and financial integration in a changing environment’ COM(2017) 542 final. 95 ECB/SSM, (n 91), 16. 96 See Commission, ‘Proposal for a Regulation of the European Parliament and of the Council (to extend powers of the ESAs)’ (n 93). 97 Ibid, 23. 98 Ibid, 24. 92

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Kern Alexander 2.42 The EBA is also responsible for administering the EU-wide stress tests and the

development of a complete methodology, whereas national competent authorities (including the ECB) are responsible for the quality of the data and operation of the stress test. Co-ordination between EBA and national supervisors (including the ECB) is required, but often lacking. Although it does not have direct control over the quality assurance process of the stress tests, the EBA is held accountable to EU policymakers for the EU-wide stress tests. It is recommended therefore that close co-operation between the EBA and ECB is necessary to ensure the quality and accountability of the stress tests.99

2.43 Related to the EU-wide stress tests, the EBA is also responsible for designing

technical standards and guidelines for the supervisory review and evaluation process (SREP) that assesses bank corporate and risk governance under the Capital Requirements Directive 2013. An important component of the SREP involves the EBA developing and refining forward-looking scenario stress tests that Member State competent authorities (including the ECB) are required to apply. The application of the SREP methodology may result in additional capital requirements, and the adjustment of bank business models and strategy. The Commission’s consultation, however, recommends that the EBA could further refine the SREP Guidelines and scenario testing for business models and strategies in order to promote enhanced supervisory convergence across EU states. Also, the EBA encourages the ECB to co-ordinate the development of its own SREP methodology to avoid legal uncertainty and divergent supervisory practices across EU states.100 2. The SSM and ESMA, EIOPA, and ESRB

2.44 Another gap in the ECB’s relationship with EU institutions and bodies is the lack

of meaningful participation with other European Supervisory Authorities (ESMA & EIOPA) in the mutual exchange of information for supervisory practices and other regulatory information. The ECB has entered into mutual agreements and memorandum of understanding (MOUs) on information exchange with ESMA and EIOPA. The ECB-ESMA MOU covers statistics, risk management, supervision of market infrastructure and regulation. A similar MOU with EIOPA is being updated. The Joint Committee of the three Supervisory Authorities, however, has utilized MOUs between the EBA, ESMA, and EIOPA to develop and adopt jointly agreed technical standards, guidelines and recommendations, but these MOUs do not include the ECB/SSM. It is submitted that this hinders the SSM’s capacity to fulfil its supervisory tasks, especially on a consolidated basis for mixed

99 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 52. 100 Ibid, 44.

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Effectiveness, Impact, and Future Challenges financial conglomerates, as information obtained through mutual assistance is crucial for carrying out prudential supervisory tasks on a cross-sectoral basis. Moreover, the ECB’s institutional representation in its supervisory capacity in 2.45 the European Systemic Risk Board’s (ESRB) General Board is not yet recognized, as the ESRB was established prior to the creation of the Banking Union and the ECB being empowered to engage in prudential supervision of individual financial institutions, but without competence for broader macroprudential oversight of the financial system. Under the SSM, however, the Commission has observed that co-operation between the ECB and the ESRB in regards to micro-and macroprudential tasks is important, and that such co-ordination—facilitated by information exchange that arises from the ECB’s obligation to provide a Secretariat and research support for the ESRB—has taken place and should improve over time.101 This co-operation and co-ordination between the ECB and the European Supervisory Agencies and the European Systemic Risk Board has had the effect of allowing the ECB to take advantage of these institutional channels to monitor risks and obtain more information on European financial markets thereby enhancing its effectiveness as a bank supervisor. 3. European Court of Auditors The European Court of Auditors has the responsibility of performing audits of 2.46 all EU institutions and agencies, including the ECB/SSM. Some Member State authorities have observed that the SSM framework should ensure that the supervision of significant institutions remain subject to a full and complete public auditing process. Presently, in most Member States, the supervision of banks is also subject to a public auditing process. For instance, the German BaFin’s supervision of non-significant financial institutions is subject to an audit by the Bundesrechnungshof, while the ECB’s supervision of significant financial institutions are subject to a public auditing by the European Court of Auditors. The German BaFin has recommended that ‘to further improve the European Court of Auditors public auditing practices, a co-operation agreement should be concluded between the Court and the ECB’.102 The ECA also issued an audit report on the SSM in 2016103 that makes 2.47 recommendations in the following areas: governance, accountability, off-site and on-site visits.104 Moreover, it was noted that the ECA had difficulties in its performing its audits of the SSM because the ECB in some cases did not share the

101 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 52–3. 102 Federal Ministry of Finance (n 30). 103 European Court of Auditors, ‘Single Supervisory Mechanism— Good start but further improvements needed’ (ECA special report No 29/2016, 2016), available online at accessed 5 December 2018. 104 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 9–10.

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Kern Alexander required information. This has been brought to the attention of the European Parliament and Council. Both encourage more co-operation between the Court and ECB. The ECB has responded by stating that it is willing to discuss these matters with the ECA.105 2.48 EU banking regulation and supervision demonstrates the complexity of the EU

federal system of laws and jurisdictions that contain layers of administrative rulemaking that overlap. The use of EU state agencies to implement Union law has long been a feature of the EU, but Union authorities and agencies have grown in influence and legal importance.106 Since the introduction of Banking Union, not only EU supervisory authorities—the ESFS: EBA, ESMA, and EIOPA—but, also, EU institutions came to be involved on a day-to-day basis with executing supervision and making decisions on whether banks should be taken into resolution. The Commission, in the area of resolution together with the Single Resolution Board, and the ECB are the major players in the oversight of the banking industry. For the ECB, its role is defined as both a direct supervisory function and an oversight role for the NCA within the SSM. As discussed in section IV, this state of affairs leads to issues of competence and, in the case of the ECB’s own powers, to the peculiar situation of a European institution applying national law.

IV. Bank Resolution, the SSM, and the Single Resolution Board (SRB) 2.49 Bank resolution laws have been deemed vital for maintaining the stability of the

financial system, especially during times of crisis. An effective banking supervisory regime requires a seamless process in which supervisory assessments of individual institutions can be co-ordinated with the monitoring of risks across the financial system and with decisions to take crisis management measures, including the use of resolution tools to stabilize individual institutions that pose a threat to financial stability. Goodhart has observed that regulators and resolution authorities should ask ‘themselves how to protect the system of banks, conditional on another bank, perhaps one of the biggest and most inter-connected, having already failed’.107

105 Ibid, 10. 106 See Miroslava Scholten, The Political Accountability of EU and US Independent Regulatory Agencies (Brill Nijhoff 2014); Edoardo Chiti, ‘European Agencies’ Rulemaking: Powers, Procedures and Assessment’ (2013) 19 European Law Journal 93; Madalina Busuioc, ‘Rule-Making by the European Financial Supervisory Authorities: Walking a Tight Rope’ (2012) 19 European Law Journal 111; Merijn Chamon, ‘EU Agencies: Between Meroni and Romano or The Devil and the Deep Blue Sea’ (2011) 48 Common Market Law Review 1055. 107 See Charles Goodhart, ‘Bank Resolution in Comparative Perspective: What Lessons for Europe?’ in Charles Goodhart et al (eds), Central Banking at a Crossroads: Europe and Beyond (Anthem Press 2014).

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Effectiveness, Impact, and Future Challenges Prior to the crisis, most EU states did not have resolution regimes for banks 2.50 and other systemically important firms. The European Union’s Bank Recovery and Resolution Directive (BRRD)108 became effective on 1 January 2016 and provides a minimum harmonization regime that requires, among other things, the 28 Member States to change their domestic laws so that resolution authorities have use of four resolution tools that are enumerated in Article 37(3), namely, the sale of the business tool, the bridge institution tool, the asset separation tool and the bail-in tool. Resolution authorities may execute the resolution tools individually or in any combination.109 The design of the BRRD bail-in tool requires covered institutions to issue minimum required eligible liabilities (MREL) as loss- absorbent capital.110 Also, the Financial Stability Board’s ‘Key Attributes of Effective Resolution 2.51 Regimes for Financial Institutions’ emphasize the clear identification of a resolution authority with a broad range of powers, including a comprehensive and common toolkit of supervisory and resolution measures, and a credible funding source so that taxpayers are not called upon to bail out a bank or to subsidize its restructuring. European states have adopted national resolution laws to meet BRRD requirements and FSB standards as follows. The Italian special administrative regime suspends many of the powers of the shareholders’ general meeting, but the Banca d’Italia appoints special administrators to convene shareholder general meetings and establish a resolution agenda.111 Similarly, the German supervisory authority (Bafin) may suspend current management and appoint a temporary administrator to manage a failing bank.112 Under French law, the Banking Commission can appoint a temporary administrator with powers to manage and act on behalf of the bank.113 The Belgian Banking, Finance and Insurance Commission (BFIC), now replaced by the Financial Services and Markets Authority (FSMA) since 2011, can appoint a special inspector with

108 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/ 25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) 1093/2010 and 648/2012 of the European Parliament and of the Council [2014] OJ L173/ 190 (‘BRRD’), 190–348. 109 Ibid, art 37(4). Resolution authorities have discretion whether or not to use the resolution tools, or in what combination to use them, including use of the bail-in tool to impose losses on bank liabilities, such as bondholders, when an institution is experiencing financial difficulties. 110 Minimum Requirement for own Funds and Eligible Liabilities (MREL) in the BRRD and total loss absorbing capacity (TLAC) from Basel III. See European Banking Authority, ‘Regulatory Technical Standards on minimum requirement for own funds and eligible liabilities (MREL)’. See also Basel Committee on Banking Supervision, ‘Standard: TLAC holdings: Amendments to the Basel III standard on the definition of capital’ (2016). 111 Italian Consolidated Banking Law, art 72(6). However, the approval of the bank’s capital structure remains with the shareholder general meeting. 112 See s 46(1) of the German Banking Act. 113 Articles L613-18 and L613-22 of the Monetary and Financial Code.

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Kern Alexander enhanced administration powers. Swiss law also provides the regulator with extensive powers to appoint a special administrator to govern the bank’s affairs.114 Moreover, the Swiss regulator can likewise impose a forced reorganization with changes to the capital structure that are not subject to shareholder approval.115 Norwegian law provides for a public administration regime that allows for a compulsory reorganization and override of the shareholders. The Norwegian supervisor may stipulate that the share capital shall be increased by a new subscription for shares and designate eligible investors to subscribe for the shares, thus diluting existing shareholders.116 Similarly, the French Banking Commission may request the courts to order the transfer of shares to another entity.117 1. Single Resolution Mechanism 2.52 The Single Resolution Mechanism (SRM) implements the BRRD in the

Banking Union (BU) and has been operating since January 2016 through the Single Resolution Board.118 The SRM serves as the second pillar of the BU that would complement the supervisory powers of the ECB in the Single Supervisory Mechanism (SSM). The Commission’s proposal to create the SRM was based on the rationale that an effective regulatory regime required a seamless process between the supervision and resolution of banking institutions in order to limit the damage to the economy and reduce taxpayer exposure to bailouts.119 The SRM aims to create a more uniform and harmonized resolution process and substantive rules across the BU that can more effectively place banks and certain investment firms experiencing solvency problems into resolution with minimal costs to taxpayers.120 The SRM applies the substantive rules of the BRRD to banks that are supervised by the ECB/SSM, but also has more extensive jurisdiction over systemically important investment firms. Unlike the SSM, the SRM’s Single 114 Article 23quater of the Swiss Banking Act. 115 Article 29 s 3 of the Swiss Banking Act. 116 Sections 3–5 of the Act on Guarantee Schemes for Banks and Public Administration etc, of Financial Institutions (Guarantee Schemes Act) of 6 December 1996 (as amended per 1 July 2004). See also art L613-25 of the Monetary and Financial Code. 117 Article L613-25 of the Monetary and Financial Code. 118 Commission, ‘Proposal for a Regulation of the European Parliament and of the Council establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single resolution Mechanism and a Single Bank Resolution Fund and amending Regulation (EU) 1093/2010 of the European Parliament and of the Council’ COM(2013) 520 (‘SRM Proposal’). 119 See SSM Regulation (n 7), Recital 85; and European Commission, Communication from the Commission to the European Parliament and the Council, ‘A Roadmap towards a Banking Union, COM(2012) 510 final, 12.09.2012, 9; and European Council, Conclusions (13– 14 December 2012), Euco 205/12, para 11, stating ‘where bank supervision is effectively moved to a single supervisory mechanism, a single resolution mechanism will be required, with the necessary powers to ensure that any bank in participating Member States can be resolved with the appropriate tools’: available online at accessed 14 November 2014. 120 SRM Regulation (n 9), Recital 12.

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Effectiveness, Impact, and Future Challenges Resolution Board (SRB) has direct oversight of resolution matters for over 6,000 credit institutions and investment firms based in the euro area, regardless of their size and cross-border operations.121 Whereas the ECB is responsible for direct supervision of the largest and systemically important banking institutions—about 130 banking groups—while NCAs exercise delegated supervision for about 3,500 banking groups in the BU. Given that the SRM Regulation was agreed in 2014 and became effective in 2016, 2.53 the SRB is not explicitly mentioned in the SSM Regulation that was agreed in 2013 and took effect in 2014, but the SSM Regulation contains a general reference to the role of a resolution authority. An important difference arises between the ECB’s scope of direct supervision and the remit of national resolution authorities falling under the competence of the SRB. Compared to the SSM, the SRB has wider jurisdiction, covering credit institutions, and non-bank financial institutions and large systemically important non-bank financial institutions not directly supervised by the ECB. These institutional and jurisdictional overlaps and gaps reflect a certain lack of symmetry in the design of the supervisory and resolution frameworks of the BU, as the ECB only has direct authority to make determinations of whether a bank should be taken into resolution under the SRM regime for about 130 banking groups and only indirect authority acting through the relevant NCAs to make such a determination for the other 3,500 small and medium sized credit institutions. In contrast, the SRB must consult with the relevant NCAs—either central banks, standalone bank supervisors, or securities regulators—in order to trigger the resolutions of covered investment firms and certain financial groups not subject to SSM supervision. The BRRD and SRM regulations provide a badly needed resolution regime for 2.54 the EU and BU, respectively, which did not previously exist, and can only supplement and enhance the EU regulatory and supervisory framework for banking institutions, particularly in the BU where the ECB has taken on important new supervisory functions. For instance, banks and covered investment firms are required to hold higher amounts of loss absorbent capital and to issue a minimum amount of bonds and certain other unsecured debt instruments that are subject to mandatory write-downs (ie bail-in) if the bank or banking group’s capital levels fall sharply.122 The ECB is responsible for overseeing and approving bank recovery plans123 whilst resolution authorities are required to write resolution plans (also known as ‘living wills’) to plan for how the bank would deal with disorderly markets and even its own failure in the event that it became unviable.124 The

SRM Regulation (n 9), arts 2 and 6(1)–(7). 122 SRM Regulation (n 8), art 27 (‘Bail-in tool’). 123 SSM Regulation, art 4(h)(1) 124 SRM Regulation (n 8), Chap 1 ‘Resolution Planning’, art 8 (‘Resolution plans drawn up by the Board’). 121

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Kern Alexander stricter requirements that banks issue debt capital that can bail-in bondholders and other creditors along with the requirements for recovery and resolution planning means that the resolution framework not only intends to reduce taxpayer exposure to a bank bailout, but also serves the regulatory objective of reducing excessive risk-taking by banks and covered investment firms.125 2.55 The effectiveness of the SSM’s interaction with the SRM was tested in 2017

in the case involving the Spanish bank Banco Popular. In this case, the SSM’s Supervisory Board (SB) made a determination that Banco Popular had lost access to the wholesale funding markets and would soon collapse without adequate funding. After the Governing Council approved the SB determination that Banco Popular was likely to fail, the SRB decided to put the institution into resolution after approval from the Spanish authorities, the Commission and Council. The SRB then conducted a valuation of Banco Popular’s assets and liabilities and decided to transfer the bank’s viable assets to Santander and to use the bail-in tool to recapitalize the bank and impose losses on most of the bank’s bondholders. Although the SRB’s valuation of the bank’s assets and liabilities has attracted some criticism and led to several lawsuits in Spanish and European courts, the restructuring of Banco Popular can be considered to be a successful exercise in co- ordination between the ECB/SSM and the SRB that demonstrates the effectiveness of the SSM-SRM framework and how it can be used effectively to restructure an ailing institution without causing a systemic crisis. The Banco Popular case also demonstrates the necessary sequence of events that should occur when a bank is determined to be unsound and should be taken into resolution: that is, (1) the ECB identifies when a bank is in serious financial difficulties and should be resolved; (2) the SRB—consisting of representatives from the Commission, the ECB, and national authorities of Member States where the bank operates— makes a recommendation on resolution to the Commission; (3) the Commission decides whether to approve the Board’s recommendation for resolution and approve a resolution plan and refers its decision to Council for final review; and (4) national resolution authorities would implement the approved resolution plan under the supervision of the SRB.

2.56 The SRM Regulation also establishes a Single Resolution Fund (SRF) that is

under the control of the SRB.126 The SRF is funded by contributions from all the banks in the participating Member States of the SRM.127 The Inter-Governmental SRM Regulation (n 8), Recital 55. 126 SRM Regulation (n 8), Chap 2 ‘Single Resolution Fund’, arts 67–79. 127 On 21 October 2014, the Commission adopted a delegated act and a draft proposal for a Council implementing act to calculate the contributions of banks to the national resolution funds and to the Single Resolution Fund (SRF), respectively. The delegated act determines how much individual credit institutions will have to pay each year to their respective resolution funds according to the bank’s size and risk profile by setting out in detail: (i) the fixed part of the contribution, which is based on the institution’s liabilities (excluding own funds and covered deposits), as the starting point for determining the contribution; and (ii) how the basic contribution is adjusted in 125

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Effectiveness, Impact, and Future Challenges Agreement (IGA) provides for the transfer of national funds towards the SRF with the Fund reaching a target level of 1% of covered deposits (around € 55 billion) in January 2024 after an eight year transition period that began on 1 January 2016.128 During the transition period, the SRF consists of ‘national compartments’ corresponding to each participating Member State’s resolution authority and fund. The IGA further provides for the activation of the mutualization of risk between the national compartments during the eight year transition period.129 The national compartments are in operation and will become gradually mutualized and will cease to exist at the end of 2023. At the end of the transition period, the Regulation requires a common backstop fund to be established and operational by 1 January 2024.130 The common backstop will facilitate borrowing by the SRF and will ultimately be reimbursed by contributions from the banking sector. Before the back-stop becomes operational, European policymakers are considering additional proposals to the SRF’s financing structuring and have agreed ‘terms of reference’ on how to give the SRF access to emergency loans from the European Stability Mechanism, which presently is responsible for sovereign bailouts. 2. SRB and Meroni A more difficult issue, however, arises regarding the scope and extent of the SRB’s 2.57 discretionary powers to take a bank into resolution, which could undermine the effectiveness of the ECB’s role in making determinations of an institution’s unviability. The Court of Justice of the European (CJEU) has adopted narrow limits to the powers that can be delegated to EU agencies. In the often-cited 1958 Meroni case, the CJEU held that delegation of powers to EU agencies can only relate to clearly defined executive powers, ‘the use of which must be entirely subject to the

accordance with the risk posed by each institution. There is a special lump-sum regime for small banks, as they are less likely to need support from resolution funds. For example, banks representing 1% of the total assets would pay 0.3% of the total contributions by institutions in the euro area. 128 The SRF IGA provides the methodology to the specificities of a unified system of contributions pooled in the SRF on the basis of a European target level. According to a Commission working document, French banks would contribute around €17bn (30%) and German bank €15bn (27%) of the €55bn target fund over eight years. French banks will pay 68% more into the SRF than under the BRRD, German banks and Spanish banks pay 9% less and 44% less respectively. The Commission working document acknowledges that the possibility of introducing a mechanism to limit these deviations is offered by Recital 114 and art 70(2)(b) of the SRM Regulation (n 8), which provide that no distortions shall be created between banking sector structures of the Member States. 129 Council, Legislative Acts and other Instruments, ‘Agreement on the transfer and mutualization of contributions to the Single Resolution Fund, 8457/14, LIMITE, EF 121, ECOFIN 342, art 3, Brussels, 14 May 2014. 130 SRF bridge financing arrangements became operational in 2016 and involve a transition from national resolution fund sources, paid for by bank levies, or from the European Stability Mechanism (ESM) and permit temporary transfers between national compartments of the SRF will also be possible.

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Kern Alexander supervision of the [Commission].’131 The CJEU elaborated further on the Meroni doctrine when it upheld the EU short-selling regulation on the basis of article 114 TFEU that allows EU legislation to delegate to EU agencies powers to adopt implementing measures (non-policy measures) to improve the conditions for the establishment and functioning of the internal market.132 In the short-selling case, the EU short-selling regulation delegated powers to the European Securities and Markets Authority to make determinations of market conditions that allow it to prohibit the short-selling of bank stocks during periods of market distress. It should be emphasized, however, that the CJEU has interpreted the Meroni doctrine as holding that the EU legislator cannot delegate discretionary powers of a policymaking nature from the Commission to an EU agency, as this would upset the EU institutional balance established by the Treaty.133 2.58 As the SRB is an EU agency, its scope of powers to take discretionary decisions

is limited by Meroni case law. The Commission has explained that this is why ultimate decision-making authority regarding whether to take a bank into resolution rests with the Commission and Council. Nonetheless, without a firm legal basis, a resolution decision recommended by the SRB to the Commission could be challenged in the courts. This has occurred in the case involving the shareholders and bondholders of the Spanish bank Banco Popular, which was taken into resolution by the SRB in May 2017, and has triggered a wave of lawsuits in Spanish and European courts regarding the issue of whether the SRB has acted ultra vires.

2.59 In addition, the SRM’s operations are limited by Member States’ fiscal sover-

eignty, that is, the right not to be compelled by the Commission and Council in approving a SRB recommendation that a bank should be restructured with temporary public financial support from the national resolution authority’s public fund if the Single Resolution Fund has inadequate funds. This means that supra- national EU resolution powers end where the Single Resolution Fund proves to be

131 Meroni & Co. Industrie Metallurgiche, SpA v High Authority of the European Coal and Steel Community [1958] ECR 133, 152 (C-9/56). See discussion of Meroni doctrine in Stefan Griller and Andreas Orator, ‘Everything Under Control? “The Way Forward” for European Agencies in the Footsteps of the Meroni Doctrine’ (2010) 35 European Law Review 3. See also Merijn Chamon, ‘EU Agencies: Does the Meroni Doctrine Make Sense?’ (2010) 17 Maastricht Journal European and Comparative Law 281. 132 UK v Parliament and Council ECLI:EU:C:2014:18 (Case C-270/12); cf Germany v Parliament and Council [2000] ECR I-8419 (Case C-376/98), however holding that the Directive on advertising and sponsorship of tobacco products did not have as its genuine objective the establishment and functioning of the internal market, but instead public health considerations. 133 See Meroni & Co. Industrie Metallurgiche, SpA v High Authority of the European Coal and Steel Community [1958] ECR 133, 152 (Case C-9/56); United Kingdom v European Parliament and Council [2005] ECR I-10553, paras 41–50 (Case C-66/04) (Smoke Flavourings); and United Kingdom v European Parliament and Council [2006] ECR I-3771, paras 42–5 (Case C-217/04) (ENISA).

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Effectiveness, Impact, and Future Challenges inadequate. The Meroni doctrine and Member State fiscal sovereignty may therefore continue to prove to be obstacles to the effective operation of the SRM.134 3. SRB’s Broad Powers and Legal Uncertainty The SRM allows the SRB and Member State resolution authorities substantial 2.60 discretion in deciding whether or not to put a failing bank into resolution, if the prospect of putting the bank into resolution might, in the view of the resolution authority, cause significant adverse consequences to the economy or financial instability.135 This type of financial crisis exemption can serve valid regulatory objectives by allowing regulators flexibility in responding to the unique circumstances of a crisis or severe economic dislocation. The SRM however provides no discernible criteria for determining whether a bank resolution is likely to cause severe adverse consequences, financial instability or a systemic crisis. The lack of agreement between resolution authorities and policymakers about what might cause financial instability or a systemic crisis may result in unjustified regulatory forbearance. Influential investor groups and financial institutions, facing potentially substantial losses in a bank resolution, may pressure politicians and regulators during a crisis to forbear in the use of resolution tools and to use taxpayer money instead to bail out a bank. Moreover, the SRB’s task is especially difficult because the definition of a systemic financial threat or systemic crisis is much debated and there is no agreed upon definition by economists nor under EU law.136 In addition, the regulation permits, under exceptional circumstances, the SRB 2.61 to exclude or partially exclude certain bank investors (ie bondholders) from mandatory write-downs or debt-to-equity conversions on their investments.137 Exceptional circumstances are not defined in the regulation and can be subjectively assessed by the SRB in its broad discretion. This occurred in the Banco Popular case and has led to may lawsuits by the bondholders who were bailed-in.

134 The Commission’s powers as a resolution authority do not include the power to require a Member State to provide extraordinary public support to a bank: SRM Regulation (n 8), art 6(4). 135 SRM Regulation (n 8), art 14(2)(a)–(e). Specifically art 14(2)(b) provides that resolution objectives include avoiding ‘significant adverse effects on financial stability, in particular by preventing contagion, including to market infrastructures, and by maintaining market discipline.’ The wide range factors relied on by the SRB in determining whether a resolution is in the public interest grants the SRB broad discretion in deciding whether to put a bank into resolution or not: SRM Regulation (n 8), art 18(5). 136 See Garry J Schinasi, Safeguarding Financial Stability: Theory and Practice (International Monetary Fund 2005) 81 (citing the Group of Ten 2001 report stating ‘[s]‌ystemic financial risk is the risk that an event will trigger a loss of economic value or confidence in, and attendant increases in uncertainty about, a substantial portion of the financial system that is serious enough to quite probably have significant adverse effects on the real economy.’ Group of Ten, ‘Report on Consolidation in the Financial Sector’ (International Monetary Fund 2001), 126–7, available online at accessed 6 December 2018. G10, 2001 Report, 126–7). 137 SRM Regulation (n 9), arts 14 and 27(5)(a)–(d).

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Kern Alexander It is submitted that the discretions and exceptions to the application of resolution powers and tools in the regulation undermine legal certainty and the predictability of the Single Resolution Mechanism for market participants, and that this undermines the effectiveness of the SSM. 4. SSM Co-ordination with SRB 2.62 As discussed above, the ECB/ SSM has established other channels of close co-

operation with the SRB. The SSM and SRB agreed a MOU that allows for the exchange of information necessary for the SRB to prepare and take resolution actions.138 However, there appears to be some overlap between the early intervention powers in the bank recovery and resolution directive (BRRD)139 and similar early intervention powers listed in the SSM Regulation, each backed by different procedures. The ECB can opt for the BRRD early intervention powers that are transposed into national legislation, or can choose the same or equivalent powers set forth in the SSM Regulation. The ECB may decide to circumvent the more complex domestic legal and procedural requirements attached to the use of early intervention powers under the BRRD, and instead rely on the more familiar early intervention powers of the SSM Regulation.

2.63 The institutional and legal complexities of co- ordinating early intervention

powers between bank supervisors and resolution authorities are discussed in a White Paper published in 2017 by the Banco Central do Portugal that analyses some of the main legal and regulatory issues involved in the allocation of powers between central banks, supervisory authorities and resolution authorities in the Banking Union. The report critically analyses the institutional gaps and legal uncertainties that limit the effectiveness of the SRM in part due to the limited role of the SSM in the resolution process. The report also analyses pre-SRM EU law on bank resolutions in the context of the Banco de Portugal case that involved the application of bail-in powers against bondholders of Banco de Portugal, a bank taken into resolution under Portugese law prior to implementation of the bail-in rules under the BRRD.140

2.64 Further complexities regarding early intervention powers and supervisory powers

arise in the context of the SRB’s (and other Member State authorities) powers to require banks and covered financial groups and conglomerates to change their organizational structure if the SRB determines that the bank or banking group’s organizational structure is a substantial impediment to a feasible and credible

Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 53–4. 139 BRRD Directive 2014/59/EU (n 108), Title III. 140 See Banco de Portugal, ‘White Paper on the regulation and supervision of the financial system’ (white paper, Banco de Portugal 2016) Pt VI, available online at accessed 6 December 2018. 138

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Effectiveness, Impact, and Future Challenges resolution of the bank or group.141 If the SRB, acting in consultation with national resolution authorities, determines that there are substantial impediments to the implementation of the resolution plan, it may order the institution to remove the impediments, including changing its organizational structure or business activities.142 Indeed, this could involve changes to the legal, operational and financial structure of institutions or the group itself and their business activities.143 In ordering the removal of such organizational impediments, the SRM Regulation sets out procedural and substantive rules about how the institution or group can be required to reduce or remove these impediments. To this end, the SRM Regulation requires the SRB to draw up resolution plans after 2.65 consultation with the national competent authorities (including the European Central Bank) and national resolution authorities, including the group resolution authority. Article 10(11) of the SRM Regulation requires the SRB, when drafting and revising the resolution plan, to identify any material impediments to resolvability and, based on the EU legal principles of necessity and proportionality, to instruct the relevant national resolution authority to take the necessary measures to address those impediments.144 The SRB can also require the relevant national resolution authority to take specific measures to require the institution to remove the impediments, if the institution subject to resolution powers can potentially draw on funds from the Single Resolution Fund.145 The SRB and the relevant national resolution authority are required to notify the 2.66 firm in writing of any substantial impediments they have identified, and the firm or group will have the opportunity to address these concerns and propose measures to eliminate these impediments. The SRM Regulation provides that if the firm’s or group’s proposals are considered inadequate, the resolution authority will have the power to take specific actions that address or remove the impediments to resolvability.146 In selecting the appropriate measure to remove the impediments, the ECB has worked with resolution authorities to choose a measure based on the

141 BRRD Directive 2014/59/EU (n 100), art 17(5). Under art 17(5) of the BRRD the resolution authority is empowered to conduct a resolvability assessment to identify whether or not there are substantial impediments to the implementation of a credible and feasible resolution plan. 142 In considering whether to order a bank to remove such organizational impediments, arts 15 and 16 of the BRRD and SRM Regulation (n 9) provide that the resolution authority must consult the competent supervisory authority regarding the resolution authority’s determination of whether or not there are substantial impediments to the resolvability of a firm. 143 The European Banking Authority has developed a Guideline on ‘Conditions for Measures to Overcome Obstacles to Resolvability’, for resolution authorities to rely on in considering whether to take measures under art 17(5). 144 SRM Regulation (n 8), art 10(11). 145 Ibid: ‘Where applicable, the national resolution authorities shall directly take the measures referred to in points (a) to (j) of the first subparagraph’. 146 BRRD Directive 2014/59/EU (n 97), art 17(5), which provides a non-exhaustive range of powers for authorities to remove firm impediments to resolvability in advance of failure that may be used if measures proposed by firms are insufficient to ensure resolvability.

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Kern Alexander nature of the impediment. These measures can be classified in three categories— structural, financial and information-related or data management. The use of these measures involve a large degree of technical analysis of bank balance sheets and corporate group structures, but nevertheless also involve a substantial amount of discretionary decision-making based on criteria that fall within a large range and are not prioritized in any meaningful way. These assessments of the nature of organizational impediments to effective resolution planning has necessarily involved the ECB in close co-operation with the SRB and Member State resolution authorities regarding the extent of organizational impediments and how they should be addressed in the context of resolution and recovery planning.

V. SSM, Macroprudential Tools, and National Competent Authorities 2.67 This section analyses the SSM’s interaction with national competent authorities

and the views of NCAs regarding the SSM’s effectiveness in achieving its regulatory objectives. The ECB is responsible for the effective and consistent functioning of the SSM and for ensuring that national competent authorities (NCAs) are fulfilling their supervisory responsibilities for less significant institutions as set forth under Articles 4, 5, and 6 of the SSM Regulation.147 This section analyses how the ECB carries out its prudential supervisory tasks in co-ordination with participating NCAs and considers some of the views of NCAs and Member State Authorities regarding how the SSM is operating and whether or not it is achieving its objectives.

2.68 The ECB Supervisory Board is responsible for overseeing the supervisory actions

of participating NCAs that supervise directly less significant institutions in the SSM regime.148 The SB has ultimate authority to decide what directives on complying with prudential requirements to issue to institutions directly supervised by the ECB and to NCAs regarding institutions not directly supervised by the ECB. For instance, the ECB has discretion to intervene—either on its own initiative or if it is requested to intervene by the NCA—and take direct oversight of less significant institutions that are ordinarily subject to direct supervisory control by NCAs if the ECB determines that it is necessary to meet its objectives under the SSM Regulation or to ensure that the relevant NCA is fulfilling its supervisory responsibilities.149

SSM Regulation (n 5), arts 4 and 6(1). 148 Ibid, art 6(7)(a)–(c). See also art 26(8) (SB shall adopt ‘draft decisions’ ‘to be transmitted ( . . . ) to the national competent authorities of the Member States concerned’). 149 Ibid, art 6(5)(b): ‘when necessary to ensure consistent application of high supervisory standards, the ECB may at any time on its own initiative after consulting with national competent authorities or upon request by a national competent authority, decide to exercise directly itself all the relevant powers for one or more credit institutions’. 147

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Effectiveness, Impact, and Future Challenges Some Member States, however, have expressed concerns about the concentration of 2.69 powers in SB governance and decision-making. For example, the BaFin has expressed a concern about SB decision-making and the allocation of competences between the SB and ECB Governing Council in which SB decisions can only have external effect on institutions with approval of the Governing Council. As the SB decides on common procedures for approximately 3,500 institutions in the SSM, it is not efficient to have all SB decisions regarding the adoption of common procedures approved by the Governing Council. This leads to an unnecessary administrative workload for the Governing Council if it has to deal with so many supervisory issues when the SB can be relied upon to take such decision. Another Member State concern has been that too much supervisory decision-making 2.70 regarding an institution’s day-to-day operations has been centralized in the SB, rather than vested with NCAs. Rather, the SB should be focusing its decision-making on more fundamental areas including monitoring institutions’ compliance with supervisory rules, approving governance strategies, including bank board appointments, and investigations and enforcement. Instead, there is a growing number of issues that the SB is expected to address in the day-to-day operations of an institution that involves a complex process of co-ordination with the relevant NCAs, the ECB’s direct supervisory teams, and ECB senior management including all members of the SB. Furthermore, regarding small, regional and non-complex institutions, the German 2.71 BaFin has emphasized the importance of supervisory practice and regulatory rules aiming to achieve a balance between harmonization and proportionality.150 For example, less strict reporting requirements should apply for medium and smaller institutions, especially those that are not systemically important. The principle of proportionality should also be applied in other supervisory processes, such as the review of bank risk governance under the Supervisory Review and Evaluation Process (SREP) and the design of stress tests and assessment of compliance with hypothetical stress testing scenarios.151 1. The SSM, NCAs, Supervisory Colleges, and Joint Supervisory Teams The ECB is responsible for direct supervision of ‘significant’ credit institutions, 2.72 which represent over 80% of banking assets in the euro area.152 The ECB is also indirectly responsible for the supervision by national competent authorities of Federal Ministry of Finance (n 30). 151 Stamegna (n 53). 152 See Deutsche Bundesbank, ‘Launch of the Banking Union: the Single Supervisory Mechanism in Europe’ (October 2014) Monthly Report 43, available online at accessed 6 December 2018. The criteria used to define a bank as significant are: total value of assets exceeding €30 billion, whether it is one of the top three largest banks in its home Member State; its importance to the economy of its home state or the EU as a whole; the extent of its cross-border activities; and whether it has requested or received direct public financial assistance from the European 150

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Kern Alexander smaller, less systemically important institutions.153 When the SSM went into effect in November 2014,154 several significant institutions objected to being subject to direct ECB supervision. One of these banks, Landeskreditbank Baden- Württemberg—Förderbank, requested a review of the decision determining it to be significant and petitioned for judicial review with the EU General Court after the SSM Administrative Board of Review (ABoR), established as an independent body of first review, rejected its request to be classified as a less significant institution.155 The General Court interpreted the language of article 4 (1) of the SSM Regulation to entrust the ECB exclusively with the tasks listed in that article (all microprudential supervision) for all credit institutions in the Euro Area.156 The court further observed in paragraph 72 of the judgment that ‘under the SSM national authorities are acting within the scope of decentralized implementation of an exclusive competence of the Union, not the exercise of national competence.’ Commentators have observed that the practical effect of the judgment is that for a request to be classified as less significant, the applicant needs to prove that direct ECB supervision would be less likely than national supervision to achieve the SSM Regulation’s overall objective of consistent application of high prudential standards;157 and that a significant entity cannot escape direct ECB supervision by showing that national supervision was just as effective as the ECB in achieving the SSM Regulation’s objectives.158 Moreover, L-Bank’s argument that the ECB’s

Stability Mechanism (ESM) or the European Financial Stability Facility (ESFS); SSM Regulation (n 5), art 6(4)(i)–(iii). 153 SSM Regulation (n 6), art 4(1): ‘in relation to all credit institutions established in the participating Member States’. 154 SSM Regulation (n 6), art 33(2). 155 See R Smits, ‘Competences and alignment in an emerging future After L-Bank: how the Eurosystem and the Single Supervisory Mechanism may develop’, (Oct 2017), ADEMU Working Paper Series, WP 2017/077, 1–40, 3–6, providing detailed analysis of the L-Bank case as it was decided by ABoR and the European General Court. 156 See Case T-122/15 Landeskreditbank Baden-Württemberg—Förderbank v European Central Bank (ECB) [2017], 4, see also the arguments made on pages 8–10. As of 2019, the CRD V directive, which amends CRD IV, expicitely excludes The ‘Landeskreditbank Baden-Württemberg— Förderbank’ from the scope of the directive in art 2(5). Various other European banking institutions are also listed in art 2, among them similar German ‘undertakings which are recognised under the “Wohnungsgemeinnützigkeitsgesetz” as bodies of State housing policy and are not mainly engaged in banking transactions, and undertakings recognised under that law as non-profit housing undertakings[.]‌’ See art 2(5) of Directive 2019/878 of the European Parliament and of the Coucil of 20 May 2019 amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures, and powers and capital conservation measures [2019] OJ L150/253 (CRD V). 157 See Regulation (EU) 468/2014 of the European Central Bank of 16 April 2014 establishing the framework for co-operation within the Single Supervisory Mechanism between the European Central Bank national competent authorities and with national designated authorities (SSM Framework Regulation) [2014] OJ L141/1, art 70. See also Smits (n 155), 5–7. 158 See Regulation (EU) 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2013] OJ L287/63, art 5(b), Recitals 12, and 83: ‘supervision of the highest quality, unfettered by other, non-prudential considerations’.

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Effectiveness, Impact, and Future Challenges classification of it as a significant institution lacked proportionality and violated the subsidiarity principle under EU Treaty law was rejected by the Court in light of the exclusive competence transferred to the ECB to supervise credit institutions against the subordinate role attributed to the NCAs under the Regulation.159 On appeal, the Court of Justice of the European Union (CJEU) upheld the 2.73 General Court’s ruling that all prudential competences covered by Article 127(6) of the TFEU have been allocated exclusively to the ECB, with NCAs acting by delegation when executing their own powers, such powers having previously been exercised by NCAs prior to adoption of the SSM Regulation.160 The effect of the L-Bank case on a bank’s right to challenge a SB decision taken pursuant to its powers in Articles 4–6 will be discussed in more detail in section IV. A. Supervisory Colleges and Joint Supervisory Teams Article 6(7)(b) of the SSM requires that the ECB and national competent au- 2.74 thorities (NCAs) establish a public framework for making practical arrangements between the ECB and the NCAs to co-ordinate oversight of ‘credit institutions’ not considered as less significant.161 Under EU banking law, the home country supervisor of a credit institution or financial conglomerate that has activities and operations in host Member States is required to form a supervisory college for that particular institution. The formation of supervisory colleges is facilitated by the European Banking Authority, but within the euro area where the ECB takes the lead in supervising significant institutions in participating Member States, the ECB plays the main role in forming supervisory colleges for credit institutions it directly supervises, whilst the NCAs of participating Member States in which the parent companies of financial conglomerates, subsidiary credit institutions and significant branches are established will participate in the college as observers.162 Also, as required by Article 9(2) of the SSM Framework Regulation, the ECB and host Member State competent authorities in non-participating Member States have established colleges of supervisors where significant entities (under direct supervision of the ECB) have significant branches in those non-participating Member States.163

159 Ibid, paras 64 and 65. 160 Case C-450/17 P Landeskreditbank Baden-Württemberg v ECB [2019] paras 108–15. 161 Regulation (EU) 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2013] OJ L287/63, art 6(7)(b). 162 Ibid, art 9(1). 163 See Regulation (EU) 468/2014 of the European Central Bank of 16 April 2014 establishing the framework for co-operation within the Single Supervisory Mechanism between the European Central Bank national competent authorities and with national designated authorities (SSM Framework Regulation) [2014] OJ L141/1, art 9(2).

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Kern Alexander 2.75 The rules governing the participation status of Member States as either a ‘member’

or an ‘observer’ in a college is set forth in Article 10 of the SSM Framework Regulation. Where the consolidating supervisor is not in a participating Member State, the following rules will apply. For a significant supervised entity, the consolidating supervisor chairs the college and the ECB is a member, while host NCAs are observers. For less significant entities, all national competent authorities where they operate are members of the college. If the supervised entities in a participating Member State are both less significant and significant entities, the ECB and NCAs are members. The country in which the significant supervised entity is established will be an observer in the college of supervisors.164

2.76 As mentioned above, the EBA has facilitated the creation of the supervisory

colleges which report primarily to the EBA. The SSM, however, has built on the college structure to create joint supervisory teams (JSTs) for ECB supervised credit institutions. The JSTs consists of supervisory representatives of many of the colleges and more technical experts in specialized areas of supervision. Participating Member States have noted the challenges in overseeing and directing the work of the JSTs. For instance, the German BaFin165 has noted some of the challenges for JSTs as geographical distance, language barriers, multi-dimensional reporting lines, different supervisory cultures. These obstacles have undermined effective communication and transparency of decision-making with the teams.

2.77 The JSTs have achieved much progress in enhancing the rigour of supervision in

such a short period of time since the creation of SSM, including enhanced collaboration between work areas and establishing a minimum level of trust between JST members from different NCAs. Nevertheless, a BaFin paper notes the challenges that remain regarding ‘integration of very different supervisory cultures, languages and banking system under one roof remains a challenge, as does the readjustment in important areas like governance and the SREP’.166 For example, NCAs have expressed some concerns including the double unco-ordinated reporting lines, such as NCA staff are required to report to NCA and JSTs.167 Also, there are concerns regarding language in relation to supervised institutions. For many less significant institutions, internal documents are not written in English, and this poses a challenge to JSTs whose members usually have diverse nationalities and who communicate in English. Moreover, JSTs sometimes suffer from insufficient staff allocations to address complex tasks.

164 Ibid, art 10(c). 165 Stefan Iwankowski and Miguel Guthausen, ‘Two years of the SSM: a lot done, a lot more to do’ (BaFin Division for SSM/SB Coordination 17 October 2016), available online at accessed 16 November 2018. 166 Ibid. 167 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 50), 30.

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Effectiveness, Impact, and Future Challenges To address these weaknesses, the President of the Banque de France and a few 2.78 NCAs have expressed the view that the SB should work with NCAs to develop common review processes.168 For instance, the common supervisory review and evaluation process (SREP) for significant institutions (SIs) is resource-intensive, but it is an important part of enhancing the quality of supervisory review and will improve the standard of supervision. Although it is important that the ECB oversees the implementation of SREP methodologies, it is submitted that NCAs should have more input in the design of the SREP process and in creating a more transparent methodology for supervisory review and addressing other process- related issues. Also, the BaFin observes that the SSM should approve a more rigorous method- 2.79 ology for supervisory review for less significant institutions.169 In response, the SB has approved a key project to introduce SREP for less-significant institutions (LSIs) in collaboration with the EBA. The responsibility for developing SREP methodologies for LSIs should remain with NCAs and should not be contradicted by SSM provisions which are unnecessarily granular and intrusive onto the NCA’s pillar 2 supervisory discretion.170 2. Regulating Home-Host Responsibilities The SSM rules apply to existing home-host supervisory arrangements, but where 2.80 the ECB has taken over prudential supervisory tasks under Article 4 of the SSM Regulation, it carries out the functions of both the home and host authorities of participating Member States.171 Moreover, the ECB acts as a host supervisor in relation to significant branches operating in participating Member States which have home offices in non-euro area countries and for other branches considered as significant institutions which have home offices in third countries outside the EU/EEA.172 This means where a branch is established in a host SSM country, the ECB will have competence to supervise the branch if it is a significant entity. If the branch is less significant, the host country national competent authority will have competence to supervise its compliance with EU bank prudential regulatory requirements.

168 Frédéric Visnovsky, ‘Le Mécanisme de Supervision Unique Deux Ans Après’ (Séminaire de Recherche Sciences-Po/Banque de France, November 2016), available online at accessed 16 November 2018. 169 Stefan Iwankowski and Miguel Guthausen, ‘Two years of the SSM: a lot done, a lot more to do’ (BaFin Division for SSM/SB Coodrination 17 October 2016), available online at accessed 16 November 2018. 170 Ibid. 171 SSM Regulation (n 6), art 4. 172 Commission, ‘Commission Staff Working Document, Report on SSM’ (n 51), 24.

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Kern Alexander 2.81 The ECB shall act as the ‘consolidated supervisor’ over credit institutions, finan-

cial holding companies and mixed holding companies on a consolidated basis. The ECB has plenary competence to supervise all the operations of the credit institution and financial holding companies established in participating Member States or in a Member State that has opted into the SSM on a cross-border basis regardless of whether the credit institution is operating through subsidiaries or branches in the participating host state. Under the SSM Framework Regulation, the ECB’s practice has been to allocate powers of consolidated supervision by direct supervision of significant institutions that are determined as such on a consolidated basis ‘where the parent undertaking either is a parent institution in a participating Member State or an EU parent institution established in a participating Member State’.173 The relevant national competent authority in the state where the credit or parent institution is established is responsible for supervising the same financial entities that are deemed by the ECB to be less significant.174

2.82 The exercise of supervisory powers by the competent authority of the host Member

State is governed by Article 14 of the SSM Framework Regulation. The ECB has supervisory competence over the host Member State where the branch is significant and will supervise the branch directly. Where the institution is less significant, the ECB allocates supervisory powers to the host Member State.175 Where a credit institution from a non-participating Member State seeks to provide services in a participating Member State, the non-participating NCA is required to notify the host participating Member State which shall then notify the ECB.176

2.83 The ECB competence to supervise credit institutions in host Member States

for the free provision of services where the institution is established in a non- participating Member State raises important legal issues regarding the scope of host Member State authority to impose conditions on the provision of services (ie consumer financial services) for the general good or pursuant to other areas of EU or domestic law.177 For instance, the ECB’s supervisory competence does not include the competence of participating host states to use their powers to adopt domestic legislation implementing EU directives that require significant or less significant institutions to comply with requirements concerning anti-money laundering, counter terrorist financing including sanctions, and conduct of business in the sale of financial products (ie MiFID II).

2.84 A significant entity seeking to establish a branch or provide services in a non-

participating Member State is required to notify its relevant NCA.178 The home

Ibid, art 8(1). 174 Ibid, art 8(2). 175 SSM Framework Regulation, art 14(2) provides that ‘the NCA of the participating Member State where the branch is established shall exercise the powers of the host MS’. 176 Ibid, art 15. 177 Ibid, art 16(1). 178 Ibid, art 17(1). 173

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Effectiveness, Impact, and Future Challenges state authority then will be required to inform the ECB, which will exercise the powers of home country supervisor under EU law. A less significant entity is required to inform the relevant NCA where it is established. The NCA will then exercise the powers of the home state supervisor. The role of the host Member State therefore depends on the significance of the supervised entity. This influences the host state authority’s right to receive notifications from the ECB and home state authorities. It also influences the role of the host state in participating in the college of supervisors for that particular institution. However, all incoming branches—either as part significant or less significant entities—are subject to the domestic law requirements that implement other EU legislation that impose conditions on the branches in the interests of the general good. Under the home-host framework, the Supervisory Board’s role in overseeing the 2.85 cross-border operation of significant institutions extends not only to banks established in participating Member States but also to banks and mixed financial conglomerates based in other EU states and third countries. This results in considerable influence for the ECB over the home operations of incoming institutions in the areas of capital and liquidity management and risk governance. The ECB has utilized multi-disciplinary and multi-lingual teams of supervisors to apply intensive scrutiny of the home country operations of systemically significant institutions with branch operations in participating Member States, butthere are concerns that the SB and the JSTs attempt to micro-manage and second guess home country authorities on matters related to bank governance and capital management has created unnecessary frictions with home country authorities. On the other hand, the governance failure at Danske bank involving the bank’s systemically important Estonian branch accepting €25 billion of deposits from Russian and Ukrainian entities without verifying the sources of the proceeds has shed light on misconduct risk and raised doubts about the ECB’s capacity to prevent or limit governance failures at institutions with systemic branches under SSM supervision.179 The ECB has also demonstrated shortcomings as a home country supervisor in co-ordinating with home country NCAs to ensure that large systemically important institutions with subsidiaries operating outside the EU are not being used as vehicles for tax evasion and money laundering.180 Brexit also poses a number of concerns for the ECB in conducting home-host 2.86 oversight of Eurozone-based banks with significant trading operations in London. In most cases to date, the ECB has deferred to UK supervisors in overseeing the

179 See Richard Milne, ‘Danske Bank plans culture revamp after money laundering scandal’ Financial Times (London, 1 November 2018), available online at accessed 11 December 2018. 180 See Olaf Storbeck, ‘Deutche Bank Reports Suscipious Tax Transactions’ Financial Times (London, 9 December 2018), available online at accessed 11 December 2018.

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Kern Alexander significant branches or subsidiaries of Eurozone-based banks with large trading operations in London. Many of these banks engage in ‘back-to-back’ trades through their London offices that require that they keep centralized risk management functions, capital and liquidity support booked in the London branches or subsidiaries. The ECB stated in 2018, however, that post-Brexit it will require Eurozone based banks with London offices to move their back-to-back trading operations back to subsidiaries based in Banking Union jurisdictions to be directly supervised by the ECB. Home-host co-ordination between the ECB and other EU states and third country states (especially the UK post-Brexit) will continue to create supervisory tensions and therefore remain a work in progress. 3. Supervisory Review and Legal Uncertainty 2.87 The SSM legal framework’s interaction with EU prudential banking legislation

has created a number of complexities and uncertainties regarding the allocation of powers between the ECB/SSM and NCAs over the implementation, application, and enforcement of prudential supervisory requirements. Some ECB supervisory requirements are defined by EU Regulations (ie Capital Requirements Regulation 2013) that apply directly to the Member States and for which the ECB has competence to interpret and apply to both significant and less institutions, whereas some supervisory powers are defined by Directives (ie the Capital Requirements Directive 2013) that must be interpreted and implemented by Member States into their domestic law before the ECB can apply them to institutions. This parallel process of applying the requirements of Regulations and Directives has created complexity and legal uncertainty because the definition and scope of prudential requirements that derive from Directives may vary across Member States due to differences in implementation and in the scope of discretion and opt-outs between NCAs. Moreover, even under SSM Regulation Article 4(3), where a regulation (ie CRR) provides for options for Member States, the ECB will ‘apply the national legislation exercising those options’. Although Article 4(3) intends to contribute to coherent supervision, it may ‘paradoxically’ prevent it,181 as the ECB can apply different opt-outs or delegations under different national laws for significant institutions, which are simultaneously also applied by NCAs for less significant institutions.182 This has resulted in the ECB having to apply different prudential requirements and opt-outs under domestic law that derive both from Regulations and Directives.183 These discrepancies in national legislative and regulatory requirements between Member States (which the ECB must apply) create an un-level playing field, legal uncertainty and potentially undermine the further 181 Florin Coman-Kund and Fabian Amtenbrink, ‘On the Scope and Limits of the Application of National Law by the European Central Bank Within the Single Supervisory Mechanism’ (2018) 33 Banking & Finance Law Review 133. 182 Ibid, 170. 183 Wymeersch, ‘SSM’ (n 16), 106–07.

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Effectiveness, Impact, and Future Challenges development of a harmonized banking supervisory framework in the Banking Union and in the EU.184 Although this could potentially create ‘inconsistencies and contradictions’ in the 2.88 interpretation and application of the new European supervisory framework because of the extent of discretions and options under Member State law, the ECB is expected to manage these discrepancies by applying the SREP in a manner that mitigates the inconsistencies between Member States, but it is recognized that more needs to be done.185 Also, further complexity arises when the ECB applies national law when EU 2.89 directives are transposed into domestic law, which demonstrates the complexity in a regulatory system in which the ECB applies and implements national law deriving from EU directives differently across participating Member States than it does when it implements national law deriving from Regulations. Beyond core areas that are ‘adjacent’ to prudential supervision, there are a number 2.90 of supervisory competences which the ECB has declared to fall within its remit. In letters of the summer of 2016 and the spring of 2017, the ECB has ‘clarified’ which ‘specific supervisory powers granted under national law which are not explicitly mentioned in Union law’ nevertheless fall within the scope of the ECB’s direct powers.186 The ECB calls this a ‘clarify[cation] (sic) of the delineation of competences between the ECB and the [NCAs] as regards the exercise of certain supervisory powers granted under national law’ which it has carried out in co-operation with the Commission. The supervised entities are requested187 to address the relevant Joint Supervisory Team on such matters (with certain exceptions, in which cases they still need to involve the NCA as the first contact point). National law continues to apply. Notably, State procedural provisions will determine the outcome of the ECB’s assessments, which will be carried out in compliance with the national legal provisions. This includes outsourcing; requests for information to auditors; approval of 2.91 holdings in non-banks or in banks outside the EU; mergers or asset transfers; the appointment of external auditors; and of key function holders. Most relate to significant institutions only, while others concern all credit institutions—this distinction goes back to the fact that the ECB exercises full supervision of significant institutions but is also responsible for authorization and assessment of the

184 Ibid,107. 185 Coman-Kund and Amtenbrink ‘Scope’ (n 176), 171. 186 See Petra Senkovic, ‘Additional clarification regarding the ECB’s competence to exercise supervisory powers granted under national law’ (ECB letters to banks SSM/2017/0140, European Central Bank 31 March 2017), available online at accessed 6 December 2018. 187 SSM Framework Regulation, art 95.

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Kern Alexander suitability of shareholders of all credit institutions. The EU legislator has made the ECB the gate-keeper of the banking market across the Euro Area. Because of the central importance of these competences to the soundness of banks, the ECB is competent to apply these national provisions, and to specify so to the supervised entities. The legislator has not been able to identify all the applicable national provisions in advance and to determine which were to be exercised by the ECB and which by NCAs. Instead, it relied on a wide description of the relevant laws the ECB is to apply. The ECB asserts that it ‘may also exercise supervisory powers granted under national law, even if they are not explicitly mentioned in Union law as they (i) fall within the scope of the ECB’s tasks under Articles 4 and 5 of the SSM Regulation; and (ii) underpin a supervisory function under Union law.’188 Article 9(1), paragraph 3 of the SSM Regulation provides that the ECB can instruct NCAs to make use of their powers ‘under and in accordance with the conditions set out in national law’ but that the ECB’s use of such powers is limited to the extent that it is necessary for it to discharge its tasks under the SSM Regulation and only to the extent that the SSM Regulation ‘does not confer such powers on the ECB.’189 Article 9(1), paragraph 3 cannot therefore be used to vest the ECB with new supervisory tasks. 2.92 Nevertheless, a certain ‘competence creep’ may seem to be implied for the super-

vised entities as they had to adapt to different modes of operations during periods of market instability such as between the winter of 2014 and the spring of 2017. Further alignment of supervisory practices may lead to harmonization of national rules, even when not implementing one-to-one provisions of EU directives, such as CRD IV. In this way, the ECB is in a position to facilitate a type of bottom-up harmonization.190

2.93 The ECB published an advisory letter in 2017 providing an overview of the

national provisions which, henceforth, are considered ECB competences.191 Although this letter provides useful insight into what areas of national prudential law that the ECB believes falls within its jurisdiction, the ECB also provides a detailed list indicating which areas of supervision remain the sole competence of NCAs/Member States. Specifically, the ECB states in the advisory letter that: national authorities remain exclusively competent to exercise powers which do not fall within the scope of the ECB’s tasks or which do not underpin the ECB’s supervisory function. This applies in particular to (i) macroprudential supervisory tasks, (ii) the approval of mergers from a competition law, (iii) the ‘supervision’ of external auditors, (iv) the imposition or enforcement of conditions attached by regulation to banking activities such as product rules; and (v) the imposition of penalties to Senkovic (n 188), 2. 189 Article 9(1) also provides that the ECB can instruct national authorities to use their only ‘where [the SSM Regulation] does not confer such powers on the ECB.’ 190 I thank Eilis Ferran for this observation. 191 Senkovic (n 188). 188

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Effectiveness, Impact, and Future Challenges absorb the economic advantage gained from the breach of prudential requirements (which primarily serve competition law purposes).192

The areas of supervision identified by the ECB as not its own, because neither 2.94 falling within the scope of the ECB’s tasks nor underpinning the ECB’s supervisory function, is a recognition of the limits of its supervisory competences and the barrier beyond which its efforts to promote harmonized standards are unlikely to go. However, it should be noted, as discussed below, that the ECB itself does have an explicit macroprudential function pursuant to Article 5(2) of the SSM Regulation, so that the ‘exclusivity’ of macro oversight for NCAs is debatable. What has become apparent since the SSM became operational and a future chal- 2.95 lenge is that the boundaries between European and national competences may be blurred regarding what the ECB should be expected to do when confronted with national law that has not, or has incorrectly, implemented Union law. Incorrect transposition has included cases where the ECB, as a European institution, cannot but find that there has been an incorrect implementation. This latter case can be distinguished from the many cases where implementation cannot be said to be incorrect but simply to deviate from the approach taken in other Member States (varied implementation). In case the ECB is confronted with national law which does not implement a directive, such as CRD IV, in order to avoid the complexity and uncertainty of a Commission infringement proceeding, the ECB might consider, in cases where applying national law would lead to obviously incorrect results while making it impossible for the ECB to implement its task of providing ‘supervision of the highest quality, unfettered by other, non-prudential considerations’193 to apply (its reading of ) the relevant directive, basing itself on its European mandate to supervise. Supervisory action would be based on the combined legal basis of the directive and the SSM Regulation, thus circumventing the prohibition of inverse vertical effect of directives,194 ie the tenet of EU law that directives cannot be invoked against individuals. Nevertheless, the SSM framework foresees a ‘crucial role for the NCAs that 2.96 clearly goes beyond the ECB in exercising its supervisory powers’. Since the establishment of the SSM, the ‘hybrid nature’ of the substantive rules has led to an ‘intensive’ co-operative relationship between the ECB and NCAs which is a condition for the success of the framework.195 This ‘bottom-up’ approach in the SSM framework where much of the activities depend on decentralized decision-making

Ibid. 193 European Commission, ‘Proposal for a Council Regulation conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions’ COM(2012) 511 final, Recitals 10 and 44. 194 Marshall v Southampton and South-West Hampshire Area Health Authority ECLI:EU:C:1986:84; [1986] ECR 723 (Case 152/84). 195 See Senkovic (n 188). 192

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Kern Alexander taken lower down the hierarchy involving JSTs and SB decisions mainly grounded on JST and NCA involvement appears to be making slow and uneven progress towards supervisory convergence.196 4. SSM, NCAs/NDAs, and Macroprudential Tools 2.97 Since the creation of the SSM, there has been legal and institutional uncer-

tainty over the extent to which the ECB/SSM has primary competence to exercise macroprudential tools, and there has been tension between the ECB/ SSM and national competent/designated authorities over the timing and use of macroprudential tools. Macro-prudential regulatory tools generally involve a broader array of prudential supervisory tools that include both some ex ante supervisory powers and ex post crisis management measures, such as liquidity and resolution tools, deposit insurance, and lender of last resort.197 In EU Member States, either central banks or other nationally-designated macroprudential supervisory authorities have the authority to utilize macroprudential levers or tools (ie counter-cyclical capital requirements and loan-to-income ratios) to address the build-up of systemic risks.198 For example, the use of counter-cyclical capital requirements can be varied depending on the riskiness of assets at points in the economic cycle. Since the creation of SSM, Denmark and the Netherlands have used counter-cyclical capital buffers to dampen credit booms in their respective housing markets by imposing higher capital requirements on home mortgage loans as opposed to other types of loans. Regarding the Dutch central bank’s use of macroprudential tools, there have been some ‘teething’ issues that have created concerns with the SSM Supervisory Board. Other macroprudential measures include liquidity tools that require financial institutions to hold certain ratio of liquid assets, ie assets that can be easily turned into cash, relative to total assets.199

Ibid. 197 See European Commission, ‘De Larosière report’ (n 52). See also Financial Services Authority, ‘The Turner Review—a regulatory response to the global banking crisis’ (UK Financial Services Authority March 2009), available online at accessed 6 December 2018. 198 See Financial Policy Committee, ‘Financial Stability Report—June 2012’ (Financial Policy Committee, Bank of England 2012). 199 Ibid. Other macroprudential tools include leverage ratios could be used to limit the amount of leverage relative to the value of the bank’s assets. Forward-looking loss provisions: Financial institutions can be required to set aside provisions against potential future losses on their lending. Collateral requirements: Lending could be limited by imposing higher collateral restrictions, for example if growth in lending appears to be unsustainable. An example is a loan to value requirement, which would limit the size of a loan relative to the value of the asset. Similarly, ‘haircuts’ on repurchase agreements would limit the amount of cash that can be lent as a proportion of the market value of a set of securities. Information disclosure: Greater transparency could help markets work better. For example, in times of crisis, more information about different institutions’ risk exposure could increase the flow of credit as uncertainty is reduced. 196

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Effectiveness, Impact, and Future Challenges The SSM Regulation allocates broad competences and powers to the ECB in 2.98 the field of prudential supervision for individual credit institutions and financial holding companies, but the scope of those competences are limited by the Treaty and the enumerated tasks set forth in Article 4 of the SSM Regulation. However, Article 5 of the SSM Regulation confers to the ECB a limited number of macroprudential tasks and tools. Under the heading in Article 5, entitled ‘Macroprudential tasks and tools’, the ECB is allocated powers to impose stricter prudential requirements, including higher capital buffers, on individual banks based on macroprudential factors in the country where the bank is based.200 Although the exercise of these macroprudential tools rests primarily with the National Competent Authorities (hereinafter the ‘NCAs’),201 the ECB may intervene and utilize these tools ‘if deemed necessary’ to apply higher requirements than those set out by the national authorities.202 In particular, it can adopt specific measures if required to take the specific circumstances of the Member State’s financial and economic situation into account203 as well as ‘duly consider’ any objection of a national competent authority that seeks to address a macroprudential risk on its own.204 Moreover, the CRR permits the ECB as the competent supervisory authority to take macroprudential tools, other than increased capital buffers, only in limited circumstances for banks based in a participating SSM Member State where the ECB has identified macroprudential or systemic risks.205 Although the ECB has specific powers to impose stricter prudential requirements 2.99 and additional capital buffers have been carved out in Article 5 of the SSM Regulation,206 the use of these tools now rests primarily with the national designated authorities. Under the SSM Regulation, the term used for national macroprudential authorities is ‘national designated authorities’ (NDAs). The NDA can, but does not have to, be identical with the national competent authority (NCA). Article 4 of CRD IV provides that the NCA or NDA (if the NDA is the same as the NCA) should have the expertise, resources, operational capacity, and the powers and independence to monitor effectively credit institution’s activities, assess compliance, and investigate breaches. However, if the NDA is not the same body as the NCA, the NDAs (not the NCAs) will be responsible SSM Regulation, art 5. 201 Ibid, art 5(1). 202 Ibid, art 5(2). 203 Ibid, art 5(5). 204 Ibid, art 5(4). 205 CRR, art 458. This article is entitled ‘Macroprudential or systemic risk identified at the level of a Member State’ and states: ‘2. Where the authority determined in accordance with paragraph 1 identifies changes in the intensity of macroprudential or systemic risk in the financial system with the potential to have serious negative consequences to the financial system and the real economy in a specific Member State and which that authority considers would better be addressed by means of stricter national measures, it shall notify the European Parliament, the Council, the Commission, the ESRB and EBA of that fact and submit relevant quantitative or qualitative evidence’. 206 SSM Regulation, art 5(2). 200

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Kern Alexander for macroprudential tasks and tools, such as imposing ‘counter-cyclical buffer rates’.207 Furthermore, NDAs are empowered to propose draft national legislation if they identify changes in the intensity of systemic or macroprudential risks in the financial system.208 The draft national legislation can be rejected within a one month period by the Council, but only upon a proposal by the Commission.209 As discussed above, the ECB may decide (instead of the NDA) to exercise a macroprudential task regarding a credit institution based in a participating Member State ‘if deemed necessary’,210 but is then required to take the specific circumstances of the Member State’s financial and economic situation into account211 as well as ‘duly consider’ any objection of an NDA or NCA proposing to address the local situation on its own.212 2.100 The ECB shall apply the macroprudential tools referred to in Article 101 of the

SSM Framework Regulation in accordance with this Regulation and with Articles 5(2) and 9(2) of the SSM Regulation, and where the macroprudential tools are provided for in a directive (ie CRD), subject to implementation of that directive into national law. If an NDA does not adopt a macroprudential tool (ie a counte- cyclical buffer), this does not prevent the ECB on its own initiative from setting a capital buffer requirement in accordance with the SSM Framework Regulation and Article 5(2) of the SSM Regulation.

2.101 Articles 101 and 102 of the SSM Framework Regulation established the scope

of macroprudential powers. Article 101 provides a list of macroprudential tools213 that include, but are not limited to, counter-cyclical capital buffers, loan-to-income limits, measures for domestically authorized credit institutions, any other measures to be adopted by NDAs or NCAs aimed at addressing systemic or macroprudential risks set forth under EU law.214 The ECB shall apply the macroprudential tools referred to in Article 101 in accordance with this Regulation and with Articles 5(2) and 9(2) of the SSM Regulation, and where the macroprudential tools are provided for in a directive, subject to implementation of that directive into national law. If an NDA does not utilize a macroprudential tool (ie set a capital buffer rate), this does not prevent the ECB from utilising that tool in accordance with this Regulation and Article 5(2) of the SSM Regulation.

207 CRD, art 136(1). 208 CRR, art 458(1) and (2). 209 CRR, art 458(4). 210 Ibid. 211 Ibid, art 5(5). 212 Ibid, art 5(4). 213 SSM Framework Regulation, art 102 provides that the ECB can exercise macroprudential tasks either in conjunction with the NDA or without the NDA exercising the macroprudential task. 214 Ibid, art 101(1). But note also art 101(2): The macroprudential procedures referred to in art 5(1) and (2) of the SSM Regulation shall not constitute ECB or NCA supervisory procedures within the meaning of this Regulation, without prejudice to art 22 of the SSM Regulation in relation to decisions addressed to individual supervised entities.

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Effectiveness, Impact, and Future Challenges Furthermore, the SSM Framework Regulation contains procedural provisions for 2.102 the use of macroprudential tools by the ECB and participating Member State authorities with competence under national law to exercise macroprudential tools (the so-called ‘NDAs’).215 Article 103 SSM Framework Regulation provides that the ECB shall compile a list of the NDAs and NCAs of participating Member States that have authority under Member State law to utilize macroprudential tools. As macroprudential tools are a limited and a shared task for the ECB under the SSM Regulation and the CRR, Member State NDAs and NCAs have retained competence to use a broader number of macroprudential tools. As part of the procedure on macroprudential tasks of the ECB, under the SSM 2.103 Framework Regulation, the NDAs and NCAs are required to inform the ECB both of their intention to use macroprudential tools, the systemic risks they are designed to address, and the actual decision to use such measures.216 The decision to use macroprudential tools must be notified to the ECB in advance not less than ten days before the decision is actually taken, and the identification of systemic risks by NDAs or NCAs must be notified to the ECB as soon as possible after the risks are identified. The ECB can object to the use of macroprudential tools but must put its objections in writing and convey them to the relevant NDA/NCA. Before deciding to use (or not) the macroprudential tools, the relevant NDA must duly consider the ECB’s objections before proceeding with the decision.217 Where the ECB has competence to apply macroprudential tools that impose 2.104 stricter requirements on banking institutions, it shall co-operate closely with the competent NDAs/NCAs and inform them of the intended decision. If the ECB decides to apply more stringent macroprudential tools to credit institutions that are subject to the CRR and the CRD IV, the ECB is required to inform the relevant NDAs/NCAs as early as possible of identification of systemic or macroprudential risks and the details of its use of specific macroprudential tools.218 NDAs and NCAs may object to the ECB’s decision to use macroprudential tools by stating their reasons in writing which shall be duly considered by the ECB.219 The ECB must notify its intention to co-operate closely with the concerned NCA or NDA ten days before taking the decision and respond to their objection by stating its reasons for action within five working days.220 It is questionable whether this five day response period for the ECB is adequate for it to formulate an appropriate response to a NCA or NDA and therefore the ECB may be reluctant to take a

215 SSM Framework Regulation, Title 2: Procedural Provisions for the Use of Macro-Prudential Tools, arts 103–5. 216 Ibid, art 104(1). 217 Ibid, art 104(3). 218 SSM Framework Regulation, art 105(1). 219 SSM Framework Regulation, art 105(2). 220 SSM Regulation, art 5(4) states that the ECB shall state its reasons [to object] in writing within five working days.

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Kern Alexander decision to adopt a macroprudential tool (ie increased counter-cyclical buffers) when a NDA does not think that such a measure is necessary because of the relatively short period of time the ECB would have to respond a NDA’s objection. Regarding the role of host state authorities where the local operations (ie branch) of a credit institution based in a participating Member State, the principle of co-operation applies as to the decision of whether to take macroprudential tools. Host country authorities are also subject to the notification obligation regarding their decision to impose macroprudential tools on the local operations of a credit institution based in a participating Member State. 2.105 Indeed, the use of macroprudential tools to monitor and control systemic risks

and related risks across the financial system—require greater regulatory and supervisory intensity that will necessitate increased intervention in the operations of cross-border banking and financial groups and a wider assessment of the risks they pose. Under the SSM, the main question that remains open regarding the use of macroprudential tools is whether the ECB has the necessary scope of authority to be an effective macroprudential supervisor. The European Commission has consulted on this issue but decided in 2017 to adopt only cosmetic changes to the current EU institutional framework of financial supervision, such as the composition of the European Systemic Risk General Board (ESRB) and making the president of the ECB automatically the Chair of the ESRB.221 Despite these incremental reforms, the ESRB remains a soft law body with no binding competence and with the authority only to issue recommendations and warnings, not technical standards like the ESAs. Thus, the proposed changes do not address the issue that the ECB has limited authority and tasks in respect of macroprudential oversight despite the fact that with the European Banking Union, the ECB has become a Euro-wide micro-prudential bank supervisor. Hence, there remains a gap in banking supervision at the EU level because there is no body with the legal competence and powers to perform fully macroprudential supervision and regulation.

2.106 From a macroprudential perspective, the SSM should help to mitigate systemic

risk at the level of the individual credit institution. However, the ECB has only the competence to supervise individual banks or ‘credit institutions’ as defined under

221 European Commission, ‘Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) 1092/2010 on European Union macroprudential oversight of the financial system and establishing a European Systemic Risk Board’ COM(2017) 538 final, available online at accessed 15 June 2018. Also note the ECB’s comment: ‘However, the Commission concluded that an overhaul of the macroprudential toolbox was not needed at the current juncture.’ See European Central Bank, ‘Targeted review of the macroprudential framework’ (Macroprudential Bulletin, European Central Bank 27 April 2018), available online at accessed 15 June 2018.

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Effectiveness, Impact, and Future Challenges EU law.222 As a result, the ECB has only limited authority to impose regulation aimed at reducing systemic risk, involving, for example, imposing higher capital and liquidity requirements on individual banks.223 It does not have competence to regulate non-bank financial intermediaries—such as shadow banks—nor does it have the competence to regulate the off-balance sheet entities involved in the securitization and structured finance markets that are increasingly playing a greater role in channelling large volume of credit and leverage to European businesses and consumers.224 In other words, the ECB has very limited authority to address macroprudential systemic risks that can arise outside the formal banking sector where non-bank financial intermediation is growing. The ECB’s limited authority to address systemic risks is likely to remain un- 2.107 changed in the near future. As discussed above, the Commission’s 2017 the CRD V Regulation and Directive225 (CRD V Package) have the aim of making prudential regulation more proportionate. One way the CRD V does this is by making the regulation of securities and investment firms that are deemed to be systemically insignificant less stringent as part of the Capital Markets Union initiative that is designed to increase the flow of capital to European companies and entrepreneurs from non-bank finance sources.226 Specifically, the CRD V reforms propose to reduce capital, liquidity, and risk management requirements for certain investment and securities firms (including investment firm groups without a credit institution) that are currently subject to the CRD IV. CRD V would create a category of securities and investment firms that would be deemed to be non- systemic and thus subject to much less stringent prudential requirements. CRD V aims to make prudential regulation for securities and investment firms more proportionate to the risks that they pose to the financial system and economy. It is also designed to support the objective of loosening regulatory requirements for securities and investment firms and companies seeking to raise capital in the EU markets.

222 ‘Credit institution’ is defined as an ‘undertaking whose business is to receive deposits or other repayable funds from the public and to grant credit for its own account’. However, it is pointed out that the concept of ‘repayable funds from the public’ and the concepts of ‘credit’ ‘and ‘deposits’ can be interpreted in different ways, meaning that financial institutions performing similar activities in different Member States may be classified as a ‘credit institution’ in one Member State, but not in another. See Communication From the Commission to the Council and the Commission, ‘Shadow Banking—Addressing New Sources of Risk in the Financial Sector’: COM(2013) 614 final. 223 CRR, art 4(1)(1). Similarly, a ‘credit institution’ subject to SSM jurisdiction for carrying on activities governed by EU prudential banking law is not subject to SSM jurisdiction for activities not subject to EU prudential banking law, such as brokering and dealing securities or the marketing and sale of retail financial products. 224 SSM Regulation, art 5. 225 Proposal for a Regulation of the European Parliament and of the Council on the prudential requirements of investment firms and amending Regulation (EU) 575/2013 (EU) 600/2014 and (EU) 1093/2010, Brussels 20.12.2017, COM(2017) 790 final, 3–4. 226 See discussion 2.25ff.

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Kern Alexander 2.108 However, a few systemically important investment firms, defined as such under

Article 131 of CRD IV, would still be subject to the CRR/CRD IV capital, liquidity and risk governance requirements because these firms incur and underwrite risks (both credit and market risks) on a largescale basis in the EU single market. The rationale for subjecting smaller and systemically less important institutions to exemptions from the CRD IV prudential requirements is based on the lower level of perceived systemic risk they pose to the financial system.227 This is meant to provide a ‘more streamlined regulatory toolkit’ to allow these firms to provide services more efficiently across different type of business models and to adjust prudential requirements accordingly to reflect the diminished systemic risk they pose to the financial system.228 An important omission in the CRD V package, however, remains that it does not address the financial stability risks that appear to be emerging the EU shadow banking market.229 5. Financial Market Infrastructure

2.109 One of the basic tasks to be carried out by the European Central Bank as a

member of the European System of Central Banks (ESCB) is the promotion of the smooth operation of the payment system.230 Further, Article 22 of the Statute of the ESCB provides the ECB with the important power to adopt regulations to ensure the efficiency and soundness of EU clearing and payment systems within the Union and between the Union and other countries.231

2.110 Based on this legal authority, the ECB argued in a legal opinion in January

2011232 that the European Market Infrastructure Regulation (EMIR) should be amended so that the ESCB’s role in exercising oversight of EU derivatives clearing systems is recognized and that it has joint authority with ESMA to review and approve regulations for CCPs and the infrastructure of clearing within the EU. It also argued that the ECB should have joint authority with ESMA to recognize the laws and regulations of third country clearing systems as equivalent in order for third country CCPs/clearing houses to be given market access to the EU markets. In addition to the ESCB’s responsibility for the smooth operation of payment systems, the ECB has argued that the ESCB’s responsibility Commission, ‘Proposal COM(2016) 0854 final’. 228 COM(2017), p 2, arts 15–20. 229 Commission, ‘Proposal COM(2016) 0854 final’ (n 52). 230 TFEU, art 127(2), fourth indent. See also art 3.1, Statute of the European System of Central Banks. 231 Article 22 of the Statute of ESCB provides: ‘The ECB and national central banks may provide facilities, and the ECB may make regulations, to ensure the efficient and sound clearing and payment systems within the Community and with other countries.’ 232 See ECB Opinion of 13 January 2011 (Con/2011/1). The legal authority cited for this proposal was the fourth indent of art 127(2) (fourth indent) of the Treaty and arts 3.1 and 22 of the Statute of the European System of Central Banks and of the European Central Bank. 227

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Effectiveness, Impact, and Future Challenges ‘to implement the monetary policy of the Union’ in Article 127(2) indent 1 (also provided in Article 3.3 of the Statute of the ESCB) depends on its ability to promote the smooth operation of clearing and settlement systems and infrastructures and therefore is a basic task of the Eurosystem.233 The ECB also observes that national central banks whose currency is not the euro would also have similar powers to oversee clearing and related infrastructure as the ECB would have in acting through the National Central Banks of the Eurosystem. The ECB adopted a location policy in 2013 for derivatives central counterparties or clearing houses to encourage those based in non-Eurozone Member State jurisdictions and that who cleared a large amount of euro-denominated derivatives to be based in a Eurozone jurisdiction. The location policy was designed to make it easier for the ECB to have direct oversight of derivatives clearing houses that cleared a large amount of euro-denominated derivatives. The United Kingdom challenged the ECB location policy on the grounds that it infringed the provisions of the EU Treaty governing free movement and that it was beyond the ECB’s Treaty competences (‘ultra vires’).234 The CJEU ruled in favour of the UK by rejecting a broad interpretation of the ECB mandate and annulled the location policy, relying on a purposive interpretation of the ESCB Statute that would require the ECB, if it wanted to grant itself powers to regulate securities clearing infrastructures, to show how that power would relate to the performance of its tasks refererd to in the fourth indent of Article 127 (2) TFEU and ‘to request the EU legislature to amend Article 22 of the Statute, by the addition of an explicit reference to securities clearing systems’.235 When EMIR was adopted in 2012, however, the suggestion that the ECB have oversight authority of CCPs and clearing houses was questioned on the grounds that it could result in national central banks and in particular the ECB operating through the Eurosystem engaging in supervisory oversight of CCPs, which are authorized credit institutions in many EU states, which could not at the time be subject to direct ‘prudential supervision’ by the ECB unless there was unanimous consent by the Council of Ministers.236 Council’s unanimous approval, however, in 2012 to authorize the ECB to be responsible for prudential policies relating to credit and financial institutions, including mixed financial conglomerates, has eliminated any doubt as to its role in supervising credit institutions, as set forth in the SSM Regulation. In some EU states, central counterparties and clearing houses are required to be

See ECB Opinion of 13 January 2011 (Con/2011/1), p 2. 234 United Kingdom v ECB [2015] 3 CMLR 8, 78 (Case T-496/11). 235 Ibid, 4, 6. See discussion of the case in Guido Ferrarini and David Trasciatti, ‘OTC Derivatives Clearing, Brexit and the CMU’ in Danny Busch and Guido Ferrarini (eds), Capital Markets Union in Europe (Oxford University Press 2018) 140–67. 236 TFEU, art 127(6) provides in relevant part: ‘The Council may, acting unanimously on a proposal from the Commission and after consulting the ECB and after receiving the assent of the European Parliament, confer upon the ECB specific tasks concerning policies relating to the prudential supervision of credit institutions.’ 233

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Kern Alexander operated and owned by credit institutions and are therefore subject to supervision by the national competent prudential authority. In other EU states, securities regulators are responsible for supervising CCPs/clearing houses. The EMIR Regulation delegates powers to ESMA to set regulatory technical standards and to oversee Member State implementation of the EMIR requirements. Although the SSM Regulation authorizes the ECB to supervise credit institutions in respect of the single rule book (CRR and CRD IV), it does not authorize the ECB to ensure that credit institutions have complied with EMIR, as this remains the responsibility of NCAs. 2.111 Further, the draft legislation to amend the CRR and CRD IV does not mention

supervision of CCPs and clearing houses or other financial market infrastructure, such as central securities depositories. The EU legislator should consider whether to extend ECB competence to supervise CCPs and clearing houses because of the potential systemic risk they pose to the financial system. The ECB’s oversight function for clearing and payment systems set forth in the Treaty provides a legal basis for the exercise of such powers without secondary legislation. However, to resolve any legal uncertainty about ECB competences more generally and the SMM more particularly it may be desirable to recognize—or reaffirm—the ECB’s competence in this area by amending the SSM regulation to provide expressly for SSM competence to supervise CCPs/clearing house— both within and outside credit institutions—to protect the financial system against the concentration of risks in financial market infrastructure that can lead to systemic risks.

2.112 In addition, the ECB’s Target2 securities framework has dramatically changed the

landscape of securities settlement in Europe and necessarily involve the central securities depositories, agent banks and custodian banks in more cross-border consolidation, especially for the settlement of cash financial instruments (eg equities and bonds). The increased consolidation of central securities depositories raises concerns about systemic risk and how CSDs and securities and derivatives settlement systems should be regulated. For example, delivery versus payment procedures in EU central securities depositories affect principal and settlement risk (a form of systemic risk) and therefore should be harmonized if possible by adopting one of the three main DvP procedures recommended by the Committee on Payment and Settlement Systems.

2.113 In its role as a central bank and supervisor, the ECB will be confronted by

the problem of the assumption of risk by CCPs and the CSD’s in the form of credit, settlement risk and principal risk exposures in complex financial markets. The role of the ECB should be examined at a deeper level, especially in times of market stress, regarding its functions for overseeing clearing, settlement and payment systems and how this can be co-ordinated with its role as a bank supervisor. 80

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VI. Member State Perspectives on the SSM The Deutsche Bundesbank has called the SSM a success story.237 Nevertheless, 2.114 Bundesbank officials have stated that there are many challenges, including ‘striking a balance between harmonization and proportionality’ that should be related to the specific characteristics (size, significance, riskiness) of individual institutions; and NCAs should retain supervisory competence over less significant institutions; and the extensive number of options and national discretions— around 150 options under EU banking regulations—to choose from can be an obstacle to a regulatory level playing field. As a result, there is recognition for the need of further harmonization of options and discretions.238 The Bundesbank also recognizes the institutional challenges posed by the SSM, 2.115 particularly how the ECB can manage the conflicts of interest that arise over monetary policy and banking supervision, as some of the ECB’s monetary policy functions for injecting liquidity into the banking system require an understanding of individual bank balance sheets that it may not have adequate knowledge of now because of ‘Chinese walls’ between the monetary policy and supervision functions. Also, the conflict of interests that arise from having the Governing Council approve all substantive decisions of the SB creates a conflict of interest within the ECB. Bundesbank officials still doubt the effectiveness of this governance structure, and suggest limiting the Governing Council’s involvement in many supervision decisions.239 EU bank capital legislation appears to contain a loophole concerning the lack 2.116 of a requirement under EU bank legislation for EU-based banks to hold regulatory capital against their holdings of their home country’s sovereign bonds. Throughout the SSM, Member States have adopted different approaches to this practice. Because it is not mandated under EU banking legislation, there is nothing the ECB/SSM can do to require banks under their supervision to hold regulatory capital against these positions. Different approaches within the SSM to sovereign risk exposures exist. Supervisors could still take these risks into consideration when conducting stress tests and requiring banks to hold capital against these exposures under hypothetical stress scenarios and under other pillar 237 See Andreas Dombret, ‘A success story? Reflecting on one year of European banking supervision’ (dinner speech at the conference ‘SSM at 1’ in Frankfurt am Main, Bank for International Settlements 3 February 2016), available online at accessed 6 December 2018. 238 Ibid. See also Commission report, p 11. 239 See Andreas Dombret, ‘Plan B—where is the banking union heading?’ (Speech at the Banken- und Unternehmensabend at the Deutsche Bundesbank’s Office in Munich, Bundesbank 12 April 2018), available online at accessed 6 December 2018.

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Kern Alexander 2 supervisory review assessments. The Bundesbank suggests the following regulatory treatment: (1) risk weights for risks arising from sovereign exposures; and (2) an upper limit for lending to individual governments. Bundesbank officials believe that sovereign bond risks pose a risk to the Banking Union because of the contagion risk of a bank failing because of high default risk on certain sovereign bonds.240 2.117 In addition, Bundesbank board member, Andreas Dombret, expressed the view

that further reforms needed to be made at the SSM, including streamlining decision-making as the current system is too bureaucratic; for instance, the 19 countries on the Governing Council are required to be consulted on most SB decisions. More delegation should occur as the ECB’s Governing Council should not decide on routine matters; and the EBA should be granted more powers. A related concern arises where the ECB makes a determination that a bank is failing or about to fail based on an assessment of its compliance with anti-money laundering and financial sanctions requirements by a non-EU authority (such as the United States in the case of the Latvian bank ABVL) where such a determination should have been made only after the EU national competent authority had also made a determination that EU law had been violated. The failing Latvian bank ABVL pointed to the need of extended powers on European level. Here, the ECB determined the bank as ‘failing or likely to fail’ only after the US Treasury claimed it was involved in money laundering))241

2.118 The Banque de France expressed similar concerns and considered the main chal-

lenge for the SSM to be growing fragmentation in regulatory rules, the need to enhance the effectiveness of the Supervisory Board’s decision-making, and excessive detailed scrutiny by the Governing Council of SB decisions. Also, there lacks

240 See Bundesbank, available online at Der Single Supervisory Mechanism— Vom europäischen Aufseher zur europäischen Aufsicht OR Auf die Größe kommt es an—Bankenaufsicht und -regulierung maßgeschneidert? 241 Andreas Kroner and Daniel Schäfer, ‘Central banker Dombret urges EU bank supervisors to merge’ (Handelsblatt Global 10 April 2018), available online at accessed 16 November 2018. Expressing the same point of view, Yasmin Osman and Daniel Schäfer, ‘ECB to beef up banking supervision staff’ (Handelsblatt Global 20 October 2015), available online at accessed 16 November 2016; Jens Weidmann, ‘From extraordinary to normal—reflections on the future monetary policy toolkit’ (Central Bank Speech 16 November 2018), available online at accessed 16 November 2018; Disagreeing Thorsten Beck and Daniel Gros, ‘Monetary Policy and Banking Supervision: Coordination instead of separation’ (No 286 CEPS Policy Brief 12 December 2012), available online at accessed 16 November 2018; Karl Whelan, ‘Should Monetary Policy be separated from Banking Supervision?’ (European Parliament Committee on Economic and Monetary Affairs December 2012), available online at accessed 16 November 2018.

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Effectiveness, Impact, and Future Challenges a European-wide supervisory culture, which hinders harmonization of supervisory practices.242 The Banco de Espana was more sanguine in its assessment of the SSM commenting 2.119 that it has led to an appreciable increase in the banking sectors capital and has prompted the most vulnerable banks to begin cleaning up their balance sheets and selling or otherwise disposing of impaired loans. The SSM has also shown itself as being capable of participating effectively in the resolution of crisis episodes’ (eg Greek banks).243 The SSM has managed to eliminate many of the ‘national regulatory particularities’ and created a common methodology for supervisory review of all banks and has made significant progress in harmonising inspection practices by drafting and developing a manual of common procedures’ The joint supervisory teams have been effective in conducting on-site inspections and building co- operation between ECB and NCAs. Although institutional co-operation between ECB and NCAs (due to complexity of tasks) could be improved, co-operation and co-ordination at a general level was present and a common supervisory culture was emerging. The Banca d’Italia has assessed the SSM’s operations as effective, even though it 2.120 was conceived over a very short period of time and has been operational for only five years.244 Admittedly there have been co-ordination difficulties among NCAs and the ECB because of different histories, traditions, and cultural practices, but ‘co-operation between the national and the central level, after some initial friction, is now smoother.’245 Indeed, the Nordea case represents an example of how the perception of an effective and co-operative relationship between the national competent authority and the ECB can lead to a bank changing the domicile of its parent company to the Eurozone to benefit from SSM oversight.246

VII. Banking Union and the Banking Industry This section analyses the impact of the Banking Union on banking market 2.121 structures and cross-border merger activity.

242 Frédéric Visnovsky, ‘Le Mécanisme de Supervision Unique Deux Ans Après’ (Séminaire de Recherche Sciences-Po/Banque de France ‘Les Banques et Système Financier: Quelle Régulation?’, 23 November 2016), available online at accessed 7 December 2018. 243 See Restoy (n 48). 244 Salvatore Rossi, ‘The Banking Union in the European integration process’ (Speech, Conference—European Banking Union and bank/firm relationship, CUOA Business School, 7 April 2016) 10. 245 Ibid. 246 See also Riksbank (n 46), 37–8, discussing SSM’s effectiveness in the context of Nordea’s relocation of its parent office from Sweden to Finland and the conseq8ences for applying high standards for prudential supervision.

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Kern Alexander 1. Banking Industry Reaction 2.122 The German Bankenverband published a report that assessed the effect for German

banks in complying with technical standards and guidelines adopted by the SSM, EBA and NCAs (Bafin). It was noted that it is sometimes not straightforward to understand which rules a bank was required to comply. The report provided examples of existing German regulatory rules (MaRisks: Mindestanforderungen an das Risikomanagement) and EBA recommendations on Cloud Service Providers. It was argued that it was in the discretion of the NCAs to follow the recommendations or not. In case they did not follow the recommendations, it was said that it may be confusing, especially for banks that are supervised by the ECB but which provide services into non-Banking Union Member States, which are subjected solely to the EBA standards.247 there seems to be an inconsistency on processes of the SSM, but the general view should be true)

2.123 Another area of concern of the banking industry has been the methodology uti-

lized by the SSM for the Supervisory Review and Evaluation Process (SREP). Prior to the SSM, national competent authorities developed SREP methodologies under guidelines set by the European Banking Authority and based on the Capital Requirements Directive 2013. However, the Directive afforded Member States with legislative and regulatory discretion regarding how the SREP was implemented. This resulted in significant differences in SREP methodologies across some Member States.248 With the ECB now overseeing the application of the SREP methodology across participating Member States, the industry has expressed two concerns. During the ECB’s first SREP exercise in 2015, the industry found it difficult to understand the rationale behind the request for discretionary capital add-ons. This made it difficult for institutions to challenge the determination of the capital ad-ons. Second, it was difficult for institutions to assess what corporate and risk governance changes they should implement in the future in order to reduce their capital add-ons.

2.124 On the other hand, the industry stated that the ECB has provided much more de-

tailed and better justified SREP reports and assessments than the previous SREP decisions made by NCAs prior to the SSM.249 The banking industry in 2015 also criticized the ECB’s lack of clarity on the interaction between the pillar 2 SREP capital add-on and the counter-cyclical capital buffer calculated under the CRD. The process for assessing these two requirements had been applied by Member

247 Frank Mehlhorn, ‘Bankgeschäfte in Europa: Wie einheitlich ist die Regulierung und Aufsicht wirklich?’ (Blog, Bankenverband 1 March 2018), available online at accessed 6 December 2018. 248 Commission, ‘Report from the Commission to the European Parliament and the Council on the Single Supervisory Mechanism established pursuant to Regulation (EU) No 1024/2013’ COM(2017) 591 final 42. 249 Ibid.

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Effectiveness, Impact, and Future Challenges States in a more transparent manner prior to SSM. The SSM assessments created legal uncertainty for the banks. Based on a Commission staff note in 2016, the ECB amended its methodology for 2016.250 Some Italian banks express the positive view that the SSM has required banks to 2.125 adopt organizational structures enabling efficient management of impaired assets. An important issue in Italy has been the slow judicial recovery procedures for collateral on impaired loans. This led the SSM and Commission to agree guidelines regarding shortening the amount of time in which a bank must fully ‘depreciate’ impaired loans.251 2. Mergers, Market Structures, and Integration A. Mergers The SSM has also been related to changes in market structures in the EU 2.126 banking sector. For instance, the mergers and acquisitions, including cross- border M&A, have substantially decreased since the SSM became effective in November 2014. Chart 2.1 below illustrates the low volume of M&As within 80

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Chart 2.1 Bank M&As involving euro area banks – value of transactions (EUR billions) Sources: Dealogic and ECB calculations Notes: “M&As” refers to transactions where the acquired stake is more than 20% of the target bank. The data do not cover participation by governments or special legal entities in the restructuring or resolution of credit institutions. Transactions whose amounts are not reported are excluded. “Domestic” refers to transactions that take place within national borders of euro area countries. “Cross-border” M&As involve euro area targets and non-domestic euro area acquirers. “Inward” refers to M&As by non-EU or non-euro area banks in the euro area and “outward” indicates M&As carried out by euro area banks outside the euro area.

Ibid, 43, subheading C.2.4. 251 Fabio Panetta, ‘Il sistema bancario italiano nel quadro dell’Unione bancaria europea’ (speech at Camera die Deputati, Seminario di aggiornamento professionale, Banca d’Italia, 10 March 2018), available online at accessed 6 December 2018. 250

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Kern Alexander the euro area, which reached its lowest level in 2016.252 It should be noted, however, that worldwide M&As in banking were significantly low in 2017 as well, with a volume of $79.6 billion compared to $359 billion in 2008.253 Therefore, it cannot be ruled out that the decline in bank M&A in the Eurozone may have been caused by other factors in global financial markets unrelated to creation of SSM. 2.127 There is speculation about future M&A activity in the Eurozone banking

sector.254 One industry commentator stated that ‘those calling for cross-border bank consolidation are getting things the wrong way around. It is not cross- border M&A that will create an integrated single market, but an integrated single market that will drive cross-border M&A. And that does not look likely any time soon.’255

2.128 Moreover, the decrease in banking M&A in the Eurozone has also been attrib-

uted to the extra costs of higher regulatory capital requirements for merged banks that have grown in size and thus may qualify for SIFI capital ad-ons. Indeed, any significant bank considering a merger with another significant institution should weigh the cost of moving up the scale of systemic importance, which brings with it extra capital requirements.256

B. Market Structures 2.129 Generally speaking, it has been said that the banking market in the Eurozone is ‘fragmented’ which can be, inter alia, seen in the fact that ‘there is one bank for about every 50,000 citizens in the Eurozone’257 ‘Since 2008, the number of banks in the euro area has declined by about 20%, to around 5,000. And the number of bank employees has fallen by about 300,000 to 1.9 million. Total assets of the euro area banking sector peaked in 2012 at about 340% of GDP. Since then, they have fallen back to about 280% of GDP.’258 The reduction in bank assets to GDP can also be attributed to the low interest rate environment in which bank customers have increasingly been buying more bank-issued financial products, in

252 European Central Bank, ‘Financial integration in Europe’ (European Central Bank May 2017), available online at accessed 6 December 2018. 253 Arnold, Jenkins, and Noonan (n 41). 254 Ibid. 255 Wyman (n 39). 256 Arnold, Jenkins, and Noonan (n 41). 257 Ibid. 258 European Central Bank, ‘Too much of a good thing? The need for consolidation in the European banking sector’ (Speech by Danièle Nouy at the VIII Financial Forum in Madrid, European Central Bank 27 September 2017), available online at accessed 6 December 2018.

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Effectiveness, Impact, and Future Challenges which the bank distributes the clients’ funds off balance sheet (rather than lending the clients’ funds on balance sheet to a borrower).259 The SSM has also been followed by an increase of cross-border branches in- 2.130 stead of subsidiaries. In general it is not clear why this has occurred as it is too early to attribute any single cause. Wymeersch, however, had predicted in the first edition of this volume that conversions of cross-border owned subsidiaries into branches would grow in number not necessarily because of Banking Union, but because of ‘the massive deleveraging’ of banks or their ‘withdrawal from certain regional markets or from certain activities considered to represent less core activities, where the more stringent capital requirements, and later the structural measures, may have more far-reaching consequences.’260 Although the SSM Regulation states that it is neutral as to the choice of a bank’s form (branch or subsidiary), he observes that many banks may be reluctant to change their form from subsidiary into branch ‘in order to preserve their local brand, to preserve the relations with their employees, for tax purposes’ or other strategic reasons.261 But the European Commission has estimated that the impact of state bailouts of the banking sector and the desire of stronger home country scrutiny of cross-border operations has influenced banks in opting for more cross-border branches as opposed to subsidiaries.262 Other concerns are that there are not enough pan-European banks. Defining pan- 2.131 European banks as consisting of branches or subsidiaries in at least three EU states, there are only two pan-European banks in Europe: BNP Paribas, (France, Italy and Benelux); and UniCredit, (Italy, Germany, and Austria). According to this view, regulation should support the creation of more pan-European banks to support the European economy.263 ECB officials believe that creating a few pan-European champions would re- 2.132 duce the reliance on US banks providing credit and trading support operations in Europe. Danièle Nouy, chair of the ECB’s supervisory board, stated that: ‘In my opinion, cross-border mergers within the euro area are the way forward.’

259 On the other hand, ‘[t]‌he banking sector in the United States, for instance, is much smaller. Total assets of the US banking sector account for just 88% of GDP. This, of course, also reflects the fact that capital markets play a much bigger role in financing the US economy.’ 260 Wymeersch, ‘SSM’ (n 16) 111–12. 261 Ibid. 262 European Commission (11 October 2017), available online at  5. 263 Arnold, Jenkins, and Noonan (n 41). See also Patrick Jenkins, Rachel Sanderson, and David Keohane ‘UniCredit seeks merger with SocGen’ Financial Times (London, 3 June 2018), available online at accessed 6 December 2018. Note that Jean-Pierre Mustier is the chief executive of UniCredit. The FT also reports that Unicredit seeks a merger with SocGen.

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Kern Alexander Moreover, ‘[w]‌hile the ECB would not reduce capital requirements for merged entities, officials indicate it could use its powers to help in other ways.’ This could involve, for example, allowing banks to offset more of their biggest exposures to individual clients across borders or increasing their flexibility to move capital and liquidity between countries.264 2.133 More generally, there appears to be growing optimism in the ECB’s role as a

tough but fair regulator that has had a positive effect on bank performance. For example, the ECB has taken control of the non-performing loan problem that has bedevilled Eurozone banks whose assets (unlike US banks) are dominated by on-balance sheet lending. At the height of the Eurozone crisis in 2012, non-performing loans (NPLs) at Eurozone banks exceeded 7% of the value of total on balance sheet loans. Since 2015, NPLs have begun to decline, most recently with NPL levels falling to 3.4% of on-balance lending in 2018.

2.134 Despite progress on many fronts, the average European bank had a return on eq-

uity (ROE) of less than 6% in 2017, much less than the average of nearly 10% ROE for US banks. Also, Eurozone bank ROE remains less than the cost of capital. This is an important concern because it limits the ability of banks to raise capital when necessary, especially during market downturns. The ROE also limits the ability of European banks to compete effectively on global stage with US and Japanese banks.

2.135 The SSM framework must also contend with persistent weak bank perfor-

mance in some European countries, such as Italy, Portugal, Cyprus, and Greece. In Italy, the fourth largest European national economy, the combination of a populist Eurosceptic government and a persistently weak banking system has revised the so-called ‘doom loop’ where banking sector fragility spreads to sovereign debt finances and can spiral downward into an economic crisis. Banks are increasing their sovereign debt exposure to their home country governments without having to hold regulatory capital against these assets. Bank exposures to sovereign debt are growing and the banks’ ability to raise capital sustainably is diminishing.265 Despite an overall positive effect on banking sector performance, the SSM has serious challenges in stabilising the Eurozone banking sector and overseeing its return to a sustainable financial position.

264 Arnold, Jenkins, and Noonan (n 41). 265 Unicredit in 2018 issued five- year bonds that required a 8% coupon rate: Robert Smith, ‘UniCredit chief defends steep price for new $3bn bond’ Financial Times (London, 28 November 2018).

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Effectiveness, Impact, and Future Challenges

VIII. Conclusion The Banking Union has ushered in dramatic changes in the institutional struc- 2.136 ture of banking regulation, supervision and resolution. The chapter analyses the major transformation underway in the European Banking Union regarding the centralization of competences with the European Central Bank acting through the Single Supervisory Mechanism as a bank supervisor for Eurozone and other participating Member States and the institutional consolidation and legal changes brought about by the Single Resolution Mechanism for bank recovery and resolution. A major objective of the Banking Union was to sever the link between banking fragility and over-indebted sovereigns. Although the SSM Regulation has been praised as a necessary regulatory reform to enhance European banking supervision and restore euro area financial stability, it raises important institutional issues regarding the accountability and effectiveness of the European Central Bank as a bank supervisor and the challenges it faces in monitoring risks in the European banking sector and co-ordinating with European and Member State resolution authorities. The Single Supervisory Mechanism began operations in November 2014 in the 2.137 shadow of the Eurozone crisis that had debilitated the banking systems of much of southern Europe and Ireland. The ECB acting through the SSM has been credited with helping the European banking system address some of its most pressing challenges. The SSM oversaw the implementation of Basel III through the Capital Requirements Directive IV which resulted in significantly higher capital and liquidity buffers and enhanced oversight of bank risk management and corporate governance. The SSM has also worked with the SRB to shore up the effectiveness of the single 2.138 resolution mechanism by ensuring ‘a coherent and uniform approach’266 to bank resolution for euro area and participating Member States.267 The SRB has responsibility for all preparatory work involving bank resolution plans and resolvability assessments and co-ordinating the implementation of resolution plans with national authorities and interpreting the scope of the systemic crisis exception. Although the SRM is an important institutional development to enhance cross- 2.139 border crisis management in the Banking Union, its institutional complexity and the vast discretion (and uncertainty) regarding how SRB can use its powers will continue to raise important issues regarding investor rights in banks and other institutions that are subject to write-downs and/or taken into resolution. For the

266 European Commission, ‘Proposal for a Single Resolution Mechanism for the Banking Union—frequently asked questions’(Memo, European Commission, 10 July 2013). 267 SRM Regulation (n 8), arts 5 and (7).

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Kern Alexander SRM’s resolution powers to be legally effective and to enhance the ECB’s role as a supervisor, they must be credible and predictable. An effective resolution regime should therefore require that resolution authorities adhere to the rules governing the use of resolution tools during a bank restructuring and even in a broader financial crisis. For example, regarding the use of the bail-in tool, market participants should have clarity about the order in which various types of bondholders will be expected to take losses. A predictable resolution mechanism is necessary to secure public acceptance and reduce market panic. 2.140 The chapter also discusses what legal powers the ECB has to supervise derivatives

central counterparties and clearing houses and whether there is any institutional conflict between it and ESMA regarding the authorization and supervision of derivatives clearing houses. Although the ECB’s own legal opinion in 2011 counselled that it did have constitutional powers to exercise oversight of derivatives clearing houses, it has not expressly assumed these powers, even though it attempted to influence EU derivatives clearing policy in 2012 by issuing a more limited location policy (later invalidated by the European Court of Justice) that would have required all EU-based clearing houses which clear over a certain threshold of euro-denominated derivatives to do so from a Eurozone-based entity. Nevertheless, as the Banking Union consolidates further, this may change with the ECB assuming more oversight powers of systemically-important derivatives clearing institutions. Another important area where the ECB’s oversight is expected to extend will be in its supervision of financial institutions in respect of environmental and social risks. In light of the European Commission’s acceptance in 2018 of the proposals of the High Level Expert Group’s report on sustainable finance and regulation, the SSM is expected to calibrate existing regulatory tools in the areas of enhanced disclosure, risk management, bank governance, capital adequacy to address environmental and social risks.

2.141 Others challenges confronting the Banking Union and its effectiveness in super-

vising and resolving banks, for instance, include Brexit, which poses numerous challenges regarding SSM oversight of Eurozone banks with significant trading operations in London. The ECB has anticipated these challenges by stating in 2018 that it will require Eurozone based banks with London offices to cease ‘back- to-back’ trades that allows them to keep centralized risk management functions, capital/ liquidity support booked in London branch/ subsidiary. This practice will end in a few years with Eurozone based banks moving these functions from London to locations in the Eurozone.

2.142 The Banking Union has confronted enormous challenges in its institutional evo-

lution but has made significant progress in its first five years in the areas of banking supervision and resolution. Despite the Union’s firm institutional and legal foundations established through the SSM and SRM, its overall tasks remain unfulfilled as political opposition remains steadfast against a Eurozone-wide deposit 90

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Effectiveness, Impact, and Future Challenges guarantee mechanism while there is growing opposition more generally to increased European supra-nationalism across the Union. The biggest obstacle to the future successful operation of the Banking Union may be whether its institutions (the SSM and SRM) can co-ordinate effectively with other EU institutions and Member State authorities in carrying out their tasks. Nevertheless, the Banking Union has brought about dramatic institutional changes to the governance and oversight of European banking markets, which is likely to spill-over to other areas of EU economic and financial policymaking.

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3 JUDICIAL PROTECTION OF SUPERVISED CREDIT INSTITUTIONS IN THE EUROPEAN BANKING UNION Tomas M C Arons

I. Introduction II. Judicial Protection for Credit Institutions under the SSM

1. Tasks 2. Powers 3. Procedural Rules 4. Review 5. Review of ECB Decisions Directly Addressed to Credit Institutions 6. Review of ECB Decisions Indirectly Affecting Credit Institutions

III. Judicial Protection for Credit Institutions under the SRM

1. Tasks 2. Powers 3. Procedural Rules 4. Review

5. Review of SRB Decisions Directly Addressed to Credit Institutions 6. Review of SRB Decisions Indirectly Affecting Credit Institutions

3.01 3.07 3.07 3.10 3.16 3.19

3.57 3.62

IV. Substantive Review by the CJEU

3.66 1. Lack of Competence 3.69 2. Infringement of an Essential Procedural Requirement 3.71 3. Infringement of the TFEU and the TEU or any Rule of Law Relating to its Application 3.76 4. Misuse of Power 3.82 5. Manifest Error of Assessment 3.83 6. Consequences of Illegality and Invalidity 3.84

3.20 3.29 3.37 3.37 3.46 3.55 3.56

V. Liability of the ECB and the SRB VI. Conclusion

3.86 3.94

I. Introduction The European Banking Union (EBU) consists of three pillars. The first pillar is 3.01 the Single Supervisory Mechanism (SSM). The SSM entails the direct supervision of euro area credit institutions by the European Central Bank (ECB) as of 4 November 2014. In this manner it can be ensured that the single rulebook for financial services is applied in the same manner to credit institutions in all Member States concerned and that those credit institutions are subject to supervision of the

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Tomas M C Arons highest quality, unfettered by other, non-prudential considerations.1 The single rulebook consists of the harmonized rules and regulations enacted in the Capital Requirements Directive IV (CRD IV)2 and the Capital Requirements Regulation (CRR)3 and its technical standards and guidelines. The second pillar is the Single Resolution Mechanism (SRM). Credit institutions are, from 1 January 2016 onwards, subject to the centralized resolution mechanism ultimately controlled by the Single Resolution Board (SRB).4 The last pillar of the EBU is the Common Deposit Guarantee System (CDGS).5 3.02 This chapter will discuss the legal position of the aforementioned credit institutions

vis-à-vis the ECB and SRB respectively. The Council Regulation establishing the SSM (SSM Regulation)6 provides the ECB with wide-ranging powers including all the powers and obligations which national competent and designated authorities have, under the relevant EU law, unless otherwise provided for by the SSM Regulation.7 The ECB may impose administrative pecuniary penalties if the credit institutions, intentionally of negligently, breach a requirement under a relevant directly applicable act of Union law subject to such penalties.8 Furthermore, the ECB may instruct the national financial supervisors to make use of their powers under, and in accordance with, the conditions set out in national law where this regulation does not confer such powers on the ECB.9 The ECB may require national financial supervisors to open proceedings with a view to taking action in order to ensure that appropriate penalties are imposed.10

1 Recital 9 of the Preamble to Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC [2013] OJ L176/338 (CRD IV). 2 Ibid. 3 Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) 648/2012 [2013] OJ L176/1 (CRR). 4 Article 99(3) of Regulation (EU) 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) 1093/2010 [2014] OJ L225/1 (SRM Regulation). 5 Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014 on deposit guarantee schemes (recast) [2014] OJ L173/149 (CDGS). Please note that this Directive does not include mutualization of funds; every Member State establishes a Deposit Guarantee Scheme; a cross-border or merged DGS of different Member States is possible. See art 4 of the Directive. 6 Council Regulation (EU) 1024/ 2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2014] OJ L287/63. 7 On the basis of SSM Regulation, art 9(1), 2nd sentence, the ECB shall have, in particular, the powers listed in arts 10–18 of this Regulation. 8 SSM Regulation, art 18(1). 9 SSM Regulation, art 9(1), 3rd sentence. 10 SSM Regulation, art 18(5).

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Judicial Protection of Supervised Credit Institutions The SSM Regulation does not contain a provision regulating a judicial review pro- 3.03 cedure. However, it does provide for a right of judicial review. The SSM Regulation explicitly states that persons affected by the ECB decisions have recourse to judicial review by the Court of Justice of the European Union (CJEU)11 on the basis of Article 263 of the Treaty on the Functioning of the European Union (TFEU). The ECB decisions may include decisions directly affecting the individual credit institution and (binding) decisions/instructions to the national financial supervisors to address an individual credit institution. Recourse against the subsequent national financial supervisors decisions addressed to and affecting the supervised credit institution is not prescribed by the SSM Regulation. Judicial protection in the SRM mechanism is established in a different manner. The 3.04 Banking Recovery and Resolution Directive (BRRD)12 requires Member States to ensure that all persons affected by a crisis prevention measure, the decision to put a credit institution under resolution, or any subsequent decision using a resolution power taken by a national resolution authority, have the right to apply for a judicial review of these decisions.13 The euro area national resolution authorities are subject to instructions of the SRB as provided for by the SRM Regulation. In accordance with these instructions, they have to take decisions based on national laws and regulations affecting individual credit institutions and their stakeholders. Even though not explicitly mentioned, it is logical to assume that the national (administrative) courts will also be competent to hear appeals against these implementing decisions. Like under the SSM Regulation, the SRM Regulation provides that persons affected by the SRB decisions have recourse to the CJEU on the basis of Article 263 of the TFEU. This contribution deals with the inherent tensions arising from the two-level 3.05 decision-making process in which the ECB or the SRB instructs national competent authorities to take decisions based on national legislation addressed to or affecting credit institutions and judicial review by the CJEU and/or national (administrative) courts applying national (administrative) procedural laws.14 Any

11 The CJEU encompasses the whole judiciary—it consists of the European Court of Justice (ECJ) and the General Court and specialized courts (Treaty on the European Union (TEU), art 19(1)). 12 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/ 25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) 1093/2010 and (EU) 648/2012, of the European Parliament and of the Council [2014] OJ L173/190 (BRRD). 13 BRRD, art 85(2). 14 Cf Kerstin Neumann, ‘The Supervisory Powers of National Authorities and Cooperation with ECB—a New Epoch Banking Supervision’ (2014) EuZW-Beilage 1, 9–14 stating that: ‘[t]‌he SSM creates complex classification issues and requires further in-depth analysis regarding the legal implications of different ECB actions. As far as the current understanding suggests, the SSM

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Tomas M C Arons (potential) lack of a clear (division of ) judicial recourse threatens to undermine the effectiveness of the SSM. 3.06 This contribution has the following structure. Section II consists of an analysis

of the ECB powers to take supervision decision addressed to and affecting credit institutions as well as the availability of judicial protection available to these credit institutions at the EU level. The powers of the SRB and the judicial protection available at the EU level to credit resolutions confronted with SRB decisions directly and indirectly affecting them will be discussed in Section III. Section IV elaborates on the substantive review of these decisions by the CJEU. The issue of liability of the ECB and/or SRB for wrongful decisions to and/or damage inflicted on third parties when exercising their supervisory and resolution powers is briefly described in Section V. Section VI provides some concluding remarks.

II. Judicial Protection for Credit Institutions under the SSM 1. Tasks 3.07 Article 127(6) of the TFEU is the legal basis of the SSM (Regulation). The

Council, acting by means of regulations, may unanimously, and after consulting the European Parliament and the ECB, confer specific tasks upon the ECB concerning policies relating to the prudential supervision of credit institutions and other financial institutions with the exception of insurance undertakings. However, a definition of prudential supervision is neither provided for in the TFEU nor in the SSM Regulation.15 Its identification is provided for by the objectives, tasks, and powers of this type of supervision.16 The SSM Regulation confers on the ECB the aforementioned specific tasks: with a view to contribute to the safety and soundness of credit institutions and the stability of the financial system within the Union and in each Member State, with full regard and duty of care for the unity and integrity of the internal markets based on equal treatment of credit institutions with a view of preventing regulatory arbitrage.17

The ultimate aim of prudential supervision is to ensure continuously that the credit institution is run prudently, diligently and responsibly, by among others meeting the formal (capital) requirements laid down in the CRD IV and the CRR. The powers of the ECB to achieve this objective will be discussed in Section I.2.

Regulation permits multiple legal proceedings which may cause inconsistent results within different fora that make up the SSM’. 15 Please note that in SSM Regulation, art 4(1) a list of prudential tasks to be exercised by the ECB is provided for. 16 See Chapter 4 in this volume. 17 SSM Regulation, art 1.

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Judicial Protection of Supervised Credit Institutions From 4 November 2014, almost all credit institutions18 established in the euro area 3.08 are subject to the prudential supervision by the SSM.19 The SSM is the system of financial supervision composed by the ECB and national financial supervisors.20 Credit institutions are subject to direct ECB supervision if they qualify as significant, or subject to indirect ECB supervision if they qualify as less significant.21 The actual supervision of less significant credit institutions is conducted by the national financial supervisor. It is noteworthy that decisions taken by the national financial supervisor with regard to the less significant credit institutions are based on national administrative law and national (administrative) (judicial) proceedings.22 In both cases, direct and indirect supervision, the ECB is ultimately respon- 3.09 sible for the effective and consistent prudential supervision of euro area credit institutions.23 In order to have the SSM function properly, the day to day supervision rests with the national financial supervisors.24 The ECB is exclusively competent to, among others, provide (or withdraw) the required authorization of all credit institutions and to assess notifications of the acquisitions and disposal of qualifying holdings in credit institutions, except in case of a bank resolution.25 The ECB is also competent to carry out supervisory tasks in relation to recovery plans, and early intervention where a credit institution or group in relation to which the ECB is the consolidating supervisor does not meet, or is likely to breach, the applicable prudential requirements and, only in the cases explicitly stipulated by relevant Union law for competent authorities, structural

18 Credit institution is defined as ‘an undertaking the business of which is to take deposits or other repayable funds from the public and to grant credits for its own account’ (SSM Regulation, art 2(3) and CRR, art 4(1)). 19 SSM Regulation, art 4(1). Under the regime of SSM Regulation, art 7 it is possible that also credit institutions established in non-euro area Member States may be subject to the ECB’s prudential supervision if close co-operation has been established between the ECB and the national financial supervisor of such Member State. In that case, the credit institutions of that Member States are subject to the powers of the ECB (SSM Regulation, art 9(3)). 20 SSM Regulation, art 2(9). 21 SSM Regulation, art 6(4). This distinction is also important with regard to the SRM: SRM Regulation, arts 7(2)(a)(i) and 7(3). For the distinction between direct and indirect, reference is made to Gunnar Schuster, ‘The Banking Supervisory Competences and Powers of the ECB’ (2014) EuZW-Beilage 1, 3–9, 4–8. See also Neumann (n 14), 13. 22 SSM Regulation, art 6(6) subpara 2. 23 SSM Regulation, art 6(1). 24 Recital 28 of the Preamble to the SSM Regulation. The other tasks remaining with the national financial supervisors include the power: (i) to receive notifications from credit institutions in relation to the right of establishment and the free provision of services; (ii) to supervise bodies which are not covered by the definition of credit institutions under Union law but which are supervised as credit institutions under national law; (iii) to supervise credit institutions from third countries establishing a branch or providing cross-border services in the Union; (iv) to supervise payments services; (v) to carry out the function of competent authorities over credit institutions in relation to markets in financial instruments; and (vi) the prevention of the use of the financial system for the purpose of money laundering and terrorist financing and consumer protection. 25 SSM Regulation, art 6(4) and (6).

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Tomas M C Arons changes required from credit institutions to prevent financial stress or failure, excluding any resolution powers.26 The latter are reserved to the SRB under the SRM Regulation to be discussed in Section III. The ECB powers include the power to direct the credit institution to review its strategy and its structure and/ or make changes to its governance structure, if the ECB assesses that the recovery plan revised by the credit institution does not adequately remedy the deficiencies or potential impediments to its implementation.27 EU law imposes requirements on credit institutions to have in place robust governance arrangements, including the fit and proper requirements for the executive and non-executive directors of credit institutions, the institutions’ risk management processes, internal control mechanisms, remuneration policies and practices, and effective international capital adequacy assessment processes, including Internal Ratings Based models. The ECB has the exclusive task to ensure compliance with these EU laws.28 2. Powers 3.10 In order to carry out its tasks, the ECB can apply all directly applicable relevant

EU law and national legislation implementing relevant EU Financial Supervision Directives.29 If an EU Regulation explicitly grants Member States options,30 the ECB can only apply national legislation exercising those options.31 It is noteworthy that such options should be construed as excluding options available only to national financial supervisors. It follows from the primacy of EU law that the ECB should, when adopting guidelines or recommendations or when taking decisions, base itself on, and act in accordance with, the relevant binding EU law.32

3.11 With regard to all directly applicable and indirectly applicable relevant EU laws,

the ECB can use all powers granted by these EU laws, and the respective national implementation legislation, to the national financial supervisors.33 These powers

26 SSM Regulation, art 4(1)(i). 27 BRRD, art 6(5) and (6), subparas 3(c) and (e), and 2(1), point 21. 28 See SSM Regulation, art 4(1)(e). 29 SSM Regulation, art 4(3) subpara 1. For an analysis of the consequences when EU Directives are not (correctly, on time) implemented in national legislation or when additional or higher supervisory standards (gold-plating) are imposed by national legislation, I refer to Neumann (n 4), 8. 30 eg (transitional) options: CRR as amended by Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) 648/2012 [2019] OJ L150/1, arts 412(5), 413(4), 493(3), and 458; CRD IV, arts 12(3), 12(4), 29(3), 32(1), 40, 94(1)(g), 133(18), and 160(6). 31 SSM Regulation, art 4(3). By this provision, the level playing field is seriously jeopardized. However, since the directly applicable EU Regulation allows such options, the national differences have to be reluctantly accepted. 32 Recital 34 of the Preamble to the SSM Regulation. 33 SSM Regulation, art 9(1), subpara 2.

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Judicial Protection of Supervised Credit Institutions include the supervisory powers granted by the CRD IV.34 For the same exclusive purpose to carry out the aforementioned tasks, the ECB shall have all the powers and obligations set out in the SSM Regulation. In particular, the ECB has the following investigatory powers (Section 1 of Chapter III of the SSM Regulation): – the power to request information (Article 10); – the general investigatory powers (Article 11); and – the power to carry out on-site inspections (Articles 12 and 13). There are also specific supervisory powers (Section 2 of Chapter III of the SSM Regulation): – the power to grant or withdraw authorization (Article 14); – the power to assess the acquisition of a qualifying holding (Article 15); – the supervisory powers enumerated (Article 16);35 and – the power to impose administrative penalties (Article 18). The power to impose administrative penalties is restricted to intentional or negligent breach by a credit institution of relevant directly applicable EU law. In cases where the SRM Regulation does not confer powers on the ECB, the 3.12 ECB may, by way of binding instructions, require national financial supervisors to make use of their powers vis-à-vis significant36 credit institutions under, and

34 CRD IV, art 104. 35 The ECB has the power: (a) to require institutions to hold own funds in excess of the capital requirements laid down in the acts referred to in SSM Regulation, art 4(3), subpara 1 related to elements of risks and risks not covered by the relevant Union acts; (b) to require the reinforcement of the arrangements, processes, mechanisms, and strategies; (c) to require institutions to present a plan to restore compliance with supervisory requirements pursuant to the acts referred to in SSM Regulation, art 4(3), subpara 1 and set a deadline for its implementation, including improvements to that plan regarding scope and deadline; (d) to require institutions to apply a specific provisioning policy or treatment of assets in terms of own funds requirements; (e) to restrict or limit the business, operations, or network of institutions or to request the divestment of activities that pose excessive risks to the soundness of an institution; (f ) to require the reduction of the risk inherent in the activities, products, and systems of institutions; (g) to require institutions to limit variable remuneration as a percentage of net revenues when it is inconsistent with the maintenance of a sound capital base; (h) to require institutions to use net profits to strengthen own funds; (i) to restrict or prohibit distributions by the institution to shareholders, members or holders of Additional Tier 1instruments where the prohibition does not constitute an event of default of the institution; (j) to impose additional or more frequent reporting requirements, including reporting on capital and liquidity positions; (k) to impose specific liquidity requirements, including restrictions on maturity mismatches between assets and liabilities; (l) to require additional disclosures; (m) to remove at any time members from the management body of credit institutions who do not fulfil the requirements set out in the acts referred to in SSM Regulation, art 4(3), subpara 1. 36 On the basis of SSM Regulation, arts 6(4), (6), 4(1)(a), and (c), the national competent authorities are not subject to binding instructions from the ECB in relation to all supervisory decisions/ policies except for the (withdrawal of the) authorization and the assessment of notifications of the acquisition and disposal of qualifying holdings in credit institutions, except in the case of a bank resolution.

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Tomas M C Arons in accordance with, the conditions set out in national law.37 When necessary to ensure consistent application of high supervisory standards, the ECB may at any time, on its own initiative after consulting with national competent authorities or upon request by a national competent authority, decide to exercise directly itself all the relevant powers for one or more less significant credit institutions, including in the case where financial assistance has been requested or received indirectly from either of the two public financial assistance facilities: European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM).38 3.13 In exercising these powers, the ECB is required to act in accordance with the rele-

vant provisions in the relevant directly applicable EU law and the national legislation implementing the relevant EU Directives.39 In this way, the ECB decision (to instruct) indirectly affects the supervised credit institution. The decision directly affecting the credit institution is taken by the national financial supervisor.

3.14 Regarding the question which (national) powers can be used by the ECB, the

SSM Regulation prescribes that the ECB is bound by the allocation of responsibilities between national home and host competent authorities as provided by the applicable EU Financial Supervision legislation.40 If, for example, a credit institution is established outside the euro-area but within the EU, the ECB may only exercise the powers as host competent authority with regard to branches established in the euro area.

3.15 It may be concluded that the SSM Regulation merely provides for the direct

power to impose sanctions on credit institutions under ECB supervision and the indirect power to instruct national supervisory authorities to make use of their powers, under and in accordance with, the conditions set out in national law. 3. Procedural Rules

3.16 Before taking supervisory decisions, the ECB has to give the persons who are

the subject of the proceedings the opportunity to be heard.41 These persons may include the credit institution as well as its individual directors or employees, depending on the circumstances. Even though the exact wording of Article 22 does not mention the individual directors or employees nor the supervised credit

37 SSM Regulation, art 9(1), subpara 3; art 22(1) of Regulation (EU) 468/2014 of the European Central Bank of 16 April 2014 establishing the framework for co-operation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and with national designated authorities (SSM Framework Regulation) (ECB/2014/17) [2014] OJ L141/1. 38 SSM Regulation, art 6(5)(b). 39 SSM Regulation, art 9(2). 40 SSM Regulation, art 6(8). 41 SSM Regulation, art 22(1), subpara 1, 1st sentence.

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Judicial Protection of Supervised Credit Institutions institutions, which are mostly legal persons,42 specifically, it is logical to assume that this right to be heard includes these legal persons as well. The crucial criterion in this regard is whether the ECB decision is either addressed to them, or is of direct and individual concern.43 Furthermore, the ECB has to base its decisions only on objections on which the parties concerned have been able to comment.44 In cases where urgent action is needed in order to prevent significant damage to the financial system, the ECB may adopt a provisional decision. In that case the persons concerned are given the opportunity to be heard as soon as possible after the decision has been taken by the ECB.45 Besides this right to be heard, the rights of defence of these persons concerned 3.17 have to be fully respected by the ECB in these proceedings.46 These rights of defence include the right to have access to the ECB’s file with regard to the person concerned. This right of access is subject to the legitimate interest of other persons in the protection of their business and does not extend to confidential information.47 Furthermore, the unit of the ECB investigating possible breaches of relevant directly applicable EU law for which an administrative penalty may be imposed on the basis of Article 18 of the SSM Regulation, has to notify the supervised credit institution concerned, in writing, of its findings and objections. This notification must be done after completion of the investigation and before the preparation of and submission of a proposal for a complete draft decision to the Supervisory Board.48 In this notification the supervised credit institution is informed of its right to make—within a reasonable time limit—submission in writing to the ECB investigating unit on the factual results and the objections raised against it, including the individual provisions which have been allegedly infringed.49 The ECB is also subject to the procedural requirement that it has to state the 3.18 reasons on which its decisions are based.50 Without this duty to motivate decisions,

42 SSM Regulation, art 22(1) refers to ‘persons’, logically including natural as well as legal persons. 43 See ECB, ‘Guide to Banking Supervision’, September 2014, point 15 (available at ). 44 SSM Regulation, art 22(1), subpara 1, 2nd sentence. 45 SSM Regulation, art 22(1), subpara 2. 46 SSM Regulation, art 22(2), subpara 1. 47 Ibid. 48 Article 126(1) of Regulation (EU) 468/2014 of the European Central Bank of 16 April 2014 establishing the framework for co-operation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and with national designated authorities (ECB/2014/17) [2014] OJ L141/1 (SSM Framework Regulation). 49 Article 126(2) of Regulation (EU) 468/2014 of the European Central Bank of 16 April 2014 establishing the framework for co-operation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and with national designated authorities (ECB/2014/17) [2014] OJ L141/1 (SSM Framework Regulation). 50 SSM Regulation, art 22(2), subpara 2.

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Tomas M C Arons the persons concerned are unable to object the decision and thus have a proper defence. 4. Review 3.19 This section is subdivided in two parts. The first part deals with the administrative

and judicial review of ECB decisions directly addressed to credit institutions.51 This analysis deals with the question whether individual credit institutions have standing to challenge the ECB decision before the CJEU. The issue of substantive review is dealt with in Section IV of this chapter. In Section II.5(B) the possibility of reviewing the ECB decisions indirectly affecting supervised credit institutions is analysed. These indirect decisions take the form of binding instructions to the national financial supervisors to use their powers granted under national law. Subsequently, the national financial supervisor takes a decision towards the supervised credit institution concerned. 5. Review of ECB Decisions Directly Addressed to Credit Institutions

A. Administrative Review 3.20 ECB decisions may be subject to two different reviews: internal administrative review and judicial review. The procedure of administrative review is provided for in Article 24 of the SSM Regulation.52 Upon request by the person(s) concerned, the Administrative Board of Review has to carry out an internal administrative review of the decision(s) taken by the ECB in the exercise of the powers conferred on it by the SSM Regulation. Clearly, ECB decisions directly addressed to the supervised credit institution may be subject to this administrative review. The person(s) concerned may immediately appeal for judicial review at the CJEU.53 3.21 However, the question has to be answered whether the ECB decisions, directly

addressed to and affecting the supervised credit institution, based on powers granted by national legislation implementing EU financial supervision law qualify as decisions taken by the ECB in the exercise of the powers conferred on it by this Regulation in the sense of paragraph 1 of Article 24 of the SSM Regulation. 51 Cf European Commission, ‘Proposal for a Council Regulation conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions’, COM(2012) 511 which did not even provide specifically for administrative or judicial accountability: see Eilís Ferran and Valia S G Babis, ‘The European Single Supervisory Mechanism’, University of Cambridge Faculty of Law Research Paper No 10/2013, 18 (available online at ). 52 For a recent overview of the statistics regarding the administrative review, I refer to R Smits, ‘Interplay of administrative review and judicial protection in European prudential supervision. Some issues and concerns’ in Quaderni di Ricerca Giuridica della Consulenza Legale No 84 [June 2018], Judicial review in the Banking Union and in the EU financial architecture Conference jointly organized by Banca d’Italia and the European Banking Institute. 53 Brescia Morra, Smits and Magliari (2017), The Administrative Board of Review of the European Central Bank: Experience After 2 Years, Eur Bus Org Law Rev (2017) 18:567-589, 572–3.

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Judicial Protection of Supervised Credit Institutions Even though the ECB makes use of the powers granted by national law, the competence to do so is established by the directly applicable SSM Regulation. Therefore, the ECB decision applying national (financial supervisory) legislation is not a decision subject to national administrative or judicial review, but an ‘EU decision’, taken by an EU institution and hence subject to review by EU courts.54 Even though the ECB exercises powers granted by national legislation implementing EU Directives, including the aforementioned national options, the ultimate source of competence is the SSM Regulation.55 The following formalities have to be fulfilled. The request for review must be 3.22 made in writing, including a statement of grounds, within one month of the date of notification of the ECB decision to the person requesting the review. In the absence of notification, the time limit starts as of the day on which the ECB decision came to the knowledge of the person requesting the review.56 The scope of this internal administrative review is limited to the procedural and substantive conformity of the ECB decision with the SSM Regulation.57 The ECB has adopted, on the basis of Article 253(5) of the TFEU,58 the Operating Rules of the Administrative Board of Review.59 After ruling on the admissibility of the request, the Administrative Board of 3.23 Review has to express an opinion within a period appropriate to the urgency of the matter but no later than two months from the receipt of the request. The Administrative Board of Review can only opine on grounds mentioned by the applicant in its notice of review.60 This opinion must be remitted to the Supervisory Board of the ECB for preparation of a new draft decision. This Supervisory Board must submit a new draft decision to the Governing Council, taking into account the Administrative Board’s opinion. The status of this draft decision depends on

54 Cf Willem H Bovenschen, Koen Holtering, Gijsbert J S ter Kuile, and Laura Wissink, ‘Europees Bankentoezicht (SSM). Juridische en Praktische Perspectieven’ (2013) 10 Nederlands Tijdschrift voor Europees Recht 364, 368; Bernard Spoor and Bart M H Fleuren, ‘De Bankenunie—Rechtsbescherming bij het Single Supervisory Mechanism’ (2013) 7/8 Tijdschrift voor Financieel Recht 233, 236; Laura Wissink, ‘Het (Nieuwe) Europese Bankentoezicht en de Uitdagingen in een Gemengde Rechtsorde’ (2015) 1 SEW, Tijdschrift voor Europees en Economisch Recht 4, 11–12. 55 In the Explanatory Memorandum to the Dutch General Administrative Act (Algemene wet bestuursrecht) the Dutch legislator indicated that the exercise of state authority by bodies created by international treaty within the territory of the Netherlands are outside the scope of that Act. See Parliamentary Papers II 1988/89, 21 221, No 3, 29 (Explanatory Memorandum); cf Bovenschen, Holtering, ter Kuile, and Wissink, ibid, 367 and Spoor and Fleuren, ibid, 235. 56 SSM Regulation, art 24(6). 57 SSM Regulation, art 24(1), 2nd sentence. 58 TFEU, art 263(5): ‘Acts setting up bodies, offices and agencies of the Union may lay down specific conditions and arrangements concerning actions brought by natural or legal persons against acts of these bodies, offices or agencies intended to produce legal effects in relation to them’. 59 Decision of the European Central Bank of 14 April 2014 concerning the establishment of the Administrative Board of Review and its Operating Rules (ECB/2014/16). 60 Article 10(2) of the Decision of the European Central Bank of 14 April 2014 concerning the establishment of the Administrative Board of Review and its Operating Rules (ECB/2014/16).

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Tomas M C Arons the Governing Council. If this Council does not object within ten working days after submission, the draft decision is deemed adopted. The (draft) decision can either abrogate, confirm, or replace the initial decision.61 The expressed opinion and the (draft) decision has to be reasoned and notified to the parties.62 It is important to mention that the request of review has no suspensory effect. However, the Governing Council, on proposal by the Administrative Board, may, if it considers that circumstance so require, suspend the application of the contested decision.63 B. Judicial Review 3.24 Article 24(11) of the SSM Regulation explicitly states that the administrative review proceedings mentioned above are without prejudice to the right to bring proceedings before the CJEU in accordance with the Treaties. Under Article 263 of the TFEU,64 the CJEU has the authority to review the legality of acts of EU bodies, offices, or agencies intended to produce legal effects vis-à-vis third parties.65 The CJEU has also jurisdiction in actions brought by a Member State, the European Parliament, the Council, the Commission, or parties addressed by a decision on grounds of lack of competence, infringement of an essential procedural requirement, infringement of the Treaties or of any rule of law relating to their application, or misuse of powers.66 Paragraph 4 of Article 263 of the TFEU prescribes that, under the same conditions, any natural or legal person may institute proceedings against an act addressed to that person or which is of direct and individual concern to them, and against a regulatory act which is of direct concern to them and does not entail implementing measures. Besides the aforementioned standing requirement, the applicant needs to have a legal interest in bringing proceedings before the CJEU.67 It suffices that the requested 61 SSM Regulation, art 24(7). 62 SSM Regulation, art 24(9). 63 SSM Regulation, art 24(8). 64 TFEU, art 263(1) (formerly Treaty on the European Community (TEC) art 230). 65 The ECB is an EU institution (TEU, art 13(1)). 66 TFEU, art 263(2). 67 Applicants can only bring proceedings in their own distinct interest, not in the interest of another legal subject. Therefore, shareholders of a company having no separate legal interest in bringing proceedings against a decision affecting that company may not bring proceedings in the interest of that company as long as that company can bring an action in its own interest. Cf A-G Kokott in her Conclusion of 11 April 2019 in Trasta Komercbanka v ECB (ECLI:EU:C:2019:323). In her conclusion, Kokott deemed the action for annulment brought by shareholders of Trasta Komercbanka AS inadmissible. The ECB withdrew this bank’s licence in accordance with art 14(5) of the SSM Regulation. This inadmissibility stems from the lack of a change in the legal position of shareholders distinct from the bank itself as a result of the ECB’s licence withdrawal. The shareholders have no interest of their own in bringing proceedings separate from the company’s interest. An exception to this principle could be made, according to its spirit and purpose—if at all—not in cases where the shareholders’ rights of participation are restricted, but in cases where the company itself cannot (effectively) bring an action against the ECB decision in question (para 127). In this case, the company can still be externally represented by its board of directors and thus may bring an action on behalf of the company, it is justified to refer the shareholders in this regard to the exercise of their rights of participation and membership under company law (para 126).

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Judicial Protection of Supervised Credit Institutions annulment of a measure is capable of having legal consequences. Repeal of a measure does not constitute recognition of its unlawfulness. Therefore, repealed measures can be subject to judicial review.68 Furthermore, it is sufficient that, by its outcome, the action for annulment brought before the CJEU would be capable of benefiting the party which brought it.69 The CJEU should, for the purposes of determining an interest in bringing proceedings before them, abstain from assessing the likelihood that an action brought before national courts under national law is well founded and, therefore, to substitute themselves for those courts in making such an assessment.70 The substantive issue of the material grounds to challenge the ECB decision will be dealt with in Section IV of this chapter. In case the SSM Regulation or any other EU legislation grants the ECB the ex- 3.25 clusive competence to decide, the CJEU has the exclusive jurisdiction to review the validity of such a decision. Moreover, in the Fininvest/Banca d’Italia-case, the ECJ71 held that this exclusiveness extends to determine whether the preparatory national acts by national competent authorities are vitiated by defects such as to affect the validity of the ECB’s decision.72 On the basis of Article 15 of the SSM Regulation the ECB has the exclusive competence to decide whether or not to approve the acquisition of a qualifying holding in a credit institution.73 Consequently, the ECJ held that EU Courts74 alone have jurisdiction to determine, as an incidental matter, whether the legality of the ECB’s decision of 25 October 2016 is affected by any defects rendering unlawful the acts preparatory to that decision that were adopted by the Bank of Italy. That jurisdiction excludes any jurisdiction of national courts in respect of those acts, and it is irrelevant in that regard that an action such as the azione di ottemperanza has been brought before a national court.75 According to the ECJ, Article 263 of TFEU precludes national courts from reviewing the legality of decisions to initiate procedures,

68 Crédit Mutuel Arkéa v ECB [2017] (Case T-712/15), paras 40–2. The appeal against the Tribunal’s ruling was rejected by the ECJ on 2 October 2019. Crédit Mutuel Arkéa v ECB [2019] (Cases C-152/18 P and C-153/18 P). 69 Mory v Commission [2015] (Case C-33/14 P), para 76. 70 BPC Lux 2 Sàrl v Commission [2018] (Case C-544/17 P), para 56. In this case, subordinated creditors of Banco Espírito Santo SA (‘BES’), holding Lower Tier 2 Bonds, sought annulment of a Commission decision that the injection of €4 899 million capital by the Portuguese authorities into a bridge bank, to which the sound business activities of BES were transferred, was compatible state aid. Annulment of the Commission state aid decision was deemed favorable to the bondholders, who were ‘left’ as claimants in the ‘bad bank’ BES, in their action before the national courts seeking annulment of and or damages in relation to the decision to put Banco Espírito Santo into resolution. 71 Please note that the CJEU consists of the ECJ (TFEU, arts 251–3) and the General Court (TFEU, arts 254–6). 72 Fininvest/Banca d’Italia [2018] (Case C-219/17), para 58. 73 Articles 22 and 23 of CRD IV. 74 EU Courts are amongst others the ECJ and the General Court. 75 See para 57.

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Tomas M C Arons preparatory acts or non-binding proposals adopted by national competent authorities in the procedure provided for in Articles 22 and 23 of CRD IV, in Articles 4(1)(c) and 15 of the SSM Regulation and in Articles 85 to 87 of the SSM Framework Regulation. Furthermore, the ECJ held that it is immaterial in that regard that a specific action for a declaration of invalidity on the ground of alleged disregard of the force of res judicata attaching to a national judicial decision has been brought before a national court.76 3.26 In conclusion, ECB decisions based on the powers granted by the SSM Regulation

and directly addressed to the supervised credit institution are subject to judicial review by the CJEU on the basis that the decision is addressed to him in the sense of the aforementioned paragraph 4 of Article 263 of the TFEU. Furthermore, paragraph 5 of Article 24 of the SSM Regulation explicitly grants any natural or legal person the right to request a review of the ECB decision under the SSM Regulation if that decision is addressed to that person, or if it is of a direct and individual concern to him.77

3.27 The question arises whether ECB decisions directly addressed to and/ or af-

fecting the credit institution but based on powers provided by national legislation implementing EU Financial Supervision Directives, are also subject to review by the CJEU on the basis of paragraph 4 of Article 263 of the TFEU. Even though standing may be refused because the application of national legislation implementing EU Financial Supervision Law renders the decision not of direct and individual concern, standing will be granted because the decision is directly addressed by the ECB to the credit institution.78 In general, it could be desirable to have the application of national (administrative) legislation interpreted by national courts, however, the admissibility to review by the CJEU on the basis of Article 263 of the TFEU is not dependent on the application of EU substantive law with direct effect.79

3.28 With regard to admissibility, the following formality is important. The pro-

ceedings must be instituted within two months of the publication of the ECB decision, or of its notification to the applicant, or, in the absence thereof, of the day on which it came to the knowledge of the latter, as the case may be.80

76 Fininvest/Banca d’Italia [2018] (Case C-219/17), para 59. 77 SSM Regulation, art 24(5). 78 TFEU, art 263(2). 79 Cf Recital 60 of the Preamble to the SSM Regulation: ‘Pursuant to Article 263 TFEU, the CJEU is to review the legality of acts of, inter alia, the ECB, other than recommendations and options, intended to produce legal effects vis-à-vis third parties’. See also Bovenschen, Holtering, ter Kuile, and Wissink (n 52), 368. 80 TFEU, art 263(5).

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Judicial Protection of Supervised Credit Institutions 6. Review of ECB Decisions Indirectly Affecting Credit Institutions The question arises whether the indirect ECB decisions/instructions to the na- 3.29 tional financial supervisors are subject to judicial review as well. If so, the question arises which court is competent. In order to answer this question, we need to qualify these ECB decision/instruction. As already mentioned, in order to have standing before the CJEU to claim review of the ECB decision, Article 263 of the TFEU provides two alternatives. The decision taken by the EU institution is either addressed to the applicant claiming review or that decision is of direct and individual concern to him. First of all, the ECB decision is clearly an act addressed by an EU institution. However, that decision is not addressed to the supervised credit institution, instead it is addressed to the national financial supervisor containing an instruction to adopt a decision towards the credit institution. Therefore, there is no standing based on the first alternative. In order to have standing based on the second alternative, the ECB decision 3.30 must be of direct and individual concern to the applicant claiming review of the decision. In cases where there are ECB decisions/instructions addressed to the national financial supervisor to take a decision addressed to the individual supervised credit institution, the question of individual concern is not problematic. Unlike challenging regulations and directives of a more generic nature, these decisions clearly concern the individual supervised credit institution individually addressed by the national financial supervisor at the instruction of the ECB.81 In cases where there is an intermediate level between the original decision and the 3.31 final addressee affected by that decision, the question of direct concern is critically important to have standing before the CJEU in order to seek a remedy against the original decision. Direct concern is only established when the intermediate level, in this case the national financial supervisor, has no autonomous, discretionary decision-making power.82 The national (administrative) institution, in this case the national financial supervisor, merely implements the decisions addressed to them by the ECB. This implementation has to be automatic and the result from EU rules without the application of intermediate rules. The difficulty is in determining whether there is some autonomous decision-making between the original EU institution’s decision, in this case the ECB decision, and its implementation.83 In the famous International Fruit case, not dealing with financial supervision, but 3.32 with agricultural measures, the national authorities did not enjoy any discretion in

81 See in general on this distinction between regulation, directives and decisions, Koen Lenaerts, Ignace Maselis, and Kathleen Gutman, EU Procedural Law (Oxford University Press 2014) paras 7.93–7.94. 82 Stichting Woonlinie et al v Commission, ECLI:EU:C:2014:105 (Case C-133/12 P) [55]. See also Lenaerts, Maselis, and Gutman, ibid, paras 7.91–7.92. 83 Lenaerts, Maselis, and Gutman (n 81), para 7.93.

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Tomas M C Arons the matter of the issue of import licences and the conditions on which applications by the parties concerned should be granted. These national authorities merely collected the data necessary for the Commission to take its decision and subsequently adopted the national measures needed to give effect to the decisions of the Commission.84 Therefore, in that case the addressee of the decision taken by the national authority had standing according to the European Court of Justice (ECJ) on the basis of paragraph 4 of Article 263 of the TFEU. 3.33 Thus standing of an addressee of a decision taken by the national financial super-

visor at the instruction of the ECB is critically dependent on the degree of detail provided in the ECB instructions addressed to that national financial supervisor. On the one hand, if the ECB decision in detail determines which powers granted by national law have to be used, and how these powers are to be used, the CJEU may have standing because there is no discretionary (material) decision-making left for the national supervisor.85 It merely performs a (formal) intermediary role. On the other hand, if the ECB decision/instruction gives the national financial supervisor supervisory goals to be achieved at the credit institution, leaving some degree of autonomous decision-making to the national financial supervision regarding the use of supervisory powers and tools and/or how they are used, the credit institution has no standing to challenge the original ECB decision/instruction before the CJEU. In that case, there is no standing to challenge the original ECB decision/instruction before the CJEU even if the autonomous decision- making by the national financial supervisor is relatively minor.

3.34 In case the credit institution does not know the (content of ) the ECB instruction

or in case the credit institution has no standing to challenge the latter before the CJEU, it has the right to challenge the national financial supervisor’s decision before a competent national (administrative) court. In these proceedings brought under national law, the claimant/applicant must be able to plead the illegality of the ECB decision on which the national financial supervisor’s decision in his regard was based.86 If the claimant had had standing to bring proceedings under Article 263 of the TFEU but failed to bring such action within the prescribed time-limits, ie two months after the publication of the measure (Article 263, paragraph 6 of the TFEU), the force of res judicata and the requirements of legal 84 NV International Fruit Company v Commission [1971] ECR 411 (ECJ Cases 41-44/70) 25–6. See also Alcan Aluminium Raeren v Commission [1970] ECR 385 (Case 69/69); Bock v Commission [1971] ECR 897 (Case 62/70); Gemeente Differdange/Commission [1984] ECR 2889 (Case 222/83); Apesco v Commission [1988] ECR 2151 (Case 207/86) [12]; Freistaat Sachsen v Commission [1999] ECR II-3663 (Cases T-132 and 143/96) 89–90; Land Oberösterreich and Austria v Commission [2005] ECR-4005 (Cases T-366/03 and 235/04) 29. 85 See also Gerard Kastelein, De bankenunie en vertrouwen in een goede afwikkeling, Preadvies voor de Vereniging voor Financieel Recht 2014, Serie vanwege het Van der Heijden Instituut deel 126 (Kluwer 2014). 86 Cf Universität Hamburg v Hauptzollamt Hamburg-Kehrwieder [1983] ECR-2771 (Case 216/ 82) 10.

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Judicial Protection of Supervised Credit Institutions certainty make a claim before a national court inadmissible.87 The competent national (administrative) courts cannot annul the original ECB decision/instruction.88 So far, the CJEU has not granted (partial) direct standing to challenge the non-autonomous part of the national authority’s decision addressed to and/or affecting third parties.89 It is the national court which has to refer the question by way of preliminary reference to the CJEU. The CJEU has exclusive jurisdiction, on the basis of Article 267, subparagraph (b) of the TFEU, to rule, by way of preliminary reference, on the validity and interpretation of acts of the institutions, bodies, offices, or agencies of the EU. The national (administrative) courts are forbidden to declare the ECB instruction invalid.90 This chapter will not give an in-depth discussion of the possibility of adminis- 3.35 trative and/or judicial review of the decision taken by the national financial supervisor at the instruction of the ECB before a national (administrative) court. However, it must be noted that the potential for conflicting judicial decisions increases if the ECB decision as well as the national financial supervisor’s decision are subject to review by two different courts.91 Furthermore, in case the ECB instructions are specific and detailed such that there is no room left for discretionary decision-making by the national financial supervisor, judicial review of the national financial supervisor’s ‘decision’ raises difficulties. For example, the national financial supervisor may raise the defence that since it had no discretionary power, no practical remedy is available under national (administrative) law. The national (administrative) court(s) can only nullify the national financial supervisor’s decision. As already mentioned, the ECB decision instructing the

87 Atzeni et al v Scalas and Lilliu [2006] ECR I-1875 (Cases C-346/03 and C-529/03) 30–1; cf Wissink, (n 52), 12. 88 Cf Inuit Tapiriit Kanatami et al v European Parliament, Council, Netherlands and Commission, ECLI:EU:C:2013:625 (Case C-583/11 P) 93–6; Telefónica SA v Commission, ECLI:EU:C:2013:852 (Case C-274/12 P) 29. 89 Laura Wissink, Ton Duijkersloot and Rob Widdershoven, ‘Shifts in Competences between member States and the EU in the New Supervisory System for Credit Institutions and their Consequences for Judicial Protection, Utrecht Law Review Vol 10 Issue 5 [2014], 92–115. 90 Berend Jan Drijber and Anne van Toor, ‘Van ESA’s, SSM en SRM: Rechtsbescherming in een Labyrint van Europese Regels voor het Financiële Toezicht’ (2015) 1 Ondernemingsrecht 13, 19–20; cf Foto-Frost v Hauptzollamt Lübeck-Ost [1987] ECR 4199 (Case 314/85) 17: ‘the coherence of the system requires that where the validity of a Community Act is challenged before a national court the power to declare the act invalid must also be reserved to the Court of Justice’. 91 The Dutch Minister of Finance in a discussion with the Dutch Senate on 25 March 2014 stated in response to a critical remark from a Senate Member that this problem of dual challenging (before the CJEU and the national court) will be solved if the national court refers a preliminary question on the interpretation of supervisory rules to the CJEU on the basis of TFEU, art 267. See Parliamentary Papers (Kamerstukken) I 2013–2014, 33 732, A, 8–9. It is noteworthy that only the highest national court is required to refer preliminary questions to the CJEU; lowers courts may use this tool on a discretionary basis. Furthermore, the Minister merely expresses his hope that some convergence between the national authorities/courts’ interpretation of supervisory rules will take place. He does not indicate how this is to be achieved other that by using the preliminary reference procedure available under the TFEU.

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Tomas M C Arons national financial supervisor to take a decision cannot be annulled by the national administrative court. The CJEU is likely to deny standing as soon as some autonomous decision-making power rests with the national financial supervisor. The national courts are bound to refer the question of annulment of the ECB instruction to the CJEU by way of preliminary reference proceedings. This extra hurdle is likely to impede an effective judicial remedy. A solution to these problems is proposed in Section VI. 3.36 In conclusion, Article 263 of the TFEU provides an opportunity for the individual

(legal) persons directly and indirectly affected by the ECB decisions standing before the CJEU to challenge these decisions. However, decisions by national financial supervisors implementing ECB decisions/instructions addressed to them have to be challenged before national (administrative) courts if some autonomous decision-making is to be left to these national financial supervisors. Whether there is standing to challenge the ECB decision/instruction addressed to the national financial supervisor has to be determined on a case by case basis. This uncertainty is a clear impediment in the protection of supervised credit institutions.

III. Judicial Protection for Credit Institutions under the SRM 1. Tasks 3.37 Articles 50 and 114 of the TFEU92 are the legal basis of the SRM.93 Under this

regime, the European Parliament and the Council may, acting in accordance with the ordinary legislative procedure and after consulting the Economic and Social Committee, adopt the measures for the approximation of the provisions laid down by law, regulation, or administrative action in Member States which have as their object the establishment and functioning of the internal market. The EU crisis-management framework for banks consists of the SRM and the BRRD.94 The BRRD is the minimum harmonization of bank resolutions rules across the Union. It prescribes common resolution tools and powers that must be available, under national law, for national resolution authorities.95 The BRRD leaves discretion to national authorities to apply these tools and powers. The national

92 Formerly TEC, art 95. 93 Recital 6 of the Preamble to the SRM Regulation. 94 For a general overview, see Charles Randell, ‘European Banking Union and Banking Resolution’ (2013) 7(1) Law and Financial Markets Review 30; Michael Schillig, ‘Bank Resolution Regimes in Europe—Part I: Recovery and Resolution Planning, Early Intervention’ (2013) 24 (6) European Business Law Review 751; Michael Schillig, Bank Resolution Regimes in Europe—Part II: Recovery Tools and Powers (2014) 25 (1) European Business Law Review 67; Valia S G Babis, ‘European Bank Recovery and Resolution Directive: Recovery Proceedings for Cross-Border Banking Groups’ (2014) 25(3) European Business Law Review 459. 95 Recital 10 of the Preamble to the BRRD.

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Judicial Protection of Supervised Credit Institutions financing arrangements are the necessary back up of these resolution procedures in the non-euro area Member States; in the euro area the Single Resolution Fund serves to a certain extent as a common back-up facility.96 At the cross-border level, the BBRD merely provides for co-operation among national resolution authorities when dealing with the failure of cross-border banks. However, this lack of centralized decision-making and the continued link between national financing arrangements and bank resolutions neither prevents separate and potentially inconsistent resolution decisions nor reduces the dependence of banks on the support of the national state budget.97 The aim of the SRM Regulation is to ensure effective uniform resolution decisions 3.38 for failing significant banks within the EU. Supervision and resolution are complementary aspects of the internal market for financial services.98 Freedom to provide cross-border financial services requires a common set of (minimum) rules regarding the behaviour vis-à-vis clients.99 The soundness of the financial markets is ensured by (common) supervisory rules, (common) supervision and ultimately orderly resolution of failing financial institutions because of the high interconnectedness of banking systems and cross-border bank groups in the internal market.100 The Single Resolution Fund (SRF) is essential to ensure that investors base their borrowing conditions for banks on the latter’s creditworthiness and not on the creditworthiness of the Member State in which it is established.101 From 1 January 2016, the SRM will be operable within the euro area.102 The 3.39 SRM applies to three different categories of institutions.103 Firstly, the SRM applies to euro area credit institutions under supervision of the ECB. Secondly, it applies to parent undertakings, including financial holding companies and mixed financial holding companies, established in the euro area and subject to consolidated supervision by the ECB.104 Thirdly, it applies to euro area investment firms and financial institutions which are covered by consolidated supervision of the parent undertaking carried out by the ECB on the basis of Article 4(1)(g) of the SSM Regulation.105 The Single Resolution Board (SRB)

96 Recital 19 of the Preamble to the SRM Regulation. 97 Recital 10 of the Preamble to the SRM Regulation. 98 Recital 11 of the Preamble to the SRM Regulation. 99 Takis Tridimas, ‘EU Financial Regulation: Federalization, Crisis Management, and Law Reform’ in Paul Craig and Gráinne de Búrca, The Evolution of EU Law (Oxford University Press 2011) 784. 100 Recital 12 of the Preamble to the SRM Regulation. 101 Recital 19 of the Preamble to the SRM Regulation. 102 Article 90(2) of the Preamble to the SRM Regulation. 103 Recitals 21–2 of the Preamble to the SRM Regulation; SRM Regulation, arts 2 and 4. 104 See SRM Regulation, art 1(1)(b)–(d). 105 On the basis of SSM Regulation, art 4(1)(g) the ECB carries out the supervision on a consolidated basis over credit institutions’ parents established in one of the participating Member States (including over financial holding companies and mixed financial holding companies) and

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Tomas M C Arons is ultimately responsible for the effective and consistent functioning of the SRM.106 3.40 The SRB is, in particular, empowered to take decisions in relation to significant en-

tities or groups, entities or groups directly supervised by the ECB or cross-border groups. The national resolution authorities assist the SRB in resolution planning and in the preparation of resolution decisions. For entities and groups which are not significant and not cross-border, the national resolution authorities remain responsible, in particular, for resolution planning, the assessment of resolvability, the removal of impediments to resolvability, the measures that the resolution authorities are entitled to take during early intervention, and resolution actions. Under certain circumstances the national resolution authorities should perform their tasks on the basis of, and in accordance with, this Regulation while exercising the powers conferred on them by, and in accordance with, the national law transposing the BRRD in so far as it is not in conflict with the SRM Regulation.107

3.41 The powers of the SRB are the following. First of all, it is responsible for drawing

up and adopting resolution plans.108 Resolution plans set out options for applying the resolution tools and resolution powers.109 Furthermore, it provides for the resolution actions which the SRB may take where a credit institutions meet the conditions for resolution.110

3.42 Secondly, the SRB determines, after consultation with national resolution au-

thorities and the ECB, the minimum requirement for own funds and eligible liabilities (MREL) of the supervised institution,111 subject to write-down and conversion powers, which the credit institutions have to meet at all times.112 The

participates in supervision on a consolidated basis (including in colleges of supervisors without prejudice to the participation of national competent authorities in those colleges as observers) in relation to parents not established in one of the participating Member States. 106 SRM Regulation, art 7(1). 107 Recital 28 of the Preamble to the SRM Regulation. 108 SRM Regulation, art 8(1). Before drawing up resolution plans, the SRB must consult the national competent authorities and the national resolution authorities of the Member State in which the credit institution is established. The SRB may require national resolution authorities to prepare and submit to it a draft (group) resolution plan: see SRM Regulation, art 8(2). 109 SRM Regulation, art 8(5). 110 SRM Regulation, art 8(6). 111 This minimum requirement is expressed as a percentage of the total risk exposure amount, calculated in accordance with art 92(3) of the CRR; and the total exposure measure calculated in accordance with arts 429 and 429a of the CRR : see SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L 150/226, art 12a. 112 SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 806/2014 as regards the loss- absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L 150/226, art 12(1). In principle, the minimum percentage is 8%. See Recital 80 of the Preamble to the SRM Regulation, SRM Regulation as amended by the Regulation of the European Parliament

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Judicial Protection of Supervised Credit Institutions SRB and national competent authorities ensure that the supervised entities meet the MREL at all times.113 The SRB must take the following the criteria into account when determining the MREL. This implies ensuring that the resolution group can be resolved by the application of the resolution tools to the resolution entity114, including, where appropriate, the bail-in tool, in a way that meets the resolution objectives.115 Secondly, the MREL must ensure that in case the bail-in tools are applied, the losses of this credit institution can be absorbed and the total capital ratio restored and, as applicable, the leverage ratio, can be restored to a level necessary to enable it to continue to comply with the conditions for authorization and to carry on its activities.116 Furthermore, the SRB needs to ensure that, if the resolution plan anticipates the possibility for certain classes of eligible liabilities to be excluded from bail-in117 or to be transferred in full to a recipient under a partial transfer, that the resolution entity has sufficient own funds and other eligible liabilities to absorb losses and to restore its total capital ratio and, as applicable, its leverage ratio, to the level necessary to enable it to continue to comply with the conditions for authorization and to carry on the activities.118 Fourthly, the SRB has to take into account the size, the business model, the funding model and the risk profile of the credit institution. Lastly, the SRB has to take into account the extent to which the failure of the supervised entity would have an adverse effect on financial stability, including through contagion to other institutions or entities, due to the interconnectedness of the entity with those other institutions or

and of the Council amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investments firms (2016/0361(COD) as adopted by the Council on 14 May 2019, art 12c(4). 113 See SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss- absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L150/226, art 12a(1). 114 ‘resolution entity’ means a legal person established in a participating Member State, which, in accordance with art 8, is identified by the Board as an entity in respect of which the resolution plan provides for resolution action (SRM Regulation, as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L150/226, art 3(1)(24a). 115 See SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss- absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L150/226, art 12d(1)(a). 116 See SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss- absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L150/226, art 12d(1)(b). 117 Bail-ins pursuant to art 27(5) of the SRM Regulation. 118 See SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss- absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L150/226, art 12d(1)(c).

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Tomas M C Arons entities or with the rest of the financial system, has to be taken into account when determining the minimum requirement for own funds and eligible liabilities.119 3.43 The ECB or the national resolution authorities have to inform the SRB of any (su-

pervisory) measure they require an institution to take or that they take themselves to address problems at an early stage.120 Also the ECB is to monitor, in co-operation with the SRB or the relevant national resolution authority, the conditions of the credit institution or the parent undertaking and their compliance with any early intervention measure that was required of them.121 Amongst others, the SRB has the power to prohibit a credit institution certain distributions (of profits, capital buyback or remuneration/pension payments) where it considers that an institution or resolution entity is failing to meet the combined buffer requirement under CRD IV122 when considered in addition to the MREL.123

3.44 The Council, the European Commission, and the SRB, in respect of their respective

responsibilities, have regard to the resolution objectives. They must choose the tools and powers that, in their view, best achieve the resolution objectives that are relevant in the circumstance of the case.124 These objectives are the following:

(1) to ensure the continuity of critical functions; (2) to avoid significant adverse effects on financial stability in the EU, in particular by preventing contagion, including to market infrastructures, and by maintaining market discipline; (3) to protect public funds by minimizing reliance on extraordinary public financial support; (4) to protect depositors covered by the DGS125 and investors covered by investor- compensation schemes;126 (5) to protect client funds and client assets.127 119 See SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss- absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L150/226, art 12d(1)(e). 120 SRM Regulation, art 13(1) explicitly referring to measures taken pursuant to SSM Regulation, art 16; BRRD, arts 27(1), 28, or 29; and CRD IV, art 104. 121 SRM Regulation, art 13(2), subpara 2. 122 CRD IV as amended by Directive (EU) 2019/878 of the European Parliament and of the Council of 20 May 2019 amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures [2019] OJ L150/253, art 141a(1)(a)–(c). 123 See SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L150/226, art 10a. 124 SRM Regulation, art 14(1). 125 Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014 on deposit guarantee schemes (recast) [2014] OJ L173/149. 126 Directive 97/9/EC of the European Parliament and of the Council of 3 March 1997 on investor-compensation schemes [1997] OJ C84/22. 127 SRM Regulation, art 14(2).

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Judicial Protection of Supervised Credit Institutions In conclusion, the SRB ultimately decides on the resolution action, ie which 3.45 resolutions tools to apply, by exercising its resolution powers when significant euro area credit institutions are failing or likely to fail.128 The decision whether a credit institutions is failing or likely to fail rests with the ECB after consultation of the SRB.129 2. Powers It is important to note that where, pursuant to the SRM Regulation, the SRB 3.46 performs its tasks and exercises its powers, which, pursuant to the BRRD are to be performed or exercised by the national resolution authority, the SRB is, for the application of the SRM Regulation and of the BRRD, considered to be the relevant national resolution authority or, in the event of cross-border group resolution, the relevant group-level resolution authority.130 The SRM Regulation provides the SRB with powers to take a decision directly addressed to and affecting a credit institution and powers to instruct a national resolution authority to take decisions addressed to and affecting a credit institution. The powers of the SRB will be discussed in chronological order, ie from early intervention to resolution. By way of early intervention, the SRB has the power to require the institution, or 3.47 the parent undertaking, to contact potential purchasers in order to prepare for the resolution of the credit institution.131 As soon as the ECB has decided that a credit institution is failing or likely to fail,132 3.48 the SRB has to decide whether there is a reasonable prospect for any alternative

128 SRM Regulation, art 16(1). 129 SRM Regulation, art 18(1). 130 SRM Regulation, art 5(1). 131 SRM Regulation, art 13(3)(1). This contact is subject to the conditions specified in BRRD, art 39(2) and the confidentiality provisions specified in SRM Regulation, art 88. 132 According to SRM Regulation, art 18(4), the entity is deemed to be failing or to be likely to fail in one or more of the following circumstances: (a) the entity infringes, or there are objective elements to support a determination that the institution will, in the near future, infringe the requirements for continuing authorization in a way that would justify the withdrawal of the authorization by the ECB, including but not limited to the fact that the institution has incurred or is likely to incur losses that will deplete all or a significant amount of its own funds; (b) the assets of the entity are, or there are objective elements to support a determination that the assets of the entity will, in the near future, be less than its liabilities; (c) the entity is, or there are objective elements to support a determination that the entity will, in the near future, be unable to pay its debts or other liabilities as they fall due; or (d) extraordinary public financial support is required except where, in order to remedy a serious disturbance in the economy of a Member State and preserve financial stability, that extraordinary public financial support takes any of the following forms: (i) a state guarantee to back liquidity facilities provided by central banks in accordance with the central banks’ conditions; (ii) a state guarantee of newly issued liabilities; or (iii) an injection of own funds or purchase of capital instruments at prices and on terms that do not confer an advantage upon the

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Tomas M C Arons private sector measure preventing the credit institution’s failure.133 The alternative private sector measures include measures by an Institutional Protection Scheme (IPS)134 or supervisory action, including early intervention measures or the write- down or conversion of capital instruments.135 If the SRB considers a satisfactory private sector measure not immediately available so as to prevent the failure of the institution or entity within a reasonable timeframe, the SRB may suspend certain contractual obligations (payment or delivery) of the credit institution on the condition that it deems exercising this power is deemed necessary to avoid the further deterioration of the financial conditions of the institution or entity.136 This power is to be exercised before the institution or entity is put under resolution. This power to suspend certain contractual obligations would allow the SRB to establish whether a resolution action is in the public interest, to choose the most appropriate resolution tools, or to ensure the effective application of one or more resolution tools.137 The duration of the suspension should be limited to a maximum of two business days. Up to that maximum, the suspension could continue to apply after the resolution decision is taken. In case there is no reasonable prospect for alternative private sector measures and the SRB deems a resolution action necessary in the public interest, the SRB has to adopt a resolution scheme.138 The effects of the resolution scheme are the following. Firstly, the resolution scheme places the credit institution under resolution.139 Secondly, it determines the application of the resolution tools, in particular any exclusions of the bail-in.140 The entity, where neither the circumstances referred to in points (a), (b) and (c) of this paragraph nor the circumstances referred to in art 21(1) are present at the time the public support is granted. 133 SRM Regulation SRM Regulation as amended by Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investments firms [2019] OJ L150/226, art 18(1)(b). 134 An IPS is usually set up by a large number of small co-operative banks (operating mainly with their shareholders/members and within geographical restrictions) and their central credit institutions (which may be incorporated as stock companies owned by the co-operative banks and act as central depository of the same). Each bank is obliged to provide the institutional protection schemes with the funds that are necessary in order to protect each member from illiquidity or insolvency risks: see European Commission, ‘Your Questions on Legislation’, Questions Related to Article 80 of 2006/ 48/ EC, ID 502 (available online at ). 135 SRM Regulation, art 18(1)(b). 136 BRRD as amended by as amended by Directive (EU) 2019/879 of the European Parliament and of the Council of 20 May 2019amending Directive 2014/59/EU as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296, art 33a. 137 Recital 27 of the Preamble to Directive (EU) 2019/879 of the European Parliament and of the Council of 20 May 2019 amending Directive 2014/59/EU as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296. 138 SRM Regulation, art 18(1), subpara 1. 139 SRM Regulation, art 18(6)(a). 140 SRM Regulation, art 18(6)(b). The conditions for a (partial) exception of certain liabilities from bail-in are laid down in SRM Regulation, art 27(5) and (14).

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Judicial Protection of Supervised Credit Institutions resolution tools are the following: (a) the sale of business tool; (b) the bridge institution tool; (c) the asset separation tool; and (d) the bail-in tool.141 Thirdly, the SRB determines the use of the SRF to support the resolution action. This support is limited to the purposes enumerated in Article 71 of the SRM Regulation.142 State and SRF aid cannot take place until a positive or conditional decision 3.49 concerning the compatibility of the use of public aid with the internal market is given by the Commission.143 The resolution scheme enters into force if no objection has been expressed by the Council (voting by simple majority) or by the Commission within 24 hours after its transmission by the Board.144 Within 12 hours, the Commission may propose to the Council to object on the ground that the public interest criterion is not fulfilled. If the Council endorses this proposal, the credit institution shall be orderly wound up in accordance with the applicable national (insolvency) law.145 Furthermore, it may also propose to approve or object to a material modification of the amount of the Fund provided for in the SRB’s scheme.146 If the Council approves the Commission’s proposal for modification, the SRB has to modify the resolution scheme accordingly within eight hours.147 Furthermore, the Commission may object, within 24 hours, to the SRB’s exercise of its discretionary powers.148 In that case, the SRB has to modify within eight hours the resolution scheme in accordance with the reasons expressed.149 It is not exactly clear what the latter requirement entails and whether the SRB may still reach the same conclusion concerning the exercise of its discretionary powers.

141 SRM Regulation, arts 18(6)(b) and 22(2); cf the resolution tools available to the national resolution authorities referred to in BRRD, art 37(3). 142 SRM Regulation, art 18(6)(c). 143 SRM Regulation, art 19(1). 144 SRM Regulation, art 18(7), subpara 5. 145 SRM Regulation, art 18(7), subpara 2 and (8). The law applicable to the insolvency of the credit institution established in the EU is not determined by the Insolvency Regulation (Council Regulation (EC) 1346/2000 of 29 May 2000 on insolvency proceedings [2000] OJ L160/1, art 1(2)) or the Insolvency Regulation Recast (applicable to insolvency proceedings opened after 26 June 2017, art 84) Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings [2015] OJ L141/19 but by (the national laws implementing) Directive 2001/24/EC of the European Parliament and of the Council of 4 April 2001 on the reorganization and winding up of credit institutions [2001] OJ L125/15. The home Member State, ie the Member State where the credit institution’s head office is situated and it actually operates its banking activities (art 2, subpara 1 and Recital 9 of the Preamble to Directive 2000/12/EC of the European Parliament and of the Council of 20 March 2000 relating to the taking up and pursuit of the business of credit institutions [2000] OJ L126/1) is exclusively competent to determine the opening of winding-up proceedings concerning a credit institution, including branches established in other Member States (art 9(1)). The laws, regulations, and procedures of this home Member State are applicable (art 10(1)). 146 SRM Regulation, art 18(6), subpara 2(b). 147 SRM Regulation, art 18(6), subpara 7. 148 SRM Regulation, art 18(7), subpara 1. 149 SRM Regulation, art 18(6), subpara 7.

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Tomas M C Arons 3.50 The SRB addresses the duly adopted resolution scheme to the relevant national

resolution authorities. It ensures that the necessary resolution action is taken by the relevant national resolution authorities to carry out this resolution scheme.150 For that purpose, the SRB has to instruct the national resolution authorities. The latter shall take all necessary measures to implement the resolution scheme by exercising any of the resolution powers provided for in the BRRD.151 The resolution powers that must be available to national resolution authorities, and thereby indirectly available to the SRB (indirect powers), are far-ranging, among others: – in general, all powers provided by national law so as to apply the resolutions tools;152 – the power to transfer to another entity, with the latter´s consent, rights, assets, and liabilities of the credit institution;153 – the power to reduce, convert, cancel, and amend the terms of (eligible) liabilities of the credit institution;154 – the power to require an issue of new shares or other capital instruments by the credit institution;155 – the power to remove rights to acquire further shares of other instruments of ownership;156 – the power to close out and terminate financial and derivatives contracts;157 – the power to remove or replace the management body and senior management;158 – the power to discontinue or suspend trading on a regulated market in the EU;159 – the power to suspend contractual payment or delivery obligations of the credit institution;160 – the power to restrict the enforcement of security interests by secured creditors of the credit institution;161 150 SRM Regulation, arts 18(9) and 28. 151 In particular, those in BRRD, arts 63–72: see SRM Regulation, arts 18(9) and 28(1)(b)(vi). Please note that BRRD, arts 66 and 67 are not about powers to national resolution authorities but about an obligation to Member States other than the Member State of the competent resolution authority to ensure the full effect of the transfer in or under the law of the respective Member State, including the powers available to administrators, receivers, or other persons exercising control of the credit institution under resolution. Affected shareholders, creditors, and third parties are not entitled to prevent, challenge, or set aside the transfer under any provision of law of the other Member States. BRRD, art 68 is about the (lack of ) effect of contractual terms when crisis prevention or crisis management measures are taken by the national resolution authorities. 152 BRRD, art 63(1), 1st sentence. In case of a sale of business or transfer to a bridge institution, the credit institution may be required to provide any services or facilities necessary to enable a recipient to operate effectively the business transferred to it (BRRD, art 65). 153 BRRD, art 63(1)(d). 154 BRRD, arts 63(1)(e)–(h) and (j). 155 BRRD, art 63(1)(i). 156 BRRD, art 64(1)(b). 157 BRRD, art 63(1)(k). 158 BRRD, art 63(1)(l). 159 BRRD, art 64(1)(c). 160 BRRD, art 69. 161 BRRD, art 70.

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Judicial Protection of Supervised Credit Institutions – the power to temporarily suspend termination rights of any contractual party of the credit institution;162 – the power to exercise control over the credit institution under resolution, so as to operate and conduct the activities and services of the credit institution under resolution with all the powers of the shareholders and management body;163 and – the power to manage and dispose of assets and property of the credit institution under resolution.164 Furthermore, the national resolution authorities have to implement all 3.51 decisions addressed to them by the SRB.165 For these purposes, they must use their respective powers under national law transposing the BRRD and in accordance with the conditions set out in national law.166 Any action must comply with the SRB decisions.167 The SRB is fully informed about the exercise of their powers. It is important to note that the SRB has no direct or indirect powers to take early intervention measures except for the power to require the credit institution to contact potential purchasers in order to prepare for the resolution by sale of business.168 These early intervention powers are exclusively exercised by the ECB.169 The powers to appoint a temporary administrator and to appoint a new senior management or management body of the credit institution under resolution is only available to the SRB.170 The power to review the (group) recovery plans drawn up by the credit institutions as required by the BRRD is restricted to the SRB as well.171 Resolution planning is also done by the SRB.172 However, the SRB may require the relevant national resolution authority to draft a preliminary resolution scheme.173 Resolution plans include a detailed description of the different resolution strategies that could be applied according to different possible scenarios and the applicable time scales.174

BRRD, art 71. 163 BRRD, art 72(1)(a). 164 BRRD, art 72(1)(b). 165 SRM Regulation, art 29(1), subpara 1. 166 SRM Regulation, art 29(2), subpara 2. 167 SRM Regulation, art 29(1), subpara 2 in fine. 168 This power has to be exercised in accordance with the procedural requirements laid down in BRRD, art 39(2) and the confidentiality provisions of SRM Regulation, art 88. See SRM Regulation, art 13(3), subpara 1. 169 SSM Regulation, art 4(1)(i). 170 BRRD, arts 29 and 28 respectively and SRM Regulation, art 5(1). 171 BRRD, arts 6–9, and SRM Regulation, art 5(1). 172 SRM Regulation, art 8(1). 173 SRM Regulation, art 13(3), subpara 2. 174 BRRD, art 10(7)(j). Resolution planning includes identifying any material impediments to resolvability of the credit institution and, where necessary and proportionate, outline relevant actions for how those impediments could be addressed: see BRRD, art 10(2). 162

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Tomas M C Arons 3.52 The powers of the SRB to directly address the credit institutions under resolution

(direct powers) are the following:

– the power to request information directly from (Article 34 of the SRM Regulation): • the credit institution under resolution; • this credit institution’s employees; and • third parties to whom its functions and activities are outsourced; – the general investigatory powers with respect to the above-mentioned persons (Article 35 of the SRM Regulation); – the power to carry out on-site inspections (Articles 36 and 37 of the SRM Regulation175); – the power to impose fines when, intentionally or negligently, the credit institution (Article 38 of the SRM Regulation):176 • does not supply the requested information; • does not submit to a general investigation and/or on-site inspection; or • does not comply with a decision directly addressed to them by the SRB; and – the power to impose a periodic penalty payment (Article 39 of the SRM Regulation). 3.53 Less significant credit institutions are, in principle, resolved at the national level.177

However, in order to ensure efficiency and uniformity of resolution action in all participating Member States, the SRB may directly address a decision to a credit institution under resolution when a national resolution authority has not applied, or has not complied, with a SRB decision or has applied it in a way which poses a threat to any of the resolution objectives or to the efficient implementation of the resolution scheme.178 The following decisions can be directly addressed to an institution under resolution:179 175 In case the on-site inspection or the necessary assistance provided for in SRM Regulation, art 36(5) require judicial authorization according to national rules, the national judicial authority’s control of the SRB decision is limited to its authenticity and the arbitrariness and/or excessiveness of the coercive measures envisaged, having regard to the subject matter of the inspection. Detailed explanations may be requested by the judicial authority from the SRB so as to control the proportionality of the coercive measure. In particular, explanations relating to the grounds the SRB has for suspecting (a serious) infringement of acts referred to in SRM Regulation, art 29 and the nature of the involvement of the person(s) subject to the envisaged coercive measures. The national judicial authority may not review the necessity for the inspection or demand to be provided with the information on the SRB’s file. The lawfulness of the SRB’s decision is exclusively subject to review by the CJEU. See SRM Regulation, art 37(2). 176 These fines have to be proportionate and dissuasive so as to ensure that decisions taken in the SRM framework are respected. See Recital 95 of the Preamble to the SRM Regulation. 177 Recital 28 of the Preamble to SRM Regulation and SRM Regulation, art 7(2)(a). 178 SRM Regulation, art 29(2)(c). Recital 87 of the Preamble to the SRM Regulation. 179 The amendments first proposed by the European Parliament would have provided the SRB the power to exercise directly any other power provided for in the BRRD: see BRRD, art 26(2) as amended by the European Parliament in its decision of 6 February 2014 (see 2013/0253 (COD), 5945/14).

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Judicial Protection of Supervised Credit Institutions – the transfer to another person of its specified rights, assets, or liabilities;180 – the conversion of any of its debt instruments containing a contractual term for conversion;181 or – any other necessary action to comply with the SRB’s initial decision addressed to the relevant national resolution authority.182 Before any decision is made, the SRB notifies the national resolution authorities 3.54 concerned and the European Commission the details and reasons of its intended measure.183 Except for exceptional circumstances, this notification has to be made at least 24 hours before the measures are to take effect.184 Any SRB decision is to be complied with by the addressed credit institution under resolution as well as by the national resolution authorities.185 Moreover, it prevails over any previous decision of the national resolution authorities on the same matter.186 Any action by the national resolution authorities restraining or affecting the SRB’s exercise of powers or functions are forbidden.187 3. Procedural Rules The SRB has to give the persons subject to the proceedings imposing fines and/or 3.55 periodic penalty payments the opportunity to be heard on its findings. This opportunity has to be given before any decision imposing these sanctions is taken. The subsequent decision is only based on findings on which the persons subject to the proceedings have had the opportunity to comment.188 Furthermore, the rights of defence have to be fully respected by the SRB. In particular, the persons concerned must have access to the SRB’s files, subject of course to the legitimate interests of other persons in the protection of their business secrets, and the SRB’s confidential information and internal preparatory documents.189 4. Review This section is subdivided in two parts. The first part consists of the administrative 3.56 and judicial review available to credit institutions which are directly addressed by SRB decisions. As in Section II of this chapter, the discussion is limited to the SRM Regulation, art 29(2)(a). 181 The conditions mentioned in SRM Regulation, art 21(1) must be met in order to be able to require the conversion (SRM Regulation, art 29(2)(b)). 182 See SRM Resolution, art 29(2)(c). This power is to be used only if the measure significantly addresses the threat to the relevant resolution objective or the efficient implementation of the resolution scheme. See SRM Regulation, art 29(2), subpara 2. 183 SRM Regulation, art 29(2), subpara 3. 184 SRM Regulation, art 29(2), subpara 4. 185 SRM Regulation, art 29(3) and (4). 186 SRM Regulation, art 29(3). 187 Recital 87 of the Preamble to the SRM Regulation. 188 SRM Regulation, art 40(1). 189 SRM Regulation, art 40(2). 180

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Tomas M C Arons issue of standing before the CJEU: the substantive grounds of review will be dealt with in the Section IV of this chapter. The second part is about the possibility of review available to credit institutions indirectly affected by SRB decisions. These indirect decisions are directed by way of instruction to the national resolution authorities. These instructions are to be followed in a decision by the national resolution authorities towards the credit institution concerned. 5. Review of SRB Decisions Directly Addressed to Credit Institutions A. Administrative Review 3.57 Any natural or legal persons, including the national resolution authorities, may ap-

peal against an SRB decision to impose fines and periodic penalty payment which are addressed to that person, or which are of direct and individual concern to that person.190 This administrative review is done by the Appeal Panel established by the SRB.191 The persons addressed directly by the SRB decision to transfer, to convert, or to adopt any other necessary action to comply with the SRB’s initial decision addressed to the relevant national resolution authority cannot appeal to the Appeal Panel. Article 85(3) of the SRM Regulation enumerates by reference to the article in the SRM Regulation which SRB decisions can be appealed against by any natural or legal person to whom they were either addressed to, or to whose direct and individual concern this decision is. Article 29 of the SRM Regulation is the legal basis for the decision to transfer, convert, or adopt any other necessary action to comply with the SRB’s initial decision. Article 29 of the SRM Regulation is not mentioned in Article 85(3) of the SRM Regulation.

3.58 The appeal, including the statement of grounds, has to be filed in writing at

the Appeal Panel not later than six weeks of the date of notification of the SRB decision to that person or, in the absence of notification, of the day on which the decision came to the knowledge of this person.192 The appeal has no automatic suspensive effect; the Appeal Panel may suspend the application of the contested decision if the situation so requires,193 but must make a decision within one month of filing.194 The parties to the appeal, ie the appealing credit institution and the SRB, are invited to file observations and to make oral representations on their own notifications and on the communications from the other parties.195 In case the decision is of direct and individual concern to the shareholders or other creditors of the credit institution, they may appeal against this decision as well.196 190 SRM Regulation, art 85(3), subpara 1. 191 SRM Regulation, art 85(1). 192 SRM Regulation, art 85(3), subpara 2. 193 SRM Regulation, art 85(6). 194 SRM Regulation, art 85(4). 195 SRM Regulation, art 85(7). 196 SRM Regulation, art 85(3). See also Trasta Komercbanka and others v ECB [2017] (Case T-247/16). An appeal is lodged by the ECB, the European Commission and Trasta Komercbanka

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Judicial Protection of Supervised Credit Institutions The Appeal Panel examines whether the SRB decision is well-founded.197 It is not clear yet whether the scope of this review is limited to questions of legality of the decision. The SRM Regulation does not explicitly confer any substitutive powers on the Appeal Panel. Unlike the Administrative Board of Review under the SSM Regulation, the Appeal Panel may not have the power to review the merits of the decision and thereby evaluate the discretionary choices made by the SRB.198 The Appeal Panel decision either confirms the SRB decision, or refers the case 3.59 to the SRB.199 In the latter case, the SRB is bound by the Appeal Panel decision

and Others (Case C-669/17 P). A-G Kokott in her Conclusion of 11 April 2019 in this case (ECLI:EU:C:2019:323) concludes to uphold the appeal against the General Court’s decision to declare the shareholder’s action admissible because in this case as a result of the liquidation of the Trasta Komercbanka (TKB), its shareholders are effectively prevented from exercising their rights if the powers of the company’s management bodies have been transferred to a liquidator who cannot be influenced by the internal legal remedies of the company which are usually available to shareholders. Accordingly, the shareholders of TKB are not able to exercise their rights as members in order to force (the management of ) TKB to bring an action against the ECB’s decision on behalf of the bank, according to the General Court (para 55, Case T-247/16). According to the A-G, the reasons to uphold the appeal are the following. Applicants need to show an interest in proceedings. Interest in bringing proceedings requires that the binding legal effects of the contested measure must be capable of affecting the interests of the applicant by bringing about a distinct change in its legal position. In principle an action for annulment of this measure brought by a shareholder in a company is admissible only if he can show an interest of his own in bringing proceedings separate from the interest the company to which the contested measure is addressed has in the annulment thereof. As a matter of law, a shareholder can defend his interest in relation to that contested measure only by exercising his rights as a member of that company. A bank’s shareholders may assert the defending of their property rights as an interest of their own in bringing proceedings, according to the case-law of the General Court. In such cases, the General Court examines whether the status of the shareholder as the owner of shares in the company is individually and directly affected by the contested measure addressed to the company. Despite the company’s liquidation or insolvency proceedings, the addressed company itself has a right to bring an action. An action brought by a shareholder is not necessary and is to be considered subordinate to the direct legal protection of the company as addressee of the measure in question. The mere fact that the withdrawal of the bank’s licence jeopardizes the object of the company and may thus be reflected in a loss in the value of shares is not sufficient to establish direct concern. The interest which the shareholders in this case have in securing the future of the company is also not sufficiently separate from the bank’s interest in retaining its licence (paras 104–6; paras 117–21). 197 SRM Regulation, art 85(7). 198 See Concetta Brescia Morra, René Smits and Andrea Magliari, ‘The Administrative Board of Review of the European Central Bank: Experience After 2 Years’ (2017) 18 Eur Bus Org Law Rev (2017) 567–89 at 571 referring to A Witte, ‘Standing and Judicial Review in the New EU Financial Markets Architecture’ (2017) 1 J Financ Regul 1–37 at 20; M Lamandini, ‘The ESAs’ Board of Appeal as a Blueprint for the Quasi-judicial Review of European Financial Supervision’ (2014) 11 Eur Co Law 290–4; W Blair, ‘Board of Appeal of the European Supervisory Authorities’ (2013) 24 Eur Bus Law Rev 165–71; E Wymeersch ‘The European Financial Supervisory Authorities or ESAs’ in Wymeersch E et al (eds), Financial Regulation and Supervision. A Post-crisis Analysis (Oxford University Press 2012), 232; P Chirulli and L De Lucia, ‘Specialized Adjudication in EU Administrative Law: The Boards of Appeal of EU Agencies. (2015) 40 Eur Law Rev 846 are of the opinion that the Appeal Panel under the SRM and the Boards of Appeal of the ESAs can review the legal and technical correctness of the merits of the contested decision. 199 See Luís Silva Morais, Lúcio Tomé Feteira, ‘Judicial Review and the Banking Resolution Regime. The evolving landscape and future prospects’ in Quaderni di Ricerca Giuridica della

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Tomas M C Arons and has to adopt an amended decision.200 So unlike the Administrative Board of Review’s opinion which is advisory and non-binding by nature, the Appeal Panel has to provide reasons for its decision and notifies it to the parties.201 The Appeal Panel has adopted and published its rules of procedures, as required by the SRM Regulation.202 B. Judicial Review 3.60 The Appeal Panel decision may be reviewed by the CJEU in accordance with Article 263 of the TFEU.203 In cases where there is no right of appeal before the Appeal Panel, as is the case in the above-mentioned direct SRB decision based on Article 29 of the SRM Regulation, proceedings against the SRB decision may also be brought before the CJEU.204 Under Article 263 of the TFEU,205 the CJEU has the authority to review the legality of acts of EU bodies, offices, or agencies intended to produce legal effects vis-à-vis third parties.206 Furthermore, all Member States, the EU institutions,207 and all natural or legal persons directly and individually concerned may bring proceedings before the ECJ against any SRB decisions on the basis of Article 263 of the TFEU.208 These persons may bring, on the basis of Article 265 of the TFEU, proceedings before the CJEU as well if the SRB has an obligation to act and fails to take a decision.209 The action shall be admissible only if the SRB has first been duly called upon to act. If, within two months of being so called upon, the institution, body, office or agency concerned has not defined its position, the action may be brought within a further period of two months.210 The SRB is bound to take all necessary measures to comply with the CJEU’s judgment.211

Consulenza Legale No 84 (June 2018), Judicial review in the Banking Union and in the EU financial architecture Conference jointly organized by Banca d’Italia and the European Banking Institute 65. 200 SRM Regulation, art 85(8). 201 SRM Regulation, art 85(9). See Concetta Brescia Morra, René Smits and Andrea Magliari, ‘The Administrative Board of Review of the European Central Bank: Experience After 2 Years’ (2017) 18 Eur Bus Org Law Rev 570. 202 SRM Regulation, art 85(10). See online at . 203 SRM Regulation, art 86(1) and (2). 204 SRM Regulation, art 86(1). 205 TFEU, art 263, subpara 1. 206 The SRB is a fully independent agency of the EU: SRM Regulation, art 42(1), 3rd sentence. 207 The EU institutions are: European Parliament, European Council, Council, European Commission, CJEU, ECB, Court of Auditors (TEU, art 13). 208 SRM Regulation, art 86(2). 209 SRM Regulation, art 86(3). 210 TFEU, art 265, subpara 2. See Comprojecto-Projectos e Construções, Lda and Others v ECB [2017] (Case T-22/16). In that case the court ruled that the applicants did not duly notify the ECB with their request to take action. The applicant could not establish any such invitation to act was received by the ECB (para 20). 211 SRM Regulation, art 86(4).

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Judicial Protection of Supervised Credit Institutions The question arises whether the initial SRB decision to adopt a resolution scheme 3.61 because: (1) the credit institution is failing or likely to fail; (2) there is no reasonable prospect for any alternative private sector measure preventing the credit institution’s failure; and (3) that a resolution action is necessary in the public interest is also subject to judicial review by the CJEU. The resolution scheme itself places the credit institution under resolution and it determines which resolution tools will be applied. Unlike the SRB decisions imposing penalties and fines, these decisions are not subject to administrative review by the Appeal Panel.212 Therefore, we have to answer the question whether these decisions may be subject of judicial review on the basis of Article 263 of the TFEU because they are of direct and individual concern. The decision to put a credit institution under resolution and which resolution tools to apply in itself leave no room for any autonomous decision-making by the national resolution authorities to which the resolution scheme is addressed. Therefore, these initial SRB decisions are in principle subject to review by the CJEU on the application of the (parties directly concerned with) the credit institution under resolution. The (third) parties concerned with the (effects of the) decision to place a particular credit institution under resolution and concerned with the resolution tools applied may be wide-ranging depending on the tool chosen for the credit institution itself, its shareholders, and bondholders and owners of other debt instruments issued by the credit institution.213 At this moment it is unclear whether the CJEU deems all these parties directly concerned. National administrative practices diverge on the matter of 212 SRM Regulation, art 18(6)(a) and (b) respectively are not referred to in art 85(3). 213 Organizations representing these groups without an explicit mandate by every individual group member may have standing before the CJEU. An association may have standing if it represents the interests of natural or legal persons who would be entitled to bring proceedings in their own right. Cf Lenaerts, Maselis, and Gutman (n 68), para 7.104. See also Sveriges Betodlares and Henrikson v Commission [1997] ECR I-7531 (Case 409/96 P) 46–7; British Aggregate Association v Commission [2008] ECR I-10515 (Case 487/06 P) 39; Associazione Italiana delle Società Concessionarie per la Costruzione e l’esercizio di Autostrade e Trafori Stradali (Aiscat) v Commission, ECLI:EU:T:2013:9 (Case T-182/10) 48: ‘It should be recalled, in that regard, that a professional association which is responsible for protecting the collective interests of its members is entitled to bring an action for the annulment of a final decision of the Commission on State aid only in two sets of circumstances, namely, first, where the undertakings which it represents or some of those undertakings themselves have locus standi and, second, if it can prove an interest of its own, in particular because its position as a negotiator has been affected by the measure of which annulment is sought (Case T-380/ 94 AIUFASS and AKT v Commission [1996] ECR II-2169, paragraph 50; Joined Cases T-227/01 to T-229/01, T-265/01, T-266/01, and T-270/01 Diputación Foral de Álava and Others v Commission [2009] ECR II-3029, paragraph 108; and Case T-236/10 Asociación Española de Banca v Commission [2012] ECR, paragraph 19).’ Under Dutch law, eg, the VEB (Dutch Shareholders Association) has standing on the basis of the Dutch Civil Code, art 3:305a. This Article enables representative associations and foundations to proceed in their own name for the benefit of the group members. For reasons of efficacy and efficiency, it is recommendable that the CJEU accepts the representative organization’s standing. Cf the SNS Bank-case where the Vereniging van Effectenbezitters (VEB) had standing in proceedings before the Council of State challenging the Dutch Minister of Finance’s decision of 1 February 2013 to expropriate the shares in SNS Reaal NV: VEB et al Dutch Minister of Finance, Administrative Court Division of the Council of State, 25 February 2013, JOR 2013/140 with commentary by Bruno P M van Ravels and Bart Joosen.

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Tomas M C Arons standing for shareholders and bondholders in case of resolution. According to settled case-law, persons other than those to whom a decision is addressed are individually concerned by that decision within the meaning of the fourth paragraph of Article 263 TFEU only if it affects them by reason of certain attributes which are peculiar to them or by reason of circumstances in which they are differentiated from all other persons, and by virtue of these factors distinguishes them individually just as in the case of the person addressed.214 The criterion of direct concern also requires in this connection that the SRB decision in question must directly affect the legal situation of those parties and leave no discretion to the authorities responsible for implementing that decision, such implementation being purely automatic and resulting from EU law alone, without the application of other intermediate rules.215 6. Review of SRB Decisions Indirectly Affecting Credit Institutions 3.62 In order to implement its resolution scheme, the SRB may use indirectly, by order

of instruction to the national resolution authorities, the resolution powers available under the BRRD.216 The national resolution authorities are obliged to fully implement the resolution scheme and the SRB instructions addressed to them.217 In accordance with the BRRD, all persons affected by a decision (of the national resolution authority, added by author) to take a crisis management measure have the right to appeal against that decision.218 A crisis management measure is a decision by the national resolution authority exercising the resolution powers granted by the national law implementing the BRRD.219 In principle, directives,

214 Plaumann v Commission (Case 25/62) ECR 1963,95, 107; Inuit Tapiriit Kanatami v Parliament and Council (Case C-583/11 P) para 72); Commission v Hansestadt Lübeck (Case C-524/14 P) para 15 as referred to by A-G Kokott in her Conclusion of 11 April 2019 in Trasta Komercbanka and others v ECB (ECLI:EU:C:2019:323). In her conclusion, Kokott deemed the action for annulment brought by shareholders of Trasta Komercbanka AS inadmissible. The ECB withdrew this bank’s licence in accordance with art 14(5) of the SSM Regulation. This inadmissibility stems from the lack of a distinct change in the legal position of shareholders and the bank itself as a result of the ECB’s licence withdrawal. The shareholders have no interest of their own in bringing proceedings separate from the company’s interest. An exception to this principle could therefore be made, according to its spirit and purpose—if at all—not in cases where the shareholders’ rights of participation are restricted, as the General Court held in paras 54–56 of the order under appeal, but in cases where the company itself cannot (effectively) bring an action against the ECB decision in question (para 127). In this case, the company can still be externally represented by its board of directors and thus may bring an action on behalf of the company, it is justified to refer the shareholders in this regard to the exercise of their rights of participation and membership under company law. 215 Glencore Grain v Commission (Case C-404/96 P), para 41; Front national v Parliament (Case C-486/01 P), para 34; Stichting Woonpunt and Others v Commission (Case C-132/12 P), para 68 as referred to by A-G Kokott in her Conclusion of 11 April 2019 in Trasta Komercbanka and others v ECB (ECLI:EU:C:2019:323). 216 SRM Regulation, arts 18(9), subpara 1 and 29. 217 SRM Regulation, arts 18(9) and 29. 218 BRRD, art 85(3). 219 BRRD, art 2(1), pt 102.

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Judicial Protection of Supervised Credit Institutions including the BRRD, do not have direct effect and must be fully implemented in national law. Furthermore, the BRRD does not provide any more guidance, therefore, it is up to national law and the national legislator to determine which court is competent to hear and other procedural matters. In my opinion, there is no room to restrict the right of appeal to administrative review. The BRRD clearly seeks to grant judicial protection to persons affected by decisions taken by national resolution authorities.220 The intention of the European legislator is to grant the concerned parties, in accordance with Article 47 of the Charter of Fundamental Rights, a right to due process and to having an effective remedy against the measures affecting them. Therefore, the decisions taken by the national resolution authorities have to be subject to judicial review.221 The scope of this judicial review is limited in several ways so as to ensure the 3.63 effectiveness of the resolution. First of all, the judicial review must be expeditious.222 Secondly, Member States are required to ensure in their national (procedural) legislation that national courts use the complex economic assessments of the facts carried out by the national resolution authority as a basis for their own assessment.223 Thirdly, the lodging of an appeal does not entail any automatic suspension of the effects of the challenged decision.224 Fourthly, the national resolution authority’s decision is immediately enforceable; it is subject to a rebuttable presumption that a suspension of its enforcement would be against the public interest.225 Where it is necessary to protect third parties who have—in good faith— bought assets, rights, and liabilities of the credit institution under resolution by virtue of the exercise of resolution powers by a national resolution authority, the judicial review should not affect any subsequent administrative act and/or transaction concluded by the national resolution authority concerned which were based on the annulled decision. In that case, the remedies for a wrongful decision or action by the national resolution authorities is limited to the award of compensation for the loss suffered by the applicant as a result of the decision or act.226 This provision in the BRRD seems to render (direct) legal challenges to administrative decisions to act or to conclude a transaction taken after the initial decision adopting a resolution scheme, inadmissible. The important question arises whether judicial review by the CJEU of the initial 3.64 SRB decision instructing the national resolution authority to exercise its resolution powers is possible. As already concluded, standing requires that the SRB

220 BRRD, art 85(3). 221 Explanatory Memorandum in the Commission Proposal of the BRRD: COM(2012) 280 Final, 14. 222 BRRD, art 85(3). 223 Ibid. 224 BRRD, art 85(4)(a). 225 BRRD, art 85(4)(b). 226 BRRD, art 85(4), subpara 2; SRM Regulation, arts 23, subpara 1, 24(2) and 5(1).

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Tomas M C Arons decision/instruction is of direct concern to the applying credit institution under resolution addressed by the national resolution authority’s decision. If the instruction by the SRB is detailed such that there is no room for autonomous (material) decision-making by the national resolution authority, the original SRB decision may be challenged before the CJEU.227 Resolution requires more autonomous decision-making by the national resolution authorities, because complex private law arise when bailing-in shares, bonds, and other financial instruments issued by the credit institution under resolution; selling its business; separating its assets; or transferring to a bridge institution. Since national private law will apply, national resolution authorities are best placed to autonomously implement the SRB decision to apply a particular resolution tool. This two-level decision-making process and judicial review available under the SRM face the same difficulties as mentioned in Section II with regard to the SSM. 3.65 In conclusion, the SRB decisions to put a credit institution under resolution and

to apply a particular resolution tool are subject to review by the CJEU on the basis of Article 263 of the TFEU. Because of the necessary autonomous decision- making by the national resolution authorities when implementing SRB decisions, the decisions addressed to the credit institution under resolution by the national resolution authority has to be challenged before the national (administrative) court. However, SRB decisions overruling the national resolution authority’s decisions deviating from the SRB instruction, which are directly addressed to and affecting the credit institution under resolution, must be challenged before the CJEU.228 Furthermore, when the national resolution authority does not take any action at all, the SRB decisions directly addressed to and affecting the credit institution under resolution has to be challenged before the CJEU as well.

IV. Substantive Review by the CJEU 3.66 Section III dealt with the issue of standing. In this section the issue of substantive

review by the CJEU will be analysed. As concluded in previously, any natural or legal person addressed by an act by or a decision of the ECB and/or the SRB, or any person to whom that act is of direct and individual concern may institute proceedings against it before the CJEU on the basis of Article 263 of the TFEU. The issues under review have been: (1) Qualification as significant credit institution;229 (2) Corporate

227 Berend Jan Drijber, ‘De Europese Bankenunie op weg naar voltooiing: het gemeenschappelijk afwikkelingsmechanisme’ (2015) 81 SEW Tijdschrift voor Europees en economisch recht 220, 230–1. 228 SRM Regulation, art 29(2)(c) and (3). 229 Landeskreditbank Baden-Württemberg –Förderbank v ECB [2017] (Case T-122/15). The court held that art 70(1) of the SSM Framework Regulation could rule out classification of the applicant as a significant entity only if it was demonstrated that direct prudential supervision by the German authorities would be better able to ensure attainment of the objectives of the SSM Regulation than

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Judicial Protection of Supervised Credit Institutions governance;230 (3) Fit-and-proper test of members of the management board; (4) Authorization withdrawal;231; (5) Sanctions; (6) Supervisory measures concerning capital and liquidity requirements,232 in some cases as outcome of the Supervisory Review & Evaluation Process (SREP); and (7) Consolidated supervision.233 The scope of this review is also determined by that Article. In these proceedings before the CJEU, the court has jurisdiction to review the legality of acts of bodies, offices, or agencies of the EU intended to produce legal effects vis-à-vis third parties.234 Furthermore, it has jurisdiction in actions brought by parties addressed by an act or a decision of the ECB and/or the SRB on grounds of lack of competence, infringement of an essential procedural requirement, infringement of the Treaties, or of any rule of law relating to their application or misuse of powers.235 The applicant who has standing must allege and prove the (legal) reasons for the 3.67 CJEU to annul or declare invalid the act by or a decision of the ECB and or the SRB. The aforementioned grounds for challenge the decision are: – lack of legality; – lack of competence; – infringement of an essential procedural requirement; – infringement of the TFEU and the TEU or any rule of law relating to its application; or – misuse of power.236

supervision by the ECB (para 81). The appeal was rejected by the ECJ in its judgment of 8 May 2019 (Case C-450/17 P, ECLI:EU:C:2019:372). 230 Caisse régionale de crédit agricole mutuel Alpes Provence, Caisse régionale de crédit agricole mutuel Nord Midi-Pyrénées, Caisse régionale de crédit agricole mutuel Charente-Maritime Deux Sèvres, and Caisse régionale de crédit agricole mutuel Brie Picardie v ECB [2018] (Cases T-133/16 to T-136/ 16 combined). The court dismissed the complaints that the ECB could not prohibit the combination of chairman and CEO on the basis of CRD IV and the applicable French Code monétaire et financier. 231 See Komercbanka and others v ECB [2017] (Case T-247/16). 232 Crédit Agricole v ECB [2018] (Case T-758/16); BNP Paribas v ECB [2018] (Case T-768/16); Société générale v ECB [2018] (Case T-757/16); Confédération Nationale du Crédit Mutuel v ECB [2018] (Case T-751/16); BPCE v ECB [2018] (Case T-745/16); and Banque Postale v ECB [2018] (Case T-733/16). The court annulled decisions by the ECB vis-à-vis these six French banks because the ECB incorrectly assessed the prudential risk of certain public-sector exposures and thereby rendering art 429(14) of the CRR ineffective. 233 Crédit Mutuel Arkéa v ECB [2017] (Cases T-712/15 and T-52/16). The court dismissed the complaint that consolidated prudential supervision of institutions affiliated with a central body (in this case the Confédération nationale du Crédit mutuel (CNCM)) is permissible if the latter has the status of credit institution itself. CNCM’s status as association does not preclude the qualification as group. The appeal against the Tribunal’s ruling was rejected by the ECJ on 2 October 2019. Crédit Mutuel Arkéa v ECB [2019] (Cases C-152/18 P and C-153/18 P). 234 TFEU, art 263(1) and (4). 235 TFEU, art 263(2) and (4). 236 See Lenaerts, Maselis, and Gutman (n 68), paras 7.148–7.184.

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Tomas M C Arons 3.68 The first ground, lack of legality, is the most encompassing concept; the other

four grounds are special categories of a lack of legality. Legality of administrative acts is achieved by respect for fundamental rights and principles of administrative legality.237 The following paragraphs deal with the aforementioned special categories. 1. Lack of Competence

3.69 As a matter of administrative principle, EU institutions and agencies, the ECB,

and the SRB respectively, have to base their power to address the individual supervised euro area credit institutions ultimately on the TFEU. As already described in Sections II and III, the SSM and SRM regulations serve as the direct basis for the their respective (formal) powers. With regard to the SRM and SSM Regulations empowering the ECB and SRB respectively to take decision addressed to individual natural and legal persons, it is important to note that the CJEU upheld Article 114 of the TFEU (harmonization of the internal market) as a valid legal basis to adopt these Regulations.238 Directives and regulations adopted on this basis are subject to the ordinary legislative procedure, whereby Member States do not have veto power and the European Parliament has to approve the legislation as well.239

3.70 The material powers, ie the kind of decisions which can be addressed to the

credit institutions, and the kind of orders which can be given to them, are derived from directly applicable EU financial regulations and national legislation implementing EU financial directives.240 Especially the latter may give reason for difficulties, because the ECB and the SRB may be required to follow particular rules applicable in the home Member State of the supervised credit institution. Despite the enhanced detail of the many EU financial directives, there is ample room for national (administrative) legal particularities left.

Lenaerts, Maselis, and Gutman (n 68), para 7.145. 238 Cf United Kingdom v European Parliament and Council [2014] ECR I 2014 (Case C-270/12); JOR 2014/130 with commentary by Bart Bierens. In this case, the UK challenged the validity of the legal basis of the power conferred on the European Securities and Markets Authority (ESMA) by art 28 of Regulation 236/2012 on short selling and certain aspects of credit default swaps to direct decisions at natural or legal persons. The court rejected all these grounds in its decision of 22 January 2014. Cf Takis Tridimas, ‘Financial Supervision and Agency Power: Reflections on ESMA’ in Niamh Nic Shuibhne and Laurence W Gormley, From Single Market to Economic Union, Essays in Memory of John A Usher (Oxford University Press 2012) 55–83. 239 TFEU, arts 114(1) (formerly TEC, art 85) and 294 (formerly TEC, art 251). In the ordinary legislative procedure voting in the Council is subject to qualified majority voting (TEU, arts 16(3) and 238 (formerly TEC, art 205(1) and (2)). 240 Please note that sometimes even directly applicable EU regulations require national implementation measures so as to achieve the effectiveness of the directly applicable EU regulation: see Alexander H Türk, Judicial Review in EU Law (Edward Elgar Publishing 2010) 55. 237

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Judicial Protection of Supervised Credit Institutions 2. Infringement of an Essential Procedural Requirement The EU courts themselves determine which procedural requirements are essential 3.71 under the EU Treaties. They are derived from, and shared by, the common fundamental rights jurisprudence in the Member States as well as the European Court of Human Rights. The following requirements have been recognized. A. Right to be Heard The right to be heard even in cases where no sanction is imposed. The fact that 3.72 the decision may have some significant (adverse) effect on the applicant’s interest suffices. This particular right to be heard is also explicitly recognised by the EU Charter of Fundamental Rights.241 This right includes the right to be notified of the nature of the case and the right to respond. As we have seen in Sections II and III of this chapter, the SSM and the SRM regulation explicitly provide for this right to be heard.242 With regard to the indirect powers granted to the ECB and SRB respectively, the applicable national (administrative) legislation provides for this explicitly or implicitly by way of case law. B. Duty to Give Reasons Besides the general duty for the EU legislator to provide reasons on which the 3.73 legislative acts are based, the CJEU’s established case law extends this duty to all legal acts, including individual administrative decisions, legislative, delegated, and implementing acts.243 The SSM and SRM Regulation explicitly imposes this duty on the ECB and SRB respectively. Furthermore, national administrative laws also require reasoned decisions. C. Duty of Confidentiality Article 339 of the TFEU imposes on members of EU institutions, EU committees 3.74 and EU officials, and other servants a duty not to disclose information of the kind covered by the obligation of professional secrecy, in particular information about undertakings, their business relations, or their cost components. In particular, the SSM and SRM Regulations provide that members of the (Supervisory) Board, staff of the ECB, the SRB and, with regard to the ECB, staff seconded by participating Member States carrying out supervisory duties—even after their duties are ceased—are subject to the professional secrecy requirements set out in Article 339 of the TFEU, Article 37 of the statute of the ESCB and of the ECB, and other relevant acts of Union law.244 The SRM Regulation specifically stipulates that 241 Charter of Fundamental Rights of the European Union [2010] OJ C83/2 (EU Charter of Fundamental Rights), art 41(2). 242 SSM Regulation, art 22(1); SRM Regulation, art 40. 243 Cf Lenaerts, Maselis, and Gutman (n 68), paras 7.170–7.174. 244 SSM Regulation, art 27(1), subpara 1; and SRM Regulation, art 88(1), subpara 1, 1st sentence. The ECB and the SRB have to ensure that individuals who provide any service, directly or indirectly, permanently or occasionally, related to the discharge of supervisory duties are subject

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Tomas M C Arons they are prohibited from disclosing confidential information received during the course of their professional activities or from a competent authority or resolution authority in connection with their functions under this Regulation, to any person or authority, unless it is in the exercise of their functions under this Regulation or in summary or collective form such that entities referred to in Article 2 cannot be identified or with the express and prior consent of the authority or the entity which provided the information.245 Information subject to the requirements of professional secrecy are not to be disclosed to another public or private entity except where such disclosure is due for the purpose of legal proceedings.246 It is noteworthy that in Altmann et al/Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) (Case 140/13), the ECJ held that Article 54(1) and (2) of Directive 2004/ 39/EC (MiFID)247 must be interpreted as meaning that, in administrative proceedings, a national supervisory authority may rely on the obligation to maintain professional secrecy against a person who, in a case not covered by criminal law and not in a civil or commercial proceeding, requests it to grant access to information concerning an investment firm which is in judicial liquidation, even where that firm’s main business model consisted in large scale fraud and wilful harming of investors’ interests and several executives of that firm have been sentenced to terms of imprisonment. The ECB decision on the implementation of separation between the monetary policy and supervision functions provides detailed rules for the exchange of confidential information between policy functions, including in emergency situations.248 3.75 The ECB and the SRB must give the concerned credit institution the opportunity

to bring an action before the EU courts to prevent its disclosure.249 The ECJ ruled that unlawful disclosure of confidential information finding an infringement of EU competition law is an infringement of an essential procedural requirement only in limited cases. The concerned party has to show that in the absence of this unlawful disclosure the contested decision might have been different. Hence,

to equivalent professional secrecy requirements (SSM Regulation, art 27(1), subpara 2; and SRM Regulation, art 88(2)). 245 SRM Regulation, art 88(1), subpara 1, 2nd sentence. 246 SRM Regulation, art 88(1), subpara 2. 247 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC (MiFID) [2004] OJ L145/1. Please note that as from 3 January 2017 MiFID will be replaced by Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (MiFID II) [2014] OJ L173/349. Article 76 of MiFID II is comparable to art 64 of MiFID. 248 Decision of the European Central Bank of 17 September 2014 on the implementation of separation between monetary policy and supervisory functions of the European Central Bank (ECB/ 2014/39) [2014] OJ L300/57. 249 Lenaerts, Maselis, and Gutman (n 68), para 7.167.

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Judicial Protection of Supervised Credit Institutions the unlawful nature of the disclosure is not sufficient to render the ECB or SRB decision void.250 It is noteworthy that the ECB and/or the SRB may be held liable by the concerned credit institution for damages suffered as a result of the unlawful disclosure.251 Section V elaborates on the liability position of the ECB and the SRB. 3. Infringement of the TFEU and the TEU or any Rule of Law Relating to its Application The CJEU does not merely review whether the decision-making process of EU 3.76 institutions and agencies comply with the primary Treaties, ie the TEU and the TFEU, it also reviews its compliance with EU secondary legislation including directives and regulations adopted on the basis of these Treaties. EU institutions and agencies such as the ECB and the SRB have to comply with the full body of EU law. This law includes any rule of law besides the published Treaties and secondary legislation. The CJEU interprets the phrase ‘any rule of law relating to its application’ to mean the general principles of (administrative) law. Some of these principles have later been enacted in the EU Charter of Fundamental Rights. This Charter entrenches all the rights found in the case law of the CJEU, the rights and freedoms enshrined in the European Convention on Human Rights, and all other rights and principles resulting from the common constitutional traditions of EU countries and other international instruments. This Charter is to be applied by EU institutions, bodies, and agencies as well as by national authorities when they implement or apply EU law. The Charter sets out the following individual rights relevant for credit institutions 3.77 and other parties directly affected by ECB and/ or SRB decisions and/ or instructions to national supervisory and/or resolution authorities: – right to good administration, including the aforementioned right to be heard, to have access to his or her file, and the obligation of the administration to give reasons for its decisions;252 – right to be compensated for any damage done to a third party by the EU (officials);253 – property rights;254 – right to an effective remedy and to a fair trial;255 – right to a fair trial;256 250 Lenaerts, Maselis, and Gutman (n 68), para 7.167 referring to Van Landewyck/Commission [1980] ECR 3125 (ECJ Cases 209-215 and 218/78), para 47. 251 Lenaerts, Maselis, and Gutman (n 68), para 7.167. 252 EU Charter of Fundamental Rights, art 41(1). 253 EU Charter of Fundamental Rights, art 41(2); and TFEU, art 340, para 3. 254 EU Charter of Fundamental Rights, art 17. 255 EU Charter of Fundamental Rights, art 47(1). 256 EU Charter of Fundamental Rights, art 47(2).

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Tomas M C Arons – presumption of innocence;257 – right of defence;258 – right against double jeopardy;259 and – principle of proportionality.260 3.78 The principle of proportionality is a key stone of EU law. It is important to con-

sider the possibility of national authorities restricting the fundamental freedoms of movement of goods, persons, capital, and services as well as the individual decisions taken by EU institutions or agencies addressed to, or directly affecting, natural or legal persons.261

3.79 The following three factors are used by the CJEU to judge the proportionality of

the decisions taken by the ECB and the SRB respectively:

– necessity of the desired goal; – suitability of the decision to achieve that goal; and – proportionality of the measure imposed in relation to the desired goal. 3.80 The CJEU is, especially, quite reticent to judge on the first factor on the necessity

of the desired goal. The goal to be achieved by the EU Banking Union as set by the EU legislator will be respected by the CJEU. The other factors on suitability and proportionality in the narrow sense will be more intensively judged by the CJEU.262 Especially in cases like resolution schemes, where individual property rights may be severally affected (expropriation), the CJEU intensifies the vigorousness of the proportionality test.

3.81 The last important principles recognized by the CJEU, and as such not enshrined

in the Charter, are the principles of legal certainty and legitimate expectations. The ECB and SRB are not allowed to retroactively apply powers or impose sanctions. Furthermore, the principle of respecting legitimate expectations forbids revocation of (favourable) administrative decisions and gives effect to precise and specific conduct or assurance given by the ECB and/or SRB to the credit institutions or other interested parties.263 4. Misuse of Power

3.82 This ground of review is closely connected to the aforementioned proportionality

test. In fact it is the a priori question whether the goal sought to be achieved is

257 EU Charter of Fundamental Rights, art 48(1). 258 EU Charter of Fundamental Rights, art 48(2). 259 EU Charter of Fundamental Rights, art 50. 260 Cf EU Charter of Fundamental Rights, art 49(3) on the principle of proportionality with regard to criminal penalties. 261 Türk (n 203), 135. 262 Ibid,  137–8. 263 Ibid, 129–30.

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Judicial Protection of Supervised Credit Institutions proper. In cases of misuse of power, applicants challenge the stated goal of the measure adopted by the EU institution or body and the real objective. The ECB and the SRB are not allowed to take decisions or make use of certain procedures with the exclusive, or main, purpose of achieving an end other than that stated. The more discretion is left to the ECB and/or the SRB, the less intensively the CJEU will review the decisions. Only in cases of manifest error or clear excess of the bounds of discretion, will the CJEU find an ECB and/or SRB decision illegal or invalid.264 5. Manifest Error of Assessment Supervisors as well as administrative institutions have to assess on a case by case 3.83 basis whether the substantive financial (supervisory) rules and regulations have been infringed by the credit institutions. This (complex) assessment of facts by the ECB and/or the SRB is only marginally tested by the CJEU; it will not substitute its own assessment for that of these supervisors. Furthermore, only the circumstances known by, and information available, to the ECB and/or the SRB will be taken into account by the CJEU.265 Only in cases of a manifest error of assessment, will the CJEU annul an ECB and/or SRB decision. 6. Consequences of Illegality and Invalidity If the CJEU finds, on any of the aforementioned grounds, the ECB and/or the 3.84 SRB decision illegal and invalid, it may declare that decision (partially) void. The decision and its effects are void retroactively. On the basis of Article 266 of the TFEU, the ECB, and/or the SRB are required to take all measures necessary to comply with the judgment. This may involve eradicating all effects of the decision declared void. Of course, they are not allowed to address an identical decision to the applicants.266 The relative effect of the CJEU judgment is restricted to the applicant(s).267 In order to guarantee the effectiveness of the sale of business resolution tool, the 3.85 SRM Regulation provides that the business transfer is not void when the initial SRB decision to use that tool is declared void by either the CJEU or a competent national court.268 This limitation is necessary to assure an acquirer of (parts of ) a credit institution in (financial) trouble that his (potential) liability is restricted Lenaerts, Maselis, and Gutman (n 68), paras 7.183–7.184. 265 Rosa Greaves, ‘Judicial Review of Commission Decisions on State Aids to Airlines’ in David O’Keeffe and Antonio Bavasso (eds), Judicial Review in European Union Law, Liber Amicorum in Honour of Lord Slynn of Hadley (Kluwer Law International 2000) 627–8. 266 Simmenthal v Commission [1979] ECR 777 (Case 92/78) [32]; AKZO Chemie v Commission [1986] ECR 1965 (Case 53/85) [21]; Apesco v Commission [1988] ECR 2151 (Case 207/86) [16]; Antillean Rice Mills NV v Commission [1995] ECR II-2941 (Case T-480/93) [60]. 267 Commission v AssisiDomän Kraft Products AB [1999] ECR I-5363 (Case C-310/97P) [57]. 268 SRM Regulation, art 5(1); and BRRD, art 85(4), subpara 2. 264

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Tomas M C Arons to the sale price. The remedies available to the interested parties applying for the annulment of the SRB decision to put a credit institution under resolution and apply the sale of business tool is limited to the award of compensation for the loss suffered by the applicant(s) as a result of the subsequent SRB decision or instruction addressed to the national resolution authority to sell the business. The business transaction itself is not excluded from the annulment’s scope of effects.

V. Liability of the ECB and the SRB 3.86 As we have seen in Section IV, one of the European principles of good administra-

tion is that the EU institution compensates the losses incurred by a third party as a result of its (official’s) performance of its duties.269 Therefore, the ECB’s liability is a specific form of accountability. Two claims for liability of financial supervisors can be distinguished. Either clients of a credit institution in (financial) trouble seek damages for losses incurred as a result of inadequate (prudential) supervision, or the supervised credit institution itself seeks damages for the losses incurred as a result of wrongful decisions by the financial supervisor. Examples are failure to intervene, wrongful granting/withdrawal of an authorization, wrongful granting of approvals, permissions, derogations, or exemptions.

3.87 On the one hand we have seen the recent development that Member States re-

strict the national financial supervisor’s liability.270 On the other hand, the SSM and the SRM Regulation explicitly provide for this liability. Article 87 of the SRM Regulation prescribes the SRB’s contractual and non-contractual liability.271 The SSM Regulation does not specifically provide for this liability. However, its preamble prescribes—just like in Article 78(3) of the SRM Regulation with regard to the SRB—that the ECB should compensate, in accordance with the general principles common to the laws of the Member States, any damage caused by

269 Cf Phoebus Athanassiou, ‘Bank Supervisors’ Liability: a European Perspective’ (2011) 30(1) Yearbook of European Law 213–54 and ECB Legal Working Paper Series No 12 (available online at ). 270 Danny Busch, ‘Naar een Beperkte Aansprakelijkheid van Financiële Toezichthouders?’ Inaugural Lecture at the Radboud University Nijmegen, OO&R Serie, Part 61; Donal Nolan, ‘The Liability of Financial Supervisory Authorities’ (2013) 4(2) Journal of European Tort Law 190; ECB, ‘Opinion of the European Central Bank on a proposal for a Council regulation conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions and a proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) No 1093/2010 establishing a European Supervisory Authority (European Banking Authority)’, 27 November 2012 (CON/2012/96) (ECB Opinion SSM Regulation) (available online at ) 4. 271 According to SRM Regulation, art 42(1), 3rd sentence, the SRB has legal personality.

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Judicial Protection of Supervised Credit Institutions it, or by its servants, in the performance of their duties.272 It could be argued that these common general principles include the aforementioned restrictions to supervisor liability or even immunity.273 In my opinion, the common intention of the various legislators to limit liability to serious neglect of the supervisor’s duties is mirrored in the elements necessary to establish liability of an EU institution or EU agency.274 These elements are the following: – the rule of law infringed must be intended to confer rights on individuals; – the breach must be sufficiently serious (qualified unlawfulness); – there must be a direct causal link between the breach of the obligation resting on the ECB and/or the SRB and the loss or damage sustained by those affected. It is a question of assessing whether the loss or damage alleged flows sufficiently directly from the breach of EU law by the ECB and/or the SRB to render them liable to make it good.275 The nature of this contribution allows for only a few remarks.276 The CJEU has 3.88 not yet ruled upon the question of whether the currently applicable EU financial supervision directives confer rights on individuals. In the Peter Paul case, the ECJ held that even though the former DGS Directive and the Banking Supervisory Directive impose on the national authorities a number of supervisory obligations, vis-à-vis credit institutions, it does not necessarily follow from that, or from the fact that the objectives pursued by those directives also include the protection of depositors, that those directives seek to confer rights on depositors in the event that their deposits are unavailable as a result of defective supervision on the part of the competent national authorities.277 It is noteworthy that the current EU financial supervision directives have the objective of client/depositor protection. The second element will be difficult to establish because of the discretionary nature of the decision-making powers given to the ECB and the SRB.278 Other relevant factors are the excusable nature of the error and the element of culpability. The third element includes the essential condicio sine qua non test and loss attribution test common to all private law liability systems.

272 Recital 61 of the Preamble to the SSM Regulation. Cf art 35(3) of Protocol No 4 on the Statute of the ESCB and the ECB [2012] OJ L326/230. According to TFEU, art 282(3) the ECB has legal personality. 273 See Eddy Wymeersch, ‘The Single Supervisory Mechanism or “SSM”, Part One of the Banking Union’, Working Paper Series 2014-01, Financial Law Institute Ghent University (available online at ) 61–2; and Working Papers of National Bank of Belgium, April 2014, No 255 (available online at ) 58–9 referring to ECB Opinion SSM Regulation, 5. 274 Cf ECB Opinion SSM Regulation, 5. 275 Brasserie du Pêcheur/Factortame III [1996] ECR I-1029 (ECJ Cases C-46/93 and C-48/93). 276 For an in-depth overview, reference is made to Lenaerts, Maselis, and Gutman (n 68), ch 11. 277 Peter Paul et al/Germany [2004] ECR I-09425 (ECJ Case 220/02). 278 Lenaerts, Maselis, and Gutman (n 68), para 11.56.

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Tomas M C Arons 3.89 It is clear that the ECB may be liable for decisions (it could have) directly addressed

to credit institutions. However, a few difficulties arise. Since the national financial supervisors are responsible for assisting the ECB in the preparation and implementation of any acts relating to the exercise of the ECB supervisory tasks, including, in particular, the ongoing day-to-day assessment of a credit institution’s situation and related on-site verifications, the attribution of wrongful decision-making is cumbersome.279 Even though the ECB has the ultimate decision-making power and therefore bears the ultimate responsibility, its functioning is critically dependent on the day-to-day supervision by the national financial supervisors. In my opinion, the ECB is in the end, as intended by the EU legislator, responsible for the decision-making (process) and should therefore be liable for it as well.

3.90 This attribution of liability problem is even more prominent in the two-level

decision-making process whereby the ECB and the SRB decisions indirectly affect the credit institution by way of decisions/instructions to the national financial supervisors/resolution authorities. The Preamble to the SSM Regulation makes clear that the liability of the ECB does not preclude the liability of national financial supervisors to compensate damages caused by them or by their servants in the performance of their duties in accordance with their respective national legislations. The right of the ECB to instruct national financial supervisors creates a potential difficulty for national courts when assessing the liability of this national financial supervisor. In my opinion, like in the case of standing before the CJEU discussed in Sections II and III, it depends on the detail of the instructions and whether the wrongful decision can be attributed to the ECB or to the national financial supervisor.

3.91 Unlike the SSM Regulation, the SRM Regulation provides for cost-sharing the

damages to be paid. The SRB is liable to compensate the national resolution authorities if a national court has ordered them to pay damages to a third party as a consequence of an act or omission committed by this national resolution authority in the course of any resolution under the SRM Regulation.280 Of course, this obligation to compensate the national resolution authority does not apply where that act or omission constituted an infringement of (i) the SRM Regulation; (ii) another provision of EU law; and (iii) a decision of the Council, the European Commission, or the SRB committed intentionally or with manifest and serious error of judgment.

3.92 With regard to jurisdiction, the SRM Regulation provides for the exclusive ju-

risdiction for the CJEU in both matters of liability of the SRM. Furthermore, it sets the limitation period for non-contractual liability claims against the SRB to five years.281 Legal disputes between the ECB, on the one hand, and its creditors, Cf Recital 37 of the Preamble to the SSM Regulation. 280 SRM Regulation, art 87(4); and see SRM Regulation, art 97(4). 281 SRM Regulation, art 87(5). 279

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Judicial Protection of Supervised Credit Institutions debtors, or any other person, on the other, are decided by the competent national courts, save where jurisdiction has been conferred upon the CJEU.282 Unfortunately the SSM Regulation has not granted exclusive jurisdiction to the CJEU. Therefore, the competent court to hear liability claims against the ECB will be determined by the Brussels I Regulation.283 In conclusion, the ECB and the SRB can be held liable by third parties on the 3.93 basis of the criteria laid down in paragraph 2 of Article 340 of the TFEU. It would be wise to adapt the SSM Regulation such that the CJEU has exclusive jurisdiction in all non-contractual liability claims against the ECB, like it has against the SRB.

VI. Conclusion As we can conclude from the previous sections, the current system of judicial 3.94 protection gives rise to a number of difficulties. These difficulties stem from the inherent tensions in a federal system with decision-making at multiple levels. For various political and socio-economic, as well as practical, reasons full-fledged centralization of EU financial supervision and bank resolution is impossible. From 1 January 1999 the ECB has the exclusive power to decide the euro area’s monetary policy; the ECB decides on monetary objectives, key interest rates, the supply of reserves in the Eurosystem (ECB plus national central banks), and the establishment of guidelines for the implementation of those decisions.284 The national central banks implement these decisions.285 The European Banking Union also provides the ultimate policy-and decision-making powers in bank supervisory and resolution to the ECB and the SRB respectively. However, the difficulty in the Banking Union is that the national authorities, on the instruction of the ECB and/or the SRB, take decisions addressed to individual credit institutions. This system of two-level decision-making, albeit with sometimes little or no room 3.95 for discretion by the national authorities, makes it necessary for individual credit institutions to challenge both decisions. If the ECB and/or the SRB decision is not challenged, they may have no practical remedy by successfully challenging the national authority’s (implementation) decisions addressed to it. If the national authority’s decision is not challenged, the annulment of the ECB and/or the SRB

282 Article 35(2) of Protocol No 4 on the Statute of the ESCB and the ECB (n 232). 283 Council Regulation (EC) 44/2001 of 22 December 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters [2001] OJ L12/1 (Brussels I Regulation). From 10 January 2015, Regulation (EU) 1215/2012 of the European Parliament and of the Council of 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters [2012] OJ L351/1 will apply. 284 TFEU, arts 127(2) (formerly TEC, art 105(2)) and 132(1) (formerly TEC, art 110(1)). 285 Article 14(3) of Protocol No 4 on the Statute of the ESCB and the ECB (n 235).

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Tomas M C Arons decision may not suffice if the national authority has some autonomous decision- making power left. Even though Article 266 of the TFEU requires the ECB and/ or the SRB to comply with the CJEU’s ruling by instructing the national authority to do the same, the autonomous decisions are not affected by this. In case the ECB and/or SRB decision is challenged before the national court, the latter has to refer the question of its validity by way of preliminary reference to the CJEU. The CJEU has jurisdiction (on the basis of Article 267, subparagraph (b) of the TFEU) to rule, by way of preliminary ruling, on the validity and interpretation of acts of the institutions, bodies, offices, or agencies of the Union. The national (administrative) courts are forbidden to declare the ECB and/or SRB instruction invalid. 3.96 Challenging both decisions may in some circumstances (when the ECB and/

or SRB instruction leaves no autonomous decision-making) require two court proceedings, one before the CJEU challenging the ECB and/ or the SRB decision and one before the national (administrative) court challenging the national authority’s decision, create the potential for conflicting court decisions. Currently, no system is available to deal with that problem. No rule requiring national courts to suspend the proceedings against the national authority until after the CJEU ruling in which the ECB and/or the SRB decision is challenged, applies. Furthermore, this two-level judicial review system does not ensure a level playing field in the EU. Divergences between national court decisions may arise. The fact that national administrative substantive as well as procedural law applies enhances this effect.

3.97 It must be noted that especially in bank resolution, the autonomy of national

decision-making and the applicability of national (private) law is essential. Even though there are common principles of European private law available, these are far too high-level to deal with the rather complex exercise of bank resolution. In this case, it is desirable that national courts rule on the national authorities’ decisions implementing the SRB decisions to put the credit institution under resolution and to apply a specific resolution tool. However, SRB decisions overruling the national resolution authority’s decisions, or solving the latter’s inaction, which are directly addressed to and affecting the credit institution under resolution must be challenged before the CJEU.

3.98 With regard to the other matters, it is suggested that the judicial review is cen-

tralized so as to reflect the centralized policy and decision-making powers. A disadvantage of this centralization may be that the EU court could be obliged to interpret national (administrative) law when the EU financial directives and/or regulation leave autonomy for the national legislator to choose between different options. Because the options themselves are mostly provided for in the EU legislation itself, the EU court essentially interprets whether (the application of ) national legislation respects (the limits of ) EU legislation. 140

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Judicial Protection of Supervised Credit Institutions Another obstacle to centralization is the fact the CJEU is already overloaded with 3.99 cases brought before it by individuals as well as national courts. The five years since the financial crisis have shown the need for urgency and speed with regard to supervisory and resolution decisions affecting credit institutions. It is submitted that the European Parliament and the Council should establish, on the basis of Article 257 of the TFEU,286 a specialized court, the Tribunal of Financial Supervisory and Resolution Affairs, attached to the General Court to hear and determine at first instance action or proceedings brought against the ECB and/ or the SRB in matters relating to decisions taken in exercising its supervisory and resolution powers.287 This Tribunal should have the exclusive jurisdiction to hear and determine actions brought by credit institutions and other directly concerned parties against ECB decisions exercising its supervisory powers; national financial supervisor decisions implementing the ECB decisions/instructions; and the SRB decisions to put a credit institution under resolution and to apply a particular resolution tool. The decisions by national resolution authorities implementing these SRB decisions (by application of national private law) should be exclusively challenged before national (administrative) courts according to national (administrative) procedural law. The decisions given by this Financial Tribunal may be subject to a right of appeal on points of law only or, when provided for in the regulation establishing this Tribunal, a right of appeal also on matters of fact before the CJEU.288 For reasons of practicality, this right of appeal should be limited to points of law.

Formerly TEC, art 225a. 287 The Financial Tribunal should be established by way of a regulation, either proposed by the European Commission after consultation with the CJEU or at the request of the CJEU after consultation with the European Commission. The regulation is adopted on the basis of the ordinary legislative procedure: see TFEU, art 257, para 1. 288 TFEU, art 257, para 2. 286

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Part II SINGLE SUPERVISION AND CRD IV

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4 THE SINGLE SUPERVISORY MECHANISM FOR BANKING SUPERVISION Institutional Aspects Eddy Wymeersch

I. Historical Introduction II. The New Regulatory Framework: The Banking Union III. Applicable Bodies of Law in Banking Supervision 1. The National Legal Systems 2. Union law 3. The European Rulebook

4.01 4.09 4.15 4.15 4.18 4.25

IV. The Choice of the ECB as the Prudential Supervisor 4.31 V. Application to the Euro Area or Beyond? 4.38 VI. The Single Supervisory Mechanism 4.46 1. The Structure of the SSM Regime 2. The Scope of the SSM 3. Criteria for Determining the SIs and LSIs

4.46 4.57

4.72

4. The Supervised Population in Practice 4.83 5. How Supervision is Effectively Exercised 4.88

VII. Legal Position of the Supervisory Board in the ECB 4.104 VIII. Independence and Accountability 4.114

1. Independence of the Supervisory Board 4.114 2. Accountability of the ECB 4.123

IX. Review of SSM Decisions

4.136

1. Non-judicial Review of the Supervisory Decisions 2. Mediation Panel 3. Judicial Review

4.136 4.140 4.142

X. Conclusion

4.143

1. Other Points of Concern Related to the Structure of the SSM

4.145

I. Historical Introduction The introduction of centralized banking supervision in the Euro area is the 4.01 major development in the field of prudential regulation and supervision for the last decades. The Single Supervisory Mechanism (‘SSM’)1 came in the place of 1 Council Regulation (EU) 1024/ 2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions, 29 October 2013, [2013] OJ L287/63 (‘SSM Regulation’)

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Eddy Wymeersch national supervision, putting an end to a long period of division, competition and inefficiency. The new system which was introduced by a Regulation of the European Council of 15 October 2013 (the ‘SSM Regulation’) installed a new pattern of regulation and supervision. It raises numerous new questions especially from an institutional point of view, some of which will the subject of this chapter. The SSM entered into force on 4 November 2014. 4.02 The SSM is not a single supervisory body but is a centralization and co-ordination

mechanism in which the European Central Bank (‘ECB’) assumes ‘specific tasks’, as detailed in the SSM Regulation and assumes ultimate leadership for the effective and consistent functioning of the SSM.2 The co-operation mechanism is based on the co-ordinated action of the ECB and of the national authorities, based on Union law and national laws, and ultimately aiming at a banking supervisory regime which ensures unity and integrity in the internal market, financial stability and avoidance of systemic risks, equal treatment in the Euro area, and avoidance of regulatory competition. It introduces a new concept of co-regulation and co-supervision, based on the action of Union and national bodies, but under the ultimate responsibility of the ECB.

4.03 Within the SSM, the ECB is in charge of prudential supervision of the largest

banking groups, while the pre-existent national competent authorities or NCAs remain competent for the other, ‘less important’ banking institutions. The dividing line is mainly but not exclusively a quantitative one, expressing the macroprudential and systemic concerns. At the same time, the ECB has been declared responsible for the consistency of supervision for all credit institutions, aimed at supporting the level playing field.

4.04 The need to adopt a coherent, financial supervisory mechanism has been on the

agenda for many years, especially in the European Parliament and in academic writing.3 However, it has always been refused by Member States as they preferred Article 6(1) of the SSM Regulation. 3 Centralization of financial supervision has been discussed several times in the European Parliament, but mainly concerning securities markets supervision. See European Parliament resolution on the Commission communication on implementing the frame-work for financial markets: Action Plan (COM (1999) 232-C5-0114/1999–1999/2117(COS)) calling attention to prudential regulation and supervision, OJ C40 of 7 February 2001, 453; European Parliament resolution of 9 October 2008 with recommendations to the Commission on Lamfalussy follow- up: Future Structure of Supervision (2008/2148(INI)) on the report of Ieke van den Burg, available online at ; Cross-border crisis management in the banking sector, 7 July 2010, 2010/2006(INI), 07/07/2010. Among the pre-SSM academic contributions, see D Schoenmaker, ‘Banking Supervision and Resolution: The European Dimension’ (Jan 2012), DSF Policy Paper 19; D Schoenmaker, ‘The financial trilemma’ (2011) 111 Economic Letters 57–9, available online at . See also D Schoenmaker, Governance of International Banking: The Financial Trilemma (OUP 2013); G Hertig, R Lee, and J McCahery, ‘Empowering the ECB to Supervise Banks: A Choice Approach’ (2010) European Company and Financial Law Review 171–215. For academic writing has mainly 2

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SSM—Institutional Aspects to keep control of their banking system as an essential economic infrastructure and a source of funding. The negative externalities of this fragmented approach are numerous and well known: a widely diverse supervisory system, often with many smaller players, with relatively large national differences in regulation and practice, obliging Europe-wide financial institutions to take account of the desires of as many banking supervisors.4 National supervisors have often taken a flexible and hesitant attitude towards banks showing signs of increasing weakness. This lack of harmonization opened wide possibilities of regulatory arbitrage, at the level of both the banking and securities systems, possible resolution and individual client behaviour. It may also endanger the existence of the euro. The large diversity in the field of regulation, including taxation, has contributed to financial systems which in terms of overall volume bear no relationship to the national economy in which they are functioning, possibly resulting in a significant threat to the financial position of these states in case of crisis. A lack of cross border competition especially in the retail markets, as often identified in the ECB’s Integration Reports,5 points to a weak degree of financial integration, contrary to the single market objective, thereby not responding to the expectation of consumers, business firms, and the overall EU economy. The financial crises have dramatically illustrated the downside of this poor state 4.05 of affairs.6 A crisis at an individual bank calls for a well-conceived regime for the recovery of the bank, or if no solution is offered, for its resolution. In the 2007–2008 crisis, most European states had no regime for the bank resolution. As a consequence, solutions were worked out on an ad hoc basis, often by having

dealt with the centralization of securities supervision, see G Tumpel-Gugerell, ‘We need a European SEC’, available online at ; ECMI Commentary, ‘Financial supervision is not well served by half-baked solutions’ (2008); ECMI, ‘Does Europe need an SEC?’ (8 March 2006); G Hertig and R Lee, ‘Four Predictions About the Future of EU Securities Regulation’, available online at ; R Lee, ‘Politics and the Creation of a European SEC: The Optimal UK Strategy—Constructive Inconsistency’, available at online at ; P M Boury, ‘Does the European Union need a Securities and Exchange Commission’ (2006) 1(2) Capital Markets Law Journal 184–94. Some of the pre- SSM studies are useful as they analysed the position of Commission, Parliament and Council, see E Ferran and V Babis, ‘The European Single Supervisory Mechanism’ (March 2013) University of Cambridge Faculty of Law Legal Studies Research Paper series, available online at . 4 Reference can be made to the repeated complaints by banks established in several EU states that they had to comply with the divergent—and sometimes incompatible—requirements in each of these states. 5 See ECB, ‘Financial Integration in Europe’ (April 2014), available online at ; see also ECB for the years 2017–2018; Special Eurobarometer 446 (April 2016), ‘Financial Products and Services’ EV-04-16-507-EN-N. 6 For a financial and institutional analysis, see G Ferrarini and L Chiarelli, ‘Common Banking Supervision in the Eurozone: Strengths and Weaknesses’ (August 2013), SSRN-id2309897 with an analysis of the original Commission proposals and comparison with the final outcomes.

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Eddy Wymeersch most of the losses absorbed by the States as the ultimate protectors of the financial systems. States confronted with large banking groups, some several times larger than their GDP, were barely able to support the fiscal load due to the bail-out of their largest banks. Supporting these huge losses negatively impacted their sovereign ratings, leading to sometimes dramatic increases in interest rates, further menacing these states’ financial position. Bail-out followed bail-out, destroying trillions of euros, endangering social cohesion and leading in some states to redundancy rates of 25% or more of the population. Their social and political balance came under severe pressure, as is still visible ten years later. Other states were confronted with insolvency and had to be rescued, officially or indirectly. The financial crisis, originally a banking and prudential crisis, rapidly evolved into a sovereign crisis, banks having invested in their sovereign’s debt. The future of the euro, one of the key angles of the European construction was put in doubt, potentially putting the Union as such in danger. The ECB promised strong support and was willing to undertake ‘whatever it takes’.7 It was inventive in finding Treaty-compatible ways8 of supporting the ailing banks, or indirectly and more controversially, the economies in difficulty. It complained that its monetary policy suffered ineffectiveness, as interest rates remained divergent depending on the weaker financial position of some Member States, in turn affecting the recovery of the local economy.9 Banks were still hesitant to increase lending, being confronted with higher prudential requirements and increased risks on their clients, but also due to weak demand especially from the SME segment. This list of causes and effects could go on: it became clear to the European and national political class that urgent measures were needed,10 while a deeper reflection was launched on the remedies for avoiding other major financial crises. In political terms this led to the ‘banking union’, in which banking supervision was reformed and centralized, followed by a similarly centralized system of resolution, both managed by independent European institutions.

7 See M Draghi, speech at the Global Investment Conference, London, 26 July 2012, available online at . 8 See the ECJ case of Gauleiter (C-62/14) ECLI:EU:C:2015:400 of 16 June 2015 stating in essence that the Treaty permits the European System of Central Banks (‘ESCB’) to adopt a program for the purchase of government bonds on secondary markets. The ECJ recognizes that indirect effects between monetary and fiscal policy are acceptable as long as each policy follows a consistent rationale and as long as the means are proportionate to the aspired ends. The principle is also applicable to secondary market purchase programs; see Weiss (C-493/17) ECJ, 11 December 2018. See also Stefania Baroncelli, ‘The Gauweiler Judgment in View of the Case Law of the European Court of Justice on European Central Bank Independence, Between Substance and Form’ (2016) Maastricht Journal of European and Comparative Law 79–98; P Craig, ‘Gauweiler and the Legality of Outright Monetary Transactions’ (2016) 41 European Law Review 1. 9 See B Coeuré, ‘Why the Euro needs a Banking Union’, speech, 8 October 2012, available online at . 10 See H Van Rompuy, ‘Towards A Genuine Economic and Monetary Union’, Report by President of the European Council Herman Van Rompuy, 26 June 2012, available online at .

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SSM—Institutional Aspects Never waste a good crisis: among the many ‘benefits’ of this deep economic, fi- 4.06 nancial and sovereign crisis, European Member States have been willing to accept a wide reorganization of the European financial system. One of the leading political tenets is the promise that taxpayers will not further be called upon to support the banks. The three European institutions launched an ambitious common initiative to reduce state debt by applying austerity programs designed to reduce over time the overly heavy state indebtedness, but also increasing efficiency in the state’s functioning.11 At the same time, important measures have been adopted, reducing the risk of failure of banks, and co-ordinating the remedial action in the different euro jurisdictions. The final point has not yet been reached: a further strengthening of the Banking Union, along with the creation of a Capital Markets Union (‘CMU’) allowing to reduce reliance on bank funding, are subjects of intense negotiations between the Member States. The new supervisory regime does not address the entire European financial 4.07 system: it is limited to the banking system, and may include indirectly some other financial institutions.12 The explanation for this limited approach is in part legal— the Treaty only allows to confer centralized supervision on banks, excluding eg insurance—but also because other parts of the financial system—securities activities, insurance, conduct of business matters to name a few—are under the supervision of the respective national supervisors allowing these to take account of the national differences of market practices. Resistance of national supervisors against centralization has played—and continues to play—an important role. The oversight of the overall financial system, including the macroprudential issues are addressed at national level, under the guidance of the ESRB. Action could be undertaken by the national authorities topped up by the ECB. Whether this fragmented system deserves to be further integrated is a subject for further research, analysis, and political controversy.13 The present chapter exclusively focuses on the SSM, more precisely the part of the 4.08 Banking Union which deals with banking supervision.14

11 See, among the numerous preparatory policy statements: A blueprint for a deep and genuine economic and monetary union (2012) 777 final (28.11.12); The Five President’s Report: Completing Europe’s Economic and Monetary Union, 22 June 2015, available online at . 12 Indirectly ‘shadow banks’ and financial conglomerates may be included as well. 13 See K Alexander, ‘The European Central Bank and Banking Supervision: The Regulatory Limits of the Single Supervisory Mechanism’, ECFR, 3/2016 at 471 pointing to the limited powers of the ECB, eg in the macroprudential field. The ECB does not cover the entire financial field, such as shadow banking industry, the wholesale debt securities markets and the OTC derivatives markets and derivatives clearing houses, which come under the supervision of the national securities supervisors, their action being co-ordinated by ESMA; nor on retail financial products, at 476. 14 See Chapter 9 for an analysis of the Single Resolution Mechanism; and Chapter 14 for the Deposit Insurance system or EDIS.

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II. The New Regulatory Framework: The Banking Union 4.09 Technically the Banking Union is a collective term covering several layers of inter-

dependent measures aimed at better protecting the European economies against future banking crises. These layers are based on a complex and interrelated system of laws and regulations, part of which belongs to the Member States’ specific legal system, part of which is directly rooted in EU law. The implementation of this prudential framework is split over the ECB, as the Union institution, and the National Competent Authorities (‘NCAs’), while for the field of resolution, the European Single Resolution Board along with the national resolution authorities are in charge of the implementation of the resolution regimes. These are the two levels of the Banking Union which are already fully operational in the Member States that use the euro as their currency. With these two layers in place and functioning effectively, the quality and strength of financial regulation and supervision in the euro area has made considerable progress. The first years of implementation have proved to be successful, and many of the previous weaknesses have been corrected. A certain number of resolution cases have tested the system to the extreme. So, the Banking Union, phases 1 and 2, is up and running.

4.10 The third layer would consist of the organization of an ultimate financial support

to an ailing banking system. The existing deposit guarantee systems might serve as a limited ‘back stop’, but a more ambitious European Deposit Insurance Scheme (EDIS) is being negotiated, along with a solid backstop offered by the European Stability Mechanism.

4.11 The complexity of the regulatory system is due to the fact that part of the pru-

dential supervision is centralized at the supranational level and administered by a Union body, while another part continues to be located at the national level. A similar structure is followed for resolution. In both cases, different sets of rules are applicable, European and national, although in many respects complementary, as the national rules are often derived from European instruments and are subject to an overall test of compatibility with their European foundation and national law, the relationship between these two levels of regulation leading to interesting legal analyses.15

4.12 The supranational part of the ‘Single Supervisory Mechanism’ does not cover the

entire Union, but only the States that use the euro as their currency. Their pre- existing national banking supervisors continue to exercise their competences nationally, on the one hand in support of the ECB supervision, on the other by

15 See E Wymeersch, ‘Financial regulation: its objectives and their implementation in the European Union’ in V Colaert, D Busch, and T Incalza (eds), European Financial Regulation: Levelling the cross-sectoral playing field (Bloomsbury Hart 2019).

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SSM—Institutional Aspects directly supervising the not so large banks. Under the overall guidance of the ECB, a strict ‘duty of co-operation in good faith’ and ‘close co-operation’ is applicable between these two levels. The SSM Regulation has attempted to convince the non-euro Member States to 4.13 join the SSM: this is the regime of ‘close co-operation’, whereby the euro prudential regime would be extended to these non-participating states. This attempt has not been successful, candidate states weighing the consequences of joining the euro against possible advantages16 As the SSM only applies to the euro area, the other Member States have maintained 4.14 their proper supervisory regime, with their proper supervisory bodies, but largely based on the European regulations as applied in the SSM area. Moreover, banks from these jurisdictions have free access to the other European states, including the SSM states, and as their regulatory regime is largely identical, co-operation between the respective supervisors is facilitated. This creates a comparable prudential regulatory area, but differently applied by their national supervisory authorities. Cooperation is institutionalized for rulemaking— at the European Banking Authority or EBA—while for supervision, colleges of supervisors, and specific MOUs elaborate common solutions.

III. Applicable Bodies of Law in Banking Supervision 1. The National Legal Systems Banks are set up under national law, and hence are governed by national law. 4.15 Their specific structure as adapted to their banking business is governed by the national banking act, which is the transposition of the European directives, in this case mainly the Capital Requirements Directive. The interpretation of this national law is governed by national law, in conformity with the EU directive and its application is subject to oversight by the ECB and ultimately to the review by the European Court of Justice. In several other aspects national law will have a considerable impact on the functioning of the bank: this will be the case for national company law, to be applied according to the EU banking law requirements.17 This would also be the case for the conditions under which banking transactions are 16 On the participation of Denmark in the Banking Union, see the position of the Danish National Bank available online at ; European Parliament, Think Tank, ‘Completing the Banking Union’, 6 February 2019, Bulgaria and Sweden were also mentioned. Individual banks may have transferred their seat to a euro jurisdiction: see n 97. 17 See, for the question of whether the chairman of the board of a bank can be an executive director, Credit Agricole v ECB, 24 April 2018 (Joined Cases T‐133/16 to T‐136/16), ECJ, illustrating the conflict between national company law and the SSM Regulation, the latter prevailing.

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Eddy Wymeersch undertaken—contract law but also negligence rules—at least to the extent that no EU rules apply. 4.16 The relative role of the national legal system has to be analysed on the background

of the increasingly far-reaching EU regulation. As a matter of principle, EU regulation takes priority over national law.18 At the same time, there is a presumption that national law conforms to EU law. As a consequence, the importance of national law in actual banking supervision is relatively limited, at least as far as the banks under direct ECB supervision are concerned. For the banks, which are exclusively in contact with the national supervisor, it is likely that both supervisor and bank will have more regard to their national regulation, although the EU regulation remains generally applicable and has priority. In case of refusal to give priority to EU law, the ECB has the right to intervene and take over supervision.19 In some cases, it would seem that banks have tried to extract themselves from ECB supervision, in order to be able to enjoy the more accommodative national supervision.20

4.17 There a few fields where the national banking law will continue to play a

significant—and sometimes disturbing—role: well-known is the case of governance of banks, with respect to the ‘fit and proper’ process relating to the members of the management body of a bank21 for which both the assessment procedure and the substantive criteria will be governed by the national provisions or precedents, but ultimately decided by the ECB on the basis of the prevailing EU law.22 This approach will prevail for all matters where the EU regulation does not impose specific requirements. It would also apply in the cases where the regulation or directive opens certain choices for the national legislator or supervisor: these are the national ‘options and discretions’.23

18 But if a national provision is clair and non-ambiguous, the application should be strict and cannot be set aside by an interpretation based on a Treaty principle, see Société Générale, 13 July 2018 (Case T-757/16), ECJ on deductions from the leverage ratio. 19 On the basis of art 4(5)(b) of the SSM Regulation. 20 This might have been the motivation underlying the ECJ cases Credit Mutuel Arkea v ECB, 13 December 2015 (Case T-712/15); Landeskreditbank Baden-Württemberg-Förderbank v ECB, 16 May 2017 (Case T-122/15). 21 Article 91 of CRD IV; see SSM Annual Report 2017, 74–76. Another example is the Dutch rule whereby banks have to request a nonobjection declaration from the Nederlandsche Bank NV for investments in other financial institutions, article 96 of the Dutch Act on Financial Supervision 3:96 WFT. The ECB would exercise this competence for large institutions, ECB Annual Report, 2017, 77. 22 The ECB will ultimately decide on the basis of the prevailing art 91 of CRD IV, taking into account the transposition of this directive into national law. 23 The ECB tried to simplify the effect of national laws: See ECB Regulation (EU) 2016/445 of the European Central Bank of 14 March 2016 on the exercise of options and discretions available in Union law (ECB/2016/4); Recommendation of the ECB of 4 April 2017 on common specifications for the exercise of some options and discretions available in Union law by national competent authorities in relation to less significant institutions (ECB/2017/10), [2017] OJ C120/2, 13.4.2017; See, for more details, M Lehman, ‘Single Supervisory Mechanism Without Regulatory

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SSM—Institutional Aspects 2. Union Law The SSM Regulation states that the ECB shall ‘apply all relevant Union law’, in- 4.18 cluding the national transpositions of Union directives. Union law has priority over national law. This obligation will apply to all credit institutions established in the participating Member States. National Competent Authorities will also apply Union law: this result is achieved by referring to the direct effect of the regulations, while national law transposing directives are subject to a conformity check with the directive. In principle, the difference between the two regimes lies to a large extent in the way the applicable rules are applied. The basic legal instruments in banking supervision are the CRD IV,24 CRR,25 4.19 BRRD, SSM, SRM, and DGS26 but these should be analysed taking into account other flanking measures, such as the EMIR27 and CSDReg28 and more recently MiFID II and MiFIR.29 Some older measures such as the settlement finality directive, or dealing with reorganization and winding up or with the financial conglomerates directives will remain in force.30 Some of these instruments are Regulations in the technical sense: a considerable number of regulations are adopted by Council and Parliament or by the Commission, pursuant to delegations contained in the directives or regulations. These regulations usually are more technical in nature and govern actual banking supervision. As regulations, they are

Harmonisation? Introducing a European Banking Act and a “CRR Light” for Smaller Institutions’, SSRN 2912166 (February 2017) calling for a European Banking Act. 24 Directive 2013/36/EU of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC OJEU 27 June 2013, [2013] OJ L176/338 (CRD IV). Additional requirements have been adopted in Directive 2019/878 of 20 May 2019. 25 Regulation (EU) 575/2013 of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) 648/2012, OJEU 27 June 2013, [2013] OJ L176/1  (CRR). 26 See Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014 on deposit guarantee schemes. 27 Regulation (EU) 648/2012 of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (EMIR). 28 Regulation (EU) 909/2014 of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories and amending Directives 98/26/EC and 2014/65/EU and Regulation (EU) 236/2012 (CSDR). 29 Directive 2014/65/EU of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU, 12 June 2014, [2014] OJ L173/349 (MiFID II); Regulation (EU) 600/2014 of 15 May 2014 on markets in financial instruments and amending Regulation (EU) 648/2012, 12 June 2014, [2014] OJ L173/84 (MiFIR). 30 Directive 98/26/EC of 19 May 1998 on settlement finality in payment and securities settlement systems, [1998] OJ L166/45 (settlement finality); Directive 2000/46/EC 18 September 2000 on the taking up, pursuit and prudential supervision of e-money, [2000] L275/39; Directive 2001/ 24/EC of 4 April 2001 on the reorganization and winding up of credit institutions, [2001] OJ L125/5; Directive 2002/87/EC on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate and amending Council Directives 73/239/EEC, 79/267/EEC, 92/49/EEC, 92/96/EEC, 93/6/EEC and 93/22/EEC, and Directives 98/78/EC and 2000/12/EC of the European Parliament and of the Council.

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Eddy Wymeersch equally binding on the ECB and on the national supervisors in their oversight of all banks. As a consequence, they increasingly limit the margins in which national banking law can come into play. 4.20 The regulations apply in the entire Union31 and will have priority over all other

provisions adopted in these states. Conflicts may arise with national provisions implementing directives, or applicable to matters that have not been the subject of Union provisions: the decisive criterion for determining which provision will govern the subject will depend on whether the subject has been dealt with in a regulation, in which case the latter has priority.

4.21 This structure of the Union legal system explains the Union’s bodies’ preference

for regulations: they guarantee that the same rules will be applied throughout the Union, applicable to both large and small banking groups, normally do not call for additional implementing measures, only rarely raise questions as to conformity with Union law, and allow the establishment of an effective and consistent supervisory regime.

4.22 The regulations apply in all twenty-eight Member States, but are of particular im-

portance to the nineteen SSM jurisdictions where they offer the basis for an equal supervisory regime as applied by or under the authority of the ECB.

4.23 A specific aspect of the SSM relates to the role of the European Banking Authority

in developing detailed banking regulations: these regulations—including the technical and implementing standards—are adopted by the Commission32 and are therefore binding on the ECB and on the NCAs as well, contributing to the level playing field.

4.24 The power of the ECB to develop its own prudential regulatory system is therefore

considerably restricted, although it may develop regulations ‘only to the extent necessary to organize or specify the arrangements for the carrying out of the tasks conferred on it by this regulation’.33 This is the case with the ECB Framework Regulation34 organising the practical arrangements concerning co- operation within the SSM between ECB and NCAs. The ECB may also adopt ‘guidelines and recommendations or take decisions’ but always staying within the limits of relevant Union law, including regulations developed by the twenty-eight Member States within the EBA.35 This restrictive attitude towards the ECB’s regulatory

31 In all EU states, whether part of the euro area or not. 32 Articles 290(2) and 291 of the TFEU are the legal basis for these two types of instruments. 33 Article 4(3) of the SSM Regulation. This implies making use of the powers in national legislation. The SSM Regulation provides for a few instances where regulatory power has been granted to the ECB: see arts 4(3), 6(5)(a), and 33(2); see also art 26(5) on the mediation panel. 34 Framework Regulation 468/2014 of the ECB of 16 April 2014, based on art 33(2) of the SSM Regulation. 35 See art 4(3) of the SSM Regulation.

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SSM—Institutional Aspects power should be attributed to the concern of creating a fragmented legal regime, fearing that the SSM states and the ECB might develop a different, and possibly a stronger and more credible supervisory regime, creating competitive distortions. 3. The European Rulebook The considerable expansion of the regulatory regime has led to calls for making 4.25 the overall regime more coherent and more easily accessible. Originally the idea to create a rulebook which would contain, directly or by reference, all regulations or relevant other statements applicable in a certain field—eg in the banking field— looked very attractive.36 This was called the ‘Single rulebook’, a political rather than a legal concept.37 The three European Supervisory Authorities (ESAs) would have to roll it out each for its own regulatory system. However, in practice this has proved to be very difficult to achieve. The European 4.26 Banking Authority has published an ‘Interactive Single Rulebook’ based on the four main instruments—CRD IV, CRR, BRRD, and PSD238—in which access to further regulations or statements is electronically enabled thereby facilitating the consultation for all statements of whatever nature (regulations, recommendations, guidelines, etc). Although a very useful tool for researching applicable regulatory regimes, it has its limitations. The rulebook is unable to give a comprehensive view of all applicable rules: while the CRR, as a regulation, is directly applicable in all EU states, the directives—such as CRD IV—have to be transposed in national legislation, leading to sometimes considerable differences in the nationally applicable regime. These legal provisions have to be researched on the national website, often in the language of the Member State concerned. Implementing regulations, which are also directly applicable, have somewhat reduced this national diversity.39 For institutional reasons, the EBA rulebook contains no reference to the ECB’s 4.27 regulations, recommendations or guidelines, although these apply to a major part of the banking industry in the EU. This feature introduces an additional element of regulatory diversity, the rulebook being based on the regulations prepared or 36 The idea was originally launched by Tomaso Padoa-Schioppa, November 2003, ‘How to Deal with Emerging Pan-European Financial Institutions?’, speech, The Hague, 3 November 2004. 37 A Lefterov, ‘The Single Rulebook: Legal Issues and Relevance in the SSM Context’, (2015) ECB Legal Working Paper Series No 15 45 who concludes to granting the ECB limited rulemaking power to bridge the gaps. The rulebook could not play the role of a European banking Act: M Lehmann, ‘Single Supervisory Mechanism Without Regulatory Harmonisation? Introducing a European Banking Act and a ‘CRR Light’ for Smaller Institutions’, EBI WP 2017, 3. SSRN 2912166, 17. 38 See the European instruments mentioned in nn 24–30. See also Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) 1093/2010, and repealing Directive 2007/64/EC (Payments Services Directive (PSD 2)). 39 This is known as the ‘options and discretions’ (n 23).

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Eddy Wymeersch adopted by the twenty-eight Member States, and is binding on the ECB, in which only nineteen Member States are represented, although all are subject to the same common rules.40 It is probably one of the explanations for the limited regulatory powers of the ECB. On the other hand, it may strengthen the ECB’s indirect influence in the common rulemaking process. 4.28 The rulebook could not reflect the diversity of national regulations, and even a

reference to similar national publications would be a difficult, risky if not impossible enterprise. Notwithstanding this criticism, it is a useful initiative and one should encourage the EBA to pursue it, further deepening and broadening its efforts in order to limit the wide dispersion of rules and regulations, and make these more easily accessible.41

4.29 By way of comparison, the two other ESAs—ESMA42 and EIOPA—were later

in engaging in a similar activity, among others because the national diversity was even greater.

4.30 This massive reregulation of the financial services industry in Europe is likely

to create, apart from considerable implementation costs,43 important structural changes in the functioning, organization and relative position of the individual banks in the European Union but also of their regulators. New streamlining reflections are being launched but often halted by national interests.44 By way of comparison, the United States is proceeding to a deregulation effort, especially benefiting the smaller institutions.45

IV. The Choice of the ECB as the Prudential Supervisor 4.31 When the idea to create a banking union characterized by more centralized su-

pervision was launched, there have been quite some discussions as to how this See art 4(3), 2nd sentence of the SSM Regulation. 41 See E Wymeersch, ‘European Financial Regulation: How to Make It More Workable’ (14 June 2016), available online at . 42 ESMA launches Interactive Single Rulebook, 14 February 2018. Previously it has mainly posted the UCITS Directive and the CRA Regulation in consolidated format, available online at . 43 For 2018, the ECB budgeted €502.5 million for supervision. See Press Release, 30 April 2018. 44 See the Proposal for a Reform of the ESAs, Communication from the Commission: Reinforcing integrated supervision to strengthen Capital Markets Union and financial integration in a changing environment 20 September 2017, COM (2017) 542 final. Amended proposal for a Regulation, Brussels, 12 September 2018 COM (2018) 646 final 2017/0230 (COD). For the most recent reform proposals: Commission, Fact sheet: Capital Market Union: creating a stronger and more integrated European Financial Supervisory Architecture, including on anti-money laundering, available online at . Also: , accessed 15 March 2019. 45 Barney Johnson, ‘What Deregulation Bill Offers US Banks Financial Times (London, 12 March 2018). 40

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SSM—Institutional Aspects new function should be structured and especially which institution should be in charge of exercising these considerable powers. Several ideas were launched, some based on a stronger form of co-ordination of the national supervisory bodies,46 others suggesting the creation of a new supervisory agency. These approaches did not meet the need for a stronger, centralized supervisory scheme at least for the euro area, or could not be pursued without a change of the Treaty, as the present legal system does not allow the creation of separate bodies or agencies to which extensive policy powers could be transferred. The choice for the ECB as the new pan-European47 prudential regulator should 4.32 also be seen in the context of the then very active financial crisis. The ECB was an already well-established institution, directly rooted in the Treaty, with a strong reputation of neutrality and expertise in the monetary field. Conferring supervision to the ECB would be a strong signal of confidence and of the will of the European political authorities to support the euro and to restore Europe’s financial system. As a Treaty based institution its decisions would also carry the same legal authority as that of other treaty based bodies.48 From a technical point of view, the choice of the ECB was the most readily 4.33 available, based on a provision of the TFEU, Article 127(6) relating to the tasks of the ECB, which could be easily activated by a Council regulation, according to which: “The Council, acting by means of regulations in accordance with a special legislative procedure, may unanimously, and after consulting the European Parliament and the European Central Bank, confer specific tasks upon the European Central Bank concerning policies relating to the prudential supervision of credit institutions and other financial institutions with the exception of insurance undertakings.”

Although there has been some hesitation as to whether this provision allows the 4.34 delegation of actual prudential supervision to the ECB,49 there can be little doubt that this has been the intention of the provision’s draftsmen, and at least is not inconsistent with its normal reading. Further criticism addressed the application

46 De Larosiere Report, ‘The High-Level Group on Financial Supervision in the EU’, 25 February 2009, available online at . 47 This was the intention before the UK and Sweden declared not to participate. For the other Member States, the regime of ‘close co-operation’ was put forward. See 4.42. 48 This authority would not apply to delegated institutions, see the Meroni doctrine, n 204 and 295. 49 Whether ‘policies relating to prudential supervision’ does relate to actual prudential supervision, see: Brescia Morra, C., From the Single Supervisory Mechanism to the Banking Union on the Intergovernmental agreement, The role of the ECB and the EBA, SSRN-id2448913.pdf, p. 5; Wymeersch, The single supervisory mechanism or ‘SSM’, part one of the banking Union, April 2014, Working Paper Series, National Bank of Belgium, p. 17 e,s,. But would it include rulemaking? This would have upset the balance within the EBA, at that time including the UK. See Ferrarini and Recine, The Single Rulebook and the SSM, Should the ECB have more say in Prudential rule making? See: Busch and Ferrarini, Banking Union, 1 st edition, 5.81, n 78, at 159

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Eddy Wymeersch of the new regime to the sole euro area, and not to the entire Union.50 Fears were expressed about potential conflicts which may arise when prudential responsibilities are attributed to the institution that is also in charge of monetary policy: decisions in one field may be directed by concerns in the other, as was highlighted in the parliamentary debate. Whether these fears are justified or not,51 the SSM Regulation adopted several measures to ensure that both fields remain clearly separated.52 In practice however, even if two institutions had been involved, decisions adopted in one field could not disregard concerns stemming from the other field, especially if the concerns are likely to create systemic risks. The ECB’s powers in the macroprudential field are based on the same reasoning: reference is made to ‘monetary policy concerns’ in case the Governing Council objects to a draft decision of the Supervisory Board.53 Moreover, a special review procedure has been introduced allowing the national central banks concerned to trigger a mediation procedure in case differences of opinion between the Supervisory Board and the Governing Council are related to differences of opinion on monetary matters.54 4.35 As will be illustrated later, the choice for the ECB as the prudential supervisor has

considerable implications with respect to the governance of the system: within the ECB the ultimate decision-making body is the Governing Council, and under the present Treaty provisions no other or separate body can be put in charge of final decision making on behalf of the ECB. Also, it would not have been reasonable to expect the Governing Council, composed of central bank governors, to adopt the technical decisions related to the supervision of individual banks. Therefore, a separate decision-making body had to be installed: this is the Supervisory Board, an internal body of the ECB. Its position within the ECB will be analysed further below.

4.36 The specific legal position can be illustrated by drawing a comparison with the po-

sition of the Single Resolution Board. The SRB is qualified as a ‘union agency’,55 a specialized structure, organized by a regulation of Parliament and Council, acting 50 See the opinions in: Wymeersch, The single supervisory mechanism n. 49; J. Carmassi, C. Di Noia and St. Micossi, Banking Union: A federal model for the European Union with prompt corrective action, CEPS Policy Brief, 282, 18 September 2012 51 Decision of the European Central Bank of 17 September 2014 on the implementation of separation between the monetary policy and supervision functions of the European Central Bank (ECB/2014/39). Lehmann (n 37), refers to a fundamental conflict. For an extensive analysis, see D Masciandaro and M Nieto, ‘Governance of the Single Supervisory Mechanism: Some Reflections’ SSRN 2384594 at 7, who conclude that the integration view although most practised in Europe is not necessarily superior to the separation view. There was more sympathy for it in the EU after the financial crisis. See Wymeersch (n 49). 52 See art 19 of the SSM Regulation on independence; art 25 of the SSM Regulation on separation from monetary policy; and art 27 of the SSM Regulation on professional secrecy. 53 Article 27(8) of the SSM Regulation. 54 See further about the Mediation Panel, see 4–140. 55 Article 42 of the SRB Regulation.

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SSM—Institutional Aspects under the guidance of the Commission and the Council for specific matters.56 The SRB decisions are those of a separate agency and are subject to judicial review by the ECJ. Certain aspects of the SRB’s decisions will have to be ‘endorsed’57 by the Commission, or refused, and this on the basis of an assessment of the discretionary aspects of the resolution scheme.58 The Commission may decide to call upon the Council, to submit the matter to its discretionary appreciation whether the scheme fulfils the ‘public interest criterion’ or whether additional charges would be imposed to the Resolution Fund.59 In both cases, the need to have the decision ultimately checked by the Union’s two top institutions was inspired by the fear that discretionary powers would be exercised by an administrative agency.60 While the SSM was set up by a regulation adopted by a Council Regulation, 4.37 as provided by the Treaty, on the proposal of the Commission, but without formal intervention of the Parliament61 the SRM is the product of a regulation of Council and Parliament, as proposed by the Commission, and further supported by an Intergovernmental Agreement62 providing for the funding for direct recapitalizations in case of resolution.

V. Application to the Euro Area or Beyond? The choice of the European Central Bank, the euro monetary authority, as the 4.38 central pillar for the new supervisory system implies that its supervision would only apply to the euro area. This choice was also dictated by the ongoing financial crisis which was especially affecting the euro area and its currency. The same approach is followed for the recovery and resolution field, and in both cases only euro area institutions qualify for the application of the supervisory or resolution measures. Within the euro area the system is fully compulsory, what is also illustrated by the 4.39 use of a Regulation as the legal basis for the new system. As with the monetary Union,63 the non-euro states do not take part in the SSM on the basis of their own 56 In that sense it can be considered a delegated body. But the intervention of Commission and Council allows to mitigate the objections on the basis of the Meroni doctrine, as mentioned in n 295. 57 This would suggest an explicit statement of support. See for a similar technique, Recital 11 of Regulation (EC) 1606/2002 on the application of international accounting standards. 58 See art 18(6) of the SRM Regulation. 59 See art 18(7) of the SRM Regulation. 60 This is a clear reference to the Meroni doctrine (n 204 and 295), but which would not apply to a Treaty based institution. 61 Although parallel discussions were held on changes to the EBA regulation which allowed the Parliament to also discuss some aspects of the SSM Regulation: Ferran and Babis (n 3), 4. 62 See, about the Intergovernmental agreement: C Brescia Morra, (n 49), 3. 63 See article 139 of the TFEU for the monetary union.

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Eddy Wymeersch decision and could be considered, as was stipulated for the monetary Union itself, as ‘Member States with a derogation’.64 4.40 The Regulation provides for extending the geographical coverage to non-euro

Member States by introducing a system of ‘close co-operation’.65 According to the close co-operation regime, a non-euro area Member State may declare to opt-in into the SSM, making the supervisory regime applicable in its jurisdiction. This Member State becomes a ‘participating State’, along with the euro area States. But the two regimes are not identical. The euro area Member States are fully and irreversibly subject to the SSM as this Regulation is directly applicable in each of them without any further national decision or implementing measure. In the non-euro states, the SSM will be applied on the basis of an agreement, according to which that participating state will implement the SSM and the ECB’s decisions and orders. Although that Member State would not be taking part in the Governing Council, it will be member of the Supervisory Board.

4.41 As a consequence, the national legislation of that State has to be adapted in

order to ensure that the Regulation and the ECB’s decisions are fully applicable. Furthermore, its national supervisor is bound to act in accordance with the rules of the Regulation and with the instructions given by the ECB. This close co- operation regime66 may lead to tensions with the national interests or with the views of the national supervisor: in this case an exit—or termination of the ‘close co-operation’—may be provided, whether on a voluntary basis by the Member State, or upon a decision of the ECB. When the national supervisor does not implement the ECB’s prudential rules and instructions, the ECB will first address a warning, and in case of non-implementation, it may either suspend or terminate the co-operation agreement. A special procedure deals with the case that the non- euro Member State objects to a draft decision submitted to the ECB’s Governing Council.67 Voluntary termination by that Member State cannot intervene in the first three years, nor can close co-operation be reintroduced unless after three years after having been terminated.

64 The SSM regime is however different, as a positive decision of the participating states is required to be allowed to the SSM, there where in the monetary field, ‘derogations’ apply as the Member States concerned have not applied to participate. The UK and Sweden were excluded from the outset. 65 Decision of the ECB of 31 January 2014 on the close co-operation with the national competent authorities of participating Member States whose currency is not the euro (ECB/2014/5); to be distinguished from the ‘enhanced co-operation’ of art 20 e.s. of the TFEU. 66 See for the modalities of this regime, art 7(2) of SSM and art 115 e.s. of the Framework Regulation. 67 See art 7(7) of the SSM Regulation allowing the objecting state to refuse to implement the decision, and the ECB may then consider the suspension or termination of the close co-operation.

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SSM—Institutional Aspects Entering into a close co-operation agreement may be attractive to Member States 4.42 where all or most of the banks are owned by, or are branches of euro area banks.68 But would this end the activity of that state in the prudential field, possibly leading to a loss of expertise? This would be unlikely. Local supervision would in any case continue for the less significant institutions. Staff and infrastructure will have to be kept in place to ensure that State’s participation in the different decision-making bodies, such as the EBA or the ESRB, or to exercise powers in matters that are outside the SSM’s remit. Recent accessions would indicate that non-euro Member States might prefer full EU accession rather than the transition status of ‘close co-operation’.69 Some Member States—the pre-Brexit UK and Sweden—have indicated that they 4.43 will not consider to apply for the ‘close co-operation’ regime. In that case, only the EU regulations70 and the directive provisions especially on co-operation and co- ordination will apply. For cross border banking groups supervisory co-operation mechanisms—including supervisory colleges—will become operational. As the case may be, the ECB will take part in the supervisory colleges, whether as lead supervisor for SSM located banking groups or as competent authority for the subsidiaries located in the euro area or in other participating states for banking groups the head office of which is located outside that area. Specific MOUs may be considered.71 The ECB’s Framework Regulation pays extensive attention to the ‘close co- 4.44 operation’,72 but up to now, no State has entered into a ‘close co-operation’ agreement, the effects of which are difficult to assess.73 Other types of co-operation agreements have been concluded with the ECB, what may be a more palatable approach for these Member States.74

68 See an analysis with figures: Chr, Hadjiemmanuil, ‘Close Cooperation Dilemma’s of EU Outsiders’, 27 October 2016, available online at . See also Decision of the ECB of 31 January 2014 on the close co-operation with the national competent authorities of participating Member States whose currency is not the euro (ECB/2014/ 5), [2014] OJ L198/7, 5.7.2014. Also the Framework Regulation, art 106 e.s. 69 For a critical analysis of this regime, see T H Troeger, ‘ The Single Supervisory Mechanism— Panacea or Quack Banking Regulation?’ (2014) European Business Organization Law 449–97, ssrn. 2311353. 70 Regulations of Council and Parliament, including Commission regulations adopted on the basis of the EBA Regulation (arts 10–15). 71 Article 3(1) and (6) of the SSM Regulation. 72 Framework Regulation, n 34 arts 106–199. 73 Report from the Commission to the European Parliament and the Council on the Single Supervisory Mechanism established pursuant to Regulation (EU) 1024/2013 SWD(2017) 336 final, 11 October 2017. 74 MOU on prudential supervision of significant branches in Sweden, Norway, Denmark, and Finland, 2 December 2016, available online at .

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Eddy Wymeersch 4.45 One banking group has followed a different path and has relocated to a euro

jurisdiction to benefit from a more favorable regulatory regime.75 It is not clear whether this case has to be considered a precedent.

VI. The Single Supervisory Mechanism 1. The Structure of the SSM Regime 4.46 The SSM Regulation introduces a ‘mechanism’, a special prudential supervisory

regime, but not a new prudential institution. This approach is comparable to the ‘mechanism’ followed in the SRM regulation for bank resolution. In both cases, these mechanisms build on the existing national bodies, organising co- ordination between them under the leadership of an existing—ECB—or new leading entity—the SRB with the support of the Commission. In both cases, the national supervisory bodies—c.q. resolution authorities—will continue to play a significant role, even if the system-wide leadership is delegated to a central body.

4.47 The national competent authorities are members of the European supervisory

system at different degrees. The central banks of the euro area are members of the Governing council, being represented by their governors or presidents. For the Supervisory Board, the structure is somewhat different, as apart from representatives of the Central banks of the SSM states, in addition representatives of seven national supervisory authorities are also taking part.76 while for the Single Resolution Board representatives of the national resolution authorities of the participating states will be represented. With respect to the EBA board, the NCAs are full members of the board, with the ECB as a non-voting member.

4.48 The SSM ‘mechanism’ refers to a rather complex set of relations as to the respec-

tive decision making competences of the ECB and the NCAs. With respect to the core supervisory tasks, the SSM Regulation states that the ECB: “Within the framework of article 6, the ECB shall be exclusively competent to carry out, for prudential supervisory purposes, the following tasks in relation to all institutions established in the participating member States . . .77

However, the way this supervision will be implemented is different depending on the category to which a specific banking institution belongs: the attributed competence of the ECB has to be applied ‘in accordance with the framework of article 6’,

75 Nordea bank relocated from Sweden to Finland, See: Nicola Billotta, ‘Nordea group: Why the Biggest Nordic banking group redomiciled to Finland’, December 2017, available online at . 76 In this case, the representatives of the two bodies will only cast a single vote. 77 Article 4(1) of the SSM Regulation. Originally the Commission and the European Parliament would have made de SSM applicable to all banks, large and small, see Ferran and Babis (n 3), 5.

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SSM—Institutional Aspects ie depending on whether the institution belongs to the group of Significant Institutions (SIs), or to the group of Less Significant Institutions (LSIs). The ECB will be fully competent for the supervision of the SIs and will exercise indirect oversight with the national authorities (NCAs) on the LSIs. This raises the question whether the SSM introduced a two-tier supervisory 4.49 system or not. This question was submitted to the European Court of Justice,78 which held as follows: “ the logic of the relationship between them—article 4(1) and 6, SSM—consists in allowing the exclusive competences delegated to the ECB to be implemented within a decentralised framework, rather than having a distribution of competences between the ECB and the national authorities in the performance of the tasks referred to in Article 4(1) of that regulation. Similarly, under Article 6(4), second subparagraph, of that same regulation the ECB has exclusive competence for determining the ‘particular circumstances’ in which direct supervision of an entity which should fall solely under its supervision might instead be under the supervision of a national authority.’

And further: . . . that direct prudential supervision by the national authorities under the SSM was envisaged by the Council of the European Union as a mechanism of assistance to the ECB rather than the exercise of autonomous competence. A further argument can be derived from the power of the ECB to ‘decide to exercise directly itself all the relevant powers with respect [to an LSI, . . . ] when necessary to ensure the consistent application of high supervisory standards’.79

These quotes indicate that the SSM Regulation has conceived the SSM supervision as an integrated model, with however different modalities of execution depending on the qualification of the bank as an SI or an LSI, whereby the NCAs intervene in an ‘assistance’ mode, while recognizing the ultimate decision-making power of the ECB. Further elaborating the preceding analysis, the SSM puts the ECB in charge of 4.50 the supervision of the SIs for both general and day-to-day supervision and is the only entity to adopt supervisory decisions. The ECB adopts supervisory decisions on the basis of the legal regime applicable to the SIs, being the directly applicable EU regulations and the national laws implementing the relevant directives to the extent that these laws have not been superseded by EU rules. The NCAs will assist in the supervisory tasks in a supporting capacity, collecting information and taking part in the Joint Supervisory Teams,80 as further detailed in the Supervisory

78 See Landeskreditbank Baden Wuertemmberg-Foederbank v ECB (Case T-122/15) ECJ, General Court, of 16 May 2017, at 54; Confirmed by ECB, Case C-450-17 P of 8 May 2019; comp. D.Bundesverfassungsgericht, 30 Juli 2019, 2 BvR 1685/14—2 BvR 2631/14. 79 See Case T-122/15, ECJ, n. 78, at 58; Article 6(5)(b) of the SSM Regulation; 80 Article 6(6) of the SSM Regulation.

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Eddy Wymeersch framework. Decisions with respect to directly supervised institutions will only be adopted by the ECB, although NCAs may submit draft decisions to the ECB. NCAs may assist in verification or day-to-assessment of a SI, always acting along the instructions of the ECB.81 Exchange of information by the NCA to the ECB is also an essential part of the NCAs tasks.82 The ECB could however not delegate decision making matters to an NCA. 4.51 The ‘less significant institutions’ (LSIs) will be directly supervised by the NCAs,

on the basis of their national supervisory regime and including the directly applicable EU regulations. Implementing tasks relating to less significant institutions will be further adopted by the NCAs. The decisions of the NCAs are not subject to individual ECB oversight, nor can they be appealed before the ECB’s Supervisory Board or the Administrative Board of Review. However, the ECB is in charge of ensuring the ‘coherent and effective implementation of the Union’s policy’83 among which the consistent functioning of the SSM, implying the application of its supervisory standards.84 The ECB will ensure that the NCA decisions relating to LSIs remain in line with its overall policies ‘exercising oversight over the functioning of the system’.85 The Regulation does not contain a general mechanism allowing the ECB to enjoin the NCA to respect the specific ‘regulations’ or decisions.86 It can only request information from the NCA as to how it has pursued its tasks,87 and expects significant developments taking place at an LSI to be notified to the ECB, such as financial difficulties, in the management or procedures with significant impact on the LSI, or the NCAs draft supervisory decisions.88 NCAs will report to the ECB how they have performed the activities under Article 6.89

4.52 The SSM Framework regulation details the relationship of the NCAs with the

ECB in detail, and lists the tools that the ECB can put at work in that respect.90 The ECB can adopt ‘regulations, guidelines or general instructions’ relating to the actions of the NCAs in the overall field of prudential supervision, as listed in

81 See article 90, Framework regulation, n 34. 82 Article 6(2) of the SSM Regulation. For the LSIs, see art 6(5)(c) of the SSM Regulation. 83 Recital 15 of the SSM Regulation. 84 Article 6(5)(e) of the SSM Regulation. 85 Article 6(5)(c) of the SSM Regulation. 86 See Landeskreditbank Baden Wuertemmberg- Foederbank v ECB (Case T-122/15), ECJ, 61, n 78. 87 Article 6(5)(c) and (6) of the SSM Regulation. 88 See Article 97 of the Framework Regulation., n 34 89 Article 6(5)(e) of the SSM Regulation. 90 Article 6(5)(c) of the SSM Regulation and arts 97–100 of the Framework Regulation, n 34. See also art 7 of the Framework Regulation, according to which, for the supervision of LSIs, the ECB can involve staff members of national supervisors, other than staff members of the supervisor of that bank to be included in the supervisory team. This approach, formulated for the significant banks (art 5), is also declared applicable to the less significant ones, based on arts 4(3), 6 and 33(2) of the SSM Regulation.

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SSM—Institutional Aspects Article 4. The ECB has adopted many ‘decisions’, binding on those to whom they are addressed,91 while its Instructions mainly deal with matters of internal relevance. The ECB has developed supervisory standards on ‘options and discretions’, SREP methodology, crisis management, fintech, recovery planning, and on-site inspections. The NCAs apply these standards under the overall ECB supervision. In case of concerns about ‘consistent application of high supervisory standards’— 4.53 in other words, if an NCA does not live up to the quality of supervision as put forward by the ECB, the ECB can take over the supervision on one or more specific institutions and exercise the supervision itself.92 This instrument allows the ECB to exert its supervision of one or more specific institutions. It could substitute itself to an NCA who has not followed the line prescribed by supervisory standards. In that sense it could be used as a disciplinary tool. But it would not allow the ECB to take over the entire supervisory activity of a specific NCA. The SSM Regulation does not contain a general mechanism allowing the ECB 4.54 to enjoin an NCA to respect a specific ‘regulation’, although it may require an NCA to submit information on how it is planning to adopt a decision in certain matters93 or, ex post, how it has exercised its tasks as part of the high supervisory standards, and this even on a continuous basis. This would include tasks based on ECB regulations, guidelines or general instructions. In case of refusal by an NCA to apply a certain standard, the ECB could avail itself of Article 17 of the EBA Regulation and request it to investigate the alleged breach of Union law. The ECB would be entitled to request the EBA to investigate as it is a ‘competent authority’. The SSM is based on a high supervisory standard of banking regulation, which is 4.55 to be applied to all institutions—the SIs and the LSIs respecting proportionality— but allowing the LSIs to follow their national regulations as applied by the NCA, although without losing out of sight the need to maintain consistency in application to be based on the outcomes. This pattern of organization of financial supervision allows on the one hand to apply the strongest level of requirements to the largest, financially most sensitive institutions, while allowing the smaller institutions to be further governed by their national regulatory system as applied by the existing national supervisory bodies including Union law, and within the overall policy lines as adopted by the ECB. This dividing line can only be maintained if based on well-defined criteria, which 4.56 will not allow for any form of regulatory arbitrage. As is evidenced from the available case law, institutions are tempted to be exempted from the SI regime, and to remain under the better known and generally more friendly LSI regime.94

91 See art 288 of the TFEU. 92 Article 6(5)(b). The group will be considered a SI; art 39(5) of the Framework Regulation, n 34. 93 Article 99(4) of the Framework Regulation, allowing the ECB to ‘express its views’. 94 See the ECJ cases cited in n 20.

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Eddy Wymeersch To avoid these tensions, it might be advisable to developed a more proportional approach and take account of the risk profile of smaller banks.95 2. The Scope of the SSM A. Credit Institutions 4.57 The SSM is applicable to ‘banks’ established in the euro area which according to the EU regulations are defined as ‘credit institutions’ meaning ‘an undertaking the business of which is to take deposits or other repayable funds96 from the public and to grant credits for its own account’.97 In some Member States this definition does not include all firms locally referred to as ‘banks’: some entities officially qualified as banks receive deposits without granting credits, and conversely, some firms grant credit without receiving deposits from the public.98 Only the European definition would apply, excluding these other entities from the ECB supervision, except if included in the group’s consolidation. Public sector institutions are also excluded from both the prudential regulation and the ECB’s supervision: these include state- subsidized, specialized institutions such as the Kreditanstalt fuer Wiederaufbau, or the Caisse de Dépôts et Consignations (CDC).99 4.58 The SSM Regulation only relates to prudential supervision and does not extend

to other forms of supervision with different objectives: activities such as money laundering,100 conduct supervision on consumer credit would remain outside the

95 See in that sense Bundesfinanzministerium, ‘The Single Supervisory Mechanism: Lessons learned after the first three years’, Report, January 2018, 5. 96 See art 2(3) of the SSM Regulation referring to art 4(1) of CRR. The ECJ case of Romanelli (C-366/97) of 11 February 1999, defining repayable funds as ‘referring not only to financial instruments which possess the intrinsic characteristic of repayability, but also to those which, although not possessing that characteristic, are the subject of a contractual agreement to repay the funds paid’. Protection of depositors is the driving motivation. (art 3 of the Second Council Directive 89/646/EEC of 15 December 1989). 97 See art 4(1) of CRR; some Member States follow a different definition, eg not requiring the use of the funds for granting credit. These banks would normally be excluded from the SSM supervision at EU level but not necessarily at national level. 98 Part of this activity may belong to what is incorrectly labelled as the ‘shadow’ banking market. The FSB will henceforth refer to ‘non-bank financial intermediation”, Annual Report, 1 December 2018. 99 Article 2(5) of the CRD IV; for Belgium the Institut de réescompte et de garantie is mentioned although it has been dissolved since many years. Mandatory Deposits to the CDC are exempt from the leverage ratio: see Société Générale (Case T-757/16), ECJ, 13 July 2018. 100 See Recital 28 of the SSM Regulation. As the competence to establish AML-CFT breaches is still national, the ECB cannot act until the breach has been established; see Claire Jones, ‘ECB lacks power to uncover Money laundering’ Financial Times (London, 22 February 2018). As a consequence the ECB could not impose sanctions for money laundering, although indirectly this may be a breach of banking law. Angeloni stated that in the medium-term, a European Authority in this field is advisable (speech, 10 July 2018). See, for recent Commission initiatives on Money Laundering, proposing to centralize this supervisory function at EBA: Proposal for a Regulation COM (2018) 646 final, 12 September 2018, available online at . See also

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SSM—Institutional Aspects purview of the Regulation, except to the extent that these may create a risk that could affect a bank’s activity and risk profile.101 The same applies to activities of banks in the field of securities or insurance, where cases of misselling have had significant consequences for the banks that were involved. The activities of Central Counterparties is explicitly excluded from the ECB’s action, although these may create significant systemic risks.102 Moreover, the SSM Regulation does not include activities that are reserved to NCA, such as receiving notifications for entities subject to NCA supervision, or activities of non-financial entities not subject to EU prudential supervision.103 The SSM regime only applies to institutions located in the euro area, but has 4.59 opened an option to cover those institutions located in the non-euro Member States which have entered into a ‘close co-operation agreement’, and have become the so-called ‘participating Member States’.104 It applies to separate entities with banking status, including branches of banks from non-participating or third country banks. The SSM does not cover other categories of financial institutions. Investment 4.60 firms are subject to supervision by the national securities market supervisors, represented within ESMA as the competent regulator and supervisor for some specific fields. Recently the Commission and the ECB have stated that they want supervision to be extended to certain large, essentially systemic, investment firms, which carry out bank-like activities, but today are supervised by the national securities regulators. Financial stability concerns are the basis of this proposal. The Commission has tabled a proposal for regulation in this respect.105 Entities which grant credit under some or other form, eg linked to the distribution sector, but do not receive deposits are not subject to the SSM regime. Article 1 states that the SSM Regulation does not confer any other supervi- 4.61 sory tasks to the ECB. It cites as a relevant example the supervision of Central counterparties, regulated under EMIR.106 CCPs are generally considered not to be Commission, ‘Capital Markets Union: Creating a Stronger and More Integrated European Financial Supervisory Architecture, including on Anti-Money Laundering’, 1 April 2019. 101 eg, in the context of the Non-Performing loans: ECB, ‘Guidance to Banks on Non-Performing Loans’, March 2017, 5.4.1 and addendum, 15 March 2018. 102 Article 1(2) of the SSM Regulation, but see art 2(20) of the Framework Regulation, n 34. 103 These entities may qualify as banks under the national definition, but not under the EU one. 104 See art 7 of the SSM Regulation. 105 Proposal for a Regulation of the European Parliament and of the Council on the prudential requirements of investment firms and amending Regulations (EU) 575/2013, (EU) 600/2014 and (EU) 1093/2010, 4 January 2019, 5021/19; Proposal for a Directive of the European Parliament and of the Council on the prudential supervision of investment firms and amending Directives 2013/36/EU and 2014/65/EU, 4 January 2019, 5021/19, 4 January 2019, 5022/19. 106 Article 1, 2nd§ of EMIR; Regulation (EU) 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories ([2012] OJ L201/1) (EMIR). But CCPs will be supervised as part of the SSM if they qualify for banking status and shall be considered a supervised entity in accordance with the SSM Regulation, this

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Eddy Wymeersch banks, as there is no maturity transformation through deposit taking and lending and related activities. However, if CCPs qualify as a credit institution, they will be qualified as a ‘supervised entity’ for the application of the SSM Regulation and other relevant Union law.107 They will be considered in the macroprudential analysis of the ECB.108 The restriction only affects the SSM Regulation: other regulations could extend the ECBs scope of action, except for the supervision of insurance, excluded by Article 127(6) of the TFEU.109 4.62 Central Securities Depositaries do not qualify for banking status, unless they offer

banking services from within the same legal entity; in that case they have to adopt banking status.110

4.63 Non-bank financial intermediaries (‘Shadow banking’) are also not included in

the ECB’s remit, usually as they do not meet the definition of activity of a ‘credit institution’. These entities may be subject to regulation for other parts of their activities (eg as they only engage in lending, or as money market funds) but these are not considered from the prudential angle. Up to now, these non-bank financing systems have developed outside the prudential sphere, such as the Money Market Funds, securitization vehicles or security financing institutions which are supervised by the securities supervisors mainly dealing with the characteristics of their transactions, less clearly their impact on financial stability. They will be included in the macroprudential recommendations of the ESRB.111 Indirectly, some of these institutions may be subject to indirect supervision being part of a group including credit institutions, as part of a financial conglomerate, or through the risk assessment by their financing banks.112 The ESRB and the Financial Stability Board are closely monitoring this market segment.113

Regulation and relevant Union law without prejudice to the supervision of CCPs by relevant NCAs as laid down under Regulation (EU) 648/2012 (art 2(20) of the Framework Regulation, n.34). 107 Article 2(20) of the Framework Regulation. 108 The ECB is following the market developments with potential financial stability impact. 109 Although insurance entities may be included for ‘supplementary supervision’ on the basis of the financial conglomerate directive: Directive 2002/87/EC of the European Parliament and of the Council of 16 December 2002 on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate and amending Council Directives 73/239/EEC, 79/267/EEC, 92/49/EEC, 92/96/EEC, 93/6/EEC and 93/22/EEC, and Directives 98/78/EC and 2000/12/EC of the European Parliament and of the Council, [2003] OJ L35/1 (Financial Conglomerates). Reference to the role of the ECB is made in art 4(1)(h) of the SSM Regulation for the supplementary supervision of conglomerates. 110 Article 54(3) of CSDR for CSDs engaging in banking activities. 111 See eg ESRB, annual report 2017, p.31. NCAs may be empowered to adopt measures, to be reinforced by ECB decisions. In the fields of insurance or securities, the ESAs have a more limited function: article 36, ESMA or EIOPA regulation. 112 See Ferran and Babis (n 3), 5 113 ESRB, ‘EU Shadow Banking Monitor, No 3’, September 2018; FSB, ‘Assessment of Shadow Banking Activities, Risks and the Adequacy of Post-Crisis Policy Tools to Address Financial Stability Concerns’, 3 July 2017; see D Busch and MB van Rijn, ‘Towards Single Supervision and Resolution

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SSM—Institutional Aspects The SSM Regulation indirectly covers a wider population than the only credit 4.64 institutions: according to the Framework regulation, ‘Supervised entity’ is defined as any of the following: ‘(a) a credit institution established in a participating Member State; (b) a financial holding company established in a participating Member State; (c) a mixed financial holding company established in a participating Member State, provided that it fulfils the conditions laid down in Article 2, point (21)(b) of the SSM Framework Regulation; (d) a branch established in a participating Member State by a credit institution which is established in a non- participating Member State.’114 Often these entities will be part of company groups: the CRR has adopted 4.65 very wide definitions of parent and subsidiary, including for the latter the ‘effective exercise of dominant influence’.115 The CRR and the SSM Framework Regulation include credit institutions in group structures based on their affiliation to a central body located in the same Member State.116 With respect to groups permanently affiliated to a central body, the ECB jurisdiction extends to all group members, and this on a consolidated basis, implying that application of the prudential requirements to individual group entities may be waived if certain conditions are fulfilled. The circumstance that the central body does not have banking status does not limit the application of the SSM and the related waiver, provided that the central body guarantees the liabilities of the affiliated entities, that solvency and liquidity of the group are monitored on a consolidated basis and that instructions can be given by the central body.117 The application of these conditions were the subject of an ECJ decision in Credit Mutuel Arkea.118 These entities will normally be included in the consolidated approach, whereby the highest level of consolidation will be subject to the ECB supervision. In other cases, the ECB may act as the leader of a college of supervisors.

of Systemically Important Non-Bank Financial Institutions in the European Union’ (EBOR, 28 March 2019). 114 As defined in article 2(20) of the Framework Regulation, n 34. See also Commission, Green Paper Shadow Banking, 19.3.2012, Com (2012) 102 final, 52012DC0102 (available online at ) suggesting the different approaches; Communication from the Commission to the Council and the European Parliament: Shadow Banking—Addressing New Sources of Risk in the Financial Sector/COM/ 2013/0614 final. See Nicola Doyle, Lieven Hermans, Philippe Molitor, and Christian Weistroffer, ‘Shadow Banking In The Euro Area: Risks And Vulnerabilities In The Investment Fund Sector’, ECB, Occasional Paper Series, June 2016. 115 Article 4(1)(15)(b) of the CRR; see the cases mentioned ECJ, T-419/14, 12 July 2018, Goldman Sachs a.o. follows a comparable criterion in a competition case. Comp ECJ, C-97/08, 10 September 2009, Akzo Nobel a.o. 116 See art 10 of CRR, for the case of the waiver from certain requirements provided the entity is permanently affiliated to a central body; and art 2(21) of Framework Regulation. 117 See art 10(1) of CRR. 118 Crédit Mutuel Arkea (Cases T-712/15–T 52/16), appeal pending (Case C-152/18P), ECJ.

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Eddy Wymeersch B. The Supervision of Subsidiaries and Branches under the SSM 4.66 SSM banks establishing subsidiaries in other SSM jurisdictions will be subject to the authorization requirements for banks: local law will define some of the applicable requirements to be applied by the NCA, which will deliver a draft decision proposing the ECB to deliver the authorization.119 The supervision will be exercised by the ECB on a consolidated basis for all subjects which belong to the ECB’s competence, irrespective whether the subsidiary is to be qualified as less significant or not. The ECB may request information from the NCA120 about the subsidiary. For matters outside the ECB’s remit, the NCAs will remain in charge, and for that purpose, may create a college of supervisors. 4.67 If the group is composed of a certain number of LSIs, the ECB may qualify it

as an SI if it is established in several participating Member States, and its cross border business is a significant part of the whole.121 If that is not the case, the individual subsidiaries will be qualified as LSIs, subject to the relevant NCA’s supervision, which will be co-ordinated in a college of supervisors composed of these NCAs. This approach was the prevailing one in pre-SSM times.122

4.68 SSM banks intending to establish a branch or provide services in another SSM

jurisdiction will enjoy the Treaty freedoms of establishment, or of provision of services, and no authorization will be required123: The bank will have to introduce a request to the competent NCA about its intention to establish a branch, and the ECB, as host, will be informed if the request originated from an SI.124 If the request relates to the branch of a LSI, this will have to be notified to the NCA of the state of location.125 Branches being part of the legal entity, the supervisory regime applicable to that entity will include the branch. Where applicable, co-operation duties between competent authorities will apply, but for consolidated supervision as exercised by the ECB, it will be the only competent authority. The procedures will be simplified as they would not apply to the tasks conferred on the ECB.126

4.69 The SSM bank establishing a subsidiary in a non-euro jurisdiction which is part of

the Union will abide by the rules for establishing a bank in that jurisdiction: the provisions of the CRD IV and the CRR will be applicable. Supervision will be exercised by the ECB for the euro-area part of the group, and by the NCA for the non-euro activity in the subsidiary. Cooperation between the supervisory authorities will have to be concluded; they will involve the ECB and the NCA,127 the See art 14 of the Framework Regulation. 120 Article 6(5)(d) and (e) of the SSM Regulation. 121 Article 6(4); see also art 17(2). 122 E J Van Praag “Europees Financieel Toezicht” (2017), 455. 123 Nor endowment capital: art 17 of CRD IV. 124 Article 11 of the Framework Regulation. 125 Article 11(2) of the Framework Regulation. 126 Article 17(1) of the SSM Regulation. 127 See art 17(1) of the SSM Regulation. 119

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SSM—Institutional Aspects ECB ‘respecting the balance between home and host state established in relevant Union law’.128 The EBA has established guidelines on the supervision of significant branches.129 When non-SSM banks located in the Union intend to establish a branch in the 4.70 euro area, its competent supervisor will have to notify the NCA of the future location according to the provision of article 35 of CRD IV. The communication from the non-SSM NCA will be submitted to the ECB in case the branch is to be considered significant or is a branch of a third country institution; the ECB will exercise the powers of the competent authority for the significant branch.130 For non-significant branches, the relevant NCA will receive the communication. Both communications aim at establishing competence for the future supervisory regime—by the ECB or an NCA—including the conditions under which activities can be carried out by the branch.131 As far as non-Union jurisdictions are concerned, incoming entities establishing 4.71 themselves as branches or subsidiaries will be subject to the general rules laid down in the CRD IV and CRR; they will have to apply for an authorization with the supervisor of the place where that entity will have its head office or CRR. Depending on the qualification of the entity as an LSI or as an SI, the supervision will be exercised by the NCA or by the ECB. Material subsidiaries of non-EU G-SIIs shall in the future be held to establish an EU intermediate parent undertaking (“IPU”) to hold higher own fund requirements, and this according to CRD 5. 3. Criteria for Determining the SIs and LSIs The SSM supervisory regime is split in two tiers, the Significant Institutions (SI) 4.72 subject to direct ECB supervision, and the Less Significant Institutions (LSI) subject to NCA supervision and indirect ECB oversight. The criteria to differentiate these two classes have been laid down in the SSM Regulation and are further detailed especially in the Framework Regulation. The basic criteria used for distinguishing significance are: • size; • importance for the economy of the Union or of a participating Member State; • significance of cross border activities.

128 Article 17(3) of the SSM Regulation. 129 On the basis of art 16 ‘Guidelines and recommendations’ of the EBA Regulation, the EBA has adopted Guidelines on supervision of significant branches, EBA-GL-2017-14. A proposal to tighten supervision on foreign branches has been discussed. 130 Article 14 of the Framework Regulation. 131 Article 13 of the Framework Regulation.

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Eddy Wymeersch 4.74 These criteria are further made explicit in the Regulation by introducing a pre-

sumption of ‘significance’ defining the content of the abovementioned basic criteria.

4.75 However, some flexibility may be applied: ‘downgrading’ and ‘upgrading’ can

take place by decision of the ECB. A presumably significant institution can be downgraded on the basic of ‘particular circumstances’, referring to the ‘need to ensure consistent application of high supervisory standards’132 as one of the important objectives of the SSM. In other cases, institutions may have reduced their activity, allowing a classification as an LSI. These decisions will be adopted by the ECB on an individual basis.

4.76 Upgrading will apply when the ECB adopts a decision to take over supervision

on one or several less significant institutions from the NCA in charge on the basis of ensuring consistent application of high supervisory standards by directly exercising the supervisory powers itself.133

4.77 On the other hand, some institutions, may be less significant in a Member State

but should be considered significant on an aggregate EU basis, in which case the ECB will decide to upgrade the entity to the level of ‘significance’.134

4.78 The decision to be qualified under one or the other class is important, as national

regulations and supervision will apply to the less significant institutions, likely to give more comfort than under the ECB supervision. In the case of reclassifying as an SI, the level of requirements will become more demanding or more strictly imposed. Reclassifications may only take place on a 12-monthly basis.

4.79 The significant institutions have been defined on the basis of several criteria, sev-

eral of which point to their systemic relevance:

1. Total balance sheet assets exceeding €30bn, calculated at the highest level of consolidation135 within the participating states, including the financial holding companies and mixed financial holding companies established in these states;136 for SIs the determination will be made by the ECB, but for the LSIs by the NCA subject to an ECB assessment. This criterion is by far the most important: about 80% of the significant institutions qualify under this volume criterion.

See art 70 of the Framework Regulation. 133 Article 6(5)(b) of the SSM Regulation. 134 See the two cases mentioned in art 6(4): relevance in the domestic economy; presence of cross border subsidiaries. 135 Article 18 of CRR. Article 52 of the Framework Regulation. According to general EU law consolidation provisions: Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC. 136 Article 50 and following of the Framework regulation; art 53 for branches from non- participating states, for which the statistical data will be used as a basis for calculation. 132

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SSM—Institutional Aspects 2. A ratio of assets in that participating state exceeds 20% of its GDP;137 in thirteen cases this was a decisive criterion. 3. Domestically significant banks: upon a notification by the national supervisor that the bank is domestically significant for the economy of that State, although not meeting the two previous criteria, the ECB may decide to extend its supervision on the basis of its assessment of the domestic significance, based on its ‘comprehensive assessment of that bank’.138 The decision will be adopted ‘following a notification of the NCA’, and is therefore not an authoritative decision. 4. Significance of cross-border activities measured by the presence of subsidiaries in more than one Member State; and cross-border assets or liabilities exceeding 20% of total assets or liabilities;139 this criterion led to the qualification as an SI in two cases in two SSM jurisdictions. The decision may be adopted by the ECB on its own initiative.

But certain exceptions may apply as detailed in the Framework Regulation.140 Apart from these three categories which correspond more or less to G-SIFIs or 4.80 Domestic SIFIs, the ECB supervision will also extend to: 5. Banks which have received direct public financial support141 from EFSF or ESM for direct recapitalization, leading to consider the entire group as an SI; but indirect ESM assistance may be taken into consideration; national public support is not included as a condition; no institution has been reported as significant on this basis. 6. The three most significant banks in each Member State, other than banks already subject to the SSM on the basis of the previous criteria; this rule addresses banks in mainly smaller Member States where the ECB wants to have a direct view on the local banking system. It may include subsidiaries of—even smaller—non- euro area banks. This criterion was applied in ten cases. 7. A further instrument allows the ECB to take over banking supervision on any ‘less significant institution’, and this in order to ensure ‘consistent application of high supervisory standards.’142 This power also applies when indirect assistance has been requested or received from the ESM. This measure can be imposed on the ECB’s own initiative but after consulting the NCA. The purpose of the provision is to ensure that the NCA and/or the institution live up to the SSM standards, and possibly to put end to their resistance. One case was reported where this provision was applied.

But is not below €5bn. 138 In art 57 of the Framework Regulation, this condition is further detailed to include: significance for sectors, interconnectedness with Union or other member Member States, business, structural or operational complexity. 139 As determined in the methodology, as laid down in the Framework Regulation. 140 Article 70 of the Framework Regulation states: ‘if inappropriate, taking into account the objectives and principles of the SSM Regulation and, in particular, the need to ensure the consistent application of high supervisory standards’. Decisions will be adopted on a case-by-case basis. 141 This also applies to LSIs: art 62 of the Framework Regulation. 142 Article 6(5)(b) of the SSM Regulation. It was applied with respect to six banking groups, see: ECB decision, AS PNB Bank in Latvia, 11 March 2019. 137

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Eddy Wymeersch 4.81 But the ECB may also decide not to classify as an SI although the objective

conditions are fulfilled and to consider it as an LSI: the formulation as to this condition is quite vague: specific and factual ‘particular circumstances’ have to be identified, making the classification as an SI ‘inappropriate’ and when there is less need to ensure the consistent application of the high supervisory standards.143 The reason for the derogation will be stated in the decision. The ECJ case Landeskreditbank Baden-Württemberg144 indicated that the ‘particular circumstances’ relate to the relative need to apply one or the other supervisory model, and this from the objective of achieving the objectives of the SSM.

4.82 To summarize: the scope of the tory system is based on the four main criteria

which differentiate Significant from Less Significant Institutions.145 Size is by far the most important criterion, extended by the notion of economic importance in a specific case; the importance of cross border activities, and financial assistance are further significant elements. 4. The Supervised Population in Practice

4.83 This dividing line between SI and LSIs is established on the basis of different cri-

teria as further developed in the Framework regulation. Logically, the ECB has been put in charge of the supervision of the largest banks, the SIs, which might create the highest level of macro risks. The SIs are mostly composed of groups of companies and stand for about 80% of the EU banking activity, many of which are active in several EU jurisdictions. As of 2018, this category is composed of 118 banking groups, including hundreds of subsidiaries and affiliates.146 There are also some smaller entities which are subject to the SI regime qualifying for direct supervision by the ECB with support by their national supervisor147 due to their Article 70 of the Framework Regulation. 144 Landeskreditbank Baden-Württemberg-Förderbank v ECB (Case T-122/15) n.78 analysing the ‘particular circumstances’ of art 70, Framework regulation, as meaning that ‘direct prudential supervision by the ECB, implied by the classification of an entity as “significant”, is less able to ensure achievement of the objectives of the Basic Regulation than direct prudential supervision of that entity by the national authorities’. See Landeskreditbank 2, Case C-450-17P of 8 May 2018, n 78, at 48 e.s. 145 What makes a bank significant? see online at . 146 Against 119 in 2017 and 2019. These banking groups stood for 869 individual banks, representing €21.171bn total assets, ECB Annual Report 2017, 74. See for details: ECB publishes final list of significant credit institutions, available online at . See also the Lists of Financial Institutions, based on the LEI, end of 2018, available online at https://www.ecb.europa. eu/stats/financial_corporations/list_of_financial_institutions/html/index.en.html. 147 Decision of the European Central Bank of 4 February 2014 identifying the credit institutions that are subject to the comprehensive assessment (ECB/2014/3). The list was updated on 4 September 2014 and contains the list of significant supervised entities and the list of the less significant entities, giving a full overview of the banking sector for the entire euro area. The full list was updated on 1 January 2018 and is available online at . 143

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SSM—Institutional Aspects specific position in their Member State.148 The list is adapted throughout the year, depending on changes in the group structure, transfer of activities, or the reassessment of the applicable criteria.149 All other banks and banking groups are considered ‘less significant’ and will there- 4.84 fore come under the supervision of the national supervisors. It is estimated that there are about 3,267 (2016 data) of these Less Significant Institutions, their number being reduced over time.150 This category includes the banking groups with assets of less than €5bn if these would exceed the 20% GDP ratio, and may be extended to banks which although meeting the stated requirement, may be considered less significant due to ‘particular circumstances’ as specified in the methodology.151 Here one finds the numerous entities belonging to the savings banks networks, to the co-operative movement—ie in Germany and Austria—or smaller local subsidiaries, including subsidiaries of major international groups. The somewhat confusing terminology of ‘significant’ or ‘less significant’ entities may have been intended to avoid psychological reactions, but allows to express the diversity of the banking groups to be addressed, as not only quantitative criteria apply. Group entities will be consolidated at the highest level within the group and the 4.85 qualification as an SI will take place at group level. The constituent parts will hence all be included in the SI supervision.152 This also applies to banks active in non-participating states through branches or by provision of services.153 With respect to the supervision of EU located branches and subsidiaries of groups 4.86 originating from non-participating banking groups, specific requirements apply. The ECB and the supervisory authorities of these non-participating states should 4.87 conclude an MoU as to how they will co-operate in the supervision of subsidiaries or branches located in SSM states on the basis of the EU law, as this is applicable in both jurisdictions.154 Special attention is to be paid to the effects of ECB decisions affecting these subsidiaries or branches of groups established in the non- participating states and how these can be co-ordinated. This is the task of the

Decision of the European Central Bank of 4 February 2014. See n 146 149 See further, ECB 2017 Annual Report, 4.1. The effect of Brexit-related decisions was also mentioned in 2019, see online at . 150 See LSI supervision within the SSM, November 2017, available online at . 151 Article 6(4)§2 of the SSM Regulation. See for the analysis Landeskreditbank Baden- Württemberg-Förderbank v ECB (Case T-122/15) of 16 May 2017; and n 78. 152 See art 40ff of the Framework Regulation, also dealing with the reclassification of the group as no longer significant; see also art 47. 153 See art 4(2) of the SSM Regulation; here also the ECB will exercise the powers of the competent authority of the home state. 154 See Recital 14 and art 7(2) of the SSM Regulation. 148

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Eddy Wymeersch colleges of supervisors in which the ECB takes part—as chair or as a member— with respect to the supervision of the euro area entities. Also, co-ordination of emergency measures call for special attention. 5. How Supervision is Effectively Exercised 4.88 The ‘Single Supervisory Mechanism’ consists of both structural and individual

co-operation, the national supervisors offering support to the ECB’s supervisory action, and the ECB developing guidance to streamline the national supervisor’s activity. They should co-operate in ‘good faith’.155 This pattern of co-operation is comparable to the one found in other fields, such as competition, in the field of medicines,156 of airplane safety,157 and this notwithstanding the differences between these different patterns of co-operation.158

4.89 The supervisory scheme is composed of two layers: for the LSIs, the NCAs are

the direct supervisors under the overall ECB guidance. For the SIs, the supervision is directly exercised by the ECB, with the assistance of the NCAs. Their co- ordination has been laid out in the ECB’s Framework Regulation.159

4.90 With respect to LSIs, the national supervisors will exercise their role as prudential

supervisors, applying the European and—to the extent this in not incompatible— national banking legislation. The ECB is not directly involved in this supervisory activity, but oversees the general application of EU law. In this field, the ECB acting in an oversight capacity mainly aims at ensuring the consistent and effective application of high supervisory standards according to the general instructions developed by the ECB across the entire euro area, and often along the same lines as applicable in the ECB’s direct supervision. Coordination of supervision takes place i.a. through the ECB country desks. Effectiveness of supervision, consistency of supervisory action but also avoidance of national bias, belong to the main objectives of the ECB’s oversight role.160 In this perspective the ECB and the NCAs have developed generally applicable Joint Supervisory Standards161 and Common Methodologies. As the ECB has limited rule-making power, the regulatory system is mainly based on the Commission and EBA based regulations, Article 6(2) of the SSM Regulation. 156 European Medicines Agency acting as the hub for forty national bodies. 157 European Aviation Safety Agency in which the Commission and the National Aviation Authorities are actively co-operating. See Brescia Morra, (n 49) at 14. 158 See Michelle Everson, Cosimo Monda, and Ellen Vos (eds), EU Agencies in Between Institutions and Member States (Kluwer International 2014). 159 See the Framework Regulation, based in part on arts 4(3) and 6(7) of the SSM Regulation. 160 See ECB Guide to Banking Supervision and SSM Supervisory Manual. The objectives of supervision are updated every year. 161 On supervisory planning, recovery planning, on-site inspections. A JSS on SREP assessment for FMI institutions (CCPs, CSDs) is in the process of being developed. The ECB proposed to extend its powers to securities infrastructure: see revision of art 22 of the ECB Statute: 23 June 2017. However, the proposal has been withdrawn: ECB letter 20 March 2019, LMD/19/078 and 079. 155

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SSM—Institutional Aspects but includes the regulations, recommendations, guidelines, or opinions provided by the ECB. Direct supervision of SIs is exercised by, and under the exclusive responsibility 4.91 of, the ECB acting through Joint Supervisory Teams (JSTs), composed for each SI, and comprised of its own supervisory staff assisted by staff from the relevant NCA. The team is led by the ECB-JST co-ordinator, and is composed of ECB staff, national subco-ordinators, staff members of the NCAs and some from the State where the bank is active.162 They have to act on the basis of the regulations on which the SSM is based and not as representatives of the NCAs. The team will be led by the ECB staff member and assisted by national supervisors’ staff who may prepare decisions for the ECB’s consideration,163 the final decisions being prepared by ECB staff and adopted at ECB level. Originally, this co-operation was quite innovative, and inevitably did not always run smoothly. This seems to have improved, although the balance between ECB and NCA members of the JSTs is always a delicate one. The teams engage in on-site inspections on a broad range of issues, eg assessing the 4.92 Non-Performing Loan (NPL) position of the banks164 or on internal models.165 In several instances, JST members attend the boards meetings of the supervised entities in order to become better acquainted with the functioning of the board of directors, including from a governance angle and to effectively assess the prudential position of the bank, or banking group, to which they have been assigned. It does not include intervention in the deliberations, as influencing the substance of the debates might raise questions with respect to the responsibility of the supervisors, or to the confidentiality obligations of the supervised entities. The ECB has developed an elaborate Supervisory Manual,166 giving a compre- 4.93 hensive overview of the way it implements supervision on banks following a formally defined supervisory cycle, and providing a full overview of its supervisory objectives, with respect to SIs and LSIs and this with a view of ensuring ‘independent, forward-looking and risk-based supervision’.

162 ‘We’ll have the best of both worlds: the proximity of supervisors to the banks and some distance for the decision making’ said Danièle Nouy, Chair of the Supervisory Board of the Single Supervisory Mechanism, Interview in Il Sole 24 Ore, 11 July nouy2014.On Joint Supervisory Teams, see: . 163 See art 91 of the Framework Regulation. 164 See ECB-SSM Annual Report, 2017, 1.2: Guide on on-site inspections, with publications of main findings. Overview of all inspections focusing the risk element, 33, 90% were undertaken by NCAs. 165 ECB publishes a guide to on- site inspections and internal model investigations (21 September 2018). 166 SSM Supervisory Manual, European banking supervision: functioning of the SSM and supervisory approach; March 2018, available online at .

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Eddy Wymeersch 4.94 The manual explains the internal organization of the ECB in four main

Departments, two addressing the SIs, one the LSIs, and a fourth, an overarching co-ordination department, developing a wide range of supervisory techniques, such as on-site inspections. The on-site inspections are one of the frequently used tools by the JSTs. Since 2018, the secretariat of the Supervisory Board is exercised by another directorate general.

4.95 Each year the ECB formulates its supervisory priorities: so eg in its annual report

for 2017, the ECB listed its supervisory priorities for 2018: among these, the treatment of NPLs, review of internal models, internal capital, and liquidity adequacy assessment processes.167 The statement on the Targeted Review of Internal Models (TRIM)168 is part of the new instruments. In the same vein, it published a guide on on-site inspections and internal model investigations for public consultation, allowing for a fully transparent and more open procedure.169

4.96 The document on Supervisory practices on crisis management and co-operation

with Resolution authorities is important due to the intense co-operation between the ECB and the SRB, as illustrated in the recent cases of bank’s failures, which were reported in its 2017 Annual Report.170 On the application of IFRS 9 in the banking sector, the ECB published a thematic review of practices.171 In these numerous documents, the ECB makes it clear that it develops a policy which is adapted to the changing situation from year to year. Noteworthy is the reference to due process, which the ECB respects in its supervisory actions, especially in its investigations, including the obligation for stating its reasons.172 But due process is of secondary importance in cases where urgent action is needed, such as financial stability issues.173

4.97 Confronted with the increasing workload which might endanger the effective-

ness and efficiency of the ECB’s decision-making process, the ECB had adopted a general framework for the delegation for legal decisions relating to supervisory tasks to its internal departments. The delegation decisions refer to core subjects of banking supervision such as the classification of banks as SIs or LSIs,174 the

167 ECB, Annual Report on Supervisory Activities 2017, 1.2. 168 From 2017 on, an assessment of Pillar I internal models has been undertaken in close co- operation with the NCA (TRIM): see ECB, Annual Report on Supervisory Activities 2017, 1.5.1. 169 See, for the key findings from these inspections in the different risk categories: ECB, Annual Report on Supervisory Activities 2017, 1.4. 170 See ECB, Annual Report on Supervisory Activities 2017, ch 2: ‘The SSM’s Contribution to the EU Crisis Management and Resolution Framework’. 171 ECB, ‘SSM Thematic Review on IFRS 9: Assessment of Institutions’ Preparedness for the Implementation of IFRS 9’, November 2017. 172 Article 22 of the SSM Regulation; see also Framework Regulation, Prt III, art 19 and following. 173 See art 22(1) of the SSM Regulation. 174 Decision (EU) 2017/933 of the ECB of 16 November 2016 on a general framework for delegating decision-making powers for legal instruments related to supervisory tasks (ECB/2016/40)

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SSM—Institutional Aspects adoption of ‘fit and proper’ decisions and the assessment of ‘fit and proper’ requirements,175 or of the power to adopt own funds decisions.176 An interesting co-operation technique is the ‘Central Notification Point’, where 4.98 NCAs can notify supervisory procedures, decisions, or messages about the deterioration of the financial position of an LSI’s financial situation.177 With respect to all banks, the NCAs maintain their power to collect informa- 4.99 tion on all banks—to be shared with the ECB—and perform on-site inspections. Detailed provisions as to how this division of competence will be organized are laid down in the ‘Framework Regulation’.178 Broad information collecting powers have been conferred to the ECB as well, as part of its investigatory competences.179 As the ECB is only in charge of ‘specific tasks’ of supervision, the question may 4.100 arise what the ECB could do if a certain action could not be classified under the list of powers defined in the SSM Regulation. These powers of the ECB—or its tasks—have been defined in very broad terms, covering in practice almost all aspects of prudential supervision.180 The supervisory powers of the ECB are based on the one hand on the SSM 4.101 Regulation, on the other on the assimilation of the ECB to an NCA181 allowing it to exercise the powers which have been conferred to the NCA on the basis of Union law, including the powers based on the national laws transposing Union directives.182 In some cases the exercise of supervisory powers will be conditioned by the intervention of other authorities. This is the case with the investigatory powers, including powers to undertake on-site inspections,183 for which, in some cases, the authorization by a judicial authority will be required. The justification has to be sought in the human rights protection. Another part of the answer may be found in the gaps in the supervisory powers which have been conferred on the

[2017] OJ L141/14, 1.6.2017; Decision (EU) 2017/934 of the ECB of 16 November 2016 on the delegation of decisions on the significance of supervised entities (ECB/2016/41). 175 Decision (EU) 2017/935 of the ECB of 16 November 2016 on delegation of the power to adopt fit and proper decisions and the assessment of fit and proper requirements (ECB/2016/42) [2017] OJ L141/21, 1.6.2017. 176 Decision (EU) 2018/546 of the ECB of 15 March 2018 on delegation of the power to adopt own funds decisions (ECB/2018/10) [2018] OJ L90/105, 6.4.2018. 177 See art 96 and following of the Framework Regulation. 178 See arts 6(6) and 7 of the SSM Regulation; and art 21 of the Framework Regulation. 179 The information is not protected by profession secrecy obligations: see art 10(2) of the SSM Regulation. The information will be made available to the relevant NCA. 180 See the subject matters or ‘tasks’ mentioned in art 4 of the SSM Regulation. The ‘early measures’ are mentioned in art 16(1). The tools to execute these tasks have been listed in art 16(2). These can be used ‘without prejudice to other powers conferred on the ECB’, a reference that is unlikely to refer to monetary matters. 181 See art 9(1) of the SSM Regulation. 182 See art 4(3) of the SSM Regulation. 183 See art 10 and following of the SSM Regulation.

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Eddy Wymeersch ECB: the regulation provides that the ECB may require the NCA to act in accordance with its national law.184 This hypothesis may happen if, eg due to technological changes, new tasks have to be executed which would not be included in the existing list of Article 4. 4.102 A different scheme applies to the authorization of banks, whether small or large.185

Requests for authorization will be submitted to the national supervisor in accordance with its national law. These decisions will be based on the preliminary investigation by the relevant NCA applying its national law in conformity with the Union regulations. Its draft decision will be submitted to the ECB and deemed to be approved by the ECB within ten working days. The ECB can only refuse the authorization, if the conditions for authorization according to Union law are not met.186 The authorization will allow the applicant to exercise the activities in accordance with national law.187

4.103 A comparable scheme applies to decisions about the acquisition of qualifying

shareholdings in both large and small banks. These transactions first have to be assessed by the national supervisor on the basis of the national law and Union law, while the ECB can only oppose on the basis of Union law.188 Withdrawal of an authorization is however an exclusive ECB competence, after consultation with the national supervisor. The policy objectives behind these provisions are clear: access to the market should be assessed locally, including indirect access through significant changes in ownership of a bank, but there should remain an overall appreciation by the ECB, as these decisions may affect the Banking Union in general, and call for ultimate disciplining (withdrawal of the authorization).

VII. Legal Position of the Supervisory Board in the ECB 4.104 With respect to the euro area banks, the ECB is the prudential supervisor, re-

sponsible for the effective and consistent functioning of the SSM. It will be ‘exclusively’ competent for the tasks specified in Article 4, but within the framework of article 6, ie recognizing the differences as to the way the competences are to be exercised in the case of SIs versus LSIs.189 The SSM Regulation—and not the ECB itself—has organized this function by creating a separate body, the Supervisory

184 eg obtaining information on illegal transactions and maybe also on money laundering. 185 See art 14 of the SSM Regulation. The procedure is laid down in art 73 and following of the Framework Regulation. 186 See art 14 of the SSM Regulation. 187 See art 78(5) Framework Regulation. 188 See art 15 of the SSM Regulation. 189 See about the way these powers have been structured: Landeskreditbank Baden Württemberg- Förderbank (Case T-122/15) ECJ. n. 78

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SSM—Institutional Aspects Board, which is qualified as an ‘internal body’,190 the ECB being the only entity legally exercising the prudential tasks. As part of the ECB as a legal entity, the Supervisory Board is not a decision-making 4.105 body of the ECB in the sense of Article 129(1) of the TFEU and Article 9.3 of the ESCB Statute.191 This qualification as an ‘internal body’192 with no formal decision- making competences for regulatory matters explains several aspects of the specific features of the organization and functioning of the Supervisory Board.193 Externally, this board is not mentioned as being in charge of exercising the supervisory powers, whether in terms of regulation or of supervision. It will only ‘plan’ or ‘execute’ the tasks conferred on the ECB.194 The SSM Regulation mainly deals with the way the supervisory powers will be 4.106 exercised by the ECB, stating that the ECB will apply ‘all relevant Union law’, and ‘the national legislation transposing directives’ if that is the form the Union law has adopted.195 No reference is made to the action by the Supervisory Board. According to the SSM Regulation, the Supervisory Board is charged with ‘prepara- 4.107 tory work’196 for the planning and execution of the supervisory tasks and with proposing ‘complete draft decisions’ destined to the Governing Council, respecting the procedural guarantees.197 These draft decisions—individual or normative—relating the prudential supervision are adopted by the ECB’s Governing Council on the proposal of the Supervisory Board.198 This draft will automatically become a formal ECB decision unless the Governing Council objects within ten days. However, the Governing Council may also decide to suspend the effect of a decision.199 These decisions do not indicate that the Supervisory Board has been involved 4.108 in the preparation of the decision.200 The absence of an explicit reference to the

190 Article 13a of the ECB Rules of Procedure state: ‘it shall fully undertake the planning and execution of the tasks conferred on the ECB relating to the prudential supervision’. 191 See Recital 4 of the Framework Regulation. Article 129(1) of the TFEU does not mention the Supervisory Board among the decision-making bodies of the ESCB, only the Governing Council and the Executive Board have this capacity. 192 Article 2.4 of the Code of Conduct of the Supervisory Board illustrates this status by declaring that its members should ‘consider themselves in public appearances to be representatives of the Supervisory Board, as an internal collective body of the ECB’. 193 It seems that the split structure was also motivated by the will to avoid confusion between the monetary and the supervisory tasks of the ECB: see Brescia Morra (n 49), 7. 194 See art 26(1) of the SSM Regulation. 195 See art 4(3) of the SSM Regulation. 196 See art 26(8) of the SSM Regulation. 197 Such as right to be heard, rules relating to witness and expert opinions, and access to files. 198 See art 33 of the Framework Regulation. Legally, the governing council cannot give a specific mandate to the Supervisory Board, nor vice-versa, as both have to act within the limits of their attributions. 199 See art 34 of the SSM Regulation. 200 As an example: Decision (EU) 2017/937 of the European Central Bank of 23 May 2017 nominating heads of work units to adopt delegated decisions on the significance of supervised

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Eddy Wymeersch Supervisory Board corresponds to the definition of an ‘internal body’, preparing decisions or following up on their implementation but ensuring at all times that the decision is being presented as that of the Governing Council. Based on this view the supervisory decisions are formulated as emanating from the ECB, most of the time without any reference to the internal preparation undertaken by the Supervisory Board. This applies to regulations and individual decisions. Rarely do ECB documents refer to the role played by the Supervisory Board.201 4.109 This somewhat secluded existence of the Supervisory Board does not correspond

to reality. The Board has an undeniable public existence, revealed by its composition, the nomination procedure, and the activity reports and interim reports submitted to Council and Parliament. In these cases, the reports expressly refer to the Supervisory Board.

4.110 The Supervisory Board has its own detailed organization, its leadership and gov-

ernance, adopting decisions according to its own rules, eg with respect to the applicable majorities. The appointments of chair and vice-chair have to be approved by the European Parliament and the Council, on the proposal of the ECB. While the chair cannot be a member of the Governing Council, the vice-chair will be a member of the Executive board of the ECB. Voting is by simple majority except for regulatory matters which require a qualified majority. A steering committee will support the activities of the Board and prepare its meetings.

4.111 The Board publishes a very detailed and informative annual report, introduced

by its chairperson, entitled: ‘ECB—Banking Supervision’.202 Its relations with the European Parliament are governed by an Interinstitutional Agreement, while a Memorandum of Understanding applies to the relations with the EU Council. The European Parliament holds regular hearings with the chair of the board.203 The same applies to the Eurogroup.

4.112 This specific position of the Supervisory Board can historically be explained by

the need to confirm the authority of the ECB at the moment the decision to put the ECB in charge of prudential supervision of the largest entities in the euro area, and thus seek to alleviate some of the concerns about the banking system which was confronted with a serious crisis. It also highlighted the will to maintain the unity of decision-making within the SSM, the ECB being the only body

entities (ECB/ 2017/ 17). See also the sanctions decisions: available online at . 201 But sometimes references are necessary: see Guideline (EU) 2015/856 of the European Central Bank of 12 March 2015 laying down the principles of an Ethics Framework for the Single Supervisory Mechanism (ECB/2015/12). 202 ECB, Annual Report on Supervisory Activities 2017; the report is introduced by the President of the ECB, with an introductory interview by the Chairperson of the Supervisory Board. 203 ECB, Presentation of the ECB Annual Report on Supervisory Activities 2017 to the European Parliament’s Economic and Monetary Affairs Committee, 26 March 2018.

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SSM—Institutional Aspects which could exercise supervisory powers. In the background, one might also notice the fear that an overt delegation of powers within the ECB may have raised objections on the basis of the Meroni doctrine.204 Although the ambit of this doctrine has been reduced in later ECJ case law,205 this concern existed at the time the Supervisory Board was created. The same concern lays at the basis of similar characteristics of the Administrative Board of Review. The strong centralization of decision making in the SSM leads however to a 4.113 considerable concentration of work: only recently has the ECB accepted that certain decisions may be internally delegated according to general rules adopted by the Governing Council, whereby individual designations will be decided by the Executive committee of the ECB, the chairperson of the Supervisory Board being consulted.206 Also, a system of internal delegation to staff has been introduced.

VIII. Independence and Accountability 1. Independence of the Supervisory Board The independence of the Supervisory Board is a multidimensional requirement: it 4.114 essentially means that ECB and NCAs will only act within the definition of their respective mandates, as laid down in the regulations, and will not be influenced by outside interferences. It is an important guarantee for the correct functioning of the institution, its objectivity and the protection of the participants in the supervisory system, including the supervised entities. The SSM Regulation states that ‘the ECB and the NCAs acting within the SSM 4.115 will act independently and act only in the interest of the Union’.207 Many NCAs would in addition be subject to their own national independence requirements, extending to their non-SSM activities.

204 For the Meroni case law, see Case 9/56 [1957-1958] ECR 133, 146, with the opinion of Advocate-General Roemer. See M Chamon, Transforming the EU administration: Legal and Political Limits to Agencification (Dr Thesis, University of Gent 2015). 205 See United Kingdom v European Council and European Parliament (Case C-270/12), 22 January 2014; E Ferran, ‘European banking Union, Imperfect. But It Can Work’ in Busch and Ferrarini, European Banking Union (1st edn, OUP 2015) at 3.42. 206 Decision (EU) 2017/933 of the European Central Bank of 16 November 2016 on a general framework for delegating decision-making powers for legal instruments related to supervisory tasks (ECB/2016/40); Decision (EU) 2017/935 of the European Central Bank of 16 November 2016 on delegation of the power to adopt fit and proper decisions and the assessment of fit and proper requirements (ECB/2016/42); see also art 14 of the Rules of Procedure. See Framework Regulation, Recital 4 where it is reminded that the ‘Supervisory Board is not a decision-making body of the ECB in accordance with Article 129(1) of the TFEU and Article 9.3 of the Statute of the ESCB’. 207 See art 19(1) of the SSM Regulation; see also Recital 73 ‘in the interest of the Union as a whole’; and art 26.

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Eddy Wymeersch 4.116 The idea is formulated in terms of independence of the ECB itself, which should

be free from political influence and interference from the industry. ‘Political influence’ has mainly to be read as influence from the Member States, their political institutions and other actors. It is reminded that this obligation applies to the monetary policy.

4.117 The independence requirement applies to the members and staff of the

Supervisory Board, and of the steering committee, who will act in the interest of the Union and will not seek or take instructions from institutions of the Union, nor from any other public of private body, including the national governments.208 The provisions applicable to the members of the Supervisory Board refer to the comparable regime for the ECB itself.209 The reverse obligation also applies: the institutions of the Union should respect the independence of the SSM: this obligation applies to ‘any other bodies’, including the Union institutions, national governments, and the supervised institutions.210

4.118 Independence of members of the Supervisory Board and of ECB staff members

active in supervisory activities could be affected by their taking up of subsequent positions within the cooling off period of two years: the ECB has adopted procedures relating to this matter, especially for the case of activities in the banking industry after the end of the mandate.211

4.119 In the Code of Conduct, the independence requirement is extended to ‘other

participants in the Supervisory Board’ including observers. The members of the Administrative Board of Review are also held to explicit procedures requiring declaration of commitments and interests that may affect their independence.212

4.120 Special mention is to be made of possible interference with monetary policy

matters or other functions of the Bank. This also applies to the NCAs acting within the context of the ECB.

4.121 But independence of the Supervisory Board from the Bank is not mentioned: this

may seem logical as the Supervisory Board is designated as an internal body of

208 Code of Conduct for the Members of the Supervisory Board of the European Central Bank, 12 Nov 2014, available online at . This would not include the ECB itself. The ECB’s principles on independence are available online at ; see also Guideline (EU) 2015/856 of the ECB of 12 March 2015 laying down the principles of an Ethics Framework for the Single Supervisory Mechanism (ECB/ 2015/12), [2015] OJ L135/29, 2.6.2015. 209 See art 37 of the Statute of the ESCB; art 27(1) of Regulation (EU) 1024/2013; and art 23a of the Rules of Procedure of the European Central Bank. 210 See art 19(1) and (2) of the SSM Regulation. 211 See art 8 of the Code of Conduct. 212 See art 24; and Decision of the European Central Bank of 14 April 2014 concerning the establishment of an Administrative Board of Review and its Operating Rules (ECB/2014/16), art 4(4).

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SSM—Institutional Aspects the Bank, and its decisions have no individual standing even after having been approved by the Governing Council. The Vice-Chair of the Supervisory Board should be a member of the Executive Board of the ECB. Professional secrecy could be mentioned in this context: it is applicable to all 4.122 members, participants in the Supervisory Board and staff and applies during and after termination of their functions.213 The obligation also applies to communications with the ECB staff except if these are involved in supervisory matters. In monetary matters, secrecy will be governed by the internal rules of the ECB. 2. Accountability of the ECB The SSM is based on a regulation, adopted by the Council, on the proposal of the 4.123 Commission, thereby establishing its fundamental decision-making structure and its related accountability. The European Parliament and the European Central Bank are involved by way of submitting a formal opinion. No changes in the regulation can be adopted except by the Council. Accountability and responsibility exist towards all these institutions.214 The accountability reflects a broader set of stakeholders and has a direct influence 4.124 on the reputation of the institution.215 With respect to monetary decisions, the ECB is accountable to the Council of ministers, acting within the Eurogroup, and to the European Parliament (ECON)—ie the political world, including strict separation for supervisory matters. In Parliamentary hearings, the President or Vice-President of the Governing Council only elaborate on general policy and monetary matters. Accountability for supervisory matters is organized along largely comparable 4.125 ways as for the monetary field: accountability of the ECB runs to the European Parliament, to the Council216 and to the Eurogroup.217 The Chair of the Supervisory Board will appear twice a year before the ECON Committee of the European Parliament to present the annual report as approved by the Governing Council.218 Numerous speeches and interviews by Supervisory Board members, 213 See art 27 of the SSM Regulation; see also art 31(3). 214 One could even add the judiciary. 215 See Masciandaro and Nieto (n 51), 2. 216 See, for more details: Interinstitutional Agreement between the European Parliament and the European Central Bank on the practical modalities of the exercise of democratic accountability and oversight over the exercise of the tasks conferred on the ECB within the framework of the Single Supervisory Mechanism (2013/694/EU), available online at ; and Memorandum of Understanding between the Council of the European Union and the European Central Bank on the co-operation on procedures related to the Single Supervisory Mechanism (SSM), December 2013, available online at . 217 See art 20(3) of the SSM Regulation. In this case including representatives of the non-euro participating states: art 20(3) of the SSM Regulation. See also art 13 of the Rules of Procedure. 218 See art 20(3) of the SSM Regulation.

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Eddy Wymeersch and SSM quarterly reports casts a light on the functioning of the Supervisory Board, apart from the statements by ECB members on more general issues. 4.126 Apart from the presentation and discussion of the annual report, accountability

consists of regular Parliamentary ad hoc hearings of the Chair of the Supervisory Board. These exchanges of view do not relate to individual supervisory cases as safeguarding confidential information about individual banking cases is strictly protected under EU secrecy rules. The Interinstitutional Agreement contains a detailed provision allowing for confidential oral discussions with the chair and vice-chair of the competent Parliament committee, when this communication is necessary for allowing the Parliament to exercise its powers under the Treaty.219 Even the taking of minutes or recordings of these meetings are not allowed.

4.127 The ECB will answer in writing questions from individual parliamentarians, the

answers being published in its press releases. The records of proceedings of the Supervisory Board are transmitted to the Parliament’s ECON as a ‘meaningful and comprehensive record’. In cases in which the Governing Council would object—especially on monetary grounds—to a draft decision of the Supervisory Board, the president of the Governing Council will inform the chairman of the Parliamentary committee, stating his reasons.220

4.128 The chair and vice chair of the Supervisory Board also regularly interact with the

EU Council and the Eurogroup.

4.129 The European Court of Auditors (ECA) annually analyses the functioning and

the management of the ECB as to its supervisory tasks. It has published in 2017221—a rather critical—report on the operational efficiency of the ECB’s crisis management for banks. The analysis identified weaknesses in the planning for a crisis at an individual institution, criticizing the lack of sufficient staff in crisis situations.222 The ECA regretted not to have full access to the internal documentation and made a reservation about the lack of ‘comprehensive evidence’ on the actual use of the powers, leading to a Commission recommendation to develop an interinstitutional agreement between the ECB and ECA.223 Improvements can be

See art 20(8) of the SSM Regulation: ‘behind closed doors’. 220 See art 26(8) of the SSM Regulation. 221 Critical report by ECA 2017, ‘The operational efficiency of the ECB’s crisis management for banks No 02/2018’, available online at . 222 The ECA Report concluded that ‘the outstanding issues have the potential to delay and restrict information-sharing and detract from the efficiency of co-ordination’. 223 This recommendation was supported by the Bundesfinanzministerium ‘significant institutions should be subject to a full and complete public auditing process by the European Court of Auditors. To further improve the European Court of Auditors’ public auditing practices, a co-operation agreement should be concluded between the Court and the ECB.’ The agreement was signed on 28 August 2019. See German Federal Ministry of Finance, ‘The Single Supervisory Mechanism: Lessons Learned after the First Three Years’, January 2018, available online at 219

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SSM—Institutional Aspects expected as a consequence of better co-ordination with the SRB for dealing with crisis cases. A reporter to the European Court of Auditors concluded that at that time, the accountability procedures as practised by the ECB are less detailed than for monetary matters.224 ECB accountability may also derive from the review of individual decisions before 4.130 the Administrative Board of Review.225 The procedure before this Board is however confidential and its decisions remain unknown, except indirectly by reference in subsequent cases before the ECJ. An important line of accountability derives from the increasing number of legal cases brought before the ECJ226 providing for extensive motivation and related argumentation of the ECB’s individual decisions. Accountability towards the national parliaments has also been provided: they will 4.131 receive the annual report, may submit written questions and invite the Chair of the Supervisory Board or its representative to take part in an exchange of views with respect to banks established in that Member State, a representative of the national supervisor involved also attending.227 Communications may relate to their activities in the context of the SSM. According to national law, national supervisors are held accountable towards their 4.132 national parliaments with respect to the discharge of their specific duties under their national law and according to the SSM Regulation.228 As part of the Commission project for the Completion of the Banking Union, 4.133 the Commission has launched an assessment of the functioning of the SSM and this with a view of assessing the effectiveness of this first pillar of the Banking Union.229 The Commission findings indicate on the one hand that the accountability 4.134 arrangements are overall effective, while improvements may be considered as to the co-ordination with the European Court of Auditors, in which case an interinstitutional agreement may usefully be considered.

. 224 M Hallenberg, ‘ECB Accountability to the European Parliament’, available online at . 225 In that sense, see Supervisory Manual, 1.1.2. 226 The cases can be found on the European Banking Institute website, with comment from R Smits; available online at . 227 See art 21 of the SSM Regulation. 228 See art 21(4) of the SSM Regulation. 229 See Report from the Commission to the European Parliament and the Council on the Single Supervisory Mechanism established pursuant to Regulation (EU) 1024/2013, 11 October 2017, available online at . European Parliament, ThinkTank, 6 February 2019, available online at (2019) 574.

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Eddy Wymeersch 4.135 Generally, most of concerns which has been formulated in the early years

with respect to the Supervisory Board’s accountability230 have been largely encountered.

IX. Review of SSM Decisions 1. Non-judicial Review of Supervisory Decisions 4.136 Decisions of the ECB are reviewable before the Administrative Board of Review

(ABoR), which is an internal body aimed a reviewing the proposed decisions before these are submitted to the Governing Council.231 Cases can be brought by parties to whom a decision of the ECB is addressed, or which is of direct and individual concern to them, but not by NCAs. Its opinion is not binding and remains unpublished.232 Decisions of the Governing Council cannot be challenged before the ABoR.233 As the review takes place prior to the Governing Council formally adopting the proposal submitted by the Supervisory Board, this review process is to be considered internal and preliminary.

4.137 The procedure before the ABoR has been laid down in an ECB decision on the

ABoR,234 providing for due process, absence of suspension of the procedure, and guarantees of confidentiality, documents being only accessible to the parties.

4.138 The Board will analyse the matter from the procedural and substantive point of

view.235 If the review concludes to being admissible, its non-binding opinion will be addressed to the Supervisory Board allowing it to prepare a new draft decision, taking into account the opinion of the ABoR, and submitting it to the Governing Council for automatic approval.

4.139 ABoR can be qualified as an internal advisory body, not as body in charge of a ju-

dicial review. It only acts upon a mandate relating to a decision of the Supervisory

230 K Alexander (n 14), 492, pointing to the need for stronger accountability in the supervisory field. It is questionable whether accountability towards national governments (at 469) should be provided. 231 See art 24 of the SSM Regulation. This analysis cannot be used for reviewing decisions of the Governing Council; see also art 24(5). For details about this procedure, see Supervisory Manual, 1.3.4. 232 See the reference to AboR’s position on the supremacy of EU law over French law: Crédit Agricole v ECB (Joined Cases T‐133/16 to T‐136/16), ECJ (n 18). 233 A fortiori, decisions of the Supervisory Board, being preliminary in nature, cannot be appealed. 234 Decision of the European Central Bank of 14 April 2014 concerning the establishment of the Administrative Board of Review and its Operating Rules (ECB/2014/16), available online at . 235 Meaning that discretion is left to the Supervisory Board with respect to the ‘opportunity of those decisions’ (Preamble [64]) A similar approach is followed in art 13 of the SSM Regulation, dealing with decisions involving on-site inspections, where the national judiciary intervenes.

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SSM—Institutional Aspects Board, and can only advise on the legality of the proposed measure, its procedural and substantive conformity. 2. Mediation Panel An ECB regulation has provided a mediation procedure allowing NCAs to apply 4.140 for mediation with respect to the objections the Governing Council has raised to draft decisions of the Supervisory Board, but only involving the separation of the monetary policy and supervision.236 The Panel will be composed of members from each of the Member States, chosen 4.141 from the members of the Governing council, and from the Supervisory Board. It is chaired by the Vice-Chair of the Supervisory Board. Cases may be brought before the mediation panel by Member States. In its opinion, the panel will aim to find a balance between the position of the Governing Council and Supervisory Board position, but its opinion is not binding on any of these parties. A new— compromise— decision may be submitted by the Supervisory Board to the Governing Council.237 3. Judicial Review Application for review of ECB decisions may also be brought before the European 4.142 Court of Justice, whether or not without these have first been submitting to the ABoR.238 Decisions of the NCAs are reviewable before their national courts and reviewable by the ECJ on the application of EU law. ABoR would not intervene in the process. Special attention has been paid to “composite acts” 239

X. Conclusion Four years in existence, the SSM construction which was set up out of the blue 4.143 has considerably changed the banking supervisory landscape in Europe. Overall confidence in the banking system has been restored which was the first, and most important, objective of the exercise. A totally new structure has been created, which has proved to be a powerful force for developing a strong banking supervisory system in the euro area, and beyond. Banking supervision has entered a new

236 See art 25(5) of the SSM Regulation. 237 Regulation (EU) 673/2014 of the European Central Bank of 2 June 2014 concerning the establishment of a Mediation Panel and its Rules of Procedure (ECB/2014/26), art 8. This regulation is based on art 25(5) of the SSM Regulation; see online at , and is part of the rules on the separation of the supervisory from the monetary function of the ECB. 238 ECB Decision 2014/16, art 19 (n 245). 239 See M. Lamandini and D. Ramos, EU Financial Law, an Introduction, 204 e. s.

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Eddy Wymeersch era in which the core objectives of financial stability, risk reduction, safety of the banking system, and financial integration are pursued at the level of the euro area, and perhaps later of the Union as a whole. Up to now, these objectives seem to have been achieved. 4.144 After such a massive change, it should not astonish that a certain number of

shortcomings have appeared. Several of these are due to the basic architecture as laid down in the Treaty and the subsequent choices made by the draftsmen of the system. There have been various doubts expressed with respect to the centralization of banking supervision at the monetary authority. Creating a separate authority was not a valid alternative, as a Treaty change could not be considered. As a consequence, prudential supervision was to be limited to credit institutions, although an increasing part of financial activity takes place elsewhere where, in many cases, no comparable prudential nor stability supervision applies. The tools for dealing with a major financial crisis are in partly left in the hands of the national decision-makers, without an effective overall European backstop. The ECB would be reduced to topping up the national decisions, financially a second choice. 1. Other Points of Concern Related to the Structure of the SSM

4.145 The legal structure of the SSM supervisory system is a complex one, with decisions

being adopted by the Supervisory Board, almost a shadow structure within the ECB, its numerous decisions being approved by the Governing Council in a non-objection procedure, an implicit and mostly silent process. For contentious matters, these decisions may be screened by a another, externally silent body, the ABoR. This is not normal decision-making, and does not allow for due process nor for the defense of the rights of the parties. Whatever the institutional reasons, it would be helpful to introduce more transparency in these processes. Today, only a recourse to the ECJ remains as ultimate remedy. It is being used more frequently.

4.146 The two- layered legal structure is another fundamental feature of the SSM.

Although the SSM is based on Union law, supervisory decisions are in some cases rooted in national banking law which remains applicable on a default basis, leading in some cases to conflicts between the two legal orders. Although the overall applicable legal system is largely governed by Union law, especially by regulations, the two-layered legal structure introduces elements of insecurity, fragmentation, and therefore of risk. Is the signature of the French PDG binding, although he is the supreme authority in the bank, but not effectively directing the bank?240

4.147 In order to remedy this problem, some academics have called for the adoption of a

European Banking Act,241 for the SIs at least, so that more clear conditions would 240 See Crédit Agricole v ECB (Joined Cases T‐133/16 to T‐136/16), 24 April 2018, ECJ (n 17). 241 See M Lehmann (n 38), 17.

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SSM—Institutional Aspects apply and gaming or regulatory arbitrage can be avoided. For those who want to accede to the upper class of the SI, adopting the ‘European Banking Act’ may be the right, even voluntary approach. The regime would be applied on a group-wide basis. Progress can only be made over time, and national resistance to a mandatory solution is likely to be considerable. But one should have no illusions: banks function in different economies, governed 4.148 by different legal rules and their operations will necessary raise questions on the application of national law, eg company law or liability rules, and the effects of national regulations on the European supervisory practice. But progress towards a more coherent legal system should be encouraged. A third weakness relates to the absence of an effective implementation framework 4.149 for ECB decisions: the ECB has some powers to fine the non-implementation of its orders, but not for breaches relating to national law, for which it has to request the national authority to impose a sanction. The latter sometimes is less sensitive to the ECB’s view. Some concerns have been voiced as to the means the ECB could mobilize to 4.150 achieve its objective in terms of budgetary means and staffing. Strong measures have been adopted allowing the SSM to be fully financed by the supervised entities, and these have allowed to hire necessary number of staff.242 In addition, the ECB can rely on the support of staff delegated by the NCAs. It seems that these concerns have now effectively been alleviated. Further progress in these fields will require a strong political motivation and the 4.151 awareness that there is no alternative to make the financial systems in Europe strong enough to withstand the next assault. One should not wait for another devastating financial crisis. Notwithstanding these doubts, further work should be undertaken on the topics 4.152 on which progress can be made, or where improvements could be introduced. The SSM project as it has been framed, has up to now proved its value and has contributed to increase confidence in the banking system, at least in the euro Member States.

242 The ECB reported 1,028.5 FTE for core supervisory tasks, with another 422.4 FTE for shared services. On funding, see Regulation (EU) 1163/2014 of the European Central Bank of 22 October 2014 on supervisory fees (ECB/2014/41).

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5 THE SINGLE RULEBOOK AND THE SSM Regulatory Polycentrism vs. Supervisory Centralization Guido Ferrarini and Fabio Recine*

I. Introduction

5.01 5.01 5.03

1. Concept of Single Rulebook 2. Plan of the Chapter

II. A Short History of the EU Regulatory Framework

5.04 1. The Single Licence and Minimum Harmonization 5.04 2. The New Supervisory Architecture: From ESFS to SSM 5.08 3. The Emerging Single Rulebook and its Limits 5.14

III. The Allocation of Regulatory and Supervisory Powers

5.17 1. Regulatory Polycentrism and Supervisory Centralization in the EU 5.17 2. Reasons for Harmonizing Regulation and Centralizing Supervision 5.20 3. Optimal Allocation of Rule-making 5.24

IV. The Decoupling of Regulatory and Supervisory Powers in the SSM

5.28 1. Rule-making in the EU 5.28 2. The ECB as an Institution and as a Supervisor 5.31 3. Guidelines, Recommendations, and the Limits to ECB Rule-making 5.39 4. The O&D Regulation and its Legal Grounds 5.50

V. Evolutionary Dynamics of the EU Institutional Regulatory Framework

1. Pending Reforms 2. Is the Current Approach Enough? 3. Where to Go from Here?

5.53 5.53 5.57 5.62

VI. Conclusion

5.68

I. Introduction 1. Concept of Single Rulebook In this chapter, we analyse the relationship between the single rulebook and the 5.01 Single Supervisory Mechanism (SSM) from the perspective of the European The views expressed in this chapter are solely those of the authors and do not necessarily reflect the positions of their respective institutions. *

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Guido Ferrarini and Fabio Recine Banking Union (EBU). By ‘single rulebook’ we refer to the harmonization of EU banking rules through directives, regulations, and soft law instruments like guidelines and recommendations. The relevant corpus consists of both EU and national implementing rules, with the EU rules being set at different levels under the regulatory framework suggested by the de Larosière Report.1 In this chapter we focus on the single prudential rulebook, which mainly consists of the Capital Requirements Directive (CRD) IV2 and the Capital Requirements Regulation (CRR),3 as we are interested in exploring the institutional separation of EU banking regulation from prudential supervision and its implications for the SSM. Other chapters in this volume touch upon the single resolution rulebook and its connection with the Single Resolution Mechanism (SRM).4 5.02 The single rulebook applies to all banks in Europe without distinguishing between

Eurozone banks and banks established in other Member States. Moreover, there are differences amongst Member States in areas which are left to their discretion in the implementation of EU directives. The SSM has to take these differences into account when exercising its supervisory powers over banks established in different countries. No doubt, the European Central Bank (ECB) has a say in the EU rule-making process (particularly through the European Banking Authority (EBA)) and to some extent it may also influence the national implementation of EU measures (especially when the national authorities have the relevant powers) but the ECB has little regulatory powers of its own over the banks directly or indirectly supervised by it.5 2. Plan of the Chapter

5.03 In Section II of this chapter, we draw a brief historical outline of banking reg-

ulation and supervision in the EU, examining the shift from the traditional approach based on the single licence and minimum harmonization to the present, post-crisis approach which is grounded on maximum harmonization and enhanced supervisory co-operation. We show, in particular, how banking regulation and supervision have been increasingly separated one from the other, reaching the apex in the EBU where EU and national rule-making are entirely decoupled from the SSM. In Section III, we illustrate the reasons

1 See ‘The High-Level Group on Financial Supervision in the EU: Report’, chaired by Jacques de Larosière, Brussels, 25 February 2009 (the ‘de Larosière Report’). 2 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms [2013] OJ L176/338. 3 Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms [2013] OJ L176/1. 4 See Chapters 2 and 9 in this volume. 5 On the ECB’s effective role in the formation of international and EU banking regulation, see Kern Alexander, Chapter 2 in this volume.

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The Single Rulebook and the SSM for harmonizing prudential regulation and centralizing bank supervision and briefly discuss the costs and benefits of either concentrating regulatory and surveillance powers in one institution or distributing the same amongst different institutions. In Section IV, we specifically analyse the decoupling of regulation from supervision and its impact on the SSM. After explaining that the ECB is both an EU institution with central banking competences and a quasi-national authority with supervisory tasks, we examine the role of the ECB guidelines in supervision and the thin border which exists between issuing supervisory guidance and rule-making. In addition, we consider the O&D Regulation adopted by the ECB as an example of its quest for regulatory powers. In Section V, we address the policy question whether the ECB, in its role as a prudential supervisor, should be allocated more rule-making powers to complement its supervisory actions and argue that the current EU institutional architecture could be improved. In particular, we explore the desirability of attributing further regulatory powers to the ECB, noting that Article 127(6) of the Treaty on the Functioning of the European Union (TFEU) might be considered as a suitable legal basis to allow the Council to delegate technical rule-making to the ECB in the prudential area (always subject to EU primary legislation) as the concept of supervisory policies is not limited to strict supervision, but may also include regulation. Nonetheless, certain key policy decisions on banking supervisory policies (such as those on non-performing loans (NPLs)) need to be taken at political level through a democratic process. Section VI concludes.

II. A Short History of the EU Regulatory Framework 1. The Single Licence and Minimum Harmonization In this section, we draw a brief historical outline of banking regulation and supervi- 5.04 sion in the EU, examining the shift from the traditional approach based on the single licence and minimum harmonization to the present, post-crisis approach, which is grounded on the single rulebook with maximum harmonization and enhanced co- operation between national supervisors under the co-ordination of the EBA. The traditional EU approach to banking regulation is epitomized by the Second 5.05 Council Directive on the co-ordination of laws, regulations, and administrative provisions relating to the taking-up and pursuit of the business of credit institutions.6 The fundamental aim of the Second Directive was ‘to create a single Community-wide banking market with no internal barriers to the movement of 6 See Directive 89/646/EEC of 15 December 1989 on the co-ordination of laws, regulations, and administrative provisions relating to the taking up and pursuit of the business of credit institutions and amending Directive 77/780/EEC [1989] OJ L386/1.

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Guido Ferrarini and Fabio Recine banking services and to the establishment of branches within the Community’.7 The instruments for attaining this banking market included the creation of a single banking licence through mutual recognition and the assurance of minimum Community standards on prudential supervision. Other Community directives and recommendations supplemented the basic standards of supervision envisioned by the Second Directive.8 5.06 The single licence is a form of supervisory centralization, to the extent that the

home country of a credit institution undertakes supervisory activities, including authorization, which are recognized by the host Member States.9 In particular, the single licence reflects the ‘lead supervisor’ model of centralization, for the home supervisor has almost exclusive responsibility over branches established in other EEA (host) countries. However, mutual recognition only applies to cross-border branches, while ‘solo’ supervision of subsidiaries falls under the competences of the authorities of their state of incorporation. The single licence system has promoted de facto harmonization of banking regulation in Europe well beyond the Community’s directives and recommendations, as a result of the liberalization of banking and capital markets, and of increased cross-border competition on those markets.

5.07 However, there are clear limits to the traditional European approach. Firstly, the

instruments used (directives and recommendations) have led to the approximation of banking laws in Europe leaving, however, wide differences in national prudential regulation and supervision. Secondly, the single supervisor’s model clearly suffers from national biases in the performance of supervisory tasks by the authorities concerned, which also determine a lack of trust between home and host authorities particularly in crisis situations.10 Thirdly, the single licence system has enjoyed limited success in practice, for international banking groups often chose to establish subsidiaries rather than branches in other Member States.11

7 See Michael Gruson and Wolfgang Feuring, ‘A European Community Banking Law: The Second Banking and Related Directives’ in Ross Cranston (ed), The Single Market and the Law of Banking (LLP Professional Publishing 1991) 49. 8 For a comprehensive overview see Georges Zavvos, ‘Banking Integration and 1992: Legal Issues and Policy Implications’ (1990) 31 Harvard International Law Journal 235. 9 See Guido Ferrarini and Filippo Chiodini, ‘Nationally Fragmented Supervision over Multinational Banks as a Source of Global Systemic Risk. A Critical Analysis of Recent EU Reforms’ in Eddy Wymeersch, Klaus Hopt, and Guido Ferrarini (eds), Financial Regulation and Supervision: A Post-Crisis Analysis (Oxford University Press 2012), 216. 10 Ibid, 200. 11 See Jean Dermine, ‘European Banking Integration, Ten Years After’ (2006) 2 European Financial Management 331.

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The Single Rulebook and the SSM 2. The New Supervisory Architecture: From ESFS to SSM The financial crisis led to a deep overhaul of financial regulation at international 5.08 level and boosted EU regulatory harmonization and supervisory centralization. We can distinguish at least three stages in the institutional overhaul of EU prudential rule-making and bank supervision, corresponding to the progressive worsening of the financial crisis particularly in the euro area: (1) the establishment of EBA and of the European Systemic Risk Board (ESRB) in 2010; (2) the adoption of the CRD IV package implementing the new global standards on capital adequacy (commonly known as the Basel III agreement) which entered into force on 17 July 2013; and (3) the establishment of the SSM in 2014. As to the first and second stages, impulse came from the de Larosière Report,12 while the third stage was accelerated by the sovereign debt crisis in the euro area. The de Larosière Report highlighted that ‘convergence towards high global 5.09 standards . . . is critical’ and that the implementation and enforcement of these standards must occur through ‘a strong and integrated system of regulation and supervision’. According to the Report, the European Institutions and the level 3 committees should have initiated a concerted effort to equip the EU financial sector with a consistent set of core rules by the beginning of 2013: ‘a process should be set-up, whereby the key-differences in national legislation will be identified and removed’.13 The Report also emphasized the need for EU supervisory repair, starting from the lack of adequate macroprudential supervision the objective of which is to limit the distress of the financial system as a whole.14 As to microprudential supervision—whose main goal is to supervise and limit the 5.10 distress of individual financial institutions, thus protecting the customers of the institution in question—the Report suggested the establishment of the European System of Financial Supervision (ESFS) constituting ‘an integrated network of European financial supervisors, working with enhanced level 3 committees (Authorities)’.15 In the proposed framework, the supervisor of the home Member State continues to function as the first point of contact for the firm, whilst the European centre should co- ordinate the application of common high- level 12 See ‘The High-Level Group on Financial Supervision in the EU: Report’, chaired by Jacques de Larosière, Brussels, 25 February 2009 (the ‘de Larosière Report’). Its main recommendations, following the endorsement by the European Council on 19 June 2009, were implemented in EU legislation through four EU regulations—establishing the ESRB, EBA, ESMA, and EIOPA—and a directive. For an overview see Fabio Recine and Pedro Teixeira, ‘The New Financial Stability Architecture in the EU’, Institute for Law and Finance Working Paper No 110, 12/2009. 13 Ibid, 50. 14 Ibid, 38. 15 Ibid, 47.

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Guido Ferrarini and Fabio Recine supervisory standards, guarantee strong co-operation with the other supervisors and that the interest of host supervisors are properly safeguarded.16 5.11 The EU legislation approved on 24 November 2010 to reform the European su-

pervisory architecture closely tracks the de Larosière Group’s recommendations and represents a significant step towards regulatory convergence and centralization of cross-border supervision.17 EU regulations established a financial stability architecture based on a two pillar structure comprising a newly established ESRB for macroprudential supervision, and the ESFS for supporting supervisory co-ordination and convergence of supervisory standards. The ESFS includes a network of national supervisors co-ordinated by the European Supervisory Authorities deriving from the transformation of pre-existing European Supervisory Committees.18 The creation of a centrally co-ordinated network is aimed at enhancing effective co-operation between competent authorities in the supervision of cross-border financial institutions, while leaving day-to-day supervision to national authorities.19

5.12 For the banking sector, the EBA was established as a Community body with legal

personality. The authority has, amongst others, the task to contribute to the establishment of high quality common regulatory and supervisory standards and practices, in particular by developing guidelines, recommendations, and draft regulatory and implementing technical standards.20

5.13 EBA’s rule- making includes the drafting of regulatory technical standards,

which the Authority shall submit to the Commission for endorsement after a public consultation on the same (Article 10, paragraph 1); and the drafting of implementing technical standards, which the Authority shall also submit to the Commission for endorsement.21 As regards rule-making, the role of EBA must be seen in the wider context of the increased use by the Commission of comitology powers, following the introduction in the Lisbon Treaty of the new categories of delegated and implementing acts (Articles 290 and 291).22 Moreover, EBA issues guidelines and recommendations addressed to competent authorities or financial institutions with a view to establishing consistent, efficient, and effective supervisory practices within the ESFS and to ensuring the common, uniform, and

Ibid. 17 See Fabio Recine and Pedro Teixeira, ‘Towards a New Regulatory Model for the Single European Financial Market’ (2009) Revue Trimestrelle de Droit Financier 4, 8. 18 Ibid, 12. 19 See Guido Ferrarini and Luigi Chiarella, ‘Common Banking Supervision in the Eurozone: Strengths and Weaknesses’, ECGI Law Working Paper No 223/2013, 57 (available at ), 31 accessed 18 August 2018. 20 See EBAR, art 8, para 1(a). 21 See EBAR, art 15, para 1. 22 See Madalina Busuioc, ‘Rule- Making by the European Financial Supervisory Authorities: Walking a Tight Rope’ (2013) 19(1) European Law Journal 111, 115. 16

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The Single Rulebook and the SSM consistent application of Union law. The competent authorities shall make every effort to comply with those guidelines and recommendations, and in the case of non-compliance inform EBA of its reasons.23 3. The Emerging Single Rulebook and its Limits While the first reform stage focused upon the institutional structure of rule- 5.14 making, the second stage was centered on the review of core EU rules concerning prudential supervision of banks, implementing the so-called Basel 3 Accord.24 The CRD/CRR package brought about two important innovations in EU prudential rule-making. First, despite being rather detailed, the CRD/CRR foresee that further provisions will be adopted through the procedure concerning regulatory and implementing technical standards. These standards have to be based on a draft prepared by the ESAs, and then endorsed by the Commission through a complex procedure, which establishes restrictions to the autonomous decision- making of the Commission. In particular, if the Commission does not endorse a draft regulatory standard or amends it, it has to inform the ESA, the European Parliament, and the Council, which may ask for clarifications.25 Thus the CRD/ CRR package provides the necessary underpinning for the new EBA powers, as it specifies in details the scope of the regulatory standards to be prepared by EBA and adopted by the Commission. A large part of the new prudential requirements were for the first time enacted 5.15 through an EU regulation (CRR), ie an instrument that is directly applicable in the Member States. Moreover, the whole package was inspired by the principle of maximum harmonization, so as to avoid the uneven implementation by Member States, which has been considered as a key ingredient in the run-up to the crisis. The main arguments behind maximum harmonization can be summarized as follows: (1) Prior directives left significant flexibility to national authorities in the definition of key prudential elements—such as the notion of capital, prudential filters for unrealized gains and losses, the determination of risk weights (for example, for real estate exposures)—while pressure by banks on national authorities led to soft approaches and regulatory competition.26

23 See EBAR, art 16, paras 1 and 3. 24 The Basel III Accord was made by the Basel Committee on Banking Supervision to strengthen the regulation, supervision and risk management of the banking sector. It aims to: (i) improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source; (ii) improve risk management and governance; (iii) strengthen banks’ transparency and disclosures. The Accord is available at http://www.bis.org/bcbs/basel3.htm (accessed 28 October 2019). 25 See the discussion by Busuioc (n 22), 111–25. 26 Andrea Enria, ‘Developing a Single Rulebook in Banking’, speech at the Central Bank of Ireland Stakeholder Conference, ‘Financial Regulation: Thinking About the Future’, 27 April

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Guido Ferrarini and Fabio Recine (2) The heterogeneity of the regulatory environment complicated significantly the effective supervision of cross-border groups. (3) If a country were to insist on higher capital, lending by its banks might shrink within other member countries, with serious macroeconomic consequences. (4) If a country were to raise its standards, customers might seek loans from banks based in other member countries (as is allowed under the EU’s regulations) thereby making the latter riskier. 5.16 Following the adoption of the CRD/CRR package, a great number of standards

have been prepared by EBA.27 However, the CRD/CRR package contains a number of national discretions to allow the standards to be implemented differently by authorities in different jurisdictions. This was deemed necessary to reflect differences in the structure and development of financial systems.

III. The Allocation of Regulatory and Supervisory Powers 1. Regulatory Polycentrism and Supervisory Centralization in the EU 5.17 In order to better understand the EU legal framework briefly summarized in the

previous section, in this section we review the theoretical reasons for harmonizing prudential regulation and centralizing banking supervision. We also discuss the costs and benefits of either concentrating regulatory and surveillance powers in one institution (like the Federal Reserve in the US)28 or distributing the same amongst different institutions, like the European Commission, EBA, ECB, and the national authorities. As we argue throughout the chapter, EU banking law is characterized by both regulatory polycentrism and supervisory centralization.29 EBA centralizes, to some extent at least, rule-setting as to technical issues and enhances supervisory co-operation in the EU. The SSM centralizes supervision in the Eurozone (at least as regards significant banks) leaving, however, rule-setting mainly to institutions other than the ECB.

5.18 Regulatory polycentrism derives from the fact that there is a plurality of rule-

makers. The ordinary legislative procedure sees the European Commission making proposals of either directives or regulations, which are then approved by

2012; available at https://eba.europa.eu/speech-by-andrea-enria-stakeholder-conference-financial- regulation-thinking-about-the-future- (accessed 28 October  2019). 27 See https://eba.europa.eu/regulation-and-policy (accessed 28 October 2019). 28 For an overview of the US framework on banking regulation and supervision, see Ashok Vir Bhatia, ‘Consolidated Regulation and Supervision in the United States’, IMF Working Paper No 23/11 (available at https://www.imf.org/external/pubs/ft/wp/2011/wp1123.pdf; accessed 28 October 2019). 29 On financial regulation as a polycentric regime see Julia Black, ‘Restructuring Global and EU Financial Regulation: Character, Capacities, and Learning’ in Wymeersch, Hopt, and Ferrarini (eds) (n 8), 6.

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The Single Rulebook and the SSM the European Parliament and the Council once they reach consent after the prescribed readings.30 When the ‘basic acts’ empower the Commission to do so, the same adopts level 2 measures by either delegated or implementing acts. If these measures concern purely technical matters and require the expertise of supervisory experts, the basic acts can determine that these measures are technical standards based on drafts developed by the European Supervisory Authorities (ESAs). A distinction is made between Regulatory Technical Standards (RTS), which are adopted by the Commission by means of a Delegated Act, and Implementing Technical Standards (ITS), which are adopted by means of an Implementing Act.31 In view of carrying out its supervisory tasks and ensuring high standards of su- 5.19 pervision, the ECB applies all relevant Union law and, where the latter consists of directives, the national legislation transposing the same.32 To that effect, the ECB adopts guidelines and recommendations, and takes decisions subject to and in compliance with the relevant Union law. The ECB may also adopt regulations, but only to the extent necessary to organize or specify the modalities for carrying out those tasks.33 2. Reasons for Harmonizing Regulation and Centralizing Supervision Regulatory harmonization is mainly grounded on the spillover effects generated 5.20 by banking and financial crises. When spillovers cross national boundaries, ‘a central issue becomes whether the governments of individual nations should take action unilaterally or by co-ordinating their activities in some way with other countries (and if so, which ones)’.34 However, in an increasingly globalized world, unilateral regulations may simply lead domestic firms to move offshore or engage in regulatory arbitrage. In addition, unilateral regulations may raise the costs of doing business in multiple markets.35 Harmonization should solve similar problems by levelling the playing field, even though it may encounter collective action problems to the extent that different countries have different preferences and find it difficult to reach an agreement. Moreover, harmonization might create additional risks to the extent that the common rules agreed upon could be flawed and negatively affect the global financial system.36 See TFEU, art 289. 31 See TFEU, arts 290 and 291. For a description of the rule-making procedure see Busuioc (n 22), 115. 32 See Regulation (EU) 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2013] OJ 2013 L287/63 (Single Supervisory Mechanism Regulation (SSMR)), art 4(3). 33 See SSMR, art 4(4). 34 See Richard Herring and Robert Litan, Financial Regulation in the Global Economy (Brookings 1995) 66. 35 Ibid. 36 See Roberta Romano, ‘Regulating in the Dark’ in Cary Coglianese (ed), Regulatory Breakdown: The Crisis of Confidence in U.S. Regulation (PENN 2012); Roberta Romano, ‘Against Financial Regulation Harmonization: A Comment’, Yale Law & Economics Research Paper No 414 30

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Guido Ferrarini and Fabio Recine 5.21 Harmonization can take different forms depending on the means used to imple-

ment it. Soft law is widely resorted to at international level, as typically shown by the Basel standards on capital adequacy.37 In the EU, however, banking regulation has been traditionally harmonized through directives and more recently through regulations. Directives allow for some flexibility in implementation by the Member States, but this often results in regulatory differences that make the playing field uneven. Regulations are more often resorted to after the financial crisis, particularly in areas subject to international standards, such as capital adequacy.38

5.22 Supervisory centralization may help to solve spillover problems. The 2008 finan-

cial turmoil vividly showed that supervisory fragmentation, such as that found in the EU, is a cause of systemic risks, for the co-operation between national supervisors is bound to fail precisely when it is most needed, i.e. in the case of a banking crisis. Ailing cross-border banking groups (such as Fortis, mainly operating in Benelux)39 were ultimately dismantled, as national authorities were unable to co-operate, while governments could not even reach an agreement on the bailing out of these groups.40

5.23 Supervisory centralization has been on the rise after the crisis. However, its

outcomes largely depend on the model of centralization used.41 If centralization occurs by enhancing supervisory co-operation—as done in Europe post- crisis through the establishment of the European System of Financial Supervisors (ESFS)—it may be negatively affected by the limits of co-operation between national supervisors, which are only reduced by the presence of co-ordinating authorities. If centralization occurs through the appointment of a lead supervisor—as in the single licence system—the home bias of this supervisor may be problematic in crisis situations, as the same will try to protect its country’s interests over those

(available at ) arguing that international regulatory harmonization is a serious source of catastrophic systemic risk, rather than diversity in regulatory regimes. See also Lawrence A Cunningham and David T Zaring, ‘The Three or Four Approaches to Financial Regulation: A Cautionary Analysis Against Exuberance in Crisis Response’ (2009) 78 George Washington Law Review 39. 37 See Charles Goodhart, The Basel Committee on Banking Supervision. A History of the Early Years 1974–1997 (Cambridge University Press 2011). 38 See Eilís Ferran, Niamh Moloney, Jennifer Hill, and John Coffee, The Regulatory Aftermath of the Financial Crisis (Cambridge University Press 2012) 63 ff; Eddy Wymeersch, ‘The European Financial Supervisory Authorities or ESAs’, in Wymeersch, Hopt, and Ferrarini (eds) (n 9), 235. 39 For a brief case study on Fortis, see Martin Cihak and Erlend Nier, ‘The Need for Special Resolution Regimes for Financial Institutions—The Case of the European Union’, IMF Working Paper 200/09 (available at ). 40 See Guido Ferrarini and Filippo Chiodini (n 9), 193. 41 A centralized approach to supervision can be achieved along three different models: (i) co- operation and co-ordination amongst authorities in different Member States; (ii) lead home (or consolidating) supervisor; and (iii) supranational authority. The three models can be combined one with another and form two-tier systems, consisting of a national and a supranational level.

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The Single Rulebook and the SSM of the other countries involved. Only the establishment of a supranational supervisor overcomes both the limits of supervisory co-operation and the national bias of the lead supervisor.42 This is the case of the SSM which, however, also includes elements of supervisory co-operation (between the ECB and the national authorities).43 3. Optimal Allocation of Rule-making A further question, which is central to the present chapter, is how to allocate regu- 5.24 latory and supervisory powers once a decision for either harmonization or centralization has been taken. In order to answer this question, we should first define the role of primary legislation. Assuming that the legislature has neither the time nor the expertise to engage in detailed regulatory rule-making—as generally happens in the case of banking and finance—the appropriate answer is that ‘primary legislation should concentrate on the general principles of regulatory law’.44 This is not to say that politics should not get involved in complex issues like those arising in banking and finance, particularly after a major crisis like the 2008 financial crisis. Rather, parliaments should abstain from dealing with the technicalities involved in those complex issues and focus on the general principles to apply in dealing with them. The crucial question therefore becomes to what extent detailed rule- making ‘should be delegated to the Executive, or rather to an agency which is, to a greater or lesser degree, independent of government’.45 In the EU, the suggestion that primary legislation should be principles-based is re- 5.25 flected by the idea that Level 1 measures of the Lamfalussy regulatory framework should only consist of high-level principles.46 Indeed, under this framework, detailed rule-making is delegated to the Commission, which adopts level 2 measures. After the crisis, the EU regulatory framework is characterized by the delegation of wide regulatory powers over banks, which pertain solely to the Commission

42 Recent economic research shows however that under certain conditions centralized policy- making is not superior to national banking regulation: see Wolfram Berger and Yoko Nagase, ‘Banking Union in Europe: how much centralization is needed?’, in Bulletin of Economic Research 70:1, 2018. As to the trade-off between federal and state supervision in the USA, see Sumit Argawal, David Lucca, Amit Seru, and Francesco Trebbi, ‘Inconsistent Regulators: Evidence from Banking’, NBER Working Paper No 17736, 2012. 43 See Ferrarini and Chiarella (n 19). 44 See Anthony Ogus, Regulation. Legal Form and Economic Theory (Oxford University Press 1994) 105. 45 Ibid. See also Colin Scott, ‘Standard-Setting in Regulatory Regimes’ in Robert Baldwin, Martin Cave, and Martin Lodge (eds), The Oxford Handbook of Regulation (Oxford University Press 2010) 104, highlighting that in the classical regulatory model which developed in the US independent regulatory agencies make the rules and standards under delegated statutory powers, while in many European countries there is reluctance to delegate rule-making powers to agencies. 46 See Eric Posner, ‘The Lamfalussy Process: Polyarchic Origins of Networked Financial Rulemaking in the EU’ in Charles Sabel and Jonathan Zeitlin (eds), EU Governance: Towards a New Architecture? (Oxford University Press 2010) 43.

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Guido Ferrarini and Fabio Recine (ie to the Executive) in areas involving policy choices, but require EBA’s assistance in technical areas where either regulatory or implementing standards are foreseen by Level 1 measures.47 A similar choice was no doubt conditioned by the present requirements of EU law as to the delegation of powers to independent agencies by the Commission under the Meroni doctrine.48 5.26 We should also consider the general criteria that legislators usually follow in de-

ciding whether to delegate regulatory powers to an independent institution rather than to the government. Firstly, expertise can be concentrated and accumulated in a regulatory agency in a way which is not always possible with government bureaucracies; moreover, ‘if the agency is also responsible for enforcement, that experience can beneficially feed back into the rule-making process’.49 Secondly, agency’s independence may reduce the risks of political interference, ‘encourage a longer term perspective, and (perhaps) facilitate consultation and more open decision-making’.50

5.27 Similar reasons can suggest concentrating both regulatory and supervisory powers

in an independent institution, with clear benefits in terms of expertise, objectivity, and long-term planning of the relevant activities. Public choice theory also explains how private interests may be served by the delegation of rule-making powers to agencies.51 Politicians, in particular, may face powerful pressure groups

47 See Recitals (21)–(23) of Regulation (EU) 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (EBA) [2010] OJ L331/12 (European Banking Authority Regulation (EBAR)). 48 This term refers to the position taken by the ECJ in Meroni v High Authority [1957–58] ECR 133 (Case 9/56).The ‘Meroni doctrine’ has long been understood to mean that delegation of powers to an agency can only refer to clearly defined executive powers, the use of which can be subject to strict review, and that it is not permissible to delegate broad discretionary powers implying a wide margin of discretion. The ECJ reviewed this doctrine in UK v Parliament and Council, 22 January 2014, ECLI:EU:C:2014:18 (Case C-270/12), concerning the powers of ESMA to directly prohibit short selling in certain circumstances. The Court held that the relevant provision of EU law—Regulation (EU) 236/2012 of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps [2012] OJ L86/1, art 28—did not infringe the Meroni doctrine that only prohibits to delegate a wide margin of discretion. The Court based its finding on the existence of strict objective criteria in the contested provision, and on the fact that its decisions are amenable to judicial review. Therefore, it did not reject the Meroni doctrine outright, but made it clear that the relevant test is a nuanced one. See Chapters 3 and 16 in this volume; Jacques Pelkmans and Marta Simoncini ‘Mellowing Meroni: How ESMA can Help Build the Single Market’, CEPS Commentaries, 18 February 2014 (available at https://www. ceps.eu/ceps-publications/mellowing-meroni-how-esma-can-help-build-single-market/; accessed 28 October 2019). 49 See Ogus (n 44), 105. 50 Ibid. A problem concerning regulatory agencies is their lack of democratic legitimacy: see, for an introduction, Karen Yeung, ‘The Regulatory State’ in Baldwin, Cave, and Lodge (n 22), 76; Domenico Majone, Regulating Europe (Routledge, 1996) 47, arguing that regulatory agencies derive legitimacy from their effectiveness in remedying market failures. 51 See Amihai Glazer, ‘Regulatory Policy’ in Michael Reksulak, Laura Razzolini, and William Shughart II (eds), The Elgar Companion to Public Choice (2nd edn, Edward Elgar Publishing 2013) 284.

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The Single Rulebook and the SSM with conflicting demands. Delegating rule-making to an agency will direct these groups’ criticism to the former rather than to the politicians.52

IV. The Decoupling of Regulatory and Supervisory Powers in the SSM 1. Rule-making in the EU To summarize, the EU regulatory arena today sees many players acting under 5.28 often unclear and overlapping mandates. In addition, reforms of the EU regulatory framework have produced several layers of rules, with no clear accountability for the final output. At Level 1, the EU institutions set out the main rules under Treaty procedures, which foresee a proposal from the Commission to be discussed and approved by the Council and Parliament. These rules were originally conceived as high-level principles, but today tend to be very detailed, mainly pursuing a maximum harmonization approach. At Level 2, the Commission and the EU regulatory agencies (EBA in the banking sector) make rules on the basis of mandates, which are set in Level 1 directives and regulations and foresee the issuance of delegated acts and regulatory technical standards under ‘comitology’ procedures. When directives are adopted at either level, Member States provide to their implementation through national rules which are adopted by parliaments, governments, or regulators. At Level 3, the EU regulatory agencies (including EBA) issue guidelines and recommendations specifying the rules set at the other two levels. This patchy approach to rule-making has clear limits. As a result of the detailed 5.29 character of most Level 1 measures and of maximum harmonization, politicians often legislate on technical issues that would generally be better left to supervisors. The regulation of bankers’ remuneration offers an example of how supervisory discretion can be pre-empted by too detailed previsions at Level 1 and 2.53 Indeed, the FSB principles on sound remuneration practices leave the individual states free to adopt either a regulatory or a supervisory approach to bankers’ pay. The majority of jurisdictions follow a mixed model, combining more or less detailed rules with ex post supervisory action. The US, for example, have adopted only a few rules at primary level and leave wide scope to the Fed’s regulatory and supervisory powers.54 However, the EU approach is based on Level 1 and 2 directives, which leave narrow room to supervisory discretion. Not only has the EU followed

See Ogus (n 21), 106. 53 See Guido Ferrarini, ‘Compensation in Financial Institutions: Systemic Risk, Regulation, and Proportionality’ in Danny Busch, Guido Ferrarini, and Gerard van Solinge (eds), Governance of Financial Institutions (OUP 2019) 261 ff. 54 Ibid, 280ff. 52

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Guido Ferrarini and Fabio Recine a mostly regulatory approach to implementation of the international principles, but CRD IV has also departed from these principles by introducing an unprecedented cap on variable remuneration. As shown in another paper, the rationale for the cap is flawed to a large extent and unintended consequences may derive from it as a result.55 Moreover, the cap on variable pay may not be consistent with other aspects of the regulation of pay, which reflect the international principles and respond to a logic that is to some extent different from that followed by the EU legislator. 5.30 The CRD IV provisions on executive pay help understand the limits of the single

rulebook as it now stands also in other areas.56 Firstly, the willingness of politicians to directly intervene in the regulation of issues that are clearly salient from their voters’ perspective led to the formulation of detailed provisions, rather than of high-level principles which should characterize Level 1 directives. Secondly, regulation of technical issues in Level 1 directives has not only politicized these issues, but also led to a rigid approach to the same.57 Thirdly, the use of directives at both Level 1 and 2 has widened the scope of banking regulation to the point of depriving supervisors of the discretion needed to a flexible approach to bank surveillance. As a result, the professional competences and independence of banking supervisors are not fully exploited, while political interference with banking regulation and supervision risks distorting the same for reasons other than technical ones.58 2. The ECB as an Institution and as a Supervisor

5.31 In the EBU, the limits to the ECB’s regulatory powers in the area of prudential

supervision highlight the decoupling of regulation from supervision and raise the question whether the ECB could have more say in rule-making with respect to the

Ibid, 266ff. 56 For example, boards of directors: see Guido Ferrarini, ‘Understanding the Role of Corporate Governance in Financial Institutions: A Research Agenda’ in Ondernemingsrecht, 2017/13, 72–83, also published as ECGI Law Working Paper No 347/2017. See, more specifically on the uncertain regulatory objectives of CRD IV, Peter Mülbert and Alexander Wilhelm, Chapter 6 in this volume. 57 In the previous edition, we made reference to the definition of the scope of banking activity as an example, arguing by way of conclusion: ‘To the extent that the ECB lacks regulatory powers, in particular with respect to the definition of activities and/or groups subject to its own supervision, also its supervisory action is negatively affected as a wide range of activities and entities remain out of the scope of the SSM even when they would deserve to be included’; see Guido Ferrarini and Fabio Recine, ‘The Single Rulebook and the SSM: Should the ECB Have More Say in Prudential Rule-making?’, Chapter 5 of the first edition of this volume, 144. For an analysis of this topic in general, see Chapter 17 in this volume. 58 In the previous edition of this volume, we made reference to macro prudential supervision as an example of ‘rigid procedures and checks by EU institutions and bodies which national authorities must follow to avoid problems for the Single Market’, adding: ‘when adopting macroprudential measures the ECB must go through the same cumbersome process foreseen by Union law for national authorities’; ibid, 142. The topic of macroprudential supervision is now dealt-with by Kern Alexander, Chapter 2 in this volume. 55

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The Single Rulebook and the SSM Eurozone. Before analysing this question, we should consider the related issue of the ECB’s nature both as a central bank and as a supervisory agency. A. The ECB as EU Institution with Central Banking Tasks The Treaty established the ECB as an institution with exclusive competence on the 5.32 tasks conferred on it by the Treaty.59 It has exclusive powers to make regulations, take decisions, make recommendations, and deliver opinions to the extent necessary to implement its tasks and carry out its responsibilities within its area of competence. The ECB regulations and decisions enjoy the status of Union law. Moreover, the ECB is entitled to exercise its powers in individual cases within the limits set out by the EC Treaty and further defined by the Council (for example, in the case of statistics, minimum reserve requirements and sanctions). However, the regulatory competences of the ECB only cover the Eurozone coun- 5.33 tries. For these countries, the Governing Council is the only responsible decision- making body as to policy, regulation, and sanctions always, however, within the boundaries of the ECB competences. The Treaty was changed to clarify that the ECB is an EU institution, albeit with very specific features (as regards for instance budget, auditing, and accountability). Article 282 of the Treaty on European Union explicitly defines the ECB as an EU institution—like the Commission, the Council, the European Parliament, and the European Court of Justice—therefore removing legal uncertainty about its status. The fact that the ECB was previously included in a section of the Treaty concerning ‘other institutions and bodies’ had indeed led some interpreters to qualify the ECB as an independent specialized organization of Community law.60 B. The ECB as a Quasi-National Authority with Micro-prudential Supervisory Tasks The SSM Regulation assigns new supervisory tasks to the ECB, somehow 5.34 overlooking that it is an EU institution while assimilating the same to national competent authorities. In fact, the SSM Regulation provides that ‘the ECB shall be considered, as appropriate, the competent authority or the designated authority 59 See Hanspeter Scheller, The European Central Bank: History, Role and Functions (2nd edn, Frankfurt am Main 2006) (available at https:// www.ecb.europa.eu/ pub/ pdf/ other/ ecbhistoryrolefunctions2006en.pdf accessed 28 October 2019). For an in-depth analysis of the SSM tasks, focusing on the respective competences of the ECB and the national authorities, see Raffaele D’Ambrosio, ‘The ECB and NCA Liability within the Single Supervisory Mechanism’ (in Banca d’Italia, Quaderni di Ricerca Giuridica (2015) (n 78)). 60 See Chiara Zilioli and Martin Selmayr, ‘The European Central Bank: an Independent Specialized Organization of Community Law’ (2000) Common Market Law Review 598, further developed in Chiara Zilioli and Martin Selmayr, The Law of the European Central Bank (Hart Publishing 2001); for a different view, see Ramon Torrent, ‘Whom is the European Central Bank the Central Bank of? Reaction to Zilioli and Selmayr’ (1999) Common Market Law Review 1229; Giandomenico Majone, ‘Europe’s “Democratic Deficit”: The Question of Standards’ (1998) 4 European Law Journal 5.

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Guido Ferrarini and Fabio Recine in the participating Member States as established by the relevant Union Law’.61 The characterization of the ECB as a quasi-national authority marks a departure from its status as an EU institution, as also shown by its limited rule-making powers and by its relative subordination to the EBA and the ESRB. 5.35 To be true, the ECB can adopt regulations, but only to the extent necessary to

either organize or specify the arrangements for carrying out the tasks conferred on it by the SSMR. Before adopting a regulation, the ECB shall conduct open public consultations and analyse the potential related costs and benefits.62 In addition, the ECB: should exercise powers to adopt regulations in accordance with Article 132 of the Treaty on the Functioning of the European Union (TFEU) and in compliance with Union acts adopted by the Commission on the basis of drafts developed by EBA and subject to Article 16 of Regulation (EU) No 1093/2010.63

5.36 As a result, a new legal hierarchy is foreseen for the ECB which is subject to:

(1) relevant Union law including the whole of primary and secondary Union law; (2) the Commission powers and decisions in the area of state aid, competition rules, and merger control; and (3) the single rulebook applicable in all Member States.64 Also the ECB guidelines and recommendations, as well as the ECB decisions are subject to and must comply with ‘the relevant Union law and in particular any legislative and non-legislative act, including those referred to in Articles 290 and 291 TFEU’. Furthermore, the ECB shall in particular: be subject to binding regulatory and implementing technical standards developed by EBA and adopted by the Commission in accordance with Article 10 to 15 of Regulation (EU) No 1093/2010, to Article 16 of that regulation, and to the provisions of that Regulation on the European supervisory handbook developed by EBA in accordance with that Regulation. 5.37 In addition, the amended EBA Regulation effects ‘a rebalancing’ of the position

of the EBA vis-à-vis the ECB, strengthening EBA in an effort to avoid ‘centrifugal forces’.65 In short, the main changes concern: (1) The legal powers of EBA towards the ECB. The regulation establishing the EBA has been modified to ensure that the same can carry out its tasks in relation to the ECB by clarifying that the notion of ‘competent authorities’ includes

See SSMR, art 9(1). 62 See SSMR, art 4(3) making an exception for the case where such consultations and analyses are disproportionate in relation to the scope and impact of the regulations concerned or in relation to the particular urgency of the matter, in which case the ECB shall justify that urgency. 63 Ibid. 64 See SSM, Recital 32. 65 See Chapter 12 in this volume. 61

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The Single Rulebook and the SSM also the latter.66 Under the amending regulation, the EBA’s powers to resolve a cross-border disagreement between supervisors and to require action in an emergency situation have been amended in the sense that EBA could request the ECB to follow its decision, but not require the same to do so. The ECB will have either to comply or to provide adequate justification for non-compliance;67 (2) The development of a European Supervisory Handbook. The tasks and responsibilities of EBA will remain essentially unchanged. The amending Regulation confirms the powers of EBA to harmonize technical standards for regulation and supervision;68 (3) Changes in EBA governance. The ECB shall continue to participate in the Board of Supervisors of the EBA through a non-voting representative. In addition, the voting modalities currently provided for in the EBA regulation have been reviewed, so as to ensure that EBA decisions are taken in a more balanced way.69 However, while in the Commission proposal of the SSM Regulation the ECB had the power to ‘co-ordinate and express a common position’ for the participating Member States, this approach has been abandoned by the Parliament in the final version, restoring the full freedom of the competent authorities of the participating Member States to agree on subjects within EBA’s competence.70 These changes are interesting also in order to assess the possibility of the ECB 5.38 influencing rule-making by the EBA. First, the amended EBA Regulation continues to allow the participation of an ECB representative to the Board of Supervisors. This representative is nominated by the ECB Supervisory Board and may be accompanied by someone with expertise on central bank tasks. However, unlike national authorities, the ECB representative has no voting rights.71 To partially correct this handicap the ECB representative is allowed to attend discussions concerning individual financial institutions, which in principle non-voting members cannot attend, apart from the EBA Chairpersons and Executive Director. As to regulation (as well as for decisions on breach of Union Law, emergency decisions, and settlement of disputes) the amended EBA regulation provides for a dual majority, according to which the needed qualified majority should include both a

66 See Regulation (EU) 1022/2013 of October 22, 2013 amending Regulation (EU) 1093/2010 [2013] OJ L 287/5 (Amending Regulation), art 2. 67 See Amending Regulation, art 1(8). 68 See Amending Regulation, art 1(5). 69 See Amending Regulation, Recital 14 and EBA Regulation, art 44 (as amended by Amending Regulation, art 3(24). 70 Article 4(l)(l) of the proposed SSM regulation gave the ECB the power to ‘co-ordinate and express a common position’ for the participating Member States; see also the Explanatory Memorandum to the Commission’s proposal at 4.2.1. 71 See Amending Regulation, art 1(21).

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Guido Ferrarini and Fabio Recine simple majority of SSM countries and a simple majority of non-SSM participating countries.72 3. Guidelines, Recommendations, and the Limits to ECB Rule-making 5.39 As already stated above, the ECB has no rule-making powers in prudential matters.

It can issue guidelines and recommendations, but these are grounded on its supervisory competences. Nonetheless, recent initiatives have shown that the ECB de facto attempts to exercise some kind of rule-making powers either through guidelines or by replacing national competent authorities, as we show in this paragraph.

A. Role of Guidelines 5.40 Under Article 4(3) of the SSM Regulation, the ECB shall apply all relevant Union law and, where Union law is composed of directives, the national legislation transposing the same. Where the relevant Union law is composed of regulations and those regulations explicitly grant options for Member States, the ECB shall also apply the national legislation exercising those options. To that effect, the ECB shall adopt guidelines and recommendations, and take decisions subject to, and in compliance with, the relevant Union law. It shall in particular be subject to binding regulatory and implementing technical standards developed by EBA and adopted by the Commission in accordance with the EBA Regulation, and to the provisions of that Regulation on the European supervisory handbook developed by EBA. The ECB may also adopt regulations, but only to the extent necessary to organize or specify the arrangements for the carrying out of the tasks conferred on it by the SSM Regulation. 5.41 When issuing guidelines, the ECB does not exercise rule-making powers, but

describes its supervisory practices and specifies its expectations vis-à-vis supervised entities. The ECB Guide to fit and proper assessments (updated in May 2018 in line with the joint ESMA and EBA Guidelines on suitability)73 makes it clear by stating what follows: The Guide aims to describe and make public the supervisory policies, processes and practices followed by the ECB when conducting fit and proper assessments. With these policies, processes and practices, the ECB aims to ensure the maximum consistency allowed by the legal frameworks applicable within the Single Supervisory Mechanism (SSM). Such consistent application aims to achieve common supervisory practices. This Guide is not, however, a legally binding document and cannot in any way substitute the relevant legal requirements stemming either from applicable EU law or applicable national law, nor does it introduce new rules or requirements.74

See Amending Regulation, art 1(24). 73 See https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.fap_guide_201705_rev_ 201805.en.pdf(accessed 28 October 2019). 74 Ibid, 3. For an analysis of the ECB approach to fit and proper assessment, see Busch and Teubner, Chapter 7 in this volume. 72

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The Single Rulebook and the SSM However, some of the ECB guidelines have been regarded by other EU institutions 5.42 as an attempt to introduce new rules in areas that are not specifically covered by EU regulation. The NPL Guidance and its Addendum offer a good example of this type of problem, being rather ambiguous as to the legal nature of their statements, as we try to explain hereafter. B. The NPL Guidance and its Legal Nature Since its operational start in 2014, the SSM has devoted special attention to the 5.43 treatment of non-performing loans (NPLs) of banks, which greatly increased as a result of the financial crisis particularly in countries that experienced the most severe economic downturn. It is argued that high levels of NPLs affect banks’ capital and funding, reduce their profitability, and divert resources from their efficient use, thus inhibiting the supply of credit to households and companies.75 Given the importance of NPLs for bank viability and macroeconomic performance, a high-level group was established within the SSM with the task of establishing a consistent and effective supervisory approach to this problem, based on European and international best practices and intended to reduce the level of NPLs on banks’ balance sheets. The ECB issued a report on national practices in September 201676 and a NPL 5.44 Guidance on 20 March 2017,77 which clarified the SSM supervisory expectations regarding the identification, management, measurement, and write-off of NPLs in the context of existing regulations, directives, and guidelines. These documents stressed the importance of timely provisioning and write-off practices related to non-performing loans. In June 2017, the ECB published an extensive report on NPLs in the nineteen Member States participating in the BU, which identified the need for further joint actions by all relevant stakeholders to address existing and future issues.78 Given the high political importance of the topic, in July 2017 the ECOFIN Council agreed on an Action plan to tackle non-performing loans in Europe. The plan called upon various institutions—including the Commission— to take appropriate measures to address the challenges of high NPL ratios in Europe.79 75 For a critical view, see P. Angelini, ‘Do High Levels of NPLs Impair Banks’ Credit Allocation?’ in Notes on Financial Stability and Supervision (n 12), 9 April 2018, available online at ). 76 See ECB Banking Supervision, ‘Stocktake of National Supervisory Practices and Legal Frameworks Related to NPLs’, available online at . 77 See ECB Banking Supervision, Guidance to banks on non-performing loans, available online at . 78 See ECB Banking Supervision, Stocktake of national supervisory practices and legal frameworks related to NPLs, available online at . 79 See .

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Guido Ferrarini and Fabio Recine 5.45 In October 2017, the ECB launched a public consultation on a draft Addendum

to the NPL Guidance, which was intended to further specify the ECB’s supervisory expectations when assessing a bank’s levels of prudential provisions for non-performing exposures (NPEs).80 The draft Addendum specified that banks would have to provision 100% of the loans that were newly considered as non- performing according to the EBA definition within two years for the unsecured portion and seven years for the secured portion. The new rule would enter into force on 1 January 2018. The Addendum further specified that its guidance should be considered as a ‘supervisory tool’ that helps ensuring that banks have sufficient coverage for their non-performing exposures. The Addendum also clarified that it was legally non-binding, but was to be used as the basis for supervisory dialogue.81 However, the draft was widely criticized for its severe impact on banks both from national supervisory authorities and politicians.82

5.46 No doubt, the combined effect of the EC and ECB measures could force EU

banks to review their credit policies and include the prospective impacts of NPL provisioning. However, it is to be seen whether a similar review would be beneficial from a social standpoint and actually increase credit supply to SMEs, which is a target of the EC proposals. The strengthening of NPL coverage levels might lead EU banks to adopt a more prudent approach to their lending strategies by over-collateralizing loans and enforcing claims as soon as they become non- performing. Moreover, the proposals on the prudential backstop for NPL provisioning fail to recognize the significant differences amongst EU Member States with respect to the average duration of debt recovery procedures. To some extent, European institutions are betting on the effectiveness of out-of-court accelerated enforcement procedures and other proposed reforms on debt restructurings to overcome national differences. But the ‘one-size-fits-all’ approach enshrined in the NPL provisioning calendar could ultimately result in an unlevel playing field within the internal market and the Banking Union, due to different judicial systems and different efficiency levels of national bankruptcy and enforcement procedures.83

80 See ECB Banking Supervision, Addendum to the ECB Guidance to banks on non-performing loans: Prudential provisioning backstop for non-performing exposures, October 2017, available online at . 81 Ibid, 2 stating: ‘This addendum does not intend to substitute or supersede any applicable regulatory or accounting requirement or guidance from existing EU regulations or directives and their national transpositions, applicable national regulation of accounting, binding rules and guidelines of accounting standard setters or equivalent, or guidelines issued by the European Banking Authority (EBA)’. 82 See, for the comments received by the ECB in the consultation, . 83 New research carries evidence on the importance of insolvency frameworks for private sector debt deleveraging and for the resolution of NPLs: see for instance A. Consolo, F. Malfa,

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The Single Rulebook and the SSM Rather than further examining the optimal treatment of NPLs,84 a brief analysis 5.47 of the legal nature of the Addendum is useful for purposes of the present chapter. The ECB stated in its consultation on the draft Addendum that the same included non-binding risk provisioning expectations and was therefore in line with the ECB’s mandate under Article 16(2)(a) of the SSM Regulation, which allows the ECB to take bank-specific measures. However, the legal services of the European Parliament and of the European Council expressed concerns about the true nature of the Addendum and the ECB’s power to adopt it. In particular, the European Parliament’s legal services, in their opinion dated 8 November 2017,85 noted that the Addendum ‘sets out the quantitative supervisory expectations in an extremely clear and precise fashion: in order to meet those expectations, banks are required to write down in full non-performing exposures within a certain period of time’. Also the possible exceptions were defined with precision. As a result, the opinion concluded that the Addendum was mandatory in character86 and was meant to introduce obligations on banks beyond the statutory requirements under the CRR. Similar arguments were put forward by the Council’s legal services in an opinion 5.48 dated 23 November 2017.87 Also this opinion concluded that the Addendum was binding on all the SSM banks and therefore went beyond the ECB powers as foreseen by Article 16(2)(a) and (c) of the SSM Regulation. The request for a specific provisioning policy could only be made vis-à-vis a specific credit institution rather than ‘by issuing requirements that apply erga omnes’. The Council legal opinion concluded: ‘(t)here is therefore a fundamental difference between the role of the ECB as regards monetary policy—which is designed and applied by the ECB— and supervisory policy—where the ECB executes the policy devised by the Union legislator, the Commission and the EBA. The above leads to the conclusion that the ECB is prevented from adopting rules of general application in the field of prudential requirements.’ As a result, the ECB modified the Addendum to the NPL Guidance so as to meet 5.49 some of the criticism received.88 At the same time, the Commission presented a proposal for a regulation amending the capital requirement regulation and introducing common minimum coverage levels for newly originated loans that

and B. Pierluigi, ‘Insolvency Frameworks and Private Debt: An Empirical Investigation’ in ECB Working Paper No 2189. 84 See, for a comprehensive discussion of this topic, Chapter 8 in this volume. 85 The document is available online at https://sven-giegold.de/wp-content/uploads/2017/11/ Legal-Opinion-EP-on-NPL-Draft-Addendum.pdf. 86 The EP also recalled that according to the caselaw whether an act is capable of having legal effects depends on its wording, its substance and the intention of the author. 87 The document is available online at https://sven-giegold.de/wp-content/uploads/2017/11/ Legal-Opinion-Council-on-NPL-Draft-Addendum.pdf. 88 The Addendum was published in final form on March 2018; see online at .

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Guido Ferrarini and Fabio Recine become non-performing,89 which however are milder than the ones foreseen by the ECB.90 4. The O&D Regulation and its Legal Grounds 5.50 Other interesting developments, which somehow support the main thesis of

this chapter, have taken place with the ECB Regulation (EU) 2016/445 of 14 March 2016 (ECB/2016/4)91 concerning the exercise of options and discretions (O&Ds) which are granted to supervisors under the Capital Requirements Regulation (CRR) and the Commission Delegated Regulation on the Liquidity Coverage Ratio (LCR Delegated Act). Some of these O&Ds are applied in a general manner, while some are applied following a case-by-case approach. The Explanatory Memorandum submitted by the ECB to consultation clarified that ‘for general O&Ds, the decision of the supervisor applies to all banks, whereas for case-by-case O&Ds supervisory decisions are bank specific’.92 Accordingly, the ECB issued two related documents: the cited Regulation 2016/445 concerning the exercise of thirty-five general O&Ds and Guideline (EU) 2017/697 of 4 April 2017 (ECB/2017/9) relating to the exercise of eighty-two case-by- case O&Ds.93

5.51 The ECB’s power to issue guidelines for specific O&Ds derives from Article

4(3), second paragraph, of the SSM Regulation, providing that the ECB can adopt guidelines for the purpose of carrying out its tasks. The power to issue a regulation on general O&Ds is not specifically mentioned in the SSM Regulation, which on the contrary states that the ECB can adopt regulations only to the extent necessary to organize or specify the arrangements for 89 The Capital Requirements Regulation (CRR) would be amended to introduce minimum loss coverage for banks’ non-performing exposures (NPEs): see online at https://ec.europa.eu/info/ law/better-regulation/initiatives/ares-2017-5467253_en#pe-2018-1453. Moreover, a Directive has been proposed by the Commission that would require all Member States to ensure that banks have out-of-court access to collateral against secured business loans, through an ‘accelerated extrajudicial collateral enforcement procedure’ (AECE). The proposed directive would also require to create a more efficient secondary market for loan agreements by setting standardized rules for specialist debt management and debt collection companies, which purchase NPLs or seek to enforce them on a bank’s behalf, and allowing them to operate throughout the EU based on the licence of a Member State. See online at . 90 For an overview of the measures proposed by the Commission, see online at . 91 Available online at . 92 European Central Bank, Public consultation on a draft Regulation and Guide of the European Central Bank on the exercise of options and discretions available in Union law: Explanatory memorandum (2015), available online at . 93 The ECB Guideline on O&D is available online at .

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The Single Rulebook and the SSM carrying out the tasks conferred on it by the Regulation. However, the ECB has relied on Article 9(1) of the SSM Regulation stating in its first paragraph that, for the purpose of carrying out its supervisory tasks, the ECB shall be considered, as appropriate, the competent authority or the designated authority in the participating member States as established by the relevant Union law. Article 9(1), second paragraph, further specifies: ‘For the same exclusive purpose, the ECB shall have all the powers and obligations set out in this Regulation. It shall also have all the powers and obligations, which competent and designated authorities shall have under the relevant Union law, unless otherwise provided for by this Regulation. In particular, the ECB shall have the powers listed in sections 1 and 2 of this Chapter.’ These are the investigatory powers and other specific supervisory powers. In fact, the Explanatory Memorandum submitted by the ECB to consultation indicates the legal basis for the Regulation and the Guide as follows: ‘Since becoming the competent authority for the significant institutions within the euro area on 4 November 2014, the ECB has had the power to determine the most appropriate way to exercise the supervisory O&Ds for the institutions under its direct supervision. Recital 2 of the SSM Regulation states that it is essential to intensify the integration of banking supervision in order to bolster the Union, restore financial stability and lay the basis for economic recovery . . . In addition, the ECB has the mandate to ensure the consistent functioning of the SSM (Article 6 of the SSM Regulation)’. Moreover, the Preamble of the ECB Regulation specifies that the O&Ds granted 5.52 by a regulation for which the ECB should apply the national implementing legislation (Article 4(1) of the SSM Regulation) ‘do not include those available only to competent authorities, which the ECB is solely competent to exercise and should exercise as appropriate’ (Recital 8). In any case, ‘in exercising options and discretions, the ECB, as the competent authority, should take account of the general principles of Union law, in particular equal treatment, proportionality and the legitimate expectations of supervised credit institutions’ (Recital 9). However, the provisions of the SSM Regulation cited in the Preamble do not specifically refer to a regulatory power of the ECB for the implementation of general O&Ds. In particular, Article 4(3) constrains the ECB regulatory power to organizational matters, so that the power to regulate prudential matters is in principle excluded. Moreover, Article 9(1) clearly refers to supervisory powers, which are different from rule-making ones (although the policies relating to prudential supervision could include rule-making, as argued in the following section). In order to overcome similar difficulties, the Explanatory Memorandum made recourse to a functional reading of the SSM Regulation, arguing that the ECB regulatory power is needed for the proper functioning of the SSM. Which is true on policy grounds, but is a thin legal basis for the ECB’s regulatory power. 215

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V. Evolutionary Dynamics of the EU Institutional Regulatory Framework 1. Pending Reforms 5.53 In order to advance the centralization of EU financial rule-making, in September

2017 the Commission put forward a package of proposals94 reviewing the tasks, powers, governance and funding of the ESAs and the ESRB, so as to adapt them to the changed context in which these agencies operate, including the establishment of the BU.95These proposals aim to address some of the constraints on ESAs’ ability to fulfil their existing mandates, due to unclear definition of powers, unbalanced decision-making by the Board of Supervisors and insufficient funding based on current budget arrangements. The current governance framework of the ESAs, according to the Commission, makes it difficult to manage conflicts between EU and national interests, creating the risk that their decisions are predominantly oriented towards national interests rather than the broader EU interests. As the Commission argues: ‘This reflects, to some extent, an inherent tension between the European mandate of the ESAs and the national mandate of the competent authorities that are members of the ESA Boards’.

5.54 The policy option preferred by the Commission as to the governance of ESAs,

‘includes independent members with voting powers alongside the national competent authorities in the decision-making process; introduces a new appointment process and role for the Chairperson and replaces the Management Board by an independent Executive Board composed of full time members that are externally appointed’.96 More precisely, the proposal provides for the creation of an executive board composed of five members and a chairman, selected with a public announcement, based on merit criteria. The Executive Board would also manage and prepare the meetings of the supervisory board. According to the proposal, the Board of Supervisors would remain the main body of the ESA, but its composition would be changed in order to include the full time members of the Executive Board (without voting rights).97 94 Commission proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) 1093/2010 establishing a European Supervisory Authority (European Banking Authority); Regulation (EU) 1094/2010 establishing a European Supervisory Authority (European Insurance and Occupational Pensions Authority); Regulation (EU) 1095/ 2010 establishing a European Supervisory Authority (European Securities and Markets Authority), COM (2017) 536 final, 2017/0230 (COD), 20.9.2017. 95 In October 2018, the Commission published an amended proposal containing provisions reinforcing the role of the EBA with regard to the risks posed to the financial sector by money laundering activities. 96 Commission Proposal (COM (2017) 536 final), Explanatory Memorandum, ‘Results of ex- post evaluations, stakeholder consultations and impact assessments—Impact assessment’, 13. 97 For further details see Commission Proposal (COM (2017) 536 final), Explanatory Memorandum, para 5, 22ff.

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The Single Rulebook and the SSM On 12 February 2019, the Council for Economic and Financial Affairs 5.55 (ECOFIN) adopted a position on the proposal to amend the ESAs’ regulation mandating the Council Presidency to negotiate with the European Parliament and the European Commission.98 This position suggests to modify the existing governance structure maintaining the principle that decisions have to be taken by the board of supervisors, while ensuring a key role for NCAs within the ESAs’ governance structure. No decision should be taken against the will of the majority of national supervisors, given that the board of supervisors is the ultimate decision-making body of the Authority. At the same time, the Council recommends to reinforce the role and powers of the Management Board as the main body preparing the Board of Supervisors’ meetings and decisions. It should be composed of a chairperson, six members of the board of supervisors and two full-time members, selected on the basis of their merit, managerial skills and experience of financial supervision. The chairperson and the fulltime members of the management board should be accountable to the European Parliament and to the Council. Unlike the Commission’s proposal, therefore, the Council proposes to maintain a Management Board composed of the chairman and six members of the supervisory board. The only new element would be the addition of two full-time members, selected with a public call, based on merit criteria. The decisions of the Management Board would continue to be taken by simple majority, and each member would have one vote, except the chairman, who would vote only in the case of a tie. As a result, the Supervisory Board would remain the main decision-making body and continue to be composed of representatives of the NCAs, in addition to the two full-time members of the Management Board. The political negotiation on the reform of the ESAs shows the tension that has 5.56 always characterized the history of EU integration under the pressure of the two competing and often complementary approaches of ‘transnationalism’ and ‘supranationalism’. As one of us argued in another paper,99 each mechanism for the joint execution of EU law is characterized by specific organizational arrangements, which respond to varying sectoral needs and reflect a mixture of transnationalism and supranationalism. The former refers to the joint action of the relevant domestic administrations, while the latter implies the involvement in the administrative process of an EU body that is required to promote the general interest of the EU and is fully independent of national governments in carrying out its

98 See Outcome of the Council Meeting, 3669th Council meeting, Economic and Financial Affairs, Brussels, 22 January 2019, available online at . 99 See Edoardo Chiti and Fabio Recine, ‘The Single Supervisory Mechanism in Action: Institutional Adjustment and the Reinforcement of the ECB position’ in (2018) 24 European Public Law 101–24.

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Guido Ferrarini and Fabio Recine tasks.100 In the case of the ESAs, their present structure seems to have been inspired by transnationalism, while the attempt of the Commission to rebalance it towards supranationalism is being opposed by the Member States. 2. Is the Current Approach Enough? 5.57 As mentioned above, there is a clear asymmetry between the ECB monetary and

supervisory roles. On the one hand, the ECB is a fully-fledged EU institution with exclusive competence in monetary policy and strong regulatory powers in its area of competence. On the other, the ECB is a prudential supervisor replacing national authorities on the basis of a delegation by EU institutions. As a banking supervisor, the ECB enjoys limited regulatory powers being rather subject to both Union law and national law. Moreover, the ECB is subject to the powers of the EBA as regards dispute settlement, emergency decisions, and breach of EU law. In addition, it is subject to the procedures provided for by the CRR when implementing macroprudential measures. In some cases the ECB has an even more limited status than national authorities, lacking for instance voting rights within the EBA Board of Supervisors.

5.58 The arguments supporting this regulatory approach are well known. Promoting

the single market whilst assuring a level playing field requires a single set of rules across the EU. Moreover, Member States outside the euro area would understandably be concerned if the ECB could leverage on the wide SSM membership to impose a regulatory approach that would likely focus on Eurozone banks. Indeed, the ECB is a fully-fledged EU institution for monetary policy, but it is a quasi- national authority as regards its newly attributed micro-and macroprudential supervisory tasks.

5.59 Even assuming that the ECB features as a central bank were rightly set aside

when constructing the SSM, we should still consider whether the present approach, resulting from hard political compromises, leads to efficient and effective supervision. On one side, rule-making powers are generally considered as an important tool for supervisory authorities who can regulate either the structure of firms or their conduct in view of reducing the probability of bank failures and safeguarding financial stability.101 On the other, regulatory independence, i.e. a high degree of autonomy of independent supervisors in rule-making, is a well-established international financial standard and crucially includes equipping

100 For a tentative taxonomy, see Edoardo Chiti, ‘The administrative implementation of European Union law: a taxonomy and its implications’ in Herwig Hofmann and Alexander Türk (eds), Legal Challenges in EU Administrative Law (Edward Elgar 2009) 9. 101 See David T Llewellyn, ‘Role and Scope of Regulation and Supervision’ in Gerard Caprio (ed), Handbook of Safeguarding Global Financial Stability: Political, Social, Cultural, and Economic Theories and Models (Academic Press 2013) 454.

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The Single Rulebook and the SSM supervisors with large discretion to set and change the rules flexibly.102 We wonder whether a similar objective is fulfilled by the complex interaction between different layers of rules concerning the SSM, which make regulatory change a very cumbersome process involving several players. No doubt, the ECB’s limited rule-making powers within the SSM could be jus- 5.60 tified by the need for legal harmonization within the Single Market. National discretion in the implementation of directives and different technical rules across national supervisory systems have been highlighted as possible causes of the financial crisis, leading to moving toward centralized supervision, on significant banks, centred on the ECB. However, the overall scenario could look different in the future and justify a uniform treatment of Eurozone banks even at the cost of lower EU harmonization. In fact, now that the financial crisis is (almost) over, the process towards closer financial integration—which started after adoption of the euro, but stopped and even reversed in the last few years—103 may well find new impetus. As a consequence, supervision in the euro area may progressively pose regulatory needs different from the SSM non-participating Member States and require further harmonization between the national laws of the euro area. This process may be further accelerated by the increasing institutional integration of euro area countries, which is taking place not only in the field of prudential supervision, but also in that of crisis management and resolution after the establishment of the SRM. To sum up, the present EU regime for prudential regulation—which is char- 5.61 acterized by maximum harmonization, several layers of regulation, multiple rule-makers and excessively detailed rules—may be suboptimal for the SSM and hinder its flexibility. Moreover, the SSM participating countries do not face a problem of regulatory competition, which maximum harmonization is aimed to solve. Rather, the SSM will need a consistent and homogenous regulatory framework in order to make supervision uniform in the Eurozone. This is not to say that EU harmonization will become irrelevant from the EBU perspective. On the one hand, harmonization will still be needed vis-à-vis the countries that do not participate in the SSM; on the other, EU-wide banking groups clearly benefit from harmonization of the rules in all countries where they are established. 3. Where to Go from Here? The ECB has been granted significant tasks in the field of prudential supervi- 5.62 sion and corresponding investigative and supervisory powers. However, the SSM

102 See Mark Quintyn and Michael Taylor, ‘Regulatory and Supervisory Independence and Financial Stability’, IMF Working Paper No 02/46 (available online at < https://www.imf.org/external/pubs/ft/wp/2002/wp0246.pdf> accessed 28 October  2019). 103 See ECB, Annual Report on Financial Integration, 2014.

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Guido Ferrarini and Fabio Recine Regulation has explicitly limited the ECB regulatory powers by making them subject to the single rulebook and the EBA standards. An argument which may have contributed to the present approach could be found in a strict reading of the Treaty and of the prerogatives of the Commission, the Council, and the Parliament as to legislative rule-making. This would support the thesis that a Treaty amendment is necessary to grant the ECB a status similar to the one already held by the same in the monetary policy arena. However, a broader reading of the Treaty already may allow the delegation of regulatory powers to the ECB in its role as a prudential supervisor. Indeed, Article 127(6) of the TFEU states that specific tasks may be conferred upon the ECB ‘concerning policies relating to the prudential supervision of credit institutions and other financial institutions with the exception of insurance undertakings’. The notion of ‘policies’ could no doubt include some rule-making powers in the areas of prudential supervision that the Council could very well specify in its mandate to the ECB grounding the SSM.104 5.63 As a result, the ECB supervisory competences would be complemented by rule-

making ones, also allowing for some flexibility in the choice between bringing supervisory actions in individual cases ex post and setting the rules for all supervised institutions ex ante. There are no doubt situations where the former solution would be preferable, as shown for banker’s remuneration where a supervisory approach has been chosen by other countries, including the US. In similar cases, rules should be formulated at a sufficient level of generality, so as to leave room for firms’ experimentation and supervisory discretion. The suggested approach would lead to the creation of a new layer of rules that would still be subject to EU primary legislation.

5.64 The discussion on the NPL Guidelines and Addendum has shown the ECB

seeking rule-making powers in order to better exercise its functions. Nevertheless we argued that key political choices affecting fundamental aspects of the economy should be taken by political bodies, which are accountable to society on a democratic basis. In the EU similar decisions should be taken by the European Parliament and the Council. The question therefore is how to locate the suggested ECB’s power to regulate technical issues within the EU institutional regulatory architecture, which clearly predates the establishment of the SSM.

5.65 In order to address this question we should consider the true nature and function

of the EBA. As already explained, the EBA was established as a first reaction to the financial crisis. The introduction of more transnationalism in the EU regulatory framework was believed to be the optimal way to increase supervisory and regulatory convergence in the EU, while more fundamental changes, such as supervisory centralization in the ECB, were discarded as politically unpalatable. EBA

104 On the origins of the relevant provision, see René Smits, The European Central Bank: Institutional Aspects (Kluwer Law International 1997) 319.

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The Single Rulebook and the SSM governance was therefore designed with a remarkable transnational approach, under which the agency, similarly to other similar EU bodies established in other sectors, was to be governed by a board of supervisors consisting of representatives from national authorities. Also, its working method, based on technical committees with national members, supports the influence of national authorities. Moreover, the recent Commission’s attempt to enhance the level of suprana- 5.66 tionalism in the ESAs’ governance has been rebuffed, showing the resistance of Member States to boost the present EU regulatory framework, which somehow combines transnationalism with supranationalism. The balance between these two principles is the result of a decade of reforms and reflects the perennial political tension between the single market and the political union ideal, leading to a system of checks and balances whereby elements of transnationalism mitigate those of supranationalism. Also the incompleteness of the Banking Union reflects a similar balance between 5.67 national interests and supranational ones. This is manifest in the case of banking crises, which in the absence of a common fiscal policy and of an EU deposit guarantee system have an impact mainly on the member States concerned.105 Similar comments can be made with respect to supervisory policies of the ECB, which might have an uneven impact in the various Member States depending on the differences between banking systems at a given time. For instance, the new strict supervisory policy on NPLs could negatively affect certain national banking systems because of the different economic conditions of the Member State concerned. No doubt, a deeper assessment should be made on the conditions under which a true supranational approach is preferable in the supervision of banks: one may wonder whether mid-level banks with national presence only would be more efficiently supervised by the SSM or by a national supervisor. It could be argued that a distinction might be made between the banks that have a substantial presence in different Member States and those having a national dimension only, as supranationalism may be a better solution for transnational banks than for purely domestic ones.

VI. Conclusion In this chapter we have analysed the single rulebook from the perspective of the 5.68 separation of EU banking regulation from prudential supervision focusing on the SSM. We argued, in particular, that banking regulation and supervision have been increasingly separated one from the other, reaching the apex in the EBU where EU and national rule-making are entirely decoupled from the SSM. We also

See, for practical examples, Chapter 12 in this volume. 105

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Guido Ferrarini and Fabio Recine argued that EU banking law is characterized by both regulatory polycentrism and supervisory centralization. The SSM centralizes supervision in the Eurozone with regard to significant banks, leaving rule-setting mainly to institutions other than the ECB and to national authorities. However, from a theoretical perspective, concentrating regulatory and supervisory powers in an independent institution would be preferable in terms of expertise, objectivity, and long-term planning of the relevant activities. 5.69 We then enquired whether the ECB should have more say in rule-making with

respect to the Eurozone. First, we highlighted the clear asymmetry between the ECB monetary and supervisory roles. As a banking supervisor, the ECB enjoys limited regulatory powers being rather subject to both Union law and national law. Moreover, the ECB is subject to the powers of the EBA as regards dispute settlement, emergency decisions, and breaches of EU law. In addition, it is subject to the procedures provided for by the CRR when implementing macroprudential measures. We concluded that the present EU regime for prudential regulation— which is characterized by maximum harmonization, several layers of regulation, multiple rule-makers, and excessively detailed rules—may be suboptimal for the SSM and hinder its flexibility.

5.70 We further argued that the present approach appears to be based on a narrow

reading of the Treaty and of the prerogatives of the Commission, the Council, and the Parliament as to legislative rule-making. A broader reading of the Treaty would allow the delegation of regulatory powers to the ECB in its role as a prudential supervisor. As a result, the ECB supervisory competences might be complemented by the possibility to adopt technical supervisory rules, leaving however key policy issues to be defined at political level by the Council and the EU Parliament.

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6 CRD IV FRAMEWORK FOR BANKS’ CORPORATE GOVERNANCE Peter O Mülbert and Alexander Wilhelm

I. Introduction II. Banking Structures in the European Union III. Historical Development IV. CRD IV Corporate Governance Standards

6.01 6.03 6.05

6.10 1. Key Features 6.10 2. Regulatory Concept 6.33 3. Neutrality in Form Regarding Fundamental Governance Structures 6.34 4. Leaving Shareholders Outside the Regulatory Perimeter 6.36 5. The Role of the Supervisor 6.38

V. Conceptual Concerns

6.46

1. The One-tier Board as the Underlying Regulatory Model 6.46 2. CRD IV Implementation Principles 6.56 3. Uncertain Regulatory Objectives 6.69 4. (Over-)Emphasis of Board Members’ Character 6.79 5. CRD IV, Board Decisions, and ‘Business Judgement’ 6.82

VI. Functional Concerns

6.87

1. Governance Failure Contributing to the Financial Crisis 2. Assessing CRD IV’s Response 3. Enhancing Proportionality: CRD V as a Turning Point?

6.102

VII. Conclusion and Outlook

6.106

6.88 6.91

I. Introduction The Capital Requirements Directive (CRD IV)1 has fundamentally transformed 6.01 the legal framework for European banks’ corporate governance.2 The

Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 [2013] OJ L176/338. 2 As to the very limited supplementary role of the Markets in Financial Instruments Directive II, Directive 2014/65/EU of 15 May 2014 [2014] OJ L173/349 (MiFID II) with respect to the governance framework of investment firms see, in particular, nn 27–8. 1

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Peter O Mülbert and Alexander Wilhelm Directive—together with the Capital Requirements Regulation (CRR)3 known as the ‘CRD IV package’4—introduced a variety of newly-designed standards with respect to banks’ organizational structures and rather strict requirements on the suitability and duties of board members, as well as detailed rules regarding banks’ remuneration policies and risk governance structures. 6.02 The following analysis and assessment of the Directive’s corporate governance

framework first offers a brief overview of banking structures in the European Union (Section II) and an overview of the development of EU harmonization of corporate governance in the financial sector, leading up to the current CRD IV framework (Section III). A subsequent more detailed description of the Directive’s corporate governance regime (Section IV) serves as the basis for an in-depth analysis of the various conceptual, ie technical (or legal) concerns raised by its framework (Section V). Section VI addresses functional concerns, ie raises the question whether the CRD IV standards will actually improve the quality of banks’ corporate governance in the European Union, taking account of recent approaches to enhance proportionality in particular. Finally, Section VII offers some concluding observations and an outlook.

II. Banking Structures in the European Union 6.03 EU harmonization of banks’ corporate governance standards should be well-

adapted to the structure of the European banking industry. Otherwise, necessary readjustments on the banks’ part could not only affect the competitive position of individual institutions but jeopardize entire pillars of the financial industry. Until today, however, aggregated data are neither readily available on the different types of organizational forms financial institutions can use in different EU Member States nor on the divergent governance structures particularly as regards the respective numbers of institutions with a single (one-tier) or dual (two-tier) board structure. Also, little information is available on the respective market shares of the various types of association in general and of publicly traded financial institutions (and groups) in particular.

3 Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 [2013] OJ L176/1. 4 The CRD IV package is one of the three sets of pan-EU-wide horizontal rules—the other two being the Bank Recovery and Resolution Directive, 2014/59/EU of 15 May 2014 [2014] OJ L173/ 190 (BRRD); and the Directive on Deposit Guarantee Schemes, 2014/49/EU of 16 April 2014 [2014] OJ L173/149 which underpin the Banking Union, ie the two mechanisms—the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM)—which transfer tasks and powers from national competent authorities upwards to the European Central Bank (ECB) (concerning the SSM) and the Single Resolution Board (SRB) (concerning the SRM).

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CRD IV Framework for Banks’ Corporate Governance Without doubt, though, the structure of domestic banking markets varies signif- 6.04 icantly among Member States. The German market, for example, traditionally displays the highest degree of fragmentation. According to the 2010 survey of the OECD Bank Profitability Statistic, that market consisted of 169 commercial banks (with five large commercial banks among them), 1,197 co-operative banks, 438 savings banks, twelve other (miscellaneous) monetary institutions, nineteen mortgage credit institutions, and seventeen development credit institutions. By contrast, the UK market landscape comprised just twenty-three large commercial banks, 338 other commercial banks, and sixty-one mortgage banks.5 Although the situation is currently changing to some extent given the trend towards banking consolidation in the EU in general and in Germany in particular,6 spurred by political calls for domestic as well as cross-border mergers and the proposed reduction of respective regulatory hurdles,7 a veritable alignment of the disparate market structures is still not in sight.8

III. Historical Development EU harmonization of corporate governance in the financial sector started off in 6.05 June 2006 with the recast Banking Directive 2006/48/EC. The Directive formed one part of the first Capital Requirements Directive (CRD I),9 implementing the

5 OECD, ‘Bank Profitability: Financial Statements of Banks, OECD Banking Statistics’, 2011, 246 (Germany), 606 (UK). With respect to the Eurozone, the ECB’s publication ‘List of supervised entities’ (as of 1 September 2018) corroborates that domestic market structures vary significantly. Note also the EBA’s aggregated statistical data on national banking sectors (available online at ); Peter O Mülbert, ‘Corporate Governance von Banken: Ein europäisches Konzept?’ (2014) 113 Zeitschrift für Vergleichende Rechtswissenschaft 520, 521; Michael Boss, Gerald Lederer, Naida Mujic, and Markus Schwaiger, ‘Proportionality in Banking Regulation’ (2018) Q2/18 Monetary Policy & the Economy 51, 54–7. 6 As to this trend, see Danièle Nouy, ‘Too Much of a Good Thing? The Need for Consolidation in the European Banking Sector’, speech at the VIII Financial Forum in Madrid, 27 September 2017 (available online at ); Christopher Cermak, ‘Europe’s Banking Consolidation Conundrum’ Handelsblatt Today, 6 May 2018 (available online at ). 7 See the Commission Proposal for a Directive of the European Parliament and of the Council amending Directive (EU) 2017/1132 as regards cross-border conversions, mergers and divisions, COM(2018) 241 final of 25 April 2018. Subject to a number of changes, the Proposal has been adopted by the European Parliament on 18 April 2019 (see online at ). 8 See Fernando Restoy, ‘The European Banking Union: What Are The Missing Pieces?’, public lecture at the International Center for Monetary and Banking Studies, 16 October 2018 (text available online at ),  3–6. 9 CRD I comprised two measures: the revised Banking Directive (2006/48/EC) and the revised Capital Adequacy Directive (2006/49/EC), both of 14 June 2006 [2006] OJ L177/1 and L177/ 201.

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Peter O Mülbert and Alexander Wilhelm revised Basel Capital Accord of 2004 (Basel II)10 into EU law.11 Pillar II of Basel II, which provides for the Supervisory Review Process (SRP) comprising the Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP),12 encouraged banks, as part of the ICAAP, to continuously improve both the adequacy of their capital and their internal procedures,13 given that ‘capital should not be regarded as a substitute for addressing fundamentally inadequate control or risk management processes’.14 Taking that idea somewhat further, Article 22(1) of the revised Banking Directive required banks to provide robust governance arrangements, including a clear organizational structure with well defined, transparent, and consistent lines of responsibility; effective risk management procedures; and adequate internal control mechanisms.15 These standards, in turn, were complemented by the Basel Committee’s paper on Enhancing Corporate Governance for Banking Organizations, first released in 1999 and revised in 2006, which drew on the earlier OECD Principles of Corporate Governance (1999 and 2004). 6.06 A first amendment to the CRD I corporate governance framework, introduced in

response to the financial crisis, dealt with remuneration policies. Directive 2010/ 76/EU of November 2010 (CRD III) supplemented Article 22(1) and Annex V of the revised Banking Directive in order to align remuneration policies with effective risk management. The relevant standards, based on earlier Recommendations of the EU Commission,16 already reflected the remuneration-related part of the 10 Basel Committee on Banking Supervision, ‘International Convergence of Capital Measurement and Capital Standards—A Revised Framework’, June 2004. 11 See Peter O Mülbert and Alexander Wilhelm, ‘Reforms of EU Banking & Securities Regulation after the Financial Crisis’ (2010) 26(2) Banking and Finance Law Review 187, 195; Mülbert (n 5),  522–3. 12 See Section IV(1)(C)(ii) (para 6.28ff). As to the principle-based regulatory approach of the SRP see in detail Peter O Mülbert and Alexander Wilhelm, ‘Risikomanagement und Compliance im Finanzmarktrecht— Entwicklung der aufsichtsrechtlichen Anforderungen’ (2014) 178 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht (ZHR) 502, 507. For current regulatory developments as regards the SREP in particular, see the EBA Guidelines on the revised common procedures and methodologies for the supervisory review and evaluation process (SREP) and supervisory stress testing, EBA/GL/2018/03 of 19 July 2018 (available online at ). These Guidelines, applicable as of 1 January 2019, are designed to amend and complement the former EBA Guidelines of 19 December 2014, EBA/GL/2014/13, providing a common framework for the work of supervisors in their assessment of risks to banks’ business models, their solvency, and liquidity. Assessment and analysis of banks’ business models and strategies are still relatively new features of EU banking supervision. According to the EBA, however, supervisors should neither undermine the responsibility of the institution’s management body for running and organizing the business nor indicate preferences for specific business models. See also the pioneering article by Peter Lutz, Christian Röhl, and Andreas Schneider, ‘Bankenaufsicht und Unternehmerische Entscheidungen’ [2012] Zeitschrift für Bankrecht und Bankwirtschaft (ZBB) 342. 13 For details, see Mülbert and Wilhelm, ibid, 506ff. 14 Basel Committee on Banking Supervision (n 10), para 723. 15 Revised Capital Adequacy Directive (2006/49/EC), art 34 extended the application of this rule to investment firms. 16 Recommendation 2009/384/EC of 30 April 2009 on remuneration policies in the financial services sector [2009] OJ L120/22.

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CRD IV Framework for Banks’ Corporate Governance Basel Committee’s Enhancements to the Basel II framework of July 2009 (so-called ‘Basel II plus’ or ‘Basel 2.5’), the FSB Principles for Sound Compensation Practices of April 2009, and the subsequent Implementation Standards of September 2009 which themselves were flanked by the Basel Committee Compensation Principles and Standards Assessment Methodology of January 2010. Alongside these legislative measures, the European Banking Authority (EBA), 6.07 mandated by Articles 11 and 22 of Directive 2006/48/EC, adopted Guidelines on Internal Governance in September 201117—consolidating, inter alia, former principles of the Committee of European Banking Supervisors (CEBS) of 2009– 201018—and on the assessment of the suitability of members of the management body and key function holders of November 2012.19 On the basis of CRD III, the CEBS had already issued Guidelines on Remuneration Policies and Practices in December 2010.20 Going forward, the European Commission’s Green Paper on Corporate 6.08 Governance in Financial Institutions and Remuneration Policies of June 201021 and its Feedback Statement of November 201022 introduced an even more comprehensive approach to the internal governance of banks. Most notably, these initiatives did not only address executive remuneration issues, but also the functioning of boards and their role in risk oversight, as well as the governance of risk management more generally, conflicts of interest, external auditors, and the role of shareholders.23 At an international level, the EU’s more comprehensive approach to bank’s corporate governance was quite in line with the Basel Committee’s October 2010 Principles for Enhancing Corporate Governance, an enhanced version of its 2006 paper on Enhancing Corporate Governance for Banking Organizations. Given the historical development, the current CRD IV framework serves two 6.09 main purposes. Firstly, it reorganizes well-established CRD-standards, including relevant post-crisis amendments, in consolidated form and with fewer options and derogations.24 Secondly, it supplements the SRP (Pillar II), which has

17 EBA Guidelines on Internal Governance (GL 44), 27 September 2011. 18 Ibid, I; Klaus J Hopt, ‘Corporate Governance of Banks and Other Financial Institutions after the Financial Crisis’ [2013] Journal of Corporate Law Studies 219, 230. 19 GL 2012/06 of 22 November 2012. 20 Available online at . 21 COM(2010) 284 Final; for critical observations see Peter O Mülbert, ‘Corporate Governance in der Krise’ (2010) 174 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht (ZHR) 375, 376–80. 22 European Commission, ‘Feedback Statement—Summary of Responses to Commission Green Paper on Corporate Governance in Financial Institutions’ (2010); see in detail Hopt (n 18), 225ff. 23 Hopt (n 18), 227. 24 See Niamh Moloney, ‘EU Financial Market Regulation after the Global Financial Crisis: “More Europe” or More Risks?’ (2010) 47 Common Market Law Review 1317, 1357.

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Peter O Mülbert and Alexander Wilhelm remained almost unaffected by the current Basel III framework,25 with ambitious corporate governance requirements.26 The result is a combination of a well- established risk-oriented supervisory mechanism (SRP) and an array of rather detailed and prescriptive rules of internal governance. More to the point, while Article 74(1)—an amended recast of Article 22(1) of Directive 2006/48/EC— still requires institutions to have ‘robust governance arrangements’, Article 74(2) provides for a crucial extension by requiring that, for the purpose of complying with the ‘robust governance arrangements’ requirement, the comprehensive governance framework of Articles 76 to 95—referred to as ‘technical criteria’—shall be taken into account.

IV. CRD IV Corporate Governance Standards 1. Key Features 6.10 The key features of the Directive’s corporate governance framework can be grouped

into three categories: organizational structure at entity level, personal requirements for board members, and board members’ specific duties and responsibilities.

A. Organizational Structure at Entity Level 6.11 A first set of rules deals with the organizational structure at entity level, or more precisely, the board structure of institutions (CRD IV, Article 3(1)(3)27), ie CRR credit institutions and CRR/MiFID II investment firms.28 They provide for rather 25 Basel Committee on Banking Supervision, ‘Basel III: A Global Regulatory Framework for more Resilient Banks and Banking Systems’, December 2010 (revised June 2011). See also Mülbert and Wilhelm (n 12), 543. 26 By contrast, the Basel Committee has only recently started to intensify its post-crisis work on banks’ corporate governance, notably by adopting its ‘Corporate Governance principles for banks’ of July 2015 (BCBS d328; available online at ) which seem to have impacted on the EBA’s recently revised Guidelines on Internal Governance (EBA/GL/ 2017/11 of 26 September 2017, latest version of 21 March 2018; applicable since 30 June 2018). 27 Referring to CRR, art 4(1)(3) which, in turn, comprises credit institutions (any undertaking ‘the business of which is to take deposits or other repayable funds from the public and to grant credits for its own account’ (CRR, art 4(1)(1)) and investment firms (CRR, art 4(1)(2)). In order to define investment firms, CRR, art 4(1)(2) refers to any person as defined in Directive 2004/39/ EC, art 4(1)(1) (ie the Markets in Financial Instruments Directive, MiFID I, [2004] OJ L145/1), which is subject to the requirements imposed by that Directive, excluding credit institutions, local firms as defined in CRR, art 4(1)(4) and a group of other specific firms. However, since MiFID II replaced MiFID I in May 2014, CRR, art 4(1)(2) must now be read as referring to the definition of investment firms laid down in MiFID II, art 4(1)(1) (‘any legal person whose regular occupation or business is the provision of one or more investment services to third parties and/or the performance of one or more investment activities on a professional basis’)—with the exception of those firms mentioned in CRR, art 4(1)(2)(a)–(c) of CRR. As to this rereading of CRR, art 4(1)(2) see MiFID II, art 94(2) and the correlation table of Annex IV. 28 For CRR/MiFID II investment firms, application of these organizational rules already follows from CRR, art 4(1)(3) in conjunction with CRD IV, art 3(1)(3) (for details see ibid). Hence, MiFID II, art 9(1) which stipulates that investment firms and their management bodies must

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CRD IV Framework for Banks’ Corporate Governance intrusive requirements for board organization and board composition. Particularly noteworthy are two elements: (1) Pursuant to Article 88(1)(e), the chairman of the ‘management body’ (or board)29 in its supervisory function must not simultaneously exercise the function of Chief Executive Officer (CEO) within the same institution, unless justified by the institution and authorized by competent authorities. In the UK, the separation of CEO and board chair has been widely practised for a long time, but is still controversial.30 (2) The Directive provides for the establishment of special board committees composed exclusively of non-executive members of the management body. Member States shall ensure that institutions set up a risk committee, a nomination committee, and a remuneration committee, provided they are ‘significant in terms of their size, internal organisation and complexity of their activities’.31 The ‘significance’ threshold is not specified in more detail, neither

comply with CRD IV, arts 88 and 91 is redundant with respect to CRR/MiFID II investment firms and only extends the regulatory perimeter for ‘pure’ (non-CRR) investment firms. Moreover, the last sentence of Recital 53 of the MiFID II (‘[i]‌n the interests of a coherent approach to corporate governance it is desirable to align the requirements for investment firms as far as possible to those included in Directive 2013/36/EU’) is misplaced at best. On the other hand, and of greater practical importance, MiFID II provides for a variety of derogations from and additions to the CRD IV governance regime, which apply to investment firms and also to credit institutions when providing investment services and/or performing investment activities, MiFID II, art 1(3)(a) and 1(4)(a). In the following, MiFID II-specific deviations from the CRD IV regime will be highlighted, where applicable. As to the nexus between CRD IV and MiFID II see also Niamh Moloney, EU Securities and Financial Markets Regulation (3rd edn, Oxford University Press 2014) 357–8. For more details of the MiFID II corporate governance regime, see Rik Mellenbergh, ‘MiFID II: New Governance Rules in Relation to Investment Firms’ (2014) 11 European Company Law 172; Danny Busch, ‘Corporate Governance of Financial Institutions According to CRD IV & MiFID II’, October 2017 (available online at ); Jens- Hinrich Binder, ‘Governance of Investment Firms under MiFID II’ in Danny Busch and Guido Ferrarini (eds), Regulation of the EU Financial Markets (Oxford University Press 2017), ch 3; same, ‘Governance of Financial Institutions: Comparative Analysis of Banks, Investment Firms, Asset Managers, and Pension Funds’ in Danny Busch, Guido Ferrarini, and Gerard van Solinge (eds), Governance of Financial Institutions (Oxford University Press 2019) 2.06ff. 29 See Section V(1)(A) (paras 6.46ff) for details. 30 Luca Enriques and Dirk Zetzsche, ‘Quack Corporate Governance, Round III? Bank Board Regulation Under the New European Capital Requirement Directive’, (2015) 16 Theoretical Inquiries in Law 211, 232; Klaus J Hopt, ‘Corporate Governance of Banks after the Financial Crisis’ in Eddy Wymeersch, Klaus J Hopt, and Guido Ferrarini (eds), Financial Regulation and Supervision (Oxford University Press 2012) 11.53. See also Mads Andenas and Iris H-Y Chiu, The Foundations and Future of Financial Regulation, Governance for Responsibility (Routledge 2014) 379; Kees Cools and Joris van Toor, ‘Why Did US Banks Fail? What Went Wrong at US Banks in the Run Up to the Financial Crisis’, February 2015, 10–11 (available online at ); Stephen M Bainbridge, ‘The Board of Directors’ in Jeffrey N Gordon and Wolf-Georg Ringe (eds), The Oxford Handbook of Corporate Law and Governance (Oxford University Press 2018), Ch 12, 5.4; Antoine Canet, ‘The Regulatory Corporate Governance Framework for Financial Institutions—A Critical Analysis of the Dodd-Frank and CRD IV Governance Provisions’, 31 August 2016 (available online at ),  10–13. 31 CRD IV, arts 76(3), 88(2), and 95(1).

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Peter O Mülbert and Alexander Wilhelm in the Directive itself nor in the recently recast EBA Guidelines on Internal Governance,32 which potentially allows for regulatory arbitrage across Member States.33 The German legislature, in transposing the Directive, stated that institutions may refrain from establishing the said committees if their supervisory body consists of less than ten members,34 even though the sheer number of board members does not necessarily correlate with the institution’s size or complexity.35 Details regarding the composition of committees are specified in the applicable EBA Guidelines, including the new Guidelines on internal governance36 and the Guidelines on sound remuneration practices of June 2016.37 For instance, each committee should be composed of at least three members which should not be members of another committee at the same time,38 and if employee representation on the management body is provided for by national law, the remuneration committee must include at least one employee representative.39 6.12 The Directive specifies the tasks and responsibilities of each committee in detail.

The tasks of nomination committees are listed in Article 88(2)(a)–(d). Most importantly, nomination committees shall identify and recommend candidates to fill management body vacancies, evaluate the balance of knowledge, skills, diversity and experience of the management body, decide on a target for the representation of the underrepresented gender, conduct periodical assessments, and review the policy for the selection and appointment of senior management.40 By contrast, the remuneration committee is responsible for the preparation of decisions regarding remuneration (Article 95(2))41 whilst the risk committee plays a significant role in monitoring the institution’s risk strategy and appetite (Article 76(3)).42

32 The new EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.1, No 39, merely emphasize that an institution’s significance must be determined ‘considering the individual, sub- consolidated and consolidated levels’. 33 See Malte Wundenberg, ‘Corporate Governance’ in Rüdiger Veil (ed), European Capital Markets Law (2nd edn, Hart Publishing 2017) §34, 680 (para 17). 34 See the explanatory memorandum to the German CRD IV Transposition Act (CRD IV- Umsetzungsgesetz), BT-Drucksache 17/10974, 88 (available online at ). 35 See also Wilhelm Wolfgarten in Karl-Heinz Boos, Reinfrid Fischer, and Hermann Schulte- Mattler (eds), KWG, CRR-VO, Vol I (5th edn, C H Beck 2016) §25d, para 87. 36 See the EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.2 in particular. 37 EBA Guidelines on sound remuneration policies under Article 74(3) and 75(2) of Directive 2013/36/EU and disclosures under Article 450 of Regulation (EU) No 575/2013, EBA/GL/2015/ 22 of 27 June 2016, designed to supersede the December 2010 CEBS Guidelines on Remuneration Policies and Practices (n 20), as of 31 December 2016. 38 EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.2, No 48–9. 39 EBA Guidelines on Sound remuneration policies (n 37), Title I, Ch 2.4.1, No 49. 40 For more details see the Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders under Directive 2013/36/EU and Directive 2014/65/EU, EBA/GL/2017/12 of 26 September 2017, applicable since 30 June 2018, Title VI, Ch 15, No 124–8. As to the nomination committee’s role in promoting board diversity in particular, see Section IV(1)(B)(iii) (para 6.21) below. 41 See Section IV(1)(C)(i) (paras 6.23ff). 42 See Section IV(1)(C)(ii) (paras 6.28ff).

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CRD IV Framework for Banks’ Corporate Governance In addition, institutions are required to establish audit committees. This follows 6.13 from Article 39 of Directive 2006/43/EC43 and the EBA Guidelines on Internal Governance.44 Article 76(3), sub-paragraph 4 of CRD IV takes that requirement as given by permitting non-significant institutions to combine their risk committee and their audit committee in a ‘combined committee’.45 The exception seems to be superfluous, though, since pursuant to Article 76(3), sub-paragraph 1 only significant institutions have to establish a risk committee. However, according to EBA’s ‘Single Rulebook Q&A’,46 even non- significant institutions may under certain circumstances be obliged to establish a risk committee ‘on the basis of proportionality under Article 74(2)’, in which case Article 76(3) may apply.47 Similarly, the EBA acknowledges that remuneration and nomination committees may (have to) be established in certain non-significant institutions, in which case the latter may under certain conditions combine the tasks of these committees with other tasks.48 Apart from that, both active co-operation between committees and the establishment of additional committees (such as ethics, conduct or compliance committees) are encouraged, where appropriate.49 B. Personal Requirements for Board Members The Directive posits ambitious personal requirements for both executive and non- 6.14 executive members of the board and its committees. While the qualification of bank board members has always been on the EU’s regulatory agenda,50 Article 91 extends the regulatory perimeter quite drastically by including the following aspects, each of which are further fleshed out in the supporting EBA Guidelines of September 2017:51 (i) individual and collective qualities of executive and non-executive board members;52 (ii) limitations on directorships; and (iii) board diversity. 43 Directive 2006/43/EC of 17 May 2006 on statuary audits of annual accounts and consolidated accounts [2006] OJ L157/87 (as amended). 44 EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.5. 45 See also ibid, Title II, Ch 5.6, No 64. 46 Available online at (Question ID: 2013_228). 47 See also the recently recast EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.6, No 65. 48 As regards remuneration committees, see the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 2.4, No 47; as regards nomination committees, see the EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.6, No 65. 49 As regards the former, see, for instance, the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 2.4.3, and Ch 5.2, No 101, or the new EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.4, No 61; as regards the latter, see the EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.1, No 41. 50 Hopt (n 30), 11.54. 51 Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40). 52 For investment firms in general see additionally MiFID II, art 9(4). Regarding a natural person licensed as an investment firm, MiFID II, art 9(6), sub-para 2 responds to the non-existence of a board by providing for an exception from the application of the board-specific requirements referred to in MiFID II, art 9(1) (ie CRD IV, art 88 (see Section IV(1)(A), paras 6.11ff) and CRD

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Peter O Mülbert and Alexander Wilhelm 6.15 i. Individual and Collective Qualities First and foremost, each individual board

member must be ‘fit and proper’, ie possess sufficient knowledge, skills, and experience to perform his or her duties (Article 91(1)). According to the EBA, the necessary assessment should consider a candidate’s ‘knowledge and skills attained through education, training and practice’, his or her ‘practical and professional experience gained in previous positions’ and the ‘knowledge and skills acquired and demonstrated by [his or her] professional conduct’.53 In addition, a detailed but non-exhaustive list of relevant skills is provided for in Annex II of the EBA’s Guidelines, including qualities like ‘authenticity’, ‘decisiveness’, ‘loyalty’, or ‘stress resistance’.54

6.16 At board level, Article 91(7) requires the management body in its entirety to

possess adequate collective knowledge, skills, and experience ‘to understand the institution’s activities, including the main risks’. According to the EBA, the management body should not only cover all areas of knowledge required for the institution’s business activities, but be able to take appropriate decisions considering the business model, risk appetite, strategy and markets in which it operates.55 More specifically, whilst board members performing managerial tasks should collectively have ‘a high level of managerial skills’, the management body in its supervisory function must merely display ‘sufficient management skills to organize its tasks effectively and to be able to understand and challenge the management practices applied and decisions taken’ by the bank’s managers.56

6.17 Moreover, board members shall at all times be of sufficiently ‘good repute’

(Article 91(1)). In order for competent authorities to assess this quality, Article 69 mandates the EBA to maintain a database for the exchange of information on administrative penalties.57 Indeed, criminal or administrative records may well disqualify a person from becoming a member of the board unless the ‘surrounding circumstances, including mitigating factors’, suggest otherwise.58 As regards character, Article 91(8) requires each individual to ‘act with honesty, integrity and IV, art 91) by mandating, in essence, alternative means to ensure the fitness and properness of the individuals concerned. 53 This pertains to theoretical and practical experience in banking-related areas in particular, including economics, accounting, law, and risk management: Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Title III, Ch 6, Nos 60, 62, and 64. 54 Ibid, Annex II: Skills. See also Danny Busch and Annick Teubner, Chapter 7 of this volume, Section VI(2)(A) (paras 7.29ff). 55 Ibid, Title III, Ch 7, No 68 and 70. 56 Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Title III, Ch 7, No 72. For details on the distinction between the management and the supervisory function, see Section V(1)(A) (paras 6.46ff) below. 57 See also CRD IV, Recital 39. 58 Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Title III, Ch 8, No 73ff. See also Danny Busch and Annick Teubner, Chapter 7 of this volume, Section VI(2)(C) (para 7.50).

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CRD IV Framework for Banks’ Corporate Governance independence of mind to effectively assess and challenge’ management decisions and to oversee decision-making.59 Whilst a candidate’s honesty and integrity may be affected by an unsuccessful business performance or financial difficulties,60 for instance, the EBA defines ‘independence of mind’—not to be confused with ‘being independent’61—as a ‘pattern of behaviour’ which is shown during discussions and required to make ‘objective and independent decisions’.62 The necessary skills include ‘courage’, ‘conviction’ or ‘being able to ask questions’.63 In addition, the EBA considers that a person’s failure to be ‘transparent, open, and co-operative in his or her dealings with competent authorities’ may well result in his or her disqualification.64 Although not explicitly provided for in the Directive, the EBA also assumes that 6.18 the management body in its supervisory function should comprise a sufficient number of ‘independent’ members, ie persons who do not have ‘any present or recent past relationships or links of any nature’ with the institution or its management that could compromise their objectivity or ‘reduce [their] ability to take decisions independently’.65 Controlling shareholders and managing board members of a parent entity, for instance, are generally deemed ‘not being independent’66 unless the institution demonstrates that the candidate’s ability ‘to exercise objective and balanced judgment and to take decisions independently are not affected by the situation’.67 Given that the EBA initially envisioned to deny the independence of such persons more or less altogether,68 the latter seems to be a concession to widespread concerns fostered in this regard, most notably since the participation of controlling shareholders and board members of a parent entity may well constitute an effective tool of board supervision in a group context.69 However, a number of national supervisors still decided to reject the EBA’s

For critical analysis, see Sections V(4) and (5) (paras 6.79ff). 60 Bankruptcy, negative credit records etc; see the Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Title III, Ch 8, No 77. 61 See para 6.18 below. See also ibid, Title III, Ch 9.1, No 80 vs No 81; Danny Busch and Annick Teubner, Chapter 7 of this volume, Section VI(2)(D) (para 7.52). 62 Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Title III, Ch 9.2, Nos 80 and 82ff. 63 Ibid, Title III, Ch 9.2, No 82(a). 64 Ibid, Title III, Ch 8, No 78(a). 65 For details see ibid, Title III, Ch 9.1, No 81, and Ch 9.3, Nos 88–93. 66 Ibid, Title III, Ch 9.3, No 91(a)–(b). 67 Ibid, Title III, Ch 9.3, No 92. 68 Consultation Paper on Joint ESMA and EBA Guidelines on the assessment of the suitability of members of the management body and key function holders under Directive 2013/36/EU and Directive 2014/65/EU, EBA/CP/2016/17 of 28 October 2016, Title III, Ch 18, Nos 123–4. 69 This holds true in dual board systems in particular. See, for instance, Susanne Kalss, ‘Plädoyer für Spielräume in den EU-Regelungen zur Unabhängigkeit von Aufsichtsratsmitgliedern’ (2017) 28 Europäische Zeitschrift für Wirtschaftsrecht (EuZW) 201– 2; Theodor Baums, ‘Unabhängige Aufsichtsratsmitglieder’ (2016) 180 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht (ZHR) 697, 702. 59

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Peter O Mülbert and Alexander Wilhelm Guidelines under Article 16(3) of Regulation (EU) 1093/201070 as far as board members’ independence is concerned: The German BaFin, for instance, not only considered the respective guidelines too extensive while ‘the intended supervisory added value is not evident’, but also argued that the CRD IV provided ‘no adequate legal basis for such rules’.71 6.19 Finally, institutions must devote adequate human and financial resources to in-

duction and training in order to promote the personal qualifications of their board members (Article 91(9)). According to the EBA, institutions should implement policies and procedures to see to the induction and training of board members both individually and collectively.72 For instance, all newly appointed members should receive key information one month after taking up their position at the latest, and the induction should be completed within six months.73

6.20 ii. Limitations on Directorships Board members need to commit sufficient time

to perform their functions (Article 91(2)). Relevant factors include the size, nature, scope and complexity of the institution’s activities, the respective member’s geographical presence and the travel time required for his or her assignment, or the number of meetings scheduled for the management body.74 Obviously related to this are the limitations on additional directorships contained in Article 91(3)– (6):75 Unless representing a Member State, members of the management body of an institution which is significant in terms of its size, internal organization, and the nature, scope, and complexity of its activities shall not hold more than: (a) one executive directorship and two non-executive directorships; or (b) four non- executive directorships at the same time (Article 91(3)).76 Article 91(4)–(5) and the supporting EBA Guidelines77 provide guidance on the calculation of such directorships, and subject to Article 91(6) competent authorities may authorize board members to assume one additional non-executive directorship.78 See Section IV(5)(C) (para 6.45) for further details on this mechanism. 71 See the compliance table published by ESMA and EBA concerning the Joint ESMA and EBA Guidelines of September 2017 (available online at ),  4–5. 72 Details are elaborated upon in the applicable Guidelines: ibid, Title IV. 73 Ibid, Title IV, Ch 10, No 95. 74 For more details see the Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Title III, Ch 4. 75 See also Enriques and Zetzsche (n 30), 236; Wundenberg (n 33), 682 (para 21). 76 See also Jaap Winter, ‘The Financial Crisis: Does Good Corporate Governance Matter and How to Achieve it?’ in Eddy Wymeersch, Klaus J Hopt, and Guido Ferrarini (eds), Financial Regulation and Supervision (Oxford University Press 2012) 12.27 (on the draft provisions); Hopt (n 18), 234. In the case of investment firms, however, competent authorities may authorize members of the management body to hold ‘one additional non-executive directorship than allowed in accordance with Article 91(3)’ of the CRD IV, see MiFID II, art 9(2). 77 Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Title III, Ch 5, No 105. 78 See also Wundenberg (n 33), 682–3 (paras 21–3). 70

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CRD IV Framework for Banks’ Corporate Governance iii. Board Diversity Board diversity is addressed in Article 91(10). Institutions and 6.21 their nomination committees79 are required to engage a broad set of qualities and competences when recruiting members to the management body and for that purpose need to put in place a special policy promoting diversity. According to the EBA, that policy should at least refer to a list of diversity aspects, including educational and professional background, gender, age, and geographical provenance. In addition, the diversity policy of significant institutions should include a quantitative target for the representation of the underrepresented gender and specify an appropriate timeframe within which the target shall be met.80 To facilitate the necessary pool of candidates, institutions are encouraged to also implement a diversity policy for lower hierarchical levels.81 All this is to tackle the phenomenon of ‘groupthink’. According to Recital 60, diversity as regards age, gender, geographical provenance, and educational and professional background fosters a variety of views and experiences which in turn helps facilitate independent opinions and improve the monitoring of management.82 C. Board Members’ Duties According to Article 88(1) of CRD IV, the management body defines, oversees, 6.22 and is accountable for the implementation of governance arrangements that ensure effective and prudent management of the institution. This implies effective oversight over senior management, but also a variety of operational tasks.83 Most notably, apart from, for example, compliance with the strict ‘Pillar I’-capital requirements stipulated by the CRR84 and the preparation of recovery plans (so-called ‘living wills’) under Article 5 of the BRRD,85 the management body is accountable for the implementation of sound remuneration policies and efficient risk governance (see below, i.–ii.). The latter includes the implementation of specific functions such as a risk management function and a compliance function.86

79 See Section IV(1)(A) (paras 6.11ff). 80 Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Title V, Ch 12, No 105. 81 Ibid, Title V, Ch 12, No 109. 82 See also ibid, Background and rationale, p 12, No 42; Danny Busch, ‘Corporate Governance of Financial Institutions According to CRD IV & MiFID II’, Preliminary Draft of 19 April 2016 (available online at ), 9. 83 See the EBA Guidelines on Internal Governance (n 26), Title II, No 20ff. 84 See CRR, arts 25ff and 92ff (as amended). See also Winter (n 76), 12.22–12.23 regarding duties of the management body and senior management under the CRR. 85 Subject to BRRD (n 4), art 5(1), sentence 2, recovery plans ‘shall be considered to be a governance arrangement within the meaning of Article 74 of Directive 2013/36/EU’. 86 In addition, in the case of investment firms and of credit institutions when providing investment services (MiFID II, art 1(3)(a) and (4)(a)), the board’s duties also encompass ‘the segregation of duties’ and ‘the prevention of conflicts of interest’ in a manner that ‘promotes the integrity of the market and the interest of clients’ (MiFID II, art 9(3)). MiFID II, art 9(3)(a)–(c) establishes a list of business standards which the board must define, approve, and oversee for the sake of the firm, concerning the firm’s organization (lit a), a policy ‘as to services, activities, products and operations offered’—most notably in accordance with the risk tolerance of the firm—(lit b) and ‘a remuneration policy of persons involved in the provision of services to clients (lit c)’.

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Peter O Mülbert and Alexander Wilhelm 6.23 i. Sound Remuneration Policies Among the CRD IV’s main objectives is to

ensure that institutions develop sound remuneration policies.87 For this purpose, Articles 92–95 establish a detailed catalogue of standards which need to be complied with on a consolidated basis, ie at group, parent company, and subsidiary levels, including branches and subsidiaries ‘established in offshore financial centres’ (Article 92(1) and Recital 67).88 The management body in its supervisory function must adopt and periodically review the adequacy of remuneration policies and oversee their implementation (Article 92(2)(c)). Relevant standards not only deal with pay governance, ie the organizational features of the decision-making process regarding remuneration, but foremost with pay design, ie the form, structure, and level of performance-based pay systems, in particular, building on earlier EU Commission Recommendations on remuneration policies in the financial sector89 and the already strict regime of CRD III.90

6.24 In a nutshell,91 the Directive intends to discourage risk-taking that exceeds the

level of institutions’ tolerated risk92 by requiring an appropriate balance between fixed and variable (ie performance-based) components of executive pay.93 This applies to senior management, but also covers ‘risk takers, staff engaged in control functions and any employee receiving a total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on their risk profile’ (Article 92(2)).94 Based on Article 94(2), the Commission adopted a delegated Regulation supplementing CRD IV as regards the identification of ‘risk takers’.95 87 See CRD IV, Recital 63. 88 See also the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 3, Nos 65–74 (‘Remuneration policies and group context’), and Ch 2.1, No 37. For recent legislation to delete CRD IV, art 92(1), however, see Section VI(3) (paras 6.102ff) below. 89 See Section III (paras 6.05ff). 90 See Section III (para 6.06). See also Winter (n 76), 12.25. The CRD III remuneration rules of 2010 were labelled ‘the world’s toughest restrictions on cash bonuses in banks’; for reference, see Moloney (n 24), 1363, fn 275; similarly European Parliament, ‘European Parliament Ushers in a New Era for Bankers’ Bonuses’, Press Release, 7 July 2010 (available online at ). For critical analysis of the CRD III regime, see Eilís Ferran, ‘New Regulation of Remuneration in the Financial Sector in the EU’ (2012) 9 European Company and Financial Law Review 1, 19–32. As to the evolution of the EU’s regulatory approach from ‘pay governance’ to ‘pay design’, see in detail Tom Dijkhuizen, ‘The EU’s Regulatory Approach to Banks’ Executive Pay: From “Pay Governance” to Pay Design’ (2014) 11 European Company Law 30. 91 For in- depth analysis, see Guido Ferrarini and Maria Cristina Ungureanu, ‘Executive Remuneration’ in Jeffrey N Gordon and Wolf-Georg Ringe (eds), The Oxford Handbook of Corporate Law and Governance (Oxford University Press 2018), ch 13, 4.4; Guido Ferrarini, ‘CRD IV and the Mandatory Structure of Bankers’ Pay’, ECGI Law Working Paper No 289/2015, April 2015 (available online at ); Moloney (n 28), 388–90. See also the EBA Guidelines on sound remuneration policies (n 37). 92 CRD IV, art 92(2)(a). 93 CRD IV, art 94(1)(f ). 94 See also the EBA Guidelines on sound remuneration policies (n 37), No 5; Winter (n 76), 12.25. 95 Commission delegated Regulation (EU) 604/2014 of 4 March 2014 [2014] OJ L167/ 30C, based on the respective EBA draft regulatory technical standard (EBA/RTS/2013/11) of 16

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CRD IV Framework for Banks’ Corporate Governance The assessment of individual performance and the calculation of respective remu- 6.25 neration as the regime’s key issues are subject to a variety of determinants (Article 94(1)). For example, institutions must take into account both financial and non-financial criteria (Article 94(1)(a)), set up a multi-year framework to ensure that assessment is based on long-term performance (Article 94(1)(b)), include adjustments for all types of current or future risks (Article 94(1)(k)), strike an appropriate balance between variable payments in cash and in non-cash instruments (Article 94(1)(l)), and provide for certain deferral (Article 94(1)(m)) and malus or clawback arrangements (Article 94(1)(n)).96 In particular, the ‘bonus cap’, introduced at the request of the European Parliament, 6.26 has been highly controversial.97 While CRD III merely required fixed and variable components of remuneration to be ‘appropriately balanced’,98 Article 94(1)(g) of CRD IV mandates that the variable component must not exceed a maximum ratio of 100% of the fixed component for each individual.99 Member States are free to set a lower maximum percentage, but may also permit the institution’s shareholders to approve a higher maximum ratio, provided the overall level of the variable component does not exceed 200% of the fixed component of total remuneration.100 In addition, the UK Financial Conduct Authority (FCA), invoking the proportionality principle referred to in Recital 66 of CRD IV, granted exemptions from the application of the bonus cap for smaller institutions and (investment) firms whose activities are less complex and non-systemic.101 Indeed, the recital stipulates that the Directive’s provisions on remuneration—such as the bonus cap—‘should reflect differences between different types of institutions in a proportionate manner’. Still, one may doubt whether the proportionality principle can serve as a justification to exempt certain types of institutions a priori from December 2013 (available online at ); critically Moloney (n 28), 389, fn 316. For more guidance on the identification process see the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 5. 96 See also the EBA Guidelines on sound remuneration policies (n 37), Title IV in particular. 97 Ferrarini (n 91), 34–8; Ferrarini and Ungureanu (n 91), 4.4. The United Kingdom, after having been outvoted in the final Council negotiations, challenged the cap before the ECJ: UK v Parliament and Council (Case C-507/13), 20 September 2013. In November 2014, however, the action was withdrawn following the Opinion of Advocate General Jääskinen delivered on 20 November 2014. See also Moloney (n 28), 390, fns 317 and 318; Dijkhuizen (n 90), 36; Andrew Johnston, ‘Preventing the Next Financial Crisis? Regulating Bankers’ Pay in Europe’ (2014) 41 Journal of Law and Society 6, 23–7. 98 See Annex V, Section 11 ‘Remuneration Policies’, para 23(l) of the revised Banking Directive as inserted by the CRD III. 99 CRD IV, art 94(1)(g)(i); see also Recital 65. 100 CRD IV, art 94(1)(g)(ii). Indeed, Belgium and the Netherlands set a lower maximum ratio of 50% and 20% respectively; see Ferrarini and Ungureanu (n 91), 4.4. For guidance on procedural aspects under CRD IV, art 94(1)(g)(ii), see also the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 2.2, No 42 and the EBA’s Single Rulebook Q&A (Question ID: 2014_1260) (available online at ). 101 See the FCA statement of 29 February 2016 (available online at ).

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Peter O Mülbert and Alexander Wilhelm the bonus cap. In line with this, the EBA maintains that the bonus cap should be applied indiscriminately to all relevant staff in institutions and subsidiaries,102 thereby suggesting that the question of whether or not the cap must be applied in principle is not subject to the proportionality principle.103 Similarly, in November 2016 the European Commission adopted a Proposal for a Directive amending CRD IV as regards certain exemptions from the remuneration requirements on grounds of proportionality, among other things, but refused to include potential exemptions from the bonus cap of Article 94(1)(g) in particular.104 6.27 The remuneration committee’s role is to prepare board decisions regarding re-

muneration (Article 95(2)).105 Most noteworthy, according to the last sentence, the committee has to take into account ‘the long-term interests of shareholders, investors and other stakeholders in the institution and the public interest’ when preparing decisions on remuneration.106 Apart from that, the committee directly oversees the remuneration of the senior officers in the risk management and compliance functions (Article 92(2)(f )).107 If no remuneration committee is established, the respective standards apply to the supervisory body in its entirety.108

6.28 ii. Risk Governance The Directive devotes a whole chapter to the internal risk

governance of institutions, putting the board centre stage. Pursuant to Article 76(1) the ‘management body’ has to approve and periodically review the strategies and policies for taking up, managing, monitoring, and mitigating risks, which includes the determination of the institution’s risk appetite.109 In addition, the Directive introduces an array of new, genuinely qualitative governance standards to the Pillar II-rulebook, thus going beyond existing risk governance- related (CRD I- III) regulations which— notwithstanding the qualitative, ie

EBA Guidelines on sound remuneration policies (n 37), Title II, Ch 8, No 72. 103 This was made even clearer in the EBA Consultation Paper on Draft Guidelines on sound remuneration policies (EBA/CP/2015/03) of 4 March 2015 (available online at ), Ch 8, No 72 (‘not subject to [the] proportionality principle’). 104 Commission Proposal for a Directive of the European Parliament and of the Council amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures, COM(2016) 854 final of 23 November 2016, art 1(16). For further details on this Proposal (including subsequent developments) see Section VI(3) (para 6.102ff). 105 As to organization and composition of the risk committee see Section IV(1)(A) (paras 6.11ff). 106 For critical assessment see Section V(3) (paras 6.69ff). 107 As to the role of these functions see Section IV(1)(C)(ii) (paras 6.28ff). For more details on the role of the remuneration committee in particular see the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 2.4.2, No 51–2. 108 EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 2.1, No 31 and Ch 2.4, No 48; EBA Guidelines on Internal Governance (n 26), Title II, Ch 3, No 33(c). 109 See also the EBA Guidelines on Internal Governance (n 26), Title II, Ch 1, No 20, 23; Winter (n 76), 12.21 (final bullet); Lodewijk van Setten, ‘Risk, Risk Management, and Internal Controls’ in Danny Busch, Guido Ferrarini, and Gerard van Solinge (eds), Governance of Financial Institutions (Oxford University Press 2019) 9.36ff. 102

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CRD IV Framework for Banks’ Corporate Governance organizational dimension of the ICAAP110—arguably focused on specific capital requirements supplementing Pillar I.111 At board level, the risk committee requirement presents the most obvious nov- 6.29 elty.112 The risk committee advises the board on the institution’s overall current and future risk appetite and strategy and assists in overseeing the implementation of strategies by senior management (Article 76(3), sub-paragraph 2). With regard to this task, the risk committee shall have adequate (direct) access to internal information (Article 76(4)) whilst its members shall have appropriate knowledge, skills, and expertise to fully understand and monitor the risk strategy and the risk appetite of the institution (Article 76(3), sub-paragraph 1). The details are specified in the revised EBA Guidelines on Internal Governance.113 In addition, institutions have to implement a specific risk management function, 6.30 independent of the operational and management functions, which shall have sufficient authority, stature, resources, and access to the management body (Article 76(5)).114 The board must appoint a head of the risk management function (Chief Risk Officer (CRO)) who shall be an ‘independent senior manager’ with distinct responsibility for that function (Article 76(5), sub-paragraph 4). According to the EBA, if the CRO is not at the same time a member of the management body,115 institutions should appoint an independent person ‘who has no responsibilities for other functions and reports directly to the management body’.116 However, the CRO should have the power to challenge decisions taken by the institution’s management, which may include a veto right.117 Where the nature, scale, and complexity of the institution’s activities do not justify a specially appointed person, another ‘senior person’ of the entity may fulfil that function, if there is no conflict of interest (Article 76(5), sub-paragraph 4).118 In addition, the CRO shall not be removed without prior board approval and must have direct access to the board if necessary (Article 76(5), sub-paragraph 5).

110 See Section III (paras 6.05ff). 111 Winter (n 76), 12.21. See also CRD IV, art 73. For a somewhat different take see Andenas and Chiu (n 30), 374–7 (with further references): the pre-crisis regulatory framework for risk management in financial institutions was ‘skeletal in nature’ (374), whereas the new (qualitative) corporate governance standards are ‘perceived to be the framework within which risk management [now] operates’ (375) and ‘in which leadership and emphasis can be provided to give risk management a new character and a key place in corporations’ (377). 112 See Section IV(1)(A) (paras 6.11ff). 113 EBA Guidelines on Internal Governance (n 26), Title II, Ch 5.4, No 60–2. 114 For details see the EBA Guidelines on Internal Governance (n 26), Title V, Ch 20, No 162–86. 115 This appears only to be an option in single board companies; see Section (V)(1)(A)(iii) (para 6.52). 116 EBA Guidelines on Internal Governance (n 26), Title V, Ch 20.5, No 184. 117 Ibid, Title V, Ch 20.5, No 185. 118 See also ibid.

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Peter O Mülbert and Alexander Wilhelm 6.31 Moreover, Article 108(2)– (3) of CRD IV requires parent undertakings and

subsidiaries of a banking group to comply with the requirements of Article 73 regarding the ICAAP on a consolidated basis, subject to the provisions of Part One, Title II, Chapter 2, Sections 2 and 3 of the CRR. This is supported by the revised EBA Guidelines on Internal Governance, mandating parent institutions to ensure that governance arrangements, processes and mechanisms are consistent and well integrated on a consolidated and sub-consolidated basis.119/120 Institutions must implement ‘group-wide governance policies’ and establish a group-wide risk management function (‘group RMF’) in order to deliver a holistic view of all risks, including those of subsidiaries, and develop a group-wide risk strategy.121 This requires efficient interaction between the entities concerned, including an intra-group exchange of data and information in particular.122 As a consequence of the so-called ‘Panama events’,123 the EBA also expects the management body to be aware of the risks that can be triggered by complex and opaque corporate structures and to improve transparency especially in a group context (‘know your structure’).124

6.32 Finally, also according to the EBA Guidelines on Internal Governance, institutions’

risk governance must include a ‘permanent and effective compliance function’ to manage their specific compliance risks125 and to implement a compliance policy.126 The head of the compliance function (Compliance Officer, Head of Compliance) shall be responsible for this function across the entire institution and group; subject to the size and complexity of the institution, the compliance function may be combined with or assisted by the risk control function.127 Another supporting role is

EBA Guidelines on Internal Governance (n 26), Title III, Ch 7, No 82. 120 See also the former EBA Guidelines on Internal Governance of September 2011 (n 17), Ch 25.3,  38–9. 121 Ibid, Title V, Ch 20, No 168. 122 For details see ibid, Title III, Ch 7, No 82–9, Title III, Ch 6.2, No 74, and Title V, Ch 19.4, No 161. 123 Cf Lawrence J Trautman, ‘Following the Money: Lessons from the Panama Papers, Part 1: Tip of the Iceberg’ (2017) 121 Penn State Law Review 807; James O’Donovan, Hannes F. Wagner, and Stefan Zeume, ‘The Value of Offshore Secrets—Evidence from the Panama Papers’, Working Paper of 19 October 2018 (available online at ). 124 See the revised EBA Guidelines on Internal Governance (n 26), Title III, Ch 6.2–6.3, No 70–81; EBA press release of 26 September 2017 (available online at ). 125 Compliance risks can be defined as the current or prospective risks to earnings and capital arising from violations or non-compliance with laws, rules, regulations, agreements, prescribed practices, or ethical standards which can lead to fines, damages and/or the voiding of contracts, and can diminish an institution’s reputation: see the former EBA Guidelines on Internal Governance of September 2011 (n 17), III, Title II, No 28(2) (no longer included in the current EBA Guidelines of March 2018 (n 26)). 126 EBA Guidelines on Internal Governance (n 26), Title V, Ch 21, No 187–96. 127 Ibid, Title V, Ch 19.3, No 159, Ch 20.5, No 184, and Ch 21, No 188–9. In detail Mülbert and Wilhelm (n 12), 523. 119

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CRD IV Framework for Banks’ Corporate Governance assigned to the internal alert (or ‘whistleblower’) procedures which institutions must install under Article 71(3) of CRD IV.128 Although the Directive does not explicitly address the compliance function, it implies its existence in Article 92(2)(f ).129 In a group context, the EBA expects institutions to also ensure compliance with applicable laws and regulations within branches and subsidiaries.130 2. Regulatory Concept The CRD IV corporate governance framework, in conceptual terms, rests on four 6.33 cornerstones. Although not explicitly highlighted in the Directive, these can be derived from the design of its key features131 and may be summarized as follows: (1) The Directive, while intending to embrace all existing governance structures used across Member States ‘without advocating any particular structure’,132 builds on the regulatory model of credit institutions and investment firms with a single board structure (one-tier board).133 (2) The regulatory method is to establish a mandatory framework of corporate governance standards indiscriminately applicable to all types of association employed in the EU financial industry. Transposition into national law, thus, requires the modification of the existing regulation of domestic legal forms, for example as regards national codes of company law, mostly by way of adding more stringent rules. (3) As regards the main objective of regulation, three separate goals of somewhat unclear relationship to each other can be identified:134 risk mitigation in financial institutions, stabilization of the EU financial market, and the promotion of public interest more generally. (4) The underlying philosophy of regulation follows two principles: – more regulation is better regulation (at least if the principle of proportionality is observed); and – character is the key to good corporate governance at board level (but money ruins everything, first and foremost character).

128 For details see the EBA Guidelines on Internal Governance (n 26), Title IV, Ch 13–4; cf also Andenas and Chiu (n 30), 383; Mülbert and Wilhelm (n 12), 524. 129 See also Section IV(1)(C)(i) (para 6.27). The ‘Internal Audit function’ subject to the EBA Guidelines on Internal Governance (n 26), Title V, Ch 22, No 197–207, which is to assess the quality of an institution’s risk management and compliance framework as a ‘third line of defence’, is not mentioned explicitly in the CRD IV. In addition, investment firms and credit institutions when offering investment services must also comply with the organizational requirements laid down by MiFID II, art 16 and most notably by art 16(2) which is an identical recast of former MiFID, art 13(2). Subject to the corresponding art 6(2) of the so-called ‘MiFID Implementing Directive’ 2006/ 73/EC of 10 August 2006 [2006] OJ L241/26 (which is still in force) this entails establishing and maintaining a permanent and effective compliance function in order to address the specific risks and issues of investment services. For more details see Mülbert and Wilhelm (n 12), 544–5. 130 EBA Guidelines on Internal Governance (n 26), Title V, Ch 21, No 196. 131 See Section IV(1) (paras 6.10ff). 132 For more details see Section IV(3) (paras 6.34ff). 133 See Winter (n 76), 12.21: ‘Definitions only encompass one-tier boards and are not easily applicable to two-tier board systems’. As to respective conceptual problems see Section V(1) (paras 6.46ff). 134 This also leads to problems, see Section V(3) (paras 6.67ff).

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Peter O Mülbert and Alexander Wilhelm 3. Neutrality in Form Regarding Fundamental Governance Structures 6.34 The CRD IV corporate governance framework is formally neutral with respect to

the fundamental organization and governance structures of financial institutions. Harmonization of legal forms available to banks in Member States is not explicitly required—for obvious political reasons. Consequently, although the Directive does refer at scattered places to national ‘company’ law or principles of ‘corporate’ governance,135 this should not be read as an implicit restriction to specific forms of association, such as stock corporations or other limited companies—thereby excluding, for example, limited or unlimited private partnerships, public legal persons, or co-operative banks—but as inaccurate wording. Likewise, the Directive is agnostic about whether a bank is set up with a view to profit maximization or to pursue a charitable (ie ‘not-for-profit’) purpose.

6.35 As regards banks’ internal governance structure at board level, CRD IV, Recital

55136 acknowledges that different governance systems—in most cases a unitary or dual board structure—are in use across Member States. With regard to that, the Directive clarifies that the definitions presented in Article 3(1)—most notably ‘management body’ (Article 3(1)(7)) and ‘management body in its supervisory function’ (Article 3(1)(8))—are ‘intended to embrace all existing structures without advocating any particular structure’ and ‘are purely functional for the purpose of setting out rules aimed at a particular outcome irrespective of the national company law’. They ‘should therefore not interfere with the general allocation of competences in accordance with national company law’.137 In addition, as regards suitable candidates for senior management and the management body in its managerial function,138 only non-natural persons are explicitly excluded (Article 3(1)(9)). 4. Leaving Shareholders Outside the Regulatory Perimeter

6.36 As a somewhat logical consequence of the Directive’s indiscriminate approach to

legal forms139 shareholders—or, as the case may be, partners of partnerships or guarantors of public legal persons—and their respective representative bodies (eg shareholder meetings) remain largely outside the scope of the CRD IV governance framework. The obvious exception is the set of rules on the notification and assessment of proposed acquisitions of qualifying holdings in a credit institution140

135 eg CRD IV, Recitals 54 and 55. 136 MiFID II, Recital 55 is an identical copy. 137 Cf also the recently revised EBA Guidelines on Internal Governance (n 26), Part 2, No 8. 138 As to the congruency of these functions in two-tier board systems, see Section V(1)(A)(iii) (para 6.51). 139 See Section IV(3) (para 6.34). 140 With respect to investment firms the corresponding provisions are laid down in MiFID II, arts  10–13.

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CRD IV Framework for Banks’ Corporate Governance (Articles 22 to 27), including competent authorities’ power to oppose such acquisitions. A second, indirect exception is of limited importance. If, for instance, the national law of partnerships requires at least one unlimited partner to take on a leading role in the association’s management, as is the case under the German Commercial Code (Handelsgesetzbuch) principle of Selbstorganschaft,141 then these partners (or, if they are themselves legal persons, their representatives142) qualify as members of the institution’s management body in its managerial function and must therefore comply with the respective requirements under Article 91.143 The CRD IV’s limited scope regarding shareholders was already indicated by 6.37 the European Commission’s Green Paper of June 2010.144 The Green Paper both acknowledged that the lack of banks’ shareholder engagement had contributed to the financial crisis and that the problem was not specific to banks’ shareholders but was a consequence, inter alia, of investor portfolio diversification and, hence, merited broader investigation. This resulted in the more comprehensive Commission Green Paper ‘EU Corporate Governance Framework’ of 5 April 2011145 which focuses on the role of (institutional) shareholders in European companies more generally, thereby paving the way to the April 2014 Commission Recommendation on the quality of corporate governance reporting (‘comply or explain’)146 and Directive (EU) 2017/828 of 17 May 2017 amending the 2007 Directive on shareholder rights (2007/36/EC).147 Subject to the latter, Articles 3g and 3h of the amended Directive 2007/36/EC will enhance shareholder engagement as of 10 June 2019 at the latest148 by requiring institutional investors of listed companies to develop both an ‘engagement policy’ and an ‘investment strategy’ and to disclose certain aspects to the public. In addition, according to Article 9a of the amended Directive, shareholder engagement shall be fostered by a binding ‘say on pay’—unprecedented at EU level149— requiring listed companies to put their remuneration policies to a shareholder For reference see Mülbert and Wilhelm (n 12), 541. 142 See Frank A Schäfer in Karl-Heinz Boos, Reinfrid Fischer, and Hermann Schulte-Mattler (eds), KWG, CRR-VO, Vol I (5th edn, C H Beck 2016) §1, para 212. 143 See Section IV(1)(B) (paras 6.14ff). 144 COM(2010) 284 Final; see Section III (para 6.08). 145 COM(2011) 164 Final. 146 Commission Recommendation 2014/208/EU of 9 April 2014. 147 Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 [2017] OJ L132/1. See also Mülbert (n 5), 525. 148 Transposition deadline; see Directive (EU) 2017/828 of 17 May 2017, art 2(1). 149 At national level, some EU Member States have been subjecting banks’ remuneration policies to a binding shareholder vote for years. See, for instance, respective legislation enacted in the UK (‘Directors’ Remuneration Reforms’ taking effect 1 October 2013) and in Sweden (pursuant to a 2006 amendment to the Swedish Companies Act). From a comparative perspective see Ferrarini and Ungureanu (n 91), 3.2.2; Ricardo Correa and Ugur Lel, ‘Say On Pay Laws, Executive Compensation, Pay Slice, and Firm Valuation Around the World’, Journal of Financial Economics 122 (2016) 500–20; Randall S Thomas and Christoph Van der Elst, ‘Say on Pay Around the World’, Vanderbilt Law and Economics Working Paper No 14–10, 20 January 2014 (available online at ) passim. 141

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Peter O Mülbert and Alexander Wilhelm vote.150 5. The Role of the Supervisor 6.38 With the perimeter of banking regulation expanding, the role of supervisors both

at EU and national level becomes ever more important. First and foremost, this holds true for the EBA’s role in shaping the CRD IV regulatory framework with draft technical standards, guidelines, and recommendations on specific issues (see Section A below), but it also applies to Member States’ authorities being mandated with the enforcement of CRD IV’s new, largely intensified sanctions regime (see Section B below). As regards supervision within the SSM in particular, however, guidelines adopted by the EBA may overlap with the supervisory practice of the European Central Bank (see Section C below).

A. EBA Guidelines 6.39 In order to ensure consistency of supervisory practices and outcomes across the EU,151 CRD IV provides for central calibration of requirements by entrusting the EBA with developing draft technical standards, guidelines, and recommendations. The number of EBA mandates in CRD IV is significant,152 illustrating the pivotal role assigned to the EBA in the supervisory architecture of EU banking regulation.153 6.40 Regarding the CRD IV corporate governance regime, in particular, the EBA

is mostly tasked with issuing guidelines. Article 74(3) provides for the EBA’s most comprehensive mandate, pointing to guidelines on banks’ governance arrangements, risk management, and internal control mechanisms.154 Article 75(2) requires the EBA to adopt guidelines on sound remuneration policies, taking into account the 2009 Commission Recommendations155 and co-operating closely with the European Securities and Markets Authority (ESMA). Perhaps most importantly,156 Article 91(12) mandates the EBA157 to issue guidelines on various requirements applicable to the management body (Article 91),158 including the

150 See Section V(3)(B) (para 6.77). 151 See CRD IV, Recitals 10, 11, and 13. 152 See arts 8(2)–(4), 22(9), 35(5)–(7), 36(5)–(7), 39(4)–(6), 50(6)–(8), 51(4)–(6), 77(4), 78(7)–(9), 94(2), 113(5), 116(4)–(5), 131(18), 140(7), and 143(3) (draft technical standards); arts 74(3), 75(2), 78(6), 91(12), 94(1)(g)(iii) sub-para 2, 100(2), 101(5), and 107(3) (guidelines); arts 78(6) and 86(3) sub-para 5 (recommendations). 153 See, for instance, CRD IV, Recital 11: EBA’s ‘legally binding mediation role is a key element’; cf also more generally Elke Gurlit, ‘The ECB’s Relationship to the EBA’ [2014] EuZW-Beilage 14,  16–17. 154 See Section IV(1)(C)(ii) (paras 6.28ff). 155 See Section III (para 6.06). 156 See Section V(4) (paras 6.79ff). 157 Jointly with the ESMA: see MiFID II, art 9(1) sub-para 2. 158 See Section IV(1)(B) (paras 6.14ff).

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CRD IV Framework for Banks’ Corporate Governance notions of sufficient time commitment, adequate collective knowledge, skills and experience, honesty, integrity, independence of mind, and diversity. Insofar as EBA guidelines interpret the CRD IV corporate governance standards, 6.41 they become a part of the Single Rulebook.159 For instance, this holds true for the recently revised EBA Guidelines on Internal Governance,160 the EBA Guidelines on sound remuneration practices,161 and the Joint ESMA and EBA Guidelines on the assessment of suitability of members of the management body and key function holders.162 A comprehensive catalogue of all relevant Guidelines is published and regularly updated on the EBA’s website.163 B. Sanctions Regime The Directive devotes an entire section (Articles 64 to 72) to the supervisory 6.42 powers of competent authorities, including the imposition of administrative penalties and other administrative measures. Their nature is being prescribed in great detail,164 as are the circumstances in which they are applied165 and the procedures through which they are imposed.166 The regime is rather draconian, being designed ‘to ensure the greatest possible scope for action following a breach and to help prevent further breaches’.167 Detailed EU harmonization of sanctions is a relatively new feature; in the past, sanctions were merely subject to the ECJ- mandated requirement that they be adequate and sufficiently dissuasive.168 As regards specific violations of the Directive’s governance regime, a first set 6.43 of provisions concerns the rules on the acquisition and disposal of qualifying holdings.169 In addition, a rather general provision deals with institutions’ failure to establish prudential governance arrangements pursuant to Article 74170 and a further provision with institutions for allowing ‘one or more persons not complying with Article 91 to become or remain a member of the management 159 Cf Eilís Ferran, ‘The Existential Search of the European Banking Authority’ (2016) 17 European Business and Organization Law Review 285, 294–9. 160 EBA/GL/2017/11 of 21 March 2018 (n 26). 161 EBA/GL/2015/22 of 27 June 2016 (n 37). 162 EBA/GL/2017/12 of 26 September 2017 (n 40). 163 Available online at . 164 See the catalogues in CRD IV, arts 66(2) and 67(2) in particular. 165 CRD IV, arts 66(1) and 67(1). 166 See, for instance, CRD IV, art 68 with respect to post-imposition publication of administrative penalties, including the identity of the natural or legal person on whom the penalty is imposed (so-called ‘naming and shaming’). 167 CRD IV, Recital 41. 168 Niamh Moloney, ‘Resetting the Location of Regulatory and Supervisory Control Over EU Financial Markets: Lessons From Five Years On’ (2013) 62 International & Comparative Law Quarterly 955, 963. 169 CRD IV, arts 66(1)(c)–(d) and 67(1)(b)–(c). As to those rules see Section IV(4) (paras 6.36–7). 170 CRD IV, art 67(1)(d).

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Peter O Mülbert and Alexander Wilhelm body’.171 In such cases, institutions may not only lose their authorization,172 but can be fined up to the per cent of their total annual net turnover,173 whereas natural persons involved may face pecuniary penalties of up to €5m.174 6.44 However, penalizing institutions for violations of Article 91 may cause frictions

if domestic company law assigns exclusive responsibility for the appointment of (supervisory) board members to the shareholders—possibly subject to domestic rules on employee representation,175 as in Germany.176 In such situations, to sanction the legal person for organizational shortcomings is to hold it responsible for shareholder misbehaviour. This presents a problem for those jurisdictions that hold a legal person liable solely for the misconduct of senior management and similar representatives.177

C. The Role of the European Central Bank 6.45 For those entities under direct supervision by the European Central Bank (ECB), such as significant institutions within the meaning of Article 6(4) of the SSM Regulation178 in particular,179 relevant EBA Guidelines may overlap with the supervisory practice of the ECB. As regards the assessment of board members’ suitability (‘fit and proper’ test), for instance, the ECB recently adopted guidelines of its own180 in order to complement the respective EBA and ESMA requirements.181

CRD IV, art 67(1)(p). 172 See CRD IV, art 18(c) in conjunction with art 13(1), sub-para 2 (concerning violations of art 91(1)). 173 CRD IV, art 67(2)(e). Member States may even provide for higher administrative pecuniary penalties than those referred to in CRD IV, arts 66(2) and 67(2): see EBA’s Single Rulebook Q&A (Question ID: 2013_410) (available online at ). 174 CRD IV, art 67(2)(f ). See also Wundenberg (n 33), 686 (paras 29–31). 175 For details in a comparative perspective see Stefan Grundmann, European Company Law— Organization, Finance and Capital Markets (2nd edn, Intersentia 2012) §12(19)ff. 176 As regards the settlement of conflicts between domestic (company) law and the corporate governance rules of CRD IV in particular see Section V(2) (paras 6.56ff). 177 See, for instance, the general s 31 of the German Civil Code (Bürgerliches Gesetzbuch) and s 30(1) of the German Code on Regulatory Offences (Ordnungswidrigkeitengesetz). Their wording limits a legal person’s liability under both private and public law to the misconduct of senior management (Vorstand) and similar representatives. 178 Council Regulation (EU) 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2013] OJ L287/63. 179 As regards licensing or decisions on the acquisition of qualifying holdings, the ECB mandate also covers the supervision of less significant institutions (LSIs): SSM Regulation, arts 14, 15. See also Kern Alexander, ‘The European Central Bank and Banking Supervision: The Regulatory Limits of the Single Supervisory Mechanism’ (2016) 13 European Company and Financial Law Review 467, 476. 180 ECB Guide to fit and proper assessments of May 2017, revised in May 2018 (both versions available online at ). 181 Joint EBA and ESMA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40); see Section IV(1)(B) (paras 6.14ff) above. See also Danny Busch and Annick Teubner, Chapter 7 of this volume. 171

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CRD IV Framework for Banks’ Corporate Governance Although this may prima facie seem like an encroachment on the EBA’s regulatory powers,182 the ECB guide, by its own account, merely provides explanations on the processes conducted by the ECB and specifies its main expectations when conducting suitability assessments.183 This is in line with the general legal framework, given that fit and proper supervision is one of the fields of competence for which the ECB has exclusive responsibility under Article 4(1)(e) of the SSM Regulation, including a power to adopt guidelines pursuant to Article 4(3)(2). In fact, in its capacity as single supervisor within the SSM, the ECB would even be entitled to deviate from the EBA’s Guidelines if it applied the ‘comply or explain’ mechanism in accordance with Article 16(3) of Regulation (EU) 1093/2010.184 The latter, however, is currently not intended.185

V. Conceptual Concerns 1. The One-tier Board as the Underlying Regulatory Model A. Divergences in Scope and Application As noted earlier,186 the Directive is intended to embrace all existing governance 6.46 structures without advocating any particular system, but, in fact, builds on the model of one-tier board corporations. A number of provisions are illustrative of this feature. Most notably, apart from the fact that the separation of CEO and board chair187 has never been an issue in dual board systems,188 the key definitions of ‘management body’—‘management body in its supervisory function’—and ‘senior management’ presented in Article 3(1)(7)–(9) of CRD IV are clearly tailored to one-tier board structures and cannot easily be applied to dual boards.189 This imbalance leads to unresolved divergences between one-tier and two-tier board systems as regards the application of several corporate governance requirements.

See Section IV(5)(A) (paras 6.39ff). 183 ECB Guide to fit and proper assessments, revised version of May 2018 (n 180), 2.3 (p 6); cf also Peter Henning and Evgenia Gissing, ‘Eignungsprüfung für Aufsichtsratsmitglieder von Instituten gemäß der Leitlinien der Europäischen Aufsichtsbehörde’ (2018) 63 Die Aktiengesellschaft (AG) 925, 932–933, 935. 184 Regulation (EU) 1093/2010 of 24 November 2010 [2010] OJ L331/12. In this respect, the ECB is to be treated like any competent Member State authority. Cf also Marta Simoncini, Administrative Regulation Beyond the Non-Delegation Doctrine—A Study on EU Agencies (Hart Publishing 2018) 128; Wundenberg (n 33), 681–2 (paras 19–20); Danny Busch and Annick Teubner, Chapter 7 of this volume, Section V(2) (paras 7.24ff). 185 See the ECB Guide to fit and proper assessments, revised version of May 2018 (n 180), 2.3, 6. 186 See Section IV(2) (para 6.33). 187 CRD IV, art 88(1)(e); Section IV(1)(A) (para 6.11). 188 On the contrary, it is a key feature of such systems that a person may not at the same time be a member of both the managing board and the supervisory board. 189 Winter (n 76), 12.21; Wundenberg (n 33), 678–9 (para 13); Mülbert (n 5), 526–8. 182

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Peter O Mülbert and Alexander Wilhelm 6.47 i. Member States’ Implementation Options: Article 3(2) The Directive

anticipates the implementation difficulties due to the existence of different board structures and confers ample regulatory discretion on Member States. Given that various provisions simply impose executive and/or supervisory duties on ‘the management body’ (board) without further specifying which one of the two bodies is to be addressed in a dual board structure, Article 3(2) stipulates that if, pursuant to national law, the ‘managerial and supervisory functions’ of ‘the management body’ are assigned to different bodies, the Member State shall identify the bodies responsible ‘in accordance with its national law, unless otherwise specified by the Directive’. Member States are thus free to determine the pertinent bodies (or members of bodies) that must comply with the respective CRD IV standards, which is to ensure effective—and hence consistent—transposition into national law.190 The few provisions that ‘specify otherwise’, ie with respect to the requirements on the ‘management body in its supervisory function’,191 require Member States, with respect to their two-tier organizational forms, to address the supervisory board. Moreover, management bodies’ risk, remuneration and nomination committees must always be established at supervisory board level, given that the committee members have to be non-executives.192

6.48 ii. Remaining Conceptual Inconsistencies Upon closer inspection, Article

3(2) does not avoid all conflicts associated with the Directive’s regulatory model. Contrasting Article 3(1)(7) on the one hand with Recital 56 on the other, frictions remain as a consequence of the Directive’s inconsistent definition of the management body’s executive duties.

6.49 Pursuant to Article 3(1)(7) ‘management body’ means:

an institution’s body or bodies, which are appointed in accordance with national law, which are empowered to set the institution’s strategy and overall direction and which oversee and monitor management decision-making, and include the persons who effectively direct the business of the institution.

According to this definition, the management body is a key figure, but not responsible for day-to-day management, notwithstanding the presence of executive directors among its members. Instead, senior management is responsible for day- to-day management (Article 3(1)(9)). This concept is perfectly in line with one- tier board systems. By contrast, Recital 56 encompasses the specific perspective of dual board systems, emphasizing that in such systems the ‘management board’, as the ‘executive function’ of the management body, is indeed ‘responsible and accountable for the day-to-day management of the undertaking’. The Directive,

Cf also the EBA Guidelines on Internal Governance (n 26), Part 2, No 9. 191 CRD IV, arts 76(4)–(5), 88(1)(e), and 92(2)(f ). 192 See Section IV(1)(A) (para 6.11). 190

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CRD IV Framework for Banks’ Corporate Governance hence, implies that the combined executive duties of a two-tier management body exceed those of its one-tier counterpart quite significantly. Obviously, the Directive’s biased focus on the relationship between management 6.50 body and senior management193 is of limited help in dual board systems. In such systems, the relationship between managing board and supervisory board is crucially important, which is why one would expect the Directive to elaborate on the role and duties of the management body (and its members) ‘in its managerial functions’, too. The latter, however, is only briefly mentioned in Article 76(5), sub-paragraph 3 of CRD IV. iii. Consequences As a consequence of the inconsistencies described, the scope 6.51 and application of some corporate governance standards diverge for one-tier and two-tier board structures. (1) In a dual board structure the management board, through its members, is ‘responsible and accountable’ for day-to-day management of the undertaking (Article 3(1)(9)) and, hence, performs the executive function of the management body referred to in Recital 56.194 Consequently, the board-specific requirements of Article 91195 not only apply to members of the supervisory board, ie the ‘management body in its supervisory function’, but to all the members of senior management, too. By contrast, in a one-tier board structure the management body is not tasked with day-to-day management. It follows that only members of senior management who are also members of the management body, namely the executive directors, are subject to Article 91. (2) In turn, the group of natural persons covered by the definition of ‘senior management’ in a two-tier board structure is smaller than in a one-tier board structure. Pursuant to Article 3(1)(9), senior management comprises those executives of an institution who are accountable to the management body for day-to-day management or, more precisely, who are subject to oversight by the ‘management body in its supervisory function’ (Article 3(1)(8)). In dual board systems, the supervisory function is performed by the supervisory board, as identified by the Member State under Article 3(2). Given that in a dual board structure only members of the managing board are accountable to the supervisory board, whereas lower-ranked individuals with executive duties are solely subject to direct oversight by the managing board, it follows that with respect to a dual board structure the term ‘senior management’ only covers members of the managing board and excludes lower-ranked executives.196 By contrast, senior management in a one-tier board structure may well comprise not only executive directors, but also high-ranking non-executives.

This divergence impacts two standards in particular. Firstly, as outlined above,197 6.52 only independent senior managers qualify to serve as CRO. In dual board 193 See, for instance, CRD IV, arts 76(3)(2), 88(1)(e), and 91(8). 194 See Section V(1)(A)(ii) (para 6.48). 195 See Section IV(1)(B) (paras 6.14ff). 196 But see Winter (n 76), 12.21: ‘It is [. . .] unclear whether senior management only includes [. . .] members of the executive board in a two-tier model’. 197 See Section IV(1)(C)(ii) (para 6.30).

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Peter O Mülbert and Alexander Wilhelm companies, only members of the managing board may serve that role,198 whereas single board companies are not required to appoint an executive director, but may choose from a larger pool of executives. Secondly, as also mentioned earlier,199 Article 92(2)(f ) requires the remuneration committee to directly oversee the remuneration of the ‘senior officers’ in risk management and compliance functions. Again, in dual board companies this rule only refers to members of the managing board, whereas in single board companies it may also apply to lower-ranked executives. B. In Particular: Corporations Without Specific Supervisory Bodies 6.53 The Directive’s reliance on the one-tier board model causes yet another conflict. As outlined earlier,200 numerous articles explicitly address the institution’s ‘management body in its supervisory function’, or even more specifically, its risk, remuneration, or nomination committee. Such provisions imply that domestic company law provides for the existence of a supervisory body in the first place. This is not, however, necessarily the case. For instance, both the German Limited Liability Companies Act (GmbH-Gesetz) and the German law of partnerships in accordance with the Commercial Code (Handelsgesetzbuch) stipulate that the executives of an association are only accountable to the association’s shareholders/ partners; the articles of association may provide for a separate supervisory body,201 but are not generally required to do so. 6.54 In these situations, Article 3(2) of CRD IV does not help. While it mandates

Member States to identify the bodies (or members of bodies) responsible for the performance of managerial and supervisory functions at board level,202 it does not offer any guidance if a specific supervisory body does not exist in the first place.203 To equate the shareholders’ meeting or the partners collectively with ‘the management body in its supervisory function’ is no option. Otherwise, not only those shareholders that take up seats on the managing board,204 but all shareholders would have to comply with the standards of Article 91,205 whereas Articles 22 to 27 of CRD IV limit shareholder control to the acquisition of qualifying holdings206 (in the course of which, by the way, Article 23(1) applies much softer criteria than 198 If national corporate law, as is the case with the German Stock Corporation Act (Aktiengesetz), confers extensive intra-body rights of control on fellow board members, potentially including veto rights, one may doubt whether respective members of the managing board qualify as independent in the sense of CRD IV, art 76(5), sub-para 4. But see Section V(2) (paras 6.56ff) for guidance on how to settle conflicts between the CRD IV regime and principles of domestic corporate law. 199 See Section IV(1)(C)(i) (para 6.27). 200 See Section IV(1)(A) (paras 6.11ff) and (C) (paras 6.22ff). 201 For details see Mülbert and Wilhelm (n 12), 539; Mülbert (n 5), 529–30. 202 See Section V(1)(A)(i) (para 6.47). 203 For guidance see Section V(2)(A) (para 6.56) and (B) (para 6.58). 204 See Section IV(4) (para 6.36). 205 As to those standards see Section IV(1)(B) (paras 6.14ff). 206 See Section IV(4) (para 6.36).

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CRD IV Framework for Banks’ Corporate Governance Article 91). Besides, the fit and proper test (Article 91(1)) is clearly designed to apply to natural persons, whereas the shareholders or partners of a bank may well comprise legal persons, for example in a bank group.207 On the other hand, Recital 55 insists that the CRD IV governance provisions 6.55 ‘embrace all existing [governance] structures’. According to the EBA, this dilemma can simply be solved by stipulating that ‘responsibilities directly exercised by shareholders, members or owners of the institution instead of the management body’ should, ‘as far as possible’, be in line with the requirements applicable to the latter.208 However, the EBA neither elaborates on what exactly it deems ‘possible’ or ‘impossible’ from a regulatory point of view, nor does it explain how it envisions an association to ensure a certain behaviour of its shareholders in the first place. This begs the more general question of how to implement the Directive into Member States’ law and, more specifically, how to resolve conflicts because of adverse rules or principles of national (company) law. This problem will be addressed in the next section. 2. CRD IV Implementation Principles A. Recitals 55 and 56 The CRD IV corporate governance framework, applicable to all EU bank 6.56 associations irrespective of their legal form,209 must be implemented by Member States in the light of Recitals 55 and 56 in particular.210 Recital 55,211 the starting point, suggests a rather generous approach to domestic company law. Although the Directive intends to embrace all existing structures of corporate governance— in most cases, either single board or dual board structures—the definitions of Article 3(1) shall ‘not interfere with the general allocation of competences in accordance with national company law’. Recital 56 adds that the term ‘management body’—comprising a supervisory function and an executive function—in single board systems necessarily refers to the board of directors and in dual board systems defines the managerial board on the one hand and the supervisory board on the other. Taking both recitals together, the Directive’s apparent self-restraint as regards its 6.57 impact on domestic company law turns out to be rather limited: Member States’ company laws are not required to favour one of the two major board systems over the other. Apart from that, nothing in the Directive indicates that Member

207 Admittedly, this problem might be overcome by applying art 91 to such legal persons’ representatives, as in the case of a legal person taking a leading role in the bank’s management, see Section IV(4) (para 6.36). 208 EBA Guidelines on Internal Governance (n 26), Part 2, No 11. 209 See Section IV(3) (para 6.34). 210 As to the following see also Mülbert (n 5), 530–1. 211 For an identical copy, see MiFID II, Recital 55.

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Peter O Mülbert and Alexander Wilhelm States shall be entitled to refrain from transposing ‘alien’ corporate governance requirements into their domestic system. On the contrary, Article 3(2)212 can be interpreted as a confirmation of the Directive’s unwillingness to acknowledge particularities of national (company) law ‘unless otherwise specified’. Such explicit deference to national (company) law is rare, but may be found, for instance, in the final sub-paragraph of Article 88(2) of CRD IV, exempting banks from setting up a nomination committee213 if ‘under national law, the management body does not have any competence in the process of selection and appointment of any of its members’. B. Implementation Options at National Level 6.58 The Directive does not prescribe the means of implementing the new corporate governance framework into national law. Member States may therefore choose among two major options in particular. For instance (i), they are free to enact a specific ‘bank organisation law’, perhaps designed as an appendix to the general company law code. Alternatively (ii), they may incorporate relevant standards into their supervisory law regime and make banks’ compliance with them a prerequisite for licensing by competent authorities. In that case, however, domestic company law should at least allow for sufficient flexibility in modifying the company’s articles of association in order to ensure that undertakings can effectively meet the supervisory requirements. For example, if the statutory model of certain associations does not encompass a separate supervisory body,214 national law must allow for the voluntary installation of such bodies in order to comply with Articles 88 and 91 of CRD IV.215 6.59 With respect to option (ii), conflicts may arise if national law does not grant

sufficient flexibility in drafting the articles of association, but still signals that the respective legal form shall qualify for banking business.216 In such cases, given that the vast majority of CRD IV’s corporate governance standards are mandatory,217 it follows that respective requirements (as transposed into national supervisory law) must effectively supersede conflicting rules of company law, for example by extending shareholders’ freedom to modify the company’s statutory constitution.

212 See Section V(1)(A)(i) (para 6.47). 213 See Section IV(1)(A) (para 6.11). 214 See Section V(1)(B) (paras 6.53ff). 215 eg, the German GmbH-Gesetz (see Section V(1)(B) (para 6.53)) permits the voluntary establishment of supervisory bodies. See Mülbert and Wilhelm (n 12), 540. 216 See, for instance, the explanatory memorandum to the German CRD IV Transposition Act (n 34), 87 as regards partnerships under the German Commercial Code (Handelsgesetzbuch). 217 See Section V(2)(A) (paras 6.56–6.57).

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CRD IV Framework for Banks’ Corporate Governance C. In Particular: Remuneration Policies and Risk Governance at Group Level i. Implications of the Separate Entity Principle Member States’ implemen- 6.60 tation of CRD IV faces particular challenges with respect to the group-wide application of governance standards. As noted earlier, institutions need to comply with the Directive’s requirements on remuneration policies, risk governance, and compliance organization on a consolidated basis.218 The imposition of group-wide responsibilities, albeit based on sound rationales and perhaps indispensable in the aftermath of the crisis,219 implies severe technical difficulties due to the ‘separate entity principle’, ie the legal principle separating the rights and duties of each legally independent entity.220 For example, depending on the legal form of the entities affected, Member States’ company laws may not provide for the possibility of a subsidiary being subject to binding directions issued by the parent company221 and/or impose strict obligations of confidentiality on respective board members. Some jurisdictions may provide for domination agreements (Beherrschungsvertrag)— cutting through the limitations of general company law—or similar affiliation agreements as a solution,222 but not necessarily for all types of association and not necessarily in a cross-border context. ii. Necessary Amendments at National Level Insofar as existing domestic 6.61 company law does not provide for adequate instruments of group control, group-wide risk management, compliance, and remuneration governance may be difficult or even impossible. Therefore, one may have expected the Directive (and EBA) not only to postulate group-wide application, but also to provide for mechanisms and instruments by which this goal shall be achieved, perhaps including powers to issue legally binding directions, intra-group rights to information and/or exemptions from board members’ confidentiality. Likewise, the Directive should set out how to reconcile the conferral of intrusive powers on parent companies with the general principle that the management body of each

218 See Section IV(1)(C)(i)–(ii) (paras 6.23ff). For recent approaches to delete CRD IV, art 92(1) regarding the group-wide implementation of remuneration policies, however, see Section VI(3) (paras 6.102ff) below. 219 Hopt (n 30), 11.43. See also Section VI(1) (paras 6.88ff). 220 Hopt (n 30), 11.19 and 11.43; Pierre- Henri Conac, ‘Directors’ Duties in Groups of Companies—Legalizing the Interest of the Group at the European Level’ (2013) 10 European Company and Financial Law Review 194, 195. For details from the perspective of German law, see Mülbert and Wilhelm, (n 12), 532; Tobias H Tröger, ‘Konzernverantwortung in der aufsichtsunterworfenen Finanzbranche’ (2013) 177 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht (ZHR) 475, 492ff. 221 See Hopt (n 30), 11.19. 222 See Mülbert and Wilhelm (n 12), 532–4; Thomas Schneider, Möglichkeiten und Grenzen der Umsetzung der gesellschaftsrechtlichen und bankaufsichtsrechtlichen Anforderungen an Risikomanagement auf Gruppenebene (Duncker & Humblot 2009) 162ff; Jens-Hinrich Binder, ‘Interne Corporate Governance im Bankkonzern’ in Klaus J Hopt and Gottfried Wohlmannstetter (eds), Corporate Governance von Banken (C H Beck 2011) 685, 704–5; Tröger (n 220), 503.

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Peter O Mülbert and Alexander Wilhelm entity, be it a stand-alone unit or a group subsidiary, must retain ‘overall responsibility’ for their respective institution (Article 88(1)(a) of CRD IV). 6.62 The Directive’s silence on those issues223 may be disappointing but certainly

not surprising insofar as subsidiaries and entities established in offshore financial centres224 are concerned, given that the respective domestic (company) laws are outside the EU regulatory perimeter. As for the rest, requiring implementation and enforcement of group-wide CRD IV regulatory standards only to the extent compatible with national (company) law225 is probably not enough. As outlined above,226 Article 3(2) accords precedence to national laws only insofar as the allocation of executive and supervisory functions at entity level is at issue; by inference, potential impediments to effective application at group level shall not prevail.227 Without prejudice to provisions that are (partly) mandated by EU law, for example those on the maintenance of share capital,228 Member States are therefore called upon to adapt their legislation, or at least to ensure that banks’ shareholders enjoy sufficient flexibility in modifying the statutory constitution of each affiliate with a view to complying with group-wide requirements.229

6.63 iii. Proposed Solutions The challenge of adapting EU law and/or national law

to provide for a legal framework that allows compliance with group-wide management requirements established by banking (and insurance) regulation is daunting. Among the various proposals for overcoming the problems resulting from the legal entity principle for group-wide risk management, two, in particular, stand out. Upon closer inspection, however, even those two fail to offer a comprehensive solution.

6.64 The first proposal intends to align national company law with the group-wide

requirements of CRD IV on the basis of a duty of loyalty owed by the subsidiary 223 The same holds true for the EBA Guidelines on Internal Governance (n 26), Title III, Ch 7 in particular, and the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 3 in particular. Even the general CRD IV, art 108(2)–(3), referring to Part 1, Title II, Ch 2, Sections 2 and 3 of the CRR as regards implementation of the ICAAP (see Section III, paras 6.05ff) on a consolidated basis does not provide sufficient guidance as the latter provisions of the CRR also remain rather vague. 224 See CRD IV, arts 92(1) and 109(3). 225 Malte Wundenberg, Compliance und die prinzipiengeleitete Aufsicht über Bankengruppen (Mohr Siebeck 2012) 204ff; Wolfgang Krauel and Marcus Klie, ‘Lenkungsmöglichkeiten im Konzern unter besonderer Berücksichtigung des Aufsichtsrechts für Kreditinstitute und Versicherungen’ (2010) 64 Wertpapier-Mitteilungen (WM) 1735, 1737ff. 226 See Section V(1)(A)(i) (para 6.47). 227 See Mülbert and Wilhelm (n 12), 533, 536–42, offering critical observations on the German legislature’s doubtful position taken in the CRD IV Transposition Act (n 34). 228 See para 6.68 below. 229 See also Section V(2)(A) and (B) (paras 6.56ff). With respect to identical problems of EU regulation and supervision in the insurance industry; cf Meinrad Dreher and Christoph Ballmaier, ‘Solvency II und Gruppenaufsicht’ (2014) 43 Zeitschrift für Unternehmens-und Gesellschaftsrecht (ZGR) 753, 767–71, 775; Meinrad Dreher, ‘Die ordnungsgemäße Geschäftsorganisation der Versicherungsgruppe’ (2015) 69 Wertpapier-Mitteilungen (WM) 649.

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CRD IV Framework for Banks’ Corporate Governance to its parent company. In principle, some jurisdictions, for example Germany, recognize the concept of specific duties of loyalty (mitgliedschaftliche Treuepflichten) that govern the vertical bi-directional relationship between shareholders (parents) and their company (subsidiary) as well as the horizontal relationship between fellow shareholders.230 Under this concept, a company must at all times be considerate of its shareholders’ legitimate interests and, in cases of conflict, may even be obliged to place the latter above its own interests.231 Building on this concept, some commentators have maintained that the subsidiary’s duty of loyalty can serve as a company law-specific justification if board members, by complying with banking (or insurance) regulation requirements to transmit information from a subsidiary to its parent, violate duties of confidentiality prescribed by company law.232 However, even if national laws were to recognize a duty of loyalty owed by the 6.65 subsidiary to the parent company and its application as outlined—both of which are not necessarily the case—the underlying concept could only serve as a piecemeal solution, at best. Leaving aside any doubts whether the duty could serve to legalize all violations of confidentiality rules,233 it is certainly too insecure a basis for efficient group-wide (risk) governance, for example as regards the installation of a Group RMF,234 since its application is usually subject to careful weighing of

230 In Germany, this duty of loyalty is a general principle of company law and applies to all types of companies and corporations. Albeit it is not mentioned explicitly in the relevant codes, it has been developed by the courts in a number of decisions. With respect to corporations (GmbH and Aktiengesellschaft) in particular see the following landmark cases of the Federal Court of Justice (Bundesgerichtshof ): Decision of 5 June 1975, BGHZ 65, 15—ITT; Decision of 1 February 1988, BGHZ 103, 184–Linotype; Decision of 20 March 1995, BGHZ 129, 136–Girmes. See also Petri Mäntysaari, Comparative Corporate Governance (Springer 2005) 363; Burkhardt W Meister, Martin H Heidenhain, and Joachim Rosengarten, The German Limited Liability Company (7th edn, C H Beck 2010) First Part, section VII.3.b, paras 339–42; Alexander Wilhelm, Dritterstreckung im Gesellschaftsrecht (Mohr Siebeck 2017), 221ff. 231 In any event, this holds true if the shareholders’ interests prove particularly important. See Federal Court of Justice (Bundesgerichtshof) Decision of 30 September 1991 (1992) 45 Neue Juristische Wochenschrift (NJW) 368, 369; Federal Court of Justice (Bundesgerichtshof) Decision of 19 September 1994, BGHZ 127, 107, 111; Wilhelm, (n 230), 226; Dirk A Verse, ‘Rechte aus der Treuepflicht der GmbH’ in Martin Henssler and Lutz Strohn (eds), Gesellschaftsrecht (4th edn, C H Beck 2019) §14 GmbHG, para 92 (including further references). 232 See Schneider (n 222), 252–7; cf also Mathias Habersack, ‘Gedanken zur konzernweiten Compliance- Verantwortung des Geschäftsleiters eines herrschenden Unternehmens’ in Stefan Bechtold, Joachim Jickeli, and Mathias Rohe (eds), Festschrift zum 70. Geburtstag von Wernhard Möschel (Nomos 2011) 1175, 1192; Uwe H Schneider and Ulrich Burgard, ‘Treuepflichten im mehrstufigen Unterordnungskonzern’ in Mathias Habersack, Uwe Hüffer, Peter Hommelhoff, and Karsten Schmidt (eds), Festschrift für Peter Ulmer zum 70. Geburtstag (De Gruyter Recht 2003) 579, 595–601; Tröger (n 220), 506ff. 233 For a sceptical analysis see also Dreher and Ballmaier (n 229), 782–3; Dirk A Verse, ‘Compliance im Konzern’ (2011) 175 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht (ZHR) 401, 422–3 (including further references). 234 See Section IV(1)(C)(ii) (para 6.31).

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Peter O Mülbert and Alexander Wilhelm all conflicting interests in every single case.235 In addition, a parent company’s CRD IV-mandated group management may also have to include entities in which the parent does not (directly or indirectly) hold any shares at all, provided the parent ‘effectively exercises a dominant influence’ over that company on the basis of other contractual or factual means.236 In such cases, prudent intra-group risk governance may fail at the outset as the parent company’s lack of shareholding will preclude any recourse to the subsidiary’s duty of loyalty. 6.66 The second proposal seeks to effectuate group-wide governance by modifying the

personal duties of managers and directors of the subsidiaries involved. With the separate entity principle as a starting point, Member States’ laws, notwithstanding differences in detail,237 generally require board members and senior management to act in the best interest of the individual entity they serve. As a consequence, they may face civil or even criminal liability if they approve of measures that are in the interests of the parent, but entail financial or other disadvantages for the subsidiary. While some jurisdictions, for example France and Belgium (‘Rozenblum doctrine’), provide for certain exceptions to this rule by allowing managers and directors to (also) consider the ‘interests of the group’ when taking decisions,238 others, for example Germany, have traditionally been reluctant to accept that kind of derogation.239

235 Cf Schneider (n 222), 258–61; Meister, Heidenhain, and Rosengarten (n 230), First Part, section VII.3.b, para 340 (with respect to the German GmbH). 236 See the relevant definition of ‘subsidiary’ under CRR, art 4(1)(16)(b) explicitly referred to in CRD IV, art 3(1)(15). For instance, a dominant influence may be exercised by virtue of close personal ties between the competent decision-makers involved, such as directors. 237 For details see Section V(3) (paras 6.69ff). 238 See European Commission, ‘Report of the Reflection Group On The Future of EU Company Law’, 5 April 2011 (available online at ) Ch 4.1.2; Peter O Mülbert, ‘Kapitalschutz und Gesellschaftszweck bei der Aktiengesellschaft’ in Uwe H Schneider, Peter Hommelhoff, and Karsten Schmidt et al (eds), Festschrift für Marcus Lutter zum 70. Geburtstag (Dr Otto Schmidt KG 2000) 535, 554–5; Peter O Mülbert, ‘Auf dem Weg zu einem europäischen Konzernrecht?’ (2015) 179 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht (ZHR) 645, 657; Conac (n 220), 199–201; Klaus J Hopt, ‘Groups of Companies—A Comparative Study on the Economics, Law and Regulation of Corporate Groups’, ECGI Law Working Paper No 286/2015, February 2015, 19 (available online at ); Loes Lennarts, ‘European Company Law and Conflicts of Interests’ in Steef M. Barman (ed), European Company Law in Accelerated Progress (Kluwer Law International 2006) 91; Eilís Ferran and Look Chan Ho, Principles of Corporate Finance Law (2nd edn, Oxford University Press 2014) 40. 239 Most notably, German law does not allow weighing the disadvantages and advantages which the subsidiary derives from being a member of the group; Klaus J Hopt (ibid), 18–19. Rather, as regards stock corporations in particular, managers of a subsidiary which—as in most cases—is not subject to a domination agreement are only permitted to undertake a disadvantageous transaction or any other act instructed by a parent if any disadvantage associated with that act will be fully compensated; see s 311 of the Stock Corporation Act (Aktiengesetz); Conac (n 220), 199–200. This rule even applies to wholly-owned subsidiaries. By contrast, a merely equitable distribution of the revenue and costs of the business, as required under the French Rozenblum doctrine—see Mülbert, ‘Kapitalschutz und Gesellschaftszweck bei der Aktiengesellschaft’ (ibid) 545–5; Ferran and Ho (ibid) 40; Loes Lennarts (ibid) 91—is not sufficient.

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CRD IV Framework for Banks’ Corporate Governance Against this backdrop, some German commentators advanced the idea that in the context of financial regulation, at least, there should be room to recognize a ‘group interest’ which all managers and directors across a group of institutions must (or are at least entitled to) pursue, thereby exempting them from personal liability.240 This approach seems to be in line with the more general legislative developments recently (re-)initiated at the EU level: In particular, the Commission-appointed Reflection Group on the Future of Company Law, in its report of April 2011, recommended a Union-wide recognition of a ‘doctrine of the group interest’, operating as a ‘safe harbour’ against the liability of managers in both parent and subsidiary undertakings.241 The Commission, in line with its earlier interest in ‘group policies’,242 has endorsed this concept243 and was recently encouraged by its Informal Company Law Expert Group (ICLEG) to launch public consultations.244 In addition, the independent committees of the European Company Law Experts (ECLE),245 the Forum Europaeum on Company Groups (FECG),246 and the European Model Company Act of September 2017 (EMCA)247 all advocated EU harmonization in this field to some extent.248 Although its latest ‘Company Law package’249 contained no considerations to this effect, it has even been suggested

240 See Daniela Weber-Rey and Evgenia Gissing, ‘Das Gruppeninteresse als Teil des internen Governance-Systems im Finanzsektor’ (2014) 59 Die Aktiengesellschaft (AG) 884, 889–91; Daniela Weber- Rey, ‘Das Gruppeninteresse als Leitungsinstrument im Bankkonzern’ (2014) 59 Die Aktiengesellschaft (AG) R233. 241 ‘Report of the Reflection Group On The Future of EU Company Law’ (n 238), 4.1. 242 For an earlier approach to ‘group policies’ see, inter alia, European Commission, ‘Modernising Company Law and Enhancing Corporate Governance in the European Union—A Plan to Move Forward’ COM(2003) 284 final of 21 May 2003, para 3.3, p 19. 243 European Commission, ‘Action Plan: European Company Law and Corporate Governance— A Modern Legal Framework for More Engaged Shareholders and Sustainable Companies’ COM(2012) 740 final of 12 December 2012, para 4.6. 244 The Informal Company Law Expert Group, ‘Report on the Recognition of the Interest of the Group’, October 2016 (available online at ). 245 European Company Law Experts (ECLE), ‘A Proposal for the Reform of Group Law in Europe’ (2017) 18 European Business Organization Law Review 1, 14–19. 246 Forum Europaeum on Company Groups, ‘Proposal to Facilitate the Management of Cross- Border company Groups in Europe’ (2015) 12 European Company and Financial Law Review 299–306. 247 European Model Company Act, adopted by the European Model Companies Act Group formed at Aarhus University (available online at ), Section 15.16. 248 See also Mülbert, ‘Auf dem Weg zu einem europäischen Konzernrecht?’ (n 238), 652–5; Klaus J Hopt, ‘Groups of Companies’ in Jeffrey N Gordon and Wolf-Georg Ringe, The Oxford Handbook of Corporate Law and Governance (Oxford University Press 2018), 608, 614; Adriaan F M Dorresteijn et al, European Corporate Law (3rd edn, Kluwer Law International 2017) 10.21a; Dániel Gergely Szabó and Karsten Engsig Sørensen, ‘Corporate Governance Codes and Groups of Companies: In Search of Best Practices for Group Governance’ (2018) 15 European Company and Financial Law Review 697. 249 Comprising the Commission Proposal for a Directive amending Directive (EU) 2017/1132 as regards cross-border conversions, mergers and divisions (n 7), and the Commission Proposal for a Directive amending Directive (EU) 2017/1132 as regards the use of digital tools and processes in

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Peter O Mülbert and Alexander Wilhelm that the Commission might revive its former Proposal on the introduction of a European Private Company250 to promote the harmonization of group law in general and the recognition of a group interest in particular.251 6.67 Taken by itself, however, the recognition of a CRD IV-specific ‘group interest’ would

probably not suffice to resolve the entire set of legal conflicts associated with the standards of intra-group governance.252 To begin with, in some cases, it may be difficult to determine what exactly is in the ‘best interest’ of the group. This holds particularly true for the principle-based regulation of risk management (ICAAP253). In this area, institutions are generally free to choose from a variety of alternative measures in order to insure their risk-bearing capacity; for example, they may close a risky business unit, change its business model, or raise additional capital to buffer against potential losses. Consequently, in a group context the entities involved may well disagree as to which strategy is ‘best’. If the parent gets the final word and the subsidiary’s managers must (or, at least, are free to) follow, this rule could—in extreme cases—result in rather arbitrary management practice and ongoing impairment of subsidiaries under the pretext of CRD IV-mandated risk governance.254

6.68 Moreover, managers’ and directors’ fiduciary duties do not present the only im-

pediment to effective intra-group governance. Many jurisdictions provide for specific provisions that limit the power of parent companies in the interest of creditors and minority shareholders, for example, on the basis of share capital maintenance rules. Certain measures of group risk management (and risk governance in particular) may thus fall foul of domestic law even if a subsidiary’s management is generally permitted to promote the group interest. A typical example would be the uncompensated transfer of assets or funds from one subsidiary to the parent. Although such a transfer may serve to cover liquidity shortfalls and thus comply with the notion of intra-group risk management, it is likely to be in conflict with the rules of capital preservation.255 From an EU law perspective, this

company law, COM(2018) 239 final of 25 April 2018 (all available online at ). 250 Commission Proposal on the introduction of a European Private Company (Societas Privata Europaea), COM(2008) 396 of 25 June 2008, as withdrawn in 2013. 251 Christoph Teichmann, ‘SPE 2.0—Die inhaltliche Konzeption’ (2018) 109 GmbH-Rundschau 713 (at III.5.); cf also the current German Federal Government’s coalition agreement, 12 March 2018 (available online at ) paras 6150ff. By contrast, the recently withdrawn (OJ 2018/ C 233/05) Commission Proposal on the introduction of a single-member private limited liability company (Societas Unius Personae), COM(2014) 212 final of 9 April 2014, is unlikely to be revived; on the conceptual shortcomings of the latter see Mülbert (n 238), 667. 252 See also Mülbert (n 238), 657–66. 253 See Sections III (paras 6.05ff) and IV(1)(C)(ii) (paras 6.28ff). 254 Cf Dreher and Ballmaier (n 229), 783. Tröger (n 220), 512 on the other hand is less concerned in this respect. 255 Similar conflicts can arise during the implementation of a group-wide risk limit system. Such systems can cause subsidiaries to refrain from certain business activities that they would

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CRD IV Framework for Banks’ Corporate Governance conflict is particularly noteworthy, given that, since the adoption of the Second Company Law Directive in December 1976,256 capital preservation has come within the ambit of EU company law harmonization.257 Hence, any reforms at EU level aiming at improving group-wide risk management must also deal with the impediments this body of law presents. As a corollary, any national law that seeks to develop a ‘doctrine of the group interest’ must align this concept with the specific provisions that serve the interests of creditors, minority shareholders and other stakeholders.258 3. Uncertain Regulatory Objectives The Directive’s regulatory objectives are ambiguous,259 creating uncertainty as to 6.69 the content and scope of some of its provisions.260 On the one hand, quite in line with CRD IV’s historical background261 and 6.70 systematic context, some of its Recitals (54 and 62) highlight the importance of effective risk management in financial institutions. Others favour a more macroprudential perspective, underlining the protection of financial stability (Recital 67262 and see also Recitals 47 and 50) or the value of a ‘sustainable and diverse Union banking culture which primarily serves the interest

have pursued otherwise: Tröger (n 220), 510; Schneider (n 222), 195–6. Under German and Austrian law, however, taking away business opportunities that would otherwise benefit the subsidiary may constitute a (disguised) distribution of share capital to the responsible parent; see Andreas Heidinger, ‘Deckungsgebot’ in Lutz Michalski (ed), Kommentar zum Gesetz betreffend die Gesellschaften mit beschränkter Haftung (GmbH-Gesetz) Band 1 (3rd edn, C H Beck 2017) §30, para 188; Peter Doralt and Martin Winner, ‘Zur Rechtslage in Österreich’ in Wulf Goette and Mathias Habersack (eds), Münchener Kommentar zum Aktiengesetz, Band 1 (5th edn, C H Beck 2019) §57 para 366 (including further references). 256 Directive 77/91/EEC of 13 December 1976 [1976] OJ L26/1 (as amended); later replaced by Directive 2012/30/EU of 25 October 2012 [2012] OJ L315/74 (art 17 and Recital 5); now consolidated by Directive (EU) 2017/1132 of 14 June 2017 [2017] OJ L169/46 (art 56 and Recital 40 in particular). As to the scope of the Directive see Mülbert, ‘Kapitalschutz und Gesellschaftszweck bei der Aktiengesellschaft’ (n 238), 544ff; Mathias Habersack and Dirk A Verse, Europäisches Gesellschaftsrecht (5th edn, C H Beck 2019) §6 V; Grundmann (n 175), §11(29)ff. 257 In fact, as regards the French Rozenblum doctrine (see references in n 239) in particular, it can be argued with good reasons that its concept is incompatible with the rules on capital maintenance stipulated under secondary EU law (ibid); Mülbert, ‘Kapitalschutz und Gesellschaftszweck bei der Aktiengesellschaft’ (n 238), 554–5; Wolfgang Schön, ‘Das Bild des Gesellschafters im Europäischen Gesellschaftsrecht’ (2000) 64 The Rabel Journal of Comparative and International Private Law (RabelsZ) 1, 23–4. 258 See also ‘Report of the Reflection Group On The Future of EU Company Law’ (n 238), 4.1.2, 60–1 in particular; The Informal Company Law Expert Group (n 244), 27 (‘Any proposal for an EU-level initiative to facilitate recognition of the interests of the group must intersect with creditor protection.’); Conac (n 220), 195, 216, 223–5. 259 See Section IV(2)–(3) (paras 6.33ff). 260 See also Mülbert (n 5), 531–3. 261 See Section III (paras 6.05ff). 262 With respect to investment firms in particular see MiFID II, Recital 37.

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Peter O Mülbert and Alexander Wilhelm of the citizens’ (Recital 49). At entity-level, the latter is held to be reflected in ‘corporate responsibility of institutions towards stakeholders and society’ (Recital 52). 6.71 This ambiguity impacts on the application of Article 95(2) of CRD IV in partic-

ular. As outlined above, Article 95(2) requires remuneration committees to take into account the ‘public interest’ when preparing ‘decisions regarding remuneration’.263 This, in turn, raises two questions: firstly, what is the exact meaning of ‘public interest’ and secondly, whether and to what extent decisions regarding remuneration and other risk-prone decisions of the management body, and perhaps even shareholder resolutions, have to take the public interest into account, as well.

6.72 Before taking up these questions in more detail, it should be noted that

the Article 95(2) requirement transcends corporate law. Admittedly, some jurisdictions such as the UK (section 172 of the Companies Act 2006) require boards to act in the primary interest of shareholders, supplemented by a duty to have regard to the interests of stakeholders, for example employees, if appropriate (concept of ‘enlightened shareholder value’).264 Other jurisdictions, such as Germany, apply an even more pluralist approach under which the interests of shareholders and stakeholders are given equal status (‘broad stakeholder concept’).265 Under both concepts, however, boards are not required to take the ‘public interest’ into account, ie mandatory incorporation of the ‘public interest’ into the decision-making is not provided for by corporate law.

See Section IV(1)(C)(i) (para 6.27). 264 Paul L Davies and Sarah Worthington, Gower’s Principles of Modern Company Law (10th edn, Sweet & Maxwell 2016) 501–14; Richard Williams, ‘Enlightened Shareholder Value in UK Company Law’ (2012) 35 UNSW Law Journal 360; Thomas Clarke, ‘The Impact of Financialisation on International Corporate Governance: The Role of Agency Theory and Maximising Shareholder Value’ (2011) 5 Law and Financial Markets Review 39, 47–8; critical as to the general assertion that the former common-law based shareholder primacy norm remained basically unaffected Jonathan Mukwiri, ‘Myth of Shareholder Primacy in English Law’ (2013) 24 European Business Law Review 217, 229ff; Jennifer G Hill and Matthew Conaglen, ‘Directors’ Duties and Legal Safe Harbours: A Comparative Analysis’, ECGI Law Working Paper No 351/ 2017, April 2018 (available online at )  7–8. 265 See Jens Koch, Hüffer, Aktiengesetz (13th edn, C H Beck 2018) §76, paras 28ff; Mülbert and Wilhelm (n 12), 538, fn 247; for a critical analysis see Peter O Mülbert, ‘Shareholder Value aus rechtlicher Sicht’ (1997) 26 Zeitschrift für Unternehmens-und Gesellschaftsrecht (ZGR) 129, 147ff. Under Dutch law, the situation appears to be similar: see Guido Ferrarini, ‘Understanding the Role of Corporate Governance in Financial Institutions: A Research Agenda’, ECGI Law Working Paper No 347/2017, March 2017 (available online at ) 21 (fn 64); Richard Novak, ‘Corporate Boards in the Netherlands’ in Paul Davies et al (eds), Corporate Boards in Law and Practice. A Comparative Analysis in Europe (Oxford University Press, 2013) 431, 435. 263

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CRD IV Framework for Banks’ Corporate Governance A. The Public Interest-Requirement for Decisions Regarding Remuneration: Contents In the light of the aforementioned recitals, one might simply equate public in- 6.73 terest with financial stability.266 Although this would amount to a rather narrow understanding, it does seem to be warranted by Article 95 of CRD IV, given that only such institutions which are significant in the meaning of Article 95(1) are explicitly required to establish a remuneration committee in the first place.267 If significant were to be understood in the sense of systemically important, one might even interpret the mandate to consider the public interest as a systemically important financial institution (SIFI)-specific adaptation of the classical shareholder value concept: if the shareholders of a SIFI are well diversified268 they will favour the management body’s concern with financial stability in general, given that sector-wide turmoil is likely also to affect the profitability of other portfolio banks and, if the shock triggers a systemic event, even of all portfolio companies.269 Yet, counter-arguments against this narrower understanding seem to prevail. 6.74 Firstly, Article 95(2) applies irrespective of a bank’s shareholder structure or diversification of its shareholders. Secondly, an institution may well be systemically important even without being ‘significant’ in the meaning of Article 95(1), ie in terms of size, internal organization, or complexity etc. The financial crisis provided evidence for this,270 and it is also implied in EBA’s understanding that even ‘non-significant’ institutions may well have to establish board committees ‘on the basis of proportionality’.271 Thirdly, Recitals 49 and 52 indicate that the Directive is not only intended to promote financial stability but to further a much wider spectrum of public concerns such as diversity, financial inclusion, etc. This is best illustrated by Article 88(2)(a)—requiring the nomination committee to prepare a policy on how to increase the number of the underrepresented gender272—but also holds true for Article 95(2).

266 Neither the EBA Guidelines on sound remuneration policies (n 37) nor the EBA Guidelines on Internal Governance (n 26) provide any guidance on this issue. 267 See Section IV(1)(A) (para 6.11). 268 Extensive diversification by shareholders and by institutional investors, in particular, is a common feature in the banking sector. For instance, see Winter (n 76), 12.17; Hopt (n 30), 11.27; Yamileh García-Kuhnert, Maria-Teresa Marchica, and Roberto Mura, ‘Shareholder Diversification and Bank Risk-Taking’ (2015) 24 J. Finan. Intermediation 602, 632. 269 For more details, see Jeffrey N Gordon, ‘Corporate Governance and Executive Compensation in Financial Firms: The Case for Convertible Equity-Based Pay’ (2012) Columbia Business Law Review 834, 838–47. 270 See, eg, the small Düsseldorfer Hypothekenbank AG (balance sheet total of €27bn) was bailed out by the Deposit Protection Fund of the Association of German Banks (Einlagensicherungsfonds des Bundesverband deutscher Banken) in order to safeguard the stability of the German covered bonds market in 2008. 271 See Section IV(1)(A) (para 6.13). 272 See Section IV(1)(A) (para 6.12).

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Peter O Mülbert and Alexander Wilhelm 6.75 Admittedly, by reaching beyond financial stability, the exact scope of the term

‘public interest’ remains extremely vague. It may well be that because of differences across Member States in applying that criterion the EBA will have to issue pertinent guidelines.

B. The Public Interest-Requirement for Decisions Regarding Remuneration: Scope 6.76 Although the Directive does not explicitly require the management body to take the ‘public interest’ into account in its decision-making, such consideration is of course intended. Article 95(2) would be superfluous if the board could simply ignore the remuneration committee’s preparatory work. 6.77 Moreover, by the same logic shareholders must also be required to take the public

interest into account when taking binding decisions on remuneration. This will become an EU-wide issue now that the amended Directive on shareholder rights introduced a binding shareholders’ ‘say on pay’.273 As a corollary, national company law will have to provide for appropriate mechanisms for a judicial review of ‘inconsiderate’ shareholder voting regarding remuneration, ie if such voting does not take the public interest into account.274 So far, however, shareholder scrutiny of remuneration policies seems to focus on concerns very different from the public interest. According to recent KPMG surveys of 2015, 2016, and 2017, shareholders in FTSE 350 companies tend to approve of more than 90% of remuneration packages as long as their expectations concerning performance, transparency, and overall quantum are met.275

C. The Public Interest-Requirement: Pertaining also to Other Decisions? 6.78 Apart from decisions on remuneration, the Directive does not explicitly subject other decisions to the public interest-criterion. However, since one of the Directive’s main goals is to promote financial stability and since decisions, other than those on remuneration, may impact financial stability even more strongly, it would be very much in line with the Directive generally to subject decisions that may affect financial stability to the public interest-criterion, ie to require the decision-making body—the management body and the shareholder meeting,

See Section IV(4) (para 6.37). 274 So far, the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 2.2, No 38–43 (‘Shareholders’ involvement’) in particular, remain reticent about the (potential) legal consequences of inconsiderate shareholder voting. With respect to violations of the CRD IV remuneration rules they merely stipulate that the ‘supervisory function remains responsible for the proposals submitted to the shareholders’ meeting, as well as for the actual implementation and oversight of any changes to the remuneration policies and practices’ (No 41). 275 KPMG, ‘KPMG’s Guide to Directors’ Remuneration 2015’, 12; KPMG, ‘Guide to Directors’ Remuneration 2016’, 10; and KPMG, ‘Guide to Directors Remuneration 2017’, 9–10 (all available online at ). See also Andenas and Chiu (n 30), 373 (with respect to KPMG’s Guide of 2012). 273

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CRD IV Framework for Banks’ Corporate Governance respectively—to take financial stability into account, at least.276 On the other hand, this would task the decision-making body with a sort of mission impossible, namely to balance the (potentially) conflicting interests of shareholders, stakeholders and the public (financial stability).277 4. (Over-)Emphasis of Board Members’ Character Pursuant to Article 88(2), sub-paragraph 4 of CRD IV, the nomination committee 6.79 shall ensure that the management body’s decision-making is not dominated by any one individual or small group of individuals. This corresponds with Article 91(8), requiring members of the management body to act with honesty, integrity, and independence of mind to effectively assess and challenge the decisions of senior management, if necessary.278 Put differently, board members need to possess specific traits of character, collectively shaping what could be described as a robust willingness to engage in (confrontational) dialogue. The Directive’s emphasis on character may be explained with poignant crisis-era 6.80 experiences of single board systems, in particular. In such a system, the pressure on non-executive directors for conformity tended to be particularly strong.279 By contrast, from a dual board perspective it seems questionable whether explicit character requirements will improve the quality of decision-making and management oversight to the same extent, given that the dual board structure mitigates the pressure for conformity from the outset by providing for an institutional separation of executive and non-executive board members. In addition, supervisory application and enforcement of the Article 91(8) 6.81 requirements is not an easy task, at best. From the very beginning, it has been suggested that guidelines on the notions of honesty, integrity, and independence of mind280 are ‘likely to contain statements of motherhood and apple pie or take unworkable and irrelevant formalistic approaches to these basic human concepts’.281 It is therefore unsurprising that the recently adopted ESMA and EBA Guidelines oscillate largely between tautological circumscriptions on the one

276 Cf also on a more general note, ie without recourse to CRD IV, art 95(2) in particular, Tröger (n 220), 500–1; Binder (n 220), 686–7. 277 Cf Andenas and Chiu (n 30), 391–2 (disapproving for that reason). 278 See Section IV(1)(B)(i) (para 6.17). 279 For more details see David Walker, ‘A Review of Corporate Governance in UK Banks and other Financial Industry Entities—Final Recommendations’, 26 November 2009, paras 4.3ff (available online at ). See also Winter (n 76), 12.13; Mülbert (n 5), 533. 280 CRD IV, art 91(12); see Section IV(5)(A) (para 6.40). 281 Winter (n 76), 12.28. Similarly Meinrad Dreher, ‘Die Gesamtqualifikation des Aufsichtsrats— Die Rechtslage in der Normal- AG und bei beaufsichtigten Versicherungsunternehmen sowie Kreditinstituten’ in Gerd Krieger, Markus Lutter, and Karsten Schmidt (eds), Festschrift für Michael Hoffmann-Becking zum 70. Geburtstag (C H Beck, 2013) 313, 328. See also Mellenbergh (n 28), 174–5 (with respect to the MiFID II).

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Peter O Mülbert and Alexander Wilhelm hand and a set of rather questionable formal criteria on the other. For instance, one may doubt whether an unsuccessful business record or a person’s failure to be ‘transparent, open, and co-operative’ in his or her dealings with competent authorities must, even if only routinely, indicate a lack of that person’s honesty and integrity.282 Since it is up to the institution to demonstrate that a candidate meets the applicable standards when concerns have been raised,283 institutions are likely to err on the side of caution and refrain from appointing a person at the slightest doubt, which is probably not what EU legislators originally intended. In any case, remaining ambiguities appear all the more disturbing in the light of the Directive’s sanctions regime, empowering domestic authorities not only to remove unfit candidates from the board, but to impose severe penalties on institutions and natural persons involved for violations of Article 91.284 5. CRD IV, Board Decisions, and ‘Business Judgement’ 6.82 Many of the CRD IV corporate governance requirements are extensive, but at the

same time rather vague,285 even after clarification through EBA Guidelines in particular.286 Their implementation in daily practice is bound to present a mélange of difficult, sometimes perhaps unanswerable, questions of a both legal and factual nature. Despite this uncertainty, shortcomings of responsible board members may not only trigger administrative sanctions against both the directors and the institution287 but may also constitute a breach of directors’ duties under national company law and hence entail directors’ internal liability towards the institution itself. Against this backdrop, from the board members’ perspective an important question is whether and to what extent CRD IV provides for, or is at least willing to accept, some sort of safe harbour rule in order to prevent hindsight-biased judicial reviews of their decisions.288

6.83 Notwithstanding differences in details, various EU Member States recognize the

idea that under certain circumstances directors may be relieved from liability for

282 As to these criteria, see Section IV(1)(B)(i) (para 6.17) above. 283 Joint ESMA and EBA Guidelines on the assessment of the suitability of members of the management body and key function holders (n 40), Background and Rationale, No 50. 284 See Section IV(5)(B) (paras 6.42ff). 285 In particular, see Sections V(2)(C) (group-wide application of remuneration and risk governance standards), V(3) (notion of ‘public interest’), and V(4) (character requirements). 286 See Section IV(5)(A) (paras 6.39ff). 287 See Section IV(5)(B) (paras 6.42ff). 288 With a view to the implementation of risk management systems in particular see also Luca Enriques and Dirk Zetzsche, ‘The Risky Business of Regulating Risk Management in Listed Companies’ (2013) 10 European Company and Financial Law Review 271, 290; Stephen M Bainbridge, ‘Caremark and Enterprise Risk Management’ (2009) 34 Journal of Corporation Law 967, 984; Andenas and Chiu (n 30), 391 (with further references). Cf also Ferrarini (n 265), 21–3; Paul Davies and Klaus J Hopt, ‘Non-Shareholder Voice in Bank Governance: Board Composition, Performance and Liability’ in: Danny Busch, Guido Ferrarini, and Gerard van Solinge (eds), Governance of Financial Institutions (Oxford University Press 2019) 6.52ff.

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CRD IV Framework for Banks’ Corporate Governance decisions taken under uncertainty even if those decisions turn out badly in retrospect.289 The usual preconditions are that directors act on an informed basis, without conflicts of interest, and in the honest belief that their actions serve the best interests of the company.290 Although this doctrine, commonly referred to as the ‘business judgement rule’, is traditionally limited to decisions taken under factual uncertainty, there is a tendency to also apply it in cases of legal uncertainty, thereby exempting board members from liability for excusable misinterpretation of the law.291 It is first and foremost a doctrine of corporate law but, at least in theory, may be recognized by banking supervisors as well.292 Although the Directive does not explicitly acknowledge the business judgement 6.84 rule, this does not necessarily imply its rejection.293 It is a matter of national law to define the spectrum of defences available to board members in administrative and/ or civil law procedures provided that these defences do not undermine the dissuasive character of CRD IV-prescribed sanctions. Put differently, the conditions under which those defences apply must be compatible with the Directive’s regulatory concept and objectives. In this respect, two aspects stand out, in particular: Firstly, in order to achieve exculpation, it is probably insufficient to act in the 6.85 best interests of the company alone. As noted above,294 board members are required to consider the public interest, ie financial stability and other issues of public concern, in their decisions regarding remuneration and, arguably, also in their decision-making in other areas. Consequently, although it may well be in the interest of the company to take certain risks, board members may want to refrain from doing so and err on the side of caution if financial stability is at stake. Likewise, if the interpretation of specific supervisory law is unclear, board

289 See Grundmann (n 175), §12(25), with further references; Enriques and Zetzsche, ibid, 290– 2; Davies and Hopt, ibid, 6.52; Davies and Worthington (n 264), 482–3; Hill and Conaglen (n 264), 27ff; Klaus J Hopt, ‘Responsibility of Banks and Their Directors, Including Liability and Enforcement’ in Lars Gorton, Jan Kleinemann, and Hans Wibom (eds), Functional or Dysfunctional— The Law as a Cure? Risk and Liability in the Financial Markets (Stockholm Centre for Commercial Law and Jure Förlag AB 2014) 159, 166–7; Virginijus Bitė and Gintarė Gumuliauskienė, ‘The Business Judgment Rule in Lithuania’ (2016) 17 European Business Organization Law Review 555; from a US perspective John Armour and Jeffrey N Gordon, ‘Systemic Harms and Shareholder Value’ (2014) 6 Journal of Legal Analysis 35, 51–3. 290 Grundmann (n 175), §12(25). For instance, see the second phrase of s 93(1) of the German Stock Corporation Act (Aktiengesetz). 291 Sometimes referred to as ‘Legal Judgment Rule’; see Dirk A Verse, ‘Organhaftung bei unklarer Rechtslage— Raum für eine Legal Judgment Rule?’ (2017) 46 Zeitschrift für Unternehmens-und Gesellschaftsrecht 174; Walter G Paefgen, ‘Organhaftung: Bestandsaufnahme und Zukunftsperspektiven’ (2014) 59 Die Aktiengesellschaft (AG) 553, 559–60; Jürgen Bürkle, ‘Aufsichtsrechtliche Selbsteinschätzung im Zeichen Prinzipienbasierter Regulierung’ in Heinrich Dörner, Dirke Ehlers, and Petra Pohlmann, et al (eds), 30. und 31. Münsterischer Versicherungstag (Verlag Versicherungswirtschaft GmbH 2014) 1, 19. 292 See Enriques and Zetzsche (n 30), 228, fn 78; Bürkle, ibid, 31ff. 293 For a more pessimistic position see Enriques and Zetzsche (n 30), 228, fn 78. 294 See Section V(3) (paras 6.69ff).

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Peter O Mülbert and Alexander Wilhelm members may want to settle with the least risk-prone interpretation rather than taking chances with the supervisor.295 6.86 Secondly, in the necessary process of balancing the company’s interests against

financial stability and other public concerns, Article 91(8) may gain in importance.296 If, as in many cases, the decision at issue is taken by a group of board members collectively, it probably aligns with the Directive’s general approach to award exculpation only to those individuals who effectively assess that decision ‘with honesty, integrity and independence of mind’—whatever that may mean precisely.297 By contrast, a mere box-ticking mentality is likely to fall short.

VI. Functional Concerns 6.87 From a policy perspective, an assessment of the CRD IV corporate governance

framework begs the question whether and to what extent the new rules will succeed in achieving the Directive’s primary goal, namely to safeguard financial stability in the EU,298 and contribute towards preventing future crises. Before turning to an attempt at such a summary assessment (Section 2), it seems helpful to briefly recall the main governance failures that became evident during the financial crisis and that regulators set out to address (Section 1). On this basis, concerns with respect to the principle of proportionality which have recently gained track on a larger scale require separate attention (Section 3).

295 For a similar approach—requiring best possible consideration of supervisory law’s objectives in order to award exemption in cases of legal uncertainty (Optimierungsthese)—see Katja Langenbucher, ‘Vorstandshaftung und Legalitätspflicht in regulierten Branchen’ [2013] Zeitschrift für Bankrecht und Bankwirtschaft (ZBB) 16, 22–3. To some extent, stability concerns-motivated restrictions on the scope and application of certain exculpation rules—such as the business judgment rule—follow a logic similar to the more general academic proposals designed to promote risk-averseness in the financial industry by expanding personal liability for those controlling or monitoring systemically important firms (see, for instance, Armour and Gordon (n 289), 61–76; Jonathan Macey and Maureen O’Hara, ‘Bank Corporate Governance: A Paradigm for the Post-Crisis World’ (2016) 22 FRBNY Economic Policy Review 85, 102–3). These general proposals, however, have not yet gained traction in the recent debate. Indeed, for several reasons, imposing stricter liability on directors/managers or controlling shareholders with a view to promoting financial stability is problematic (cf Andenas and Chiu (n 30), 392; Ferrarini (n 265), 22–3). Firstly, systemic risk-increasing decisions may result in inflicting financial losses on other banks, but not the institution taking the risk-increasing action. Secondly, an increase in systemic risk may well result from other banks imitating the business strategy, risk strategy, etc of a first-mover bank (herding). More generally, liability rules are ill-suited to deal with the fact that, because of (large) banks’ interconnectedness due to contractual or indirect contagion channels, a (large) bank’s funding and investment decisions may have a negative external effect on other banks and, hence, contributes to overall systemic risk. 296 See Sections IV(1)(B)(i) (para 6.17) and V(4) (para 6.79). 297 Regarding the difficulties of specifying the requirements of art 91(8), see Section V(4) (paras 6.79ff). 298 See Sections IV(2) (para 6.33) and V(3) (paras 6.69ff).

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CRD IV Framework for Banks’ Corporate Governance 1. Governance Failure Contributing to the Financial Crisis The emergent EU-wide and international consensus ‘among regulatory bodies 6.88 at international level’299 as to the role of governance failures in the run-up to the financial crisis of 2007–2008 is succinctly captured by Recital 55 of the CRD IV: weaknesses in corporate governance ‘have contributed to excessive and imprudent risk-taking in the banking sector which has led to the failure of individual institutions and systemic problems in Member States and globally’.300 Among the failures most often listed are the following, in particular:301 – deficiencies in risk management practices and organization at even the largest banks:302 overreliance on quantitative risk models and failure to see the ‘fat’ (tail) risks, misidentification and/or underestimation of specific types of risks (such as liquidity or leverage risks or structured products such as collateralized

299 MiFID II, Recital 55. Indeed, empirical studies arrived at more cautious conclusions than the accepted wisdom among regulators at international level: see Andrea Beltratti and René M Stulz, ‘The Credit Crisis around the Globe: Why did Some Banks Perform Better?’ (2012) 105 Journal of Financial Economics 1; Vincent Aebi, Gabriele Sabato, and Markus Schmid, ‘Risk Management, Corporate Governance, and Bank Performance in the Financial Crisis’ (2012) 36 Journal of Banking & Finance 3213; Cools and van Toor (n 30); Ferrarini (n 265), 7–9; Klaus J Hopt, ‘Corporate Governance von Finanzinstituten’ (2017) 46 Zeitschrift für Unternehmens-und Gesellschaftsrecht 438, 440 (fn 6). More specifically, CEOs and senior management more generally responded to contractual incentives to take on more risk (see n 305 with references), while the presence of institutional shareholders was correlated with an increase in a bank’s riskiness (see n 306 with references). 300 For similar assessments see, for instance, ‘High- level Expert Group on reforming the Structure of the EU Banking Sector: Final Report’, chaired by Erkki Liikanen, Brussels, 2 October 2012, 105 (the ‘Liikanen Report’); EBA Guidelines on Internal Governance of September 2011 (n 17), II, No 17 (‘not a direct trigger’ but a ‘key contributory factor’); ‘The High-Level Group on Financial Supervision in the EU: Report’ (2009), para 110ff (‘de Larosière Report’); Financial Services Authority, ‘Effective Corporate Governance’ (2010) Consultation Paper No 10/3, 3, para 1.1, 1.2; Walker (n 279), 9. For further reference, see Peter O Mülbert, ‘Managing Risk in the Financial System’ in Niamh Moloney, Eilís Ferran, and Jennifer Payne (eds), The Oxford Handbook of Financial Regulation (Oxford University Press 2015) Ch 13, 372–3; Hopt, ibid, 440. 301 See, for instance, Hopt (n 30), 11.16–11.21 (with further reference); OECD, ‘Corporate Governance and the Financial Crisis: Key Findings and Main Messages’, June 2009, 7–11; see also Peter O Mülbert, ‘Corporate Governance von Banken’ (2009) 173 Zeitschrift für das gesamte Handelsrecht und Wirtschaftsrecht (ZHR) 1, 3. 302 As to the different failures see, for instance, Senior Supervisors Group, ‘Risk Management Lessons from the Global Banking Crisis of 2008’, 21 October 2009, 20–8; Nestor Advisors, ‘Banks Boards and the Financial Crisis: A Corporate Governance Study of the 25 Largest European Banks’ (2009) 46–92; Grant Kirkpatrick, ‘The Corporate Governance Lessons from the Financial Crisis’ (2009) 1 Financial Market Trends 6–12; UK Financial Services Authority, ‘The Turner Review— A Regulatory Response to the Global Banking Crises’, March 2009, 22–4, 44–5; cf also Basel Committee on Banking Supervision, ‘Enhancements to the Basel II Framework’, July 2009, 10–11; Andenas and Chiu (n 30), 378; Thomas Clarke, ‘Corporate Governance Causes of the Global Financial Crisis’ in William Sun, Jim Stewart, and David Pollard (eds), Corporate Governance and the Global Financial Crisis: International Perspectives (Cambridge University Press 2012) 28, 39–41 (with respect to reported failures at UBS); Ferrarini (n 265), 9–10; more generally René M Stulz, ‘Risk Management Failures: What are they and When do they Happen?’ (2008) 20 Journal of Applied Corporate Finance 39, 41–7; Andrew Ellul and Vijay Yerramilli, ‘Stronger Risk Controls, Lower Risk: Evidence from US Bank Holding Companies’ (2013) 68 Journal of Finance 1757–803.

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Peter O Mülbert and Alexander Wilhelm debt obligations, asset backed securities, and others) insensitivity to systemic risks in highly-interwoven markets, stress-testing using past events instead of identifying new risks and possible new scenarios, and inappropriate control mechanisms at group level (leading to severe intra-group financial contagion); – deficiencies in the profile and practice of directors, including poor non-executive oversight over senior management, most notably due to insufficient expertise,303 a lack of regular self-evaluation, and inadequate involvement in the institution’s affairs and strategies (particularly, but not exclusively, in state-owned banks);304 – flawed remuneration schemes and skewed incentives for board members and senior management, most notably regarding the specific design of performance- based executive pay, providing an incentive to generate short-term revenues while taking on high long-term risks;305 – insufficient shareholder engagement with respect to controlling institutions’ management bodies, due to the short-term focus of institutional investors in particular.306 303 Hopt (n 30), 11.18; Roman Tomasic, ‘The Failure of Corporate Governance and the Limits of Law: British Banks and the Global Financial Crisis’ in William Sun, Jim Stewart, and David Pollard (eds), Corporate Governance and the Global Financial Crisis: International Prespectives (Cambridge: Cambridge University Press, 2012) 50, 62–7 (case study of corporate governance failures at Northern Rock). 304 Winter (n 76), 12.13–12.16; Hopt (n 18), 251; Andenas and Chiu (n 30), 379; see also Tomasic, ibid, 57–69. 305 See Directive 2010/76/EU of 24 November 2010 (CRD III) [2016] OJ L329/3, Recitals 1–4; Winter (n 76), 12.11–12.12; Hopt (n 30), 11.20; Ferrarini and Ungureanu (n 91), 1.2; Clarke (n 302), 42–3; Ferran (n 90), 4–7 (with further references). However, if benchmarked against shareholder interests empirical support for the flawed incentives-thesis is mixed, at best. Indeed, a succinct summary of the findings of several studies on the effects of remuneration arrived at the following conclusion: ‘shareholders gave CEOs the incentives to take on risk, which happened not to pay out in this realisation [ie the GFC]’, Hamid Mehran, Alan Morrison, and Joel Shapiro, ‘Corporate Governance and Banks—What Have We Learned from the Financial Crisis?’ in Mathias Dewatripont and Xavier Freixas (eds), The Crisis Aftermath: New Regulatory Paradigms (CEPR 2012) 1119; similarly Emilios Avgouleas and Jay Cullen, ‘Market Discipline and EU Corporate Governance Reform in the Banking Sector: Merits, Fallacies, and Cognitive Boundaries’ (2014) 41 Journal of Law and Society 28, 46; Robert DeYoung, Emma Y Peng, and Meng Yan, ‘Executive Compensation and Business Policy Choices at U.S. Commercial Banks’ (2013) Journal of Financial and Quantitative Analysis 165, 193 (‘bank CEOs respond[ed] in a systematic fashion to wealth incentives’); cf Martin J Conyon, Nuno Fernandes, Miguel A Ferreira, Pedro Matos, and Kevin J Murphy, ‘The Executive Compensation Controversy: A Transatlantic Analysis’ Institue for Compensation Studies, 13 February 2011 (available online at ) 112. But see Jakob de Haan and Razvan Vlahu, ‘Corporate Governance of Banks: A Survey’, DNB Working Paper No 386, July 2013, 34–5 for a somewhat different assessment based on a partly different set of studies. 306 Winter (n 76), 12.17–12.18; see also Andenas and Chiu (n 30), 393. Here as well, empirical evidence is mixed, at best. In particular, several studies found that the presence of institutional shareholders increases the risk of the bank; see Luc Laeven and Ross Levine, ‘Bank Governance, Regulation, and Risk-Taking’ (2009) 93 Journal of Financial Economics 259; David Erkens, Mingyi Hung, and Pedro P Matos, ‘Corporate Governance in the 2007–2008 Financial Crisis: Evidence from Financial Institutions Worldwide’ (2012) 18(2) Journal of Corporate Finance 389; Andrew Ellul and Vijay Yerramilli, ‘Stronger Risk Controls, Lower Risk: Evidence from US Bank Holding Companies’ (2013) 68 The Journal of Finance 1757. On a related note, some studies found that owner- controlled banks suffered larger losses during the crisis than management- controlled

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CRD IV Framework for Banks’ Corporate Governance The CRD IV, although not explaining the need for the new rules in detail,307 does 6.90 respond to all but the last governance failure listed above; deficiencies in shareholder engagement are now seen as a general problem of listed companies and, thus, to be addressed in general.308 2. Assessing CRD IV’s Response Initial academic reactions to the CRD IV’s new standards on risk governance,309 6.91 board profiles and practice,310 and remuneration policies311 were rather disapproving, to the point of alleging legislative quackery.312 Upon a closer look, though, some of the criticisms voiced are less convincing. The Directive’s risk governance regime does not warrant downright rejection: – Admittedly, mandatory risk management requirements have weaknesses. It should be noted, though, that for the Basel II risk-weighted regulatory capital framework to work, minimum regulatory requirements with respect to risk management are essential. Without them, banks could easily comply with a wide range of capital requirements by tweaking their internal risk management models. Moreover, value-at-risk (VaR) as a risk-measure is hard-wired into law only for internal models used by banks to calculate own funds requirements with respect to a limited number of risks (Articles 362 to 369 of the CRR) even though VaR, despite its theoretical weaknesses compared to expected shortfall as risk-measure,313 is widely used in practice also with respect to other risks. On a somewhat different note, although the additional burden on institutions will be significant,314 qualitative enhancements to conventional Pillar II supervision,315 banks, see Reint Gropp and Matthias Köhler, ‘Bank Owners or Bank Managers: Who is Keen on Risk? Evidence from the Financial Crisis’, European Business School Research Paper No 10- 02, 23 February 2010 (available online at ); Hanna Westman, ‘The Role of Ownership Structure and Regulatory Environment in Bank Corporate Governance’, January 2010 (available online at ). 307 Hopt (n 18), 235. 308 See Section IV(4) (paras 6.36–6.37). 309 See Section IV(1)(C)(ii) (paras 6.28ff). 310 See Section IV(1)(A) (paras 6.11ff) (with a focus on organizational standards in particular). 311 See Section IV(1)(C)(i) (paras 6.23–6.27). 312 See Enriques and Zetzsche (n 30), passim (with respect to bank boards’ regulation). 313 See, for instance, John C Hull, Risk Management and Financial Institutions (3rd edn, Wiley 2012) 186–8; in defense of VaE see René M Stulz, ‘Governance, Risk Management, and Risk- Taking in Banks’, ECGI Finance Working Paper No 427/2014, June 2014, 17–22 (available online at ). In any event, criticism to the effect that VaR models assume a loss probability based on normal distribution around the bell curve resulting in uniformity of the results and uniform behaviour of banks and other market participants (herding) (see Enriques and Zetzsche (n 288), 297–300) is unfounded or outdated, at least. In particular, even though (fat-tailed) market-risk can often be approximated by the normal distribution, the distributions for credit risk and for operational risk are both fat-tailed and highly skewed (Stulz, above, 21). 314 Mülbert and Wilhelm (n 12), 543. 315 See Sections III (paras 6.05ff) and IV(1)(C)(ii) (paras 6.28ff).

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Peter O Mülbert and Alexander Wilhelm including stronger risk management and compliance functions in particular, may help to overcome the notorious overreliance on quantitative standards and prevent the sort of full-scale failures seen throughout the crisis.316 – Obviously, commitment of the people involved is crucial. The Directive moves in the right direction by underpinning personal responsibility and prescribing more explicit roles for CROs and compliance officers,317 but also for non- executives, for example concerning the risk committees’ involvement in calibrating the risk appetite and strategy of their firms. Likewise, notwithstanding all the technical concerns, the personal commitment and risk-awareness of board members is bound to improve if the impact of CRD IV’s key regulatory objective—financial stability—on the content and scope of directors’ duties and liabilities318 gains track. – Most importantly, the risk culture in financial institutions has to change fundamentally, tackling behavioural and cultural obstacles that may impede effective risk management throughout the industry.319 In this respect, the recently revised EBA Guidelines on Internal Governance have provided regulatory impetus by dedicating an entire section to the notion of risk culture, also including guidance on the development of adequate corporate values.320 Prior to that, the ECB had already adopted a supervisory statement on governance and risk appetite within the SSM, suggesting that a ‘well developed risk appetite framework’ will help implementing a ‘strong risk culture’,321 thereby drawing on earlier work undertaken at the FSB-level in 2013/14.322 Regarding risk management at group level,323 by contrast, the evaluation is less positive: If future EU standard-setting does not specify the means and mechanisms

316 Also rather optimistic: Winter (n 76), 12.24. For a rather sceptical view of the EU’s regulatory intervention in the area of risk management see Andenas and Chiu (n 30), 370, 383–9. 317 See Aebi, Sabato, and Schmid (n 299), 3213; cf further Hopt (n 30), 11.47. 318 See Section V(5) (paras 6.82ff). 319 See Mülbert (n 300), 374; Winter (n 76), 12.10; Hopt (n 18), 233; Ferrarini (n 265), 25– 6; Falko Glasow, ‘Nachhaltige Vergütungspolitik’ in Denise A Bauer and Gunnar Schuster (eds), Nachhaltigkeit im Bankensektor (Dr. Otto Schmidt KG, 2016) 135; Guido Ferrarini and Shanshan Zhu, ‘Culture of Financial Institutions’ in Danny Busch, Guido Ferrarini, and Gerard van Solinge (eds), Governance of Financial Institutions (Oxford University Press, 2019) ch 16. For recent empirical findings concerning risk culture in the EU banking system see Alessandro Carretta, Franco Fiordelisi, and Paola Schwizer (eds), Risk Culture in Banking (Springer International Publishing, 2017), ch 10. 320 EBA Guidelines on Internal Governance (n 26), Title IV, Ch 9–10, No 94–102. 321 SSM supervisory statement on governance and risk appetite, June 2016 (available online at ). 322 See Financial Stability Board, ‘Thematic Review on Risk Governance, Peer Review Report’, 12 February 2013; Financial Stability Board, ‘Principles for an Effective Risk Appetite Framework’, 18 November 2013; Financial Stability Board, ‘Guidance on Supervisory Interaction with Financial Institutions on Risk Culture (A Framework for Assessing Risk Culture’, 7 April 2014). 323 See Section V(2)(C) (paras 6.60ff).

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CRD IV Framework for Banks’ Corporate Governance by which it shall be achieved, implementation in day-to-day practice will probably remain inefficient. As regards board organization324 and board composition,325 many of the new rules 6.93 face efficiency concerns. For instance, the mandatory separation of the CEO and board chair seems questionable, as there is neither an apparent theoretical rationale nor clear empirical evidence to suggest that all financial institutions would actually benefit from it.326 Possibly, a ‘comply or explain’ approach would serve better in this area. Similarly, although a number of empirical studies suggest that the presence of a certain percentage of female directors enhances the risk- awareness of financial institutions,327 one may question whether explicit rules on board diversity, and gender diversity in particular, will indiscriminately improve the internal governance of all institutions in the market. In any event, given that small and mid-sized banks played a very limited role in the crisis, it is unfortunate that they will probably suffer most from the additional costs inherent in inflexible board rules.328 The same goes for personal requirements for members of the management body 6.94 and for non-executives in particular.329 Although to shift the regulatory focus from board members’ independence to their qualifications and experience— which the CRD IV has effected even in spite of the EBA’s partial relapse of September 2017330—may adequately reflect recent experiences,331 the additional requirements set forth in Article 91 and the supporting Guidelines overshoot the mark. Most notably, because of enforcement problems, the (over-)emphasis placed on character in Article 91(8) is unlikely to effect changes in day-to-day practice.332 Others have argued, with good reasons, that all too formal requirements might 324 See Section IV(1)(A) (paras 6.11ff). 325 See Section IV(1)(B) (paras 6.14ff). 326 In detail, see Enriques and Zetzsche (n 30), 236–8 (with further references); similarly Cools and van Toor (n 30), 23–4; de Haan and Vlahu (n 305), 26–7 (also with further references). For another perception see Hopt (n 30), 11.53. 327 See Enriques and Zetzsche (n 30), 222–4; Andenas and Chiu (n 30), 388. 328 See Enriques and Zetzsche (n 30), 241; Boss et al (n 5), 52–3. But see also Section VI(3) below for current developments in terms of proportionality (paras 6.102ff). 329 See Section IV(1)(B) (paras 6.14ff). 330 See Section IV(1)(B)(i) (para 6.18) concerning the EBA and ESMA guidelines on the independence of members of the management board in its supervisory function. 331 See Hopt (n 30), 11.54; Winter (n 76), 12.15–12.16; cf also Hopt (n 18), 248–9, and Hopt (n 299), 444, 451–2. Indeed, while the evidence on the relationship between board independence and financial firm performance clearly does not provide much support that board independence is positively related to performance (see de Haan and Vlahu (n 305), 22–3 summarizing the empirical findings), the empirical evidence on the relationship between director experience and firm performance is mixed (same 18) or even challenges the regulators’ view that more financial expertise on the boards of banks would unambiguously lower their risk profile (Bernadette A Minton, Jérome P Taillard, and Rohan Williamson, ‘Financial Expertise on the Board, Risk Taking, and Performance: Evidence from Bank Holding Companies’ (2014) 49 Journal of Financial and Quantitative Analysis 351, 377). 332 See Section V(4) (paras 6.79ff).

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Peter O Mülbert and Alexander Wilhelm not enhance board members’ personal responsibility, but in fact reduce it; it may well be that ‘board members’ behaviours, perceptions, attitude, drives, fears and the dynamics in the group’ are what really matters, yet escape any effort at direct regulatory intervention.333 6.95 Against this backdrop, external facilitators, such as corporate governance

consultants, might indeed take on an important role in promoting more efficient board practices, including regular self-evaluation in particular.334 However, (over-)reliance on the guidance of external advisors seems bound to trigger yet further EU regulatory intervention, as was recently the case with respect to proxy advisors,335 and may thus result in yet a further layer of financial regulation.

6.96 Moreover, the rationale for the limits set forth in Article 91(3) with respect to the

number of directorships held by a person is questionable due to the fact that these limits only apply ‘unless representing the Member State’. Although the exception is motivated by obvious political reasons, it also illustrates the limited credibility of arguments in favour of such mandatory limitations that point to improvements in the functioning of the board and its members.336

6.97 Finally, the regulation of performance-based pay design, aimed at minimizing

directors’ and senior management’s incentives for excessive risk-taking, should ensure that banks’ remuneration schemes are ‘aligned with the risk appetite, values and long-term interests of the institution’ (Recital 63). Trying to assess whether and to what extent the Directive’s regime is suited to the task requires clarity as to what is meant by the ‘long-term interests of the institution’ as the point of reference for optimal risk-taking behaviour. In this respect, three perspectives come to mind:337 – Directors and senior management of banks should not take risks not favoured by shareholders, ie excessive risks from a shareholder perspective. To derive restrictions on performance-based remuneration schemes, however, begs the follow-up problem of the ‘optimal’ shareholder, ie, whether diversified Winter (n 76), 12.28–12.29 and see also 12.14. 334 Ibid, 12.29; see also Enriques and Zetzsche (n 30), 238–9. The EBA, too, acknowledges institutions’ need for external consultants’ advice on matters of internal governance under CRD IV; cf, for instance, the EBA Guidelines on sound remuneration policies (n 37), Title I, Ch 2.4.2, No 51(e), and Ch 2.5, No 60. 335 See Directive (EU) 2017/828 of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement [2017] OJ L132/1, Ch 1b, art 3j. 336 Enriques and Zetzsche (n 30), 236, fn 108. 337 As to the following see also Peter O Mülbert, ‘Corporate Governance of Banks after the Financial Crisis—Theory, Evidence, Reforms’, ECGI Law Working Paper No 130/2009, April 2010, 10–21 (available online at ); Hopt (n 289), 163; Peter O Mülbert and Ryan Citlau, ‘The Uncertain Role of Banks’ Corporate Governance in Systemic Risk Regulation’ in Hanne S Birkmose, Mette Neville, and Karsten Engsig Sørensen (eds), The European Financial Market in Transition (Kluwer Law International, 2012) 275, 279–84 (with further references). 333

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CRD IV Framework for Banks’ Corporate Governance shareholders, block owners, long-term investors of the Warren Buffett-type, or more short-term oriented traders should serve as the benchmark. – From the perspective of depositors and other debtholders, as well as from the financial stability perspective of regulators and supervisors, banks will take on too much risk even when acting in the best interest of diversified shareholders.338 Those owners will favour more risky (volatile) business strategies since they capture higher, theoretically unlimited, expected returns for the low price of potential loss of the value of their share upon insolvency, whereas the creditors will bear additional losses—and this limited liability-driven fundamental conflict of interests between shareholders (interested in high expected returns) and debtholders (interested in the long-term stability and solvency of financial institutions) is particularly acute for banks.339 In fact, it seems that in jurisdictions which prioritize shareholder supremacy, bank managements are indeed encouraged to take significantly more risk.340 – Finally, from the regulator’s/supervisor’s financial stability perspective, banks may take on too much systemic risk even when reducing firm-specific risk, for example by diversifying their portfolio of risky assets and/or their funding sources. This results from the fact that, because of (large) banks’ interconnectedness due to contractual or indirect contagion channels, a (large) bank’s funding and investment decisions may have a negative external effect on other banks and, hence, increases overall systemic risk.341 Against this background, regulation of performance-based pay design can ei- 6.98 ther aim at aligning risk-taking behaviour with the interests of some ‘optimal’ shareholders or go further by promoting the interests of more risk-averse depositors, debtholders and supervisors. The CRD IV framework seems to be designed to

338 It should be noted, though, that financial stability concerns may warrant even more intrusive restrictions of banks’ business than limitations on risk-taking geared to shareholder interests. This is due to the fact that banks’ risk-portfolios, funding structures, and business models may have negative external effects on other banks due to banks’ interconnectedness via indirect contagion channels (information). 339 Mülbert and Citlau (n 337), 282; Mülbert (n 337), 16–21; Hopt (n 30), 11.24–11.32; Armour and Gordon (n 289), 36; Andenas and Chiu (n 30), 364; see also the 2010 EU Commission Green Paper (n 20), 4. For empirical support, see (n 306). For a rather different perception based on empirical studies see Christoph Van der Elst, ‘Corporate Governance of Banks: How justified is the match?’, ECGI Law Working Paper No 284/2015, February 2015, 12–16 (available online at ). 340 Avgouleas and Cullen (n 305), 43; Armour and Gordon (n 289), 38; see also Hopt (n 289), 163. 341 For an illustrative example, see Markus Brunnermeier, Andrew Crockett, Charles Goodhart, Avinash D Persau, and Hyun Sin Shin, ‘The Fundamental Principles of Financial Regulation’ (2009) Geneva Reports on the World Economy 11, 7. With a view to systemically important financial institutions (SIFIs), however, it has recently been suggested to extend the liability of such institutions’ shareholders, which might function as an antidote to excessive risk-taking; for details see Alessandro Romano, Luca Enriques, and Jonathan R. Macey, ‘Extended Shareholder Liability for Systemically Important Financial Institutions’, ECGI Law Working Paper No. 477/2019, October 2019 (available online at ).

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Peter O Mülbert and Alexander Wilhelm curb risk-taking further, given that Article 95(2) requires the decisions of the remuneration committee, the management body and, arguably, the shareholders to take into account not only the interests of shareholders, but also those of investors and other stakeholders in the institution and the public interest.342 6.99 Whether the CRD IV remuneration framework will succeed in achieving even

the second, more ambitious, goal remains to be seen—at worst in a great financial crisis in the future. So far, the performance-based pay regime has resulted in an increase in the percentage of fixed components of total remuneration, thereby making banks more vulnerable to business cycles343 and driving up total remuneration.344 The bonus cap seems to have exacerbated the latter effect as can notably be seen at some large European banks, for example at Deutsche Bank.345 As a consequence, the scope for remuneration to be cut back on the basis of malus or clawback clauses is reduced, provoking proposals for even putting non-bonus or fixed pay at risk in case of conduct which resulted in significant losses to the institution or failed to meet appropriate standards of fitness and propriety, for example requiring certain staff’s fixed remuneration to be paid in ‘performance bonds’.346 Moreover, the current rules might impair the chances of EU banks to attract suitable candidates for positions in senior management. This, in turn, would hamper their operational competitiveness in relation to non-EU competitors.347

6.100 Predictably, some firms soon adopted a special technique to deal with the new re-

gime, namely using discretionary ‘position’ or ‘role-based’ allowances in addition

See Sections IV(1)(C)(i) (paras 6.23ff) and V(3) (paras 6.69ff). 343 See Ferrarini and Ungureanu (n 91), 4.4; Ferrarini (n 91), 36; most recently Guido Ferrarini, ‘Regulating Bankers’ Pay in Europe: The Case for Flexibility and Proportionality’ in Helmut Siekmann (ed), Festschrift für Theodor Baums zum siebzigsten Geburtstag, Vol I (Mohr Siebeck 2017) 401, 413. 344 See the EBA’s Reports on Benchmarking of Remuneration and High Earners published between 2016 and 2018 concerning data as of end 2014, 2015, and 2016 respectively (all available online at ); Ferrarini (n 343), 414–5. It should be noted, however, that the level of compensation is not consistently related to the level of risk taking (see International Monetary Fund, ‘Global Financial Stability Report, Risk Taking, Liquidity, and Shadow Banking: Curbing Excess While Promoting Growth’, October 2014, Ch 3, 20–1) but strongly impacts the perception and social acceptance of bank(er)s (see Andenas and Chiu (n 30), 361, 365–6). Cf also John Thannasoulis, ‘The Case for Intervening in Bankers’ Pay’ (2012) 67 The Journal of Finance 849 (proposing that total executive remuneration be capped at a prudent proportion of the balance sheet). 345 Ferrarini (n 343), 413 (fn 35). 346 William C Dudley, ‘Enhancing Financial Stability by Improving Culture in the Financial Services Industry’, speech at the ‘Workshop on Reforming Culture and Behaviour in the Financial Services Industry’, Federal Reserve Bank of New York, 20 October 2014 (available online at ); Mark Carney, ‘The Future of Financial Reform’, speech at the 2014 Monetary Authority of Singapore Lecture, Singapore, 17 November 2014 (available online at ). 347 Ferrarini and Ungureanu (n 91), 4.4; Ferrarini (n 91), 37, and Ferrarini (n 343), 413–4; Moloney (n 28), 389. 342

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CRD IV Framework for Banks’ Corporate Governance to the base salary of their senior staff. The EBA considers this to be a tool to circumvent the new limitations of CRD IV.348 More generally, as in the case of the personal requirements pursuant to Article 6.101 91, ‘regulating the design and governance of remuneration in ever greater detail is likely to have the paradoxical effect of reducing the sense of personal responsibility rather than enhancing it’.349 This is a price exacted by the fact that the CRD IV, in substance if not in words, perceives executives and other staff in leading positions as a major risk for the bank they are working for rather than an asset. Whether the price paid is too high depends on whether one considers that idea as a disturbing concept to begin with, or whether one finds it disturbing that the culture at (large) banks gave reason to develop such a concept in the first place. 3. Enhancing Proportionality: CRD V as a Turning Point? Soon after its adoption, the CRD IV package attracted criticism regarding its 6.102 volume and complexity, highlighting the substantial administrative costs it imposed on small and medium-sized banks in particular. More specifically, concerns were raised in terms of proportionality, arguing that the ‘Single Rulebook’ was fitted to large, internationally active banks rather than smaller, locally oriented institutions, thereby putting the latter at a competitive disadvantage insofar as they are unable to benefit from economies of scale when allocating resources to compliance functions. Concerns were not only raised by bankers350 and academics,351

348 EBA Report, ‘On the Application of Directive 2013/36/EU (Capital Requirements Directive) Regarding the Principles on Remuneration Policies of Credit Institutions and Investment Firms and the Use of Allowances’, 15 October 2014; EBA Follow-Up Report, ‘On the actions taken by competent authorities following the publication of the Opinion of the European Banking Authority on the application of Directive 2013/36/EU regarding the principles on remuneration policies for credit institutions and investment firms and the use of allowances’, 12 November 2015. For the EBA’s position on other particular cases of remuneration components (such as retention bonuses or discretionary pension benefits) as well as more general notes on potential circumventions of the CRD IV remuneration requirements see the EBA Guidelines on sound remuneration policies (n 37), Title II, Ch 8, No 120–36. 349 Winter (n 76), 12.26. 350 See, for instance, the National Association of German Cooperative Banks, ‘Taking proportionality seriously—protecting the diversity of the banking sector’, position paper of 23 February 2016 (available online at ). 351 eg Ferrarini (n 265), 14; Ferrarini (n 343), 406ff; Bart Joosen et al, ‘Stability, Flexibility and Proportionality: Towards a two-tiered European Banking Law?’, EBI Working Paper Series 2018, No 20, 21 February 2018 (available online at ) 14– 9; Andreas Schenkel, ‘Proportionality of Banking Regulation— Evidence from Germany’, Conference Paper of 31 March 2017 (available online at ); Andreas Horsch, Jacob Kleinow, and Christian Schiele, ‘Proportionale Bankenregulierung—Chance für Genossenschaftsbanken?’ (2018) 68 Zeitschrift für das gesamte Genossenschaftswesen 56; Dan Costin Niţescu, ‘Diversity and Proportionality, Challenges or Opportunities for the European Banking Sector?’ (2018) 25 Theoretical and Applied Economics 133–6,  145.

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Peter O Mülbert and Alexander Wilhelm but also by domestic supervisors352 and the EBA’s Banking Stakeholder Group.353 Although the lion’s share of criticism may have targeted CRR-related issues such as Pillar I reporting and the disclosure of capital and liquidity requirements,354 it also addressed the CRD IV’s standards on internal governance, including aspects of performance-based pay design in particular.355 While German supervisors advocated the concept of a ‘small banking box’, ie the creation of a whole new framework for smaller banks and low-risk institutions, others favoured a small- scale approach by introducing more simplifications and exceptions to the existing rules.356 6.103 The European Commission heeded these concerns to some extent in November

2016 by adopting the ‘EU banking reform package’, including proposals to amend the CRR357 and the CRD IV358 in particular.359 The latter, informally known as ‘CRD V’, addresses carefully selected remuneration issues, notably by deleting Article 92(1) concerning the implementation of remuneration policies on a consolidated basis360 and by providing exemptions from the rules on deferral and payment in non-cash instruments under Article 94(1)(l)–(m) for smaller, less complex institutions and with respect to lower-paid members of staff.361 The

352 Andreas Dombret, ‘On the road to greater regulatory proportionality?’, speech at the strategy conference of the Rhineland Savings Banks and Giro Association, Bonn, 29 August 2017 (available online at ); Yannis Stournaras, speech at the ‘Conference on Proportionality in European Banking Regulation’, Bank of Greece, 13 February 2017 (available online at ); Boss et al (n 5). 353 EBA Banking Stakeholder Group, ‘Proportionality in Bank Regulation’, Report of 10 December 2015 (available online at ). 354 CRR, arts 99 and 430 respectively; cf Boss et al (n 5), 61–2; Joosen et al (n 351), 3–4; European Commission, Staff Working Document SWD(2016) 377 final, 23 November 2016, 24–5. 355 See, for instance, the EBA Banking Stakeholder Group’s Report (n 353), 39–41; Ferrarini (n 265), 14; Ferrarini (n 343), 406–15; Guido Ferrarini, ‘Compensation in Financial Institutions— Systemic Risk, Regulation, and Proportionality’ in Danny Busch, Guido Ferrarini, and Gerard van Solinge (eds), Governance of Financial Institutions (Oxford University Press, 2019) 11.63ff; Joosen et al (n 351), 19. 356 Andreas Dombret, ‘Basel III: A strong foundation for a thriving economy’ in Andreas Dombret and Patrick S Kenadjian (eds), Basel III: Are we done now? (De Gruyter, 2019) 23, 30; Boss et al (n 5), 63–7; Joosen et al (n 351), 3–6, 24–8. 357 COM(2016) 850 final of 23 November 2016. 358 COM(2016) 854 final of 23 November 2016 (n 104). 359 Further proposals concerned amendments to the BRRD (n 4) and Regulation (EU) 2015/ 81 underlying the SRM (also n 4): Commission’s press release of 23 November 2016 (available online at ). See also the preceding Commission Communication of 24 November 2015, ‘Towards the completion of the Banking Union’, COM(2015) 587 final. 360 Article 1(15)(a) of the Proposal. As to the existing rules see Section IV(1)(C)(i) (paras 6.23ff) above. 361 Article 1(16)(b) and Recital 5 of the Proposal. In addition, the Proposal removes listed institutions’ obligation to pay out part of the variable remuneration exclusively in shares, allowing them to use share-linked instruments instead of—or in addition to—shares in fulfilment of CRD IV,

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CRD IV Framework for Banks’ Corporate Governance proposal also suggests amendments to streamline the SREP and the Pillar II capital requirements,362 inter alia, thereby bringing more proportionality into the ICAAP.363 Although a final version had not been published as of end-2018, the European Parliament and Council reached a provisional political agreement on the banking package in December 2018.364 It is expected to enter into force at some point in 2019.365 In principle, the Commission’s efforts to enhance proportionality are to be wel- 6.104 comed, not least since respective projects are obviously part of a larger trend, impacting on reforms in banking regulation all over the world.366 The general problem, however, is that the upsides of proportionality may come at the cost of unwanted side-effects: For instance, more exceptions and derogations may actually mean more complexity, thereby thwarting the goal of reducing administrative burdens,367 whilst excessive regulatory relief may even run the risk of compromising financial stability.368 In addition, enhanced proportionality for smaller and medium-sized banks may to some extent undermine the incentives for efficiency-improving consolidation,369 despite the latter being arguably needed in the EU banking sector in particular.370 Regarding banks’ corporate governance, however, such concerns are less warranted. 6.105 Given that the CRD IV’s respective general provisions mandate proportionality to a large extent anyway,371 the introduction of more explicit derogations and art 94(1)(l)(i) (art 1(16)(a) and Recital 7 of the Proposal). As to the hitherto existing requirements of CRD IV, art 94(1)(l)–(m) see Section IV(1)(C)(i) (para 6.25). 362 As to these see Section III (paras 6.05ff). 363 For comprehensive summaries see Carla Stamegna, ‘Amending capital requirements—The CRD V package’, Briefing Document of the EPRS, September 2018 (available online at ); Imre Sabahat Ersoy, ‘Strategic Decision Making and Risk Management in the EU’ in Hasan Dinçer and Serhat Yüksel (eds), Handbook of Research on Managerial Thinking in Global Business Economics (IGI Global 2019) Ch 16, 292; Thomas Stern, ‘CRR II & CRD V: (De-)Regulierung mit zittriger Hand’ (2018) 12 Zeitschrift für Finanzmarktrecht (ZFR)  55–60. 364 European Commission, ‘Completing the Banking Union: Commission welcomes political agreement to further reduce risks in the EU banking sector’, press release of 4 December 2018 (available online at ). 365 The banking package (including CRD V) finally entered into force in June 2019 after this Chapter had already been completed. Changes to CRD IV, arts 92(1) and 94(1)(l)–(m) are now contained in Article 1(26) and (27) of the new Directive (EU) 2019/878 of the European Parliament and of the Council of 20 May 2019 [2019] OJ L 150/253. 366 See Ana Paula Castro Carvalho et al, ‘Proportionality in banking regulation: a cross-country comparison’, FSI Paper No 1, 2 August 2017 (available online at ); Ferrarini (n 355), 11.64–11.69; Boss et al (n 5), 58–60; Joosen et al (n 351), 11– 14 (with a view to the United States and Japan in particular). 367 Cf Joosen et al (n 351), 26; Boss et al (n 5), 53–4. 368 Carvalho et al (n 366), 12; Boss et al (n 5), 53. 369 Ibid, 12; but see also Joosen et al (n 351), 16 for remarks to the contrary. 370 See Section II (paras 6.03–6.04). 371 Most importantly, see CRD IV, art 74(2) (‘proportionate to the nature, scale and complexity of the risks inherent in the business model and the institution’s activities’). But see also CRD IV, arts 76(5), 91(3), 97(4); Boss et al (n 5), 60; Carvalho et al (n 366), 14.

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Peter O Mülbert and Alexander Wilhelm distinctions seems just a matter of reinforcing the spirit of the Directive, so to speak. This may not only provide relief in areas where parts of its wording— perhaps accidently—overshoot the mark, including issues of executive pay and board organization,372 but also inspire regulators such as the EBA to actually implement the law more proportionately.373 Concerning the latter, it may be a start to abstain from the adoption of guidelines that seem to have no basis in the Directive whatsoever, as is arguably the case in terms of board members’ independence.374 But even beyond that there should be room to expand the Commission’s small-scale approach in the future,375 preferably in the shape of comply or explain- mechanisms as submitted earlier.376

VII. Conclusion and Outlook 6.106 Slightly more than five years into the brave new world of banks’ corporate gover-

nance, it seems about time for a preliminary review of the CRD IV’s achievements. As its key objectives were to make banks more resilient and to secure financial stability in the European Union, regulatory success should manifest itself in a strengthened financial economy, an absence of major governance scandals, and a sustainable restoration of public trust. Judged by these yardsticks, the outcome has been disappointing: many European banks face substantial efficiency concerns,377 the stream of compliance failures seems relentless,378 and the signs of a new financial crisis are 372 Section VI(2) (paras 6.93–5 and 6.97–9). 373 The National Association of German Cooperative Banks (n 350, p 2) complained that general proportionality clauses ‘have a purely declaratory significance and do not allow the law to be applied proportionately on a case-by-case basis’, and that according to the EBA ‘proportionality is only possible where the primary text of regulations and directives expressly and specifically allows for flexibility’. Similarly Joosen et al (n 351), 18. 374 Section IV(1)(B)(i) (para 6.18). In addition, insofar as the CRD V (n 365) actually deletes CRD IV, art 92(1), it seems questionable if the EBA can maintain its Guidelines on ‘Remuneration policies and group context’ (n 88). 375 The Commission clarified at an early stage that it is only prepared to adopt a small-scale approach, dispelling the widespread hopes for a ‘small banking box’: SWD(2016) 377 final (n 354), 25. Cf also Carvalho et al (n 366), 6–7; Joosen et al (n 351), 25. 376 Section VI(2) (para 6.91 concerning board organization and composition in particular). For further ideas see Carvalho et al (n 366), 2 (proposing regulatory relief under the condition of higher capital requirements); Joosen et al (n 351), 19 (proposing to simplify corporate governance standards ‘if risk management and regulatory compliance were in turn better supervised on an ongoing basis by local oversight teams’, thereby drawing on the Japanese example). 377 See sections II (paras 6.03–4) and VI(3) (para 6.104); further Enrica Detragiache, Thierry Tressel, and Rima Turk-Ariss, ‘Where Have All the Profits Gone? European Bank Profitability Over the Financial Cycle’, IMF Working Paper of 9 May 2018 (available online at ). 378 Recently reported cases include large-scale money-laundering (see the European Parliament’s Think Tank Report, ‘Money Laundering—Recent cases from a EU banking supervisory perspective’, 15 November 2018, available online at ), ‘cum- ex’ tax evasion (Thiess Buettner et al, ‘Withholding-Tax Non-Compliance: The Case of Cum-Ex Stock-Market Transactions’, October 2018, available online at ), and the notorious ‘Panama events’ (n 123).

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CRD IV Framework for Banks’ Corporate Governance continuously looming.379 The lesson from this, however, is probably not that the regulation of bank’s corporate governance is per se insignificant or even counter- productive, but that there are limits to what it can actually achieve. Indeed, it seems that even regulators have started to realize that the impact of banks’ corporate governance on financial stability may, at least to some extent, have been overrated.380 Against this backdrop, the leeway for additional standards is limited. A possible 6.107 exception concerns the Basel Committee’s latest document finalizing the Basel III reforms, informally known as ‘Basel IV’.381 Although its main objective is to reform some of the Pillar I requirements, the document also contains a small number of related governance standards which may require transposition into EU law.382 Beyond that, imminent legislative action should rather focus on alleviating the functional and conceptual concerns of the existing CRD IV framework, eg by pushing on the quest for more proportionality383 or the harmonization of EU group law in order to facilitate intra-group risk management.384 In the longer run, further impetus may spring from a series of developments 6.108 whose repercussions are not yet entirely foreseeable. The first and most important of these is Brexit. Although as of end-2018 it is still unclear on which terms the UK will leave the European Union precisely, it is conceivable that the UK might sooner or later discard some of the CRD IV governance standards which it found difficult to embrace, including the bonus cap of Article 94(1)(g) in particular.385 Whether this would place EU banks at a competitive disadvantage386 and, as a corollary, induce regulatory relief in the EU as well in order to maintain a level playing field seems an open issue.387

379 eg Tobias Adrian, ‘Outlook for Global Stability: A Bumpy Road Ahead’, speech at the Sixth Joint Conference, People’s Bank of China and IMF, 27 April 2018 (available online at ). 380 For instance, whilst the 2011 EBA Guidelines on Internal Governance considered governance failures a ‘key contributory factor’ to the last financial crisis (n 300), the revised EBA Guidelines of September 2017/March 2018 (n 26, Background and rationale, No 2) only submit that they ‘were closely associated with it and were questionable’. See also Hopt (n 299), 440 (fn 6); Danny Busch, Guido Ferrarini, and Gerard van Solinge, ‘Governing Financial Institutions: Law and Regulation, Conduct and Culture’ in Danny Busch, Guido Ferrarini, and Gerard van Solinge (eds), Governance of Financial Institutions (Oxford University Press 2019) 1.12–5, including further reference. 381 Basel Committee on Banking Supervision, ‘Basel III: Finalising post-crisis reforms’, December 2017 (available online at ). 382 Ibid, Ch ‘Internal ratings-based approach for credit risk’, H5, No 206–11. The respective standards form part of the minimum requirements for entry and on-going use of the IRB (Internal Ratings Based) approach to capital requirements for credit risk (No 154). 383 Section VI(3) (paras 6.102ff). 384 Section V(2)(C)(iii) (para 6.67). 385 See, for instance, Longjie Lu, ‘The End of Bankers’ Bonus Cap: How Will the UK Regulate Bankers’ Remuneration after Brexit?’ (2016) 27 European Business Law Review 1091–1125. For details on the UK’s critical stance vis-à-vis the bonus cap see Section IV(1)(C)(i) (para 6.26); and above (n 97). 386 Compare Section VI(2) (para 6.99). 387 For a rather optimistic view on the implications of Brexit see Wolf-Georg Ringe, ‘The Irrelevance of Brexit for the European Financial Market’, Oxford Legal Studies Research Paper No 10/2017 (available online at ).

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Peter O Mülbert and Alexander Wilhelm 6.109 In addition, it remains to be seen whether the recently amended Directive on

shareholder rights388 is sufficiently aligned with the particularities of banks’ corporate governance. Given the fundamental tension between the interests of a bank’s diversified long-term shareholders, on the one hand, and its creditors and the supervisor, on the other, it may not be sufficient to simply establish a framework for responsible long-term shareholding and expect that large banks will succumb to shareholder ‘guidance’ (ie pressure) by adopting business models and by pursuing business strategies that are less risky and contribute less to systemic risk.389

6.110 Finally, the digital transformation of the financial sector will continue to pose a

major challenge to traditional banking structures and respective governance systems. From a regulatory perspective, the most pressing issues include the impact of new technologies such as the blockchain technology on the corporate governance of banks,390 but also the governance structures of financial technology (‘FinTech’) companies and their supervision.391 More recently, the discussion also extended to the regulation of ‘TechFins’, ie the increasing number of pre-existing technology and e-commerce companies that are entering the financial services sector, such as Amazon or Apple,392 and even to the regulation of entirely unprecedented, eg blockchain-based, organizations like ‘the DAO’.393 Although research on these topics is still in a fledgling stage, it seems certain that they will determine the future of financial regulation to a significant extent.

388 Section IV(4) (para 6.37). 389 But see Jonathan Mukwiri and Mathias Siems, ‘The Financial Crisis: A Reason to Improve Shareholder Protection in the EU?’ (2014) 41 Journal of Law and Society 51, 66–7. 390 See David Yermack, ‘Corporate Governance and Blockchain’, Working Paper of 28 November 2016 (available online at ); Anna Lafarre and Christoph Van der Elst, ‘Blockchain Technology for Corporate Governance and Shareholder Activism’, Tilburg Law School Legal Studies Research Paper Series, No 07/2018 (available online at ). 391 See David Ahlstrom, Douglas J Cumming, and Silvio Vismara, ‘New Methods of Entrepreneurial Firm Financing: Fintech, Crowdfunding and Corporate Governance Implications’ (2018) 26 Corp Govern Int Rev 310; European Parliament, ‘Financial technology (FinTech): Prospects and challenges for the EU’, Briefing document of March 2017 (available online at ). 392 Dirk A Zetzsche et al, ‘From FinTech to TechFin: The Regulatory Challenges of Data-Driven Finance’, ECGI Working Paper Series 2017, No 6 (available online at ). 393 See Robert Leonhard, ‘Corporate Governance on Ethereum’s Blockchain’, Working Paper of 30 May 2017 (available online at ); Usman W Chohan, ‘The Decentralized Autonomous Organization and Governance Issues’, Working Paper of 4 December 2017 (available online at ); Maximilian Mann, ‘Die Decentralized Autonomous Organization— ein neuer Gesellschaftstyp?’ (2017) 21 Neue Zeitschrift für Gesellschaftsrecht 1014.

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7 FIT AND PROPER ASSESSMENTS WITHIN THE SINGLE SUPERVISORY MECHANISM Danny Busch and Annick Teubner*

I. Introduction II. Key Terms and Definitions

7.01 7.02 7.02 7.05

1. ‘Management body’ 2. ‘Key function holders’

III. Fit and Proper Assessments as an Element of Corporate Governance IV. Division of Responsibilities Between the Banks, the ECB, and the NCAs 1. The Role of Banks 2. The Role of Supervisors

V. Relevant Sources of Substantive Requirements

1. CRD IV and National Law 2. EBA Guidelines on Suitability and ECB Guide

VI. Convergence

7.06

7.11 7.11 7.12 7.23 7.23 7.24 7.28

1. General 7.28 2. Fit and Proper Requirements for the Members of the Bank’s Management Body 7.29 3. Assessment of Key Function Holders 7.75 4. Convergence of Assessment Process 7.76

VII. National Variations and Limits

1. General 2. Transposition of and Level of Harmonization by CRD IV 3. Limits to Harmonization through the EBA Guidelines on Suitability 4. Application of National Law by the ECB

VIII. Concluding Observations

7.78 7.78 7.80 7.85 7.88 7.96

I. Introduction This chapter analyses and discusses the degree and limits of convergence of fit and 7.01 proper assessments within the Single Supervisory Mechanism (‘SSM’). We will discuss fit and proper assessments of members of the management body of credit institutions (hereafter ‘banks’), in particular of banks under the direct supervision

* Annick Teubner has co-drafted this chapter in her own personal capacity. The views expressed in this chapter are personal and do not necessarily represent the views of the European Central Bank or De Nederlandsche Bank NV.

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Danny Busch and Annick Teubner of the European Central Bank (‘ECB’), and of their key function holders.1 Before going into details, we will provide some key terms and definitions (Section II); describe the role of fit and proper assessments as an element of corporate governance of banks (Section III); set out the division of responsibilities between the banks themselves, the ECB and the national competent authorities (‘NCAs’) (Section IV); and provide an overview of the relevant sources of substantive requirements (Section V). Subsequently, an overview will be provided of what has been achieved so far in terms of convergence of fit and proper assessments (Section VI). Currently, there is still a large variety of national practices despite the harmonization efforts and there are limits to convergence in this area. These variations and limits are discussed in Section VII. We end this chapter with some concluding observations (Section VIII).

II. Key Terms and Definitions 1. ‘Management  body’ 7.02 For the purpose of this chapter and in accordance with the definition of the

Capital Requirements Directive IV (‘CRD IV’), the term ‘management body’ has a broad meaning. It is defined in the directive as ‘an institution’s body or bodies, which are appointed in accordance with national law, which are empowered to set the institution’s strategy, objectives and overall direction, and which oversee and monitor management decision-making, and include the persons who effectively direct the business of the institution’.2 The term ‘management body in its supervisory function’ is separately defined as ‘the management body acting in its role of overseeing and monitoring management decision-making’.3

1 ‘Credit institution’ is defined in art 4(1)(1) of Regulation (EU) 575/2013 of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) 648/2012 [2013] OJ L176/1–337, 27 June 2013 (‘CRR’). Please note that Regulation (EU) 2019/876, amending Regulation (EU) 573/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) 648/2012 [2019] OJ L150/ 1 will amend CRR in various respects, but not in respect of the definition of ‘credit institution’. 2 See art 3(1)(7) of Directive 2013/36/EU of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC [2013] OJ L176/ 338, 27 June 2013 (‘CRD IV’). Please note that Directive (EU) 2019/878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253 will amend CRD IV in various respects. To the extent relevant to the topic of this chapter, these changes will be highlighted in the footnotes. 3 See art 3(1)(8) of the CRD IV.

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Fit and Proper Assessments within the Single Supervisory Mechanism A broad definition of the term ‘management body’ has been chosen, as different 7.03 governance structures are used in the Member States. The most common governance structures are one-tier boards (monistic board structure) and two-tier boards (dualistic board structure).4 CRD IV is intended to apply to all existing models, without indicating a preference for any given structure. CRD IV stresses that the definitions are purely functional to achieve a given result, regardless of the national company law applicable in a Member State. The relevant definitions do not affect the general allocation of competences between the management function (the executives) and the supervisory function (the non-executive directors) under domestic company law.5 The EBA Guidelines on suitability6 also take a functional approach, meaning that 7.04 the management function includes all persons performing executive functions, even when these functions have been delegated to them by the management body or when the said persons have not been proposed or appointed as formal members of the management body.7 In addition, the EBA Guidelines on suitability clarify that where shareholders, members or owners of a bank directly exercise management body’s responsibilities, the bank should ensure that the responsibilities are exercised, as far as possible, in line with the EBA Guidelines on suitability applicable to the management body.8 Thus the fit and proper requirements for members of the management body discussed in this chapter apply to all persons exercising responsibilities of the management function and the supervisory function, irrespective of the governance model prescribed by national law. 2. ‘Key function holders’ Not only the members of the management body, but also so-called ‘key function 7.05 holders’ are subject to fit and proper assessments. The EBA Guidelines on 4 In some Member States, such as Portugal and Italy, there exist also other board structures. 5 See Recital (55) of CRD IV. See also art 3(2) of CRD IV, which clarifies that where CRD IV ‘refers to the management body and, pursuant to national law, the managerial and supervisory functions of the management body are assigned to different bodies or different members within one body, the Member State shall identify the bodies or members of the management body responsible in accordance with its national law, unless otherwise specified by [CRD IV]’. 6 ‘Joint ESMA and EBA Guidelines on the assessment of the suitability of members of the management body and key function holders under Directive 2013/36/EU and Directive 2014/65/ EU’, EBA/GL/2017/12/ESMA71-99-598 (26 September 2018) (‘EBA Guidelines on suitability’), paras  11–14. 7 In some Member States the CEO is not always member of the management body. 8 The requirements of the EBA Guidelines on suitability only apply to ‘senior management’ as defined in CRD IV, when these persons are considered to be a key function holder or a member of the management body. However, the EBA Guidelines on suitability clarify that ‘all staff of institutions should be suitable to perform their job’ (Background and rationale, p 11, para 33). For the definition of ‘senior management’ see art 3(1)(9) of CRD IV: ‘those natural persons who exercise executive functions within an institution, and who are responsible, and accountable to the management body, for the day-to-day management of the institutions’.

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Danny Busch and Annick Teubner suitability define ‘key function holders’ as ‘persons who have significant influence over the direction of the bank, but who are neither members of the management body nor the CEO. They include (i) the heads of internal control functions and the CFO, where they are not members of the management body; and (ii) where identified on a risk-based approach by banks, other key function holders. Other key function holders might include heads of significant business lines, European Economic Area/ European Free Trade Association branches, third country subsidiaries and other internal functions’.9

III. Fit and Proper Assessments as an Element of Corporate Governance 7.06 The ECB considers the supervision of the suitability of management body

members to be a key task, as governance is one of the priorities of the SSM10 and the composition of the management body is one of the key drivers of its effectiveness.11 The central role of the management body in the overall governance framework and the need for suitability is well expressed by Solomon and Solomon: ‘a company’s board is its heart and as a heart it needs to be healthy, fit and carefully nurtured for the company to run effectively’.12 The management body has the ultimate and overall responsibility for the sound and prudent management of the bank and its long-term success and sustainability. A fit and proper management body is a key driver of good governance. The assurance of good governance is not only in the interest of the bank itself, but also contributes to the trust of the wider public in the banking sector as a whole.

7.07 For a management body to be effective, it has to provide leadership, strategic

direction and oversight of the bank. It has to ensure the implementation of a corporate culture which promotes ethical behaviour and integrity. In order to be able to take informed decisions, the management function and supervisory function of the management body should provide each other with adequate information and collect all necessary information. The management body also has an important role to play regarding effective controls and risk management. It has to set, approve and, oversee the implementation by the senior management of the strategy and risk appetite, and of independent and effective risk management and internal control frameworks. The management body should enable the

9 See EBA Guidelines on suitability, 20. 10 ECB, ‘SSM Supervisory Statement on Governance and Risk Appetite’ (June 2016) 4 available online at . 11 ECB, ‘SSM Supervisory Statement on Governance and Risk Appetite’ (June 2016), 7. 12 J Solomon and A Solomon, Corporate Governance and Accountability (John Wiley & Sons 2004) 65.

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Fit and Proper Assessments within the Single Supervisory Mechanism internal control functions to act independently and provide them with sufficient authority, stature, and resources.13 To be able to fulfil the responsibilities described above, management body 7.08 members have to be fit, meaning that they have sufficient time to fulfil their responsibilities, that they are independent of mind, and that they have the necessary skills and experience, as well as the knowledge of the main areas relevant to the business of the bank. The knowledge and experience requirement applies not only to the members individually, but also collectively, thereby linking it (indirectly) to the composition of the management body. In addition, the members should also have a good reputation, meaning that they should not create a reputational risk to the bank. The members of the management body should not only be suitable at the mo- 7.09 ment they take up their position, but should remain suitable during the fulfilment of their mandate. Therefore, banks have to assess the suitability at appointment and monitor their ongoing fitness and propriety. Banks must also ensure that the management body members have sufficient time and resources for induction and training. Although CRD IV does not explicitly provide for the fit and proper assess- 7.10 ment of key function holders,14 it is important that they are fit and proper as they have a significant influence over the direction of the bank. This applies in particular to the heads of the internal control functions, who constitute the second and third lines of defence of the internal control framework and are therefore regarded as the most important key function holders of banks. The heads of control functions have to ensure that the risk management and internal control functions perform their roles effectively and that the management body is provided with all information relating to their areas of responsibility that is necessary for sound decision making. Also other key function holders, such as the CFO, where he/she is not a member of the management body, and heads of business lines or other internal functions can have a significant impact on the implementation of the strategy and day-to-day management of the bank. In view of this, the EBA considers their suitability to be of ‘utmost importance’ and the assessment of key function holders as a necessary

13 See art 88(1) of CRD IV; ‘Guidelines on internal governance under Directive 2013/36/EU’, EBA/GL/2017/11 (26 September 2017) (‘EBA Guidelines on Internal Governance’), 18 [22], 18–21 [23–33]. See, for an example of national legislation, ‘Supervisory Statement SS5/16 of the UK Prudential Regulation Authority’ (‘PRA’) (March 2016) 6–7, available online at . 14 Several respondents to the public consultation of the EBA draft guidelines commented that the requirement to assess key function holders would go beyond the mandate provided to EBA under CRD IV. See further Section VII.3 below.

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Danny Busch and Annick Teubner measure to ensure robust governance arrangements as required by Article 74 of CRD IV.15

IV. Division of Responsibilities Between the Banks, the ECB, and the NCAs 1. The Role of Banks 7.11 The banks are primary responsible for setting the selection and succession poli-

cies and for defining the desired capabilities, both of individual members of the management body and of the management body as a whole (board composition). They have the responsibility to select, with the current and future needs of the bank in mind, the management body members and key function holders who comply with the suitability requirements.16 By doing so, the banks determine the level of quality of the management body and key function holders. By monitoring the suitability and assessing the effective functioning of the management body, through self-assessments and other tools, banks can ensure the suitability on an ongoing basis. 2. The Role of Supervisors

A. General 7.12 The fit and proper assessments conducted by the competent authorities have a prudential aim, namely to ensure that banks comply with the requirements regarding robust governance arrangements and the suitability requirements for members of the management body.17 7.13 When assessing the suitability, supervisors take a proportionate approach,

meaning that they take into account the specific role of the relevant member of the management body or key function holder, the specificities of the bank and the nature and complexity of its activities. For example, the supervisory expectations for the time commitment of a management body member will differ depending on whether the member fulfils an executive or a non-executive role.

15 EBA Guidelines on suitability, 11 [33] and 98. Please note that Directive (EU) 2019/ 878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253 will amend art 74 of CRD IV in various respects. 16 EBA Guidelines on suitability, ‘Background and rationale’, 11 [34]; section 17[135] and following and section 21[162] and following. 17 See arts 4(1)(e) and 6(4) of the SSM Regulation. See also ECB, ‘Guide to fit and proper assessments—Updated in May 2018 in line with the joint ESMA and EBA Guidelines on suitability’ (‘ECB Guide’) 7; available online at .

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Fit and Proper Assessments within the Single Supervisory Mechanism And a non-executive who chairs the audit committee is expected to commit more time and to have more experience of audit than a non-executive who does not have any additional committee memberships. B. Division of Tasks and Responsibilities Between the ECB and the NCAs Within the SSM, there exists a division of tasks and responsibilities between the 7.14 NCAs and the ECB, also with regard to fit and proper assessments. A distinction can be made between (i) assessments of members of management bodies of significant and non-significant banks; and between (ii) the different triggers of fit and proper assessments. The division of responsibilities regarding the assessment of key function holders is discussed separately (see ‘Assessments of Key Function Holders of Significant Banks’ below). i. Significant and Non-significant Banks The ECB is responsible for taking decisions 7.15 regarding assessments of members of the management bodies of banks under its direct supervision (hereafter ‘significant banks’18). The fit and proper assessments are conducted in co-operation with NCAs.19 In the case of licensing or qualifying holdings the ECB is also responsible for taking decisions on new appointments of members of the management bodies of less significant banks as part of the licensing or qualifying holding procedure.20 In this capacity, the ECB acts as gatekeeper for the significant banks.21 The NCAs remain responsible for appointments in less significant banks, except in 7.16 the context of licensing or a qualifying holding procedure.22 However, when necessary for the consistent application of high supervisory standards, the ECB may at any point in time decide to use directly the NCA’s supervisory powers for one or more less significant banks. This also includes the assessment of appointments of members of the management body in those banks.23 ii. Assessments of Management Body Members of Significant Banks The division 7.17 of responsibilities regarding the members of the management body depends

18 ‘Significant’ is defined in art 6 of Council Regulation (EU) 1024/2013 of 15 October 2013 conferring specific tasks on the European Central bank concerning policies relating to the prudential supervision of credit institutions [2013] OJ EU L28/63, 29 October 2013 (‘SSM Regulation’). The ECB is also responsible for taking decisions on the appointment of the members of the management bodies of (mixed) financial holding companies under its direct supervision, see art 121 of CRD IV. See also ECB Guide, 4. In the remainder of this chapter, where reference is made to ‘significant banks’, this also includes (mixed) financial holding companies under the ECB’s direct supervision. 19 Article 6(4) read in conjunction with art 4(1)(e) of the SSM Regulation. 20 Article 6(4) read in conjunction with arts 4(1)(a) and (c) and 14 (licensing)/15 (qualifying holdings) of the SSM Regulation. 21 See ECB Guide, 7. 22 Article 6(4) read in conjunction with art 4(1)(e) of the SSM Regulation. See also ECB Guide, 4. 23 See art 6(5)(b) of the SSM Regulation.

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Danny Busch and Annick Teubner on how the fit and proper assessment is triggered. There are different reasons for starting a fit and proper assessment: (1) a new appointment, a change of role or a renewal;24 or (2) new facts or any other issue.25 7.18 For the first category, the NCAs always serve as entry point. This means that

new appointments within significant banks and appointments in the context of a licensing or a qualifying holding procedure are communicated by the bank (or exceptionally the appointee) to the NCA, and the NCA subsequently informs the ECB. Significant banks must also notify the NCA of any change to the members of its management bodies, including the renewal of the management body members’ mandate. The ECB and the NCA collaborate closely in collecting information and in carrying out the assessment. For the assessment, the ECB has the supervisory powers that NCAs have under the relevant union and national law.26 The decision is taken by the ECB and notified to the bank within the time limit determined by the relevant national law.27

7.19 A decision can be negative, in which case the appointee cannot be appointed or

has to resign when he/she has been appointed or has already taken up the position.28 The number of negative decisions taken is low, because of the following reasons. Firstly, appointees often withdraw (or are withdrawn by the bank) during the fit and proper assessment procedure, when the competent authority informs the bank and/or the appointee of serious doubts about the suitability of the appointee.29 Secondly, the principle of proportionality also applies to the decision of the ECB. This means that when the appointee does not satisfy all fit and proper criteria, but the shortcomings can be adequately remedied by imposing a condition, the ECB will take a positive decision with a condition instead of a negative decision.30 Lastly, after a few years of fit and proper supervision, the banks have got a better view of what is expected of appointees. This helps to propose appointees who are more likely to be considered fit and proper. Besides positive decisions with or without conditions, the ECB may also take positive decisions with a recommendation or an obligation. Unlike conditions, these do not affect 24 Articles 78, 86 and 93 of Regulation (EU) 468/2014 of 16 April 2014 establishing the framework for co-operation within the Single Supervisory Mechanism between the European Central Bank and the national competent authorities and with national designated authorities [2014] OJ EU L141/1–50, 14 May 2014 (‘SSM Framework Regulation’). 25 See art 94 of the SSM Framework Regulation. 26 See art 93(2) of the SSM Framework Regulation. 27 See art 93(1) of the SSM Framework Regulation. 28 In some Member States the fit and proper assessment is conducted after the appointee has been appointed or taken up the position. In the latter case the member already fulfils his or her role. 29 Several fundamental principles and rights have to be observed during the assessment, if an intended decision could adversely affect the rights of the bank and/or appointee. One of these is the principle of due process and fairness. See art 22 of the SSM Regulation; arts 27–33 of the SSM Framework Regulation; and ECB Guide, 8 and 30. 30 When the bank and/or the appointee do not fulfil the condition within the given time, the appointee will be considered not suitable. See ECB Guide, 31.

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Fit and Proper Assessments within the Single Supervisory Mechanism automatically the suitability of the appointee.31 Decisions taken by the ECB can be reviewed by the Administrative Board of Review on request of the appointee or the bank and can be challenged before the Court of Justice of the European Union.32 The second category of triggers for a fit and proper assessment are new facts or 7.20 ‘any other issues’. The ECB could become itself aware of new facts or issues during its supervision or via other ways, such as the press. New facts or other issues may also be notified to the ECB by banks and NCAs, as banks must inform the relevant NCA in case of new facts that may affect an initial assessment of suitability or any other issue which could impact the suitability of a member of the management body. This should be done without undue delay once these facts or issues are known to the bank or the relevant member of the management body. The relevant NCA on its turn must notify the ECB.33 The ECB may initiate a reassessment of a member of the management body, if the new facts may have an impact on the initial assessment of the relevant manager or if any other issue could impact the suitability of a manager. The ECB decides on the appropriate action in accordance with the relevant Union and national law and informs the relevant NCA of such action without undue delay.34 Whether the management body members remain suitable during the fulfilment 7.21 of the mandate is supervised as an element of the ongoing governance supervision of the ECB. Also the follow-up of recommendations or obligations or the fulfilment of conditions, imposed by the ECB as part of a positive fit and proper decision, is monitored during the governance supervision. iii. Assessments of Key Function Holders of Significant Banks Not all Member 7.22 States have provided the competent authority with the power to assess key function holders. In such cases the ECB did not have such powers either. However, the EBA Guidelines on suitability, published in 2017, now require competent authorities to also assess the fitness and propriety of certain key function holders of banks, namely the heads of internal control functions and the chief financial officer (CFO) where they are not members of the management body.35 In so far as Member States comply with this requirement (see Section VII), the ECB will conduct the assessment of the categories of key function holders which are mentioned in the EBA Guidelines. The banks will communicate a new appointment to the NCA, as is the case for members of the management body. The decision on the suitability will be taken by the ECB.

ECB Guide, 31. 32 ECB Guide, 32. 33 See art 94(1) of the SSM Framework Regulation. 34 See art 94(2) of the SSM Framework Regulation. 35 EBA Guidelines on suitability, paras 171, 172, and 176. 31

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V. Relevant Sources of Substantive Requirements 1. CRD IV and National Law 7.23 For the purposes of carrying out its supervisory tasks the ECB must apply all rel-

evant union law and, where this law is composed of directives, the national law implementing those directives.36 Suitability requirements are included in Article 91 of CRD IV, which has to be implemented by national law. Therefore, the ECB has to apply the fit and proper requirements laid down in the national legislation which implements Article 91 of CRD IV, when taking fit and proper decisions.37 2. EBA Guidelines on Suitability and ECB Guide

7.24 The fit and proper requirements included in Article 91 of CRD IV are

complemented by and further specified in the EBA Guidelines on suitability. The Guidelines have the aim of improving and harmonising fit and proper assessments within the EU by providing common assessment criteria and an explanation as to how Union law should be applied, and by setting out supervisory practices regarding suitability.38 Competent authorities and banks should make every effort to comply with the guidelines.39 Two months after publication of the EBA Guidelines on suitability, the competent authorities had to confirm whether they (intended to) comply40 or alternatively, had to explain to EBA why they will not incorporate the Guidelines into their supervisory practices. With the aims of providing transparency and strengthening compliance by national authorities with the guidelines,41 the EBA has published a table of compliance. This table provides an overview of the statements of compliance or the reasons for non-compliance of all competent authorities, including the ECB.42

7.25 Whereas the EBA Guidelines on suitability are part of the EU Single rule book

and apply to fit and proper assessments within all banks, the ECB Guide to fit and proper assessments is a legally non-binding, supervisory tool which describes the ECB’s supervisory policies, processes and practices regarding fit and proper assessments for the banks under its direct supervision. Due to the non-binding 36 Article 4(3), first para of the SSM Regulation. 37 See ECB Guide, 5. 38 EBA Guidelines on suitability, 4 (executive summary) and 16 (status of these guidelines). 39 Article 16(3) of Regulation (EU) 1093/2010 [2010] OJ L331/12, 15 December 2010 (‘EBA Regulation’). 40 Measures can be taken in case competent authorities while having stated that they will comply, do not apply or incorrectly apply the guidelines and thereby breach Union law (art 17 of the EBA Regulation). 41 Recital (26) of the Preamble to the EBA Regulation. 42 See online for the table of compliance regarding the Guidelines on suitability: .

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Fit and Proper Assessments within the Single Supervisory Mechanism nature of the ECB Guide, it cannot substitute relevant union law or national legal requirements.43 Nevertheless, the SSM policies, practices and processes inform the EBA guidelines on suitability, as the EBA looks at existing supervisory practices when developing guidelines. In addition, when applying EBA guidelines, competent authorities will develop supervisory practices or encounter questions of interpretation or unintended consequences, which may be taken into account in a revision of existing guidelines. Thus the policy cycle will show a continuous influence and interplay between the EBA guidelines and SSM policies, practices and processes. The policies, processes and practices described in the ECB Guide explain how the 7.26 ECB applies Union law, on a case-by-case basis, to significant banks within the SSM.44 These policies, processes and practices are developed by the ECB jointly with the NCAs. They should ensure as much consistency within the SSM as possible, taking into account the applicable legal frameworks. The latter means that the policies apply without prejudice to national law. The ECB and NCAs should adhere to the policies unless there is contradicting binding national law. For example, the policies on experience include a presumption that a CEO has adequate experience in case he/she has ten years of recent practical experience in areas related to banking or financial services.45 Should there be a similar explicit presumption in binding national banking law requiring five years of recent practical experience in areas related to banking or financial services, then this national threshold will apply in the relevant Member State. However, if the supervisory practice is to use a five years threshold or this threshold is included in legally non-binding national banking law, the SSM policy will apply. In case the binding national law does not include an explicit threshold, the national competent authorities interpret the national law as much as possible in accordance with the SSM policies. New national law should also be developed in line with the SSM policies to the extent possible.46 Although the ECB policies, practices and processes are only applicable to signifi- 7.27 cant banks, they are likely to have some impact on the fit and proper assessments regarding non-significant banks within the SSM by NCAs. NCAs may apply the policies, practices and processes in a proportionate way to non-significant banks with a view to creating a level playing field and efficiency of processes. On the other hand, NCAs may apply different policies, practices or processes because of prudential or practical considerations.

ECB Guide, 3. 44 ECB Guide, 6. Fit and proper assessments of members of the management bodies and key function holders of non-significant banks within the SSM are conducted by the NCAs. 45 ECB Guide, 12. 46 ECB Guide, 6. 43

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VI. Convergence 1. General 7.28 We will now describe the convergence that has been achieved so far regarding fit and

proper assessments of members of the management body and key function holders. Convergence is on the one hand achieved through harmonization of the rules laid down in CRD IV and the EBA Guidelines on suitability (the Single rule book), and on the other hand through consistent application of the rules set out in the Single rule book. 2. Fit and Proper Requirements for the Members of the Bank’s Management Body

A. Five Assessment Criteria 7.29 Article 91(1) of CRD IV provides that members of the management body should at all times be of sufficiently good repute and possess sufficient knowledge, skills, and experience to perform their duties, while the overall composition of the management body must reflect an adequately broad range of experiences.47 In Article 91(2)–(8) of CRD IV these overarching requirements are fleshed out in further detail. Article 91(2) of CRD IV specifies that all members of management bodies must commit sufficient time to perform their function, while Article 91(3)–(6) of CRD IV set certain limits on the number of directorships which a member of the management body of a bank may hold at the same time in different entities. Article 91(7) of CRD IV specifies that the management body must possess adequate collective knowledge, skills and experience to understand the bank’s activities, including the main risks.48 Finally, Article 91(8) of CRD IV requires each 47 Please note that Directive (EU) 2019/878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253 will amend art 91(1) of CRD IV as follows (amendments are shown in italics): ‘Institutions, financial holding companies and mixed financial holding companies shall have the primary responsibility for ensuring that members of the management body shall at all times be of sufficiently good repute and possess sufficient knowledge, skills and experience to perform their duties. Members of the management body shall, in particular, fulfil the requirements set out in paragraphs 2 to 8. Where members of the management body do not fulfil the requirements set out in this paragraph, competent authorities shall have the power to remove such members from the management body. The competent authorities shall in particular verify whether the requirements set out in this paragraph are still fulfilled where they have reasonable grounds to suspect that money laundering or terrorist financing is being or has been committed or attempted, or there is increased risk thereof in connection with that institution.’ The sentence in the current CRD IV, art 91(1): ‘The overall composition of the management body shall reflect an adequately broad range of experiences’ will be moved to art 91(7) of CRD IV. 48 Please note that Directive (EU) 2019/878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253 will amend art 91(7) of CRD IV as follows (amendments are shown in italics): ‘The management

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Fit and Proper Assessments within the Single Supervisory Mechanism member of the management body to act with honesty, integrity and independence of mind to effectively assess and challenge the decisions of the senior management where necessary, and to effectively oversee and monitor management decision-making.49 In view of the above, the fitness and propriety of members of the management 7.30 body is assessed against five criteria: (i) knowledge, skills and experience; (ii) reputation; (iii) independence of mind; (iv) time commitment; and (v) collective suitability. These criteria are further explained and specified in the EBA Guidelines on suitability. EBA’s power to issue these guidelines is based on the specific mandate provided 7.31 for in CRD IV (Article 91(12) of CRD IV). To the extent that a specific mandate is lacking, the authority to issue guidelines is based on EBA’s general power to issue guidelines with a view to establishing consistent, efficient and effective supervisory practices within the European System of Financial Supervisors (‘ESFS’), and to ensure the common, uniform and consistent application of union law.50 B. Knowledge, Skills, and Experience The EBA Guidelines on suitability provide further detail on the requirement that 7.32 members of the management body must possess sufficient knowledge, skills and experience to fulfil their functions.51 The ECB has explained in its guide how it will apply this in its fit and proper assessments. In Article 91(1) of CRD IV and the EBA Guidelines on suitability the terms 7.33 knowledge, skills, and experience are used. In the ECB Guide the term ‘experience’ is used as an ‘umbrella term’ to cover all aspects, namely practical, professional experience gained in previous occupations, and theoretical experience gained through education and training.52 In this chapter the CRD IV terminology will be used.

body shall possess adequate collective knowledge, skills and experience to be able to understand the institution’s activities, including the main risks. The overall composition of the management body shall reflect an adequately broad range of experience.’ 49 Please note that Directive (EU) 2019/878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253 will amend art 91(8) of CRD IV as follows (amendments are shown in italics): ‘Each member of the management body shall act with honesty, integrity and independence of mind to effectively assess and challenge the decisions of the senior management where necessary and to effectively oversee and monitor management decision-making. Being a member of affiliated companies or affiliated entities does not in itself constitute an obstacle to acting with independence of mind.’ 50 See art 16(1) of the EBA Regulation. 51 EBA Guidelines on suitability, 32–4. 52 ECB Guide, 10.

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Danny Busch and Annick Teubner 7.34 With the aim of enhancing efficiency and decreasing the time needed for the

assessment, the ECB has introduced a two-step approach. The ECB has defined certain thresholds for the CEO, Chairman, and directors. When the appointee meets the relevant number of years of experience, he/she is presumed to have adequate knowledge, skills and experience. Should the appointee not meet the relevant threshold, then he/she could still have sufficient knowledge, skills, and experience, but this should be assessed in a complementary assessment.53

7.35 For the assessment of the knowledge, skills and experience the following should

be considered: ‘(a) the role and duties of the position and the required capabilities; (b) the knowledge and skills attained through education, training and practice; (c) the practical and professional experience gained in previous positions; and (d) the knowledge and skills acquired and demonstrated by the professional conduct of the member of the management body’.54

7.36 i. Knowledge and Experience In order to be able to understand the bank’s

business and comprehend its main risks, an appointee should have basic theoretical banking knowledge and experience. The most important areas of theoretical knowledge are banking, financial services, finance, economics, law, administration, financial regulation, information and technology, financial analysis, and quantitative methods.55

7.37 The required level of understanding of each of these areas will depend on the

appointee’s function within the management body. The knowledge and experience should be commensurate with his/her responsibilities. For example, the knowledge and experience may differ depending on whether the appointee will have an executive or a non-executive role, especially in a two-tier board where the management and supervisory functions are clearly separated.56 Or if the appointee is to become CTO, he/she should have an in-depth knowledge of the ICT aspects of the bank’s business and the ICT risks involved. In addition, he/she will be expected to possess sufficient understanding of areas for which he/she is collectively accountable, jointly with the other members of the management body.57

7.38 The appointee should also have a clear understanding of the governance

arrangements of the bank itself and of those of the group of which it is part, as well as any conflicts of interests that may arise within the group. In particular, the appointee should have a good understanding of his/her tasks and responsibilities and his/her role within the broader governance framework of the bank and the group.58 53 ECB Guide, 11–13. 54 EBA Guidelines on suitability, 32 [60]. 55 ECB Guide, 11; EBA Guidelines on suitability, 32 [62]. 56 ECB Guide, 10. 57 EBA Guidelines on suitability, 31 [58]. 58 EBA Guidelines on suitability, 32 [59].

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Fit and Proper Assessments within the Single Supervisory Mechanism Since the financial crisis, it is acknowledged that an appropriate culture, sound 7.39 corporate values and appropriate behaviour are key for achieving good governance within banks.59 The ‘tone at the top’ is of paramount importance. The members of the management body should take the lead in creating an appropriate culture, defining corporate values, and showing appropriate behaviour. Therefore the ability of the appointee to contribute to the culture and corporate values and the behaviour shown in the past will be taken into account in the assessment.60 ii. Skills Like executives and non-executives in any organization, an appointee 7.40 for a position to the management body of a bank needs to have certain skills. The EBA Guidelines on suitability provide a non-exhaustive list of skills which are considered to be relevant for members of the management body: authenticity, language, decisiveness, communication, judgement, customer and quality-oriented, leadership, loyalty, external awareness, negotiating, persuasive, teamwork, strategic acumen, stress resistance, sense of responsibility, and chairing meetings.61 Many of these skills are not specific for the banking sector, but generally required for managers of organizations. The relevance of each skill will vary, depending on the specific position of the appointee or the bank. Some skills are relevant for all members of the management body, such as leadership, communication, or teamwork. Others are important for a specific role, such as the capability of chairing meetings for the CEO and the Chairman of the management body or of committees. Language skills may be specifically relevant in cross-border groups. iii. Diversity It is a well-known fact that a diverse composition of the manage- 7.41 ment body reduces the risk of group-think. Having a broad set of experience, knowledge and skills enhances constructive challenge and sharing of independent opinions and thus the sound decision taking of the management body. Therefore, Article 91(10) of CRD IV stipulates that Member States or NCAs ‘must require banks and their respective nomination committees to engage a broad set of qualities and competences when recruiting members of the management body and for that purpose must put in place a policy promoting diversity on the management body’.62 How does this relate to the requirement for management body members to always possess banking experience? Diversity is not one of the fit and proper assessment criteria. Therefore, it cannot 7.42 override the requirement of adequate knowledge, skills or experience for management body members. However, diversity should be taken into account when selecting and assessing a new member.63 In particular for members of the

59 BCBS, ‘Corporate governance principles for banks’, Principle 1, Boards responsibilities, 8 [26]; EBA, Guidelines on Internal governance, 35 [99]–[102]. 60 EBA Guidelines on suitability, 32 [59]. See also the EBA Guidelines on Internal Governance. 61 EBA Guidelines on suitability, 32 [61], read in conjunction with Annex II. 62 The EBA Guidelines on suitability provide further detail, see 43–4 [104]–[109]. 63 EBA Guidelines on suitability, 12 ‘Background and rationale’ [42].

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Danny Busch and Annick Teubner supervisory function, diversity is important for the fulfilment of their role, as they have to provide constructive challenge to the management function. The EBA Guidelines on suitability and the ECB Guide provide examples of how a balance can be struck between the need for adequate knowledge, skills, experience, and diversity.64 7.43 The EBA Guidelines on suitability leave room for taking into account knowledge,

skills and experience ‘gained from relevant academic or administrative positions or through the management, supervision or control of financial institutions or other firms’.65 This means that not only previous positions in the banking sector may count, if they are relevant for the fulfilment of the new mandate in the bank. By looking also at other previous positions the positive impact of diversity on the fulfilment of the role of the supervisory role is acknowledged.

7.44 Also the ECB acknowledges the need for and positive impact of broad experience

and diversity.66 A lower level of practical banking experience might be acceptable for an appointee for a supervisory function under certain conditions, when he/she brings knowledge and experience to the supervisory function which is specifically needed. For example, ICT and cybercrime knowledge are nowadays of paramount importance in the banking sector. Often, younger individuals possess such knowledge and experience, but they may have less banking experience and managerial experience. However, from the perspective of ensuring the management body to have the necessary ICT or cybercrime knowledge and experience, it is important to be able to appoint such experts to the management body. Therefore, the ECB will conduct a complementary case-by-case assessment in such cases, in which all relevant elements and justifications will be taken into account, such as the specific knowledge and experience, the commitment to follow a training plan67 and the overall composition of the management body.

7.45 iv. Assessment and Proportionality An appointee’s theoretical banking knowl-

edge is assessed against the education and training he/she has enjoyed. For the assessment of the practical experience previous positions are taken into account. Of course, not all previous experience may be relevant for the new position to the same extent. Important factors for the assessment are the length of service, the size of the entity, the type of responsibilities, the number of subordinates and the nature of the activities carried out.68 Even though educational degrees or previous positions are an indication of the acquired knowledge and experience, these may not provide a complete picture. Therefore the ECB makes also use of so-called ‘fit

64 Diversity is not limited to knowledge and experience, but covers also aspects such as gender, age, geographical provenance, background, etc. See EBA Guidelines on suitability, 44 [105]. 65 EBA Guidelines on suitability, 33 [66]. 66 ECB Guide, 12. 67 ECB Guide, 12. 68 ECB Guide, 11; EBA Guidelines on suitability, 32–3 [63]–[65].

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Fit and Proper Assessments within the Single Supervisory Mechanism and proper’ interviews to gather all information. These interviews are also an adequate tool to assess the skills of the appointee.69 When assessing an appointee, the main characteristics of the position are taken 7.46 into account, including whether the appointee will become member of the management function or the supervisory function of the management body, and whether this person will also become member of committees (eg the audit or remuneration committee). In addition, the main characteristics of the bank involved are taken into account, such as the type of activities and the organization of its business lines. In this way, proportionality is inherently part of fit and proper assessments. Proportionality always works both ways: for less complex institutions, the re- 7.47 quirement can be complied with in a simpler way. However, for more complex institutions the requirement will mean a more stringent or detailed application. In the case of fitness of management body members, the application of proportionality means that the more complex the characteristics of the position and institution are, the more knowledge, skills, and experience will be required.70 v. Induction and Training The bank should prepare its new members of the 7.48 management body for their new position. To that end the bank should set up an induction program.71 As members have different roles and responsibilities (members of the supervisory function may also be member of one or more committees), the induction program should be tailored to the specific needs of a member. During the fulfilment of their mandate members should keep their knowledge and skills up-to-date. Therefore they should be able to follow training programs,72 both individually and collectively, which are tailored to the current and future needs of the bank. Underlining the need for induction and training and ensuring that members have access to it, Article 91(9) of CRD IV explicitly provides that adequate human and financial resources must be devoted to the induction and training of members of the management body. The EBA Guidelines on suitability further specify this by requiring banks to have in place policies and procedures for induction and training, which should be adopted by the management body.73

69 See also, on interviews, Section VI.4 below. 70 ECB Guide, 10. 71 The EBA Guidelines on suitability define ‘induction’ as any initiative or programme to prepare a person for a specific new position as a member of the management body. 72 ‘Training’ means any initiative or programme to improve the skills, knowledge or competence of the members of the management body, on an ongoing or ad-hoc basis. EBA Guidelines on suitability, 21 [15]. 73 EBA Guidelines on suitability, 42–3 [97]–[103].

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Danny Busch and Annick Teubner C. Reputation 7.49 i. No Principle of Proportionality Trust is fundamental for modern banking and goes hand in hand with reputation, honesty and integrity. As trust will be based on the perception of an individual’s character and behaviour, it is crucial that members of the bank’s management bodies have a good reputation and show honest behaviour. The reputation can deemed to be either good or bad; a little bit good reputation does not exist. Therefore, there is no room for a proportionate application of the reputation requirement.74 7.50 ii. Issues Affecting Reputation If there is no evidence of a reputational issue and

if there is no reason to have a reasonable doubt, an appointee will be considered to be of good repute.75 Fraud, financial crime, tax and other legal offences will impact the reputation, honesty and integrity of an appointee.76 Also pending and concluded criminal or administrative proceedings (or other analogous regulatory proceedings) may be (perceived as) an indication of incorrect personal or business conduct. As these can impact the reputation of the appointee and the bank, such proceedings are taken into account in the fit and proper assessment.77 The ECB will assess in this case several factors, such as the nature of the charge or accusation, the personal involvement of the appointee and the time that has passed since the alleged wrongdoing.78

7.51 If the personal or business conduct of an appointee raises any doubts with respect

to his/her reputation which could affect the sound and prudent management of the institution, the bank and/or the appointee should inform the competent authority, who will then assess whether these circumstances should be considered material.79

D. Independence of Mind 7.52 Each member of the management body must act with independence of mind to effectively: (a) assess and challenge the decisions of the senior management where necessary; and (b) oversee and monitor decision-making.80 The aim of this 74 ECB Guide, 13. 75 EBA Guidelines on suitability, 35 [73]; ECB Guide, 13. 76 EBA Guidelines on suitability, 35–6 [75]. 77 EBA Guidelines on suitability, 35–6 [74]–[76]; ECB Guide, 13. 78 Pending proceedings are also relevant from the perspective of sufficient time commitment. If an appointee is involved in legal proceedings, this may well impact his ability to commit sufficient time to his/her functions. See ECB Guide, 13 n 14. 79 ECB Guide, 13. 80 See art 91(8) of CRD IV. Please note that Directive (EU) 2019/878, amending Directive 2013/ 36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253 will amend art 91(8) of CRD IV as follows (amendments are shown in italics): ‘Each member of the management body shall act with honesty, integrity and independence of mind to effectively assess and challenge the decisions of the senior management where necessary and to effectively oversee and monitor management decision-making. Being a member of affiliated companies or affiliated entities does not in itself constitute an obstacle to acting with independence of mind.’

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Fit and Proper Assessments within the Single Supervisory Mechanism requirement is to enhance objective decision-making and to ensure that management body members do not pursue their self-interest, but act in the best interest of the bank and its customers. This also contributes to enhancing trust in the banking sector. i. Distinction Between Independence of Mind and the Principle of Being Independent A distinction must be made between ‘independence of 7.53 mind’ and ‘being independent’. The former applies to all the members of the management body of a bank. The latter only applies to certain members of the management body in its supervisory function on the basis of national law.81 It should be noted that an independent member of the supervisory function may not necessarily be independent of mind, as he/she can lack the necessary behavioural skills (see below).82 So, the independence of mind should always be assessed. ii. Independence of Mind Acting with ‘independence of mind’ is ‘a pattern of 7.54 behaviour, shown in particular during discussions and decision-making within the management body’.83 For the assessment of the independence of mind, two factors are relevant. Members should: (1) have the necessary behavioural skills. The EBA Guidelines provide a non-exhaustive list of behavioural skills: (i) courage, conviction and strength to effectively assess and challenge the proposed decisions of other members of the management body; (ii) being able to ask questions to the members of the management body in its management function; and (iii) being able to resist ‘group think’.84 (2) not have a conflict of interest which could hinder him/her to perform his/her duties independently and objectively.85 According to the ECB Guide a conflict of interest exists, if the attainment of the interests of a member may adversely affect the interests of the bank.86 Not only actual or potential conflicts of interest can affect the independence of mind, but also conflicts of interest that are perceived by the public.87 In order to avoid conflicts of interest or deal with such conflicts, banks should 7.55 develop policies to identify, assess, manage and mitigate conflicts of interest.88 If a conflict of interest arises, the bank should take the actions described in the

81 EBA Guidelines on suitability, 37 [79]. 82 EBA Guidelines on suitability, 37 [81]. 83 EBA Guidelines on suitability, 37 [80]. 84 EBA Guidelines on Internal Governance, 36. 85 EBA Guidelines on suitability, 38 [82]. 86 ECB Guide, 15. 87 EBA Guidelines on suitability, 38 [84]; ECB Guide, 15. 88 See art 88(1) of CRD IV.

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Danny Busch and Annick Teubner policies and inform the competent authority, when the conflict of interest may impact the independence of mind of the relevant member.89 The EBA Guidelines on suitability describe what information should be provided by the bank in a statement to the competent authority.90 7.56 The ECB Guide describes the process for the assessment of conflicts of interest.91

The ECB will assess the materiality of the conflict of interest. The ECB Guide provides a list of situations in which a material conflict of interest is presumed to exist. The ECB distinguishes personal, professional, financial and political conflicts of interests.92 As it is a presumption, the conflicts of interest described in the list are not automatically considered to be material, but will be assessed in detail by the ECB on a case-by-case basis.93

7.57 The fact that an appointee has a conflict of interest will not make him/her auto-

matically not suitable for being member of the management body. Non-material conflicts will in principle not impact the independence of mind. However, even if the conflict of interest poses a material risk, the appointee could be considered suitable, if the risk can be prevented, adequately mitigated or managed through either: (a) measures taken by the bank based on its conflicts of interest policies; or (b) through a condition imposed by the ECB.94 In the ECB Guide the following possible conditions are mentioned: ‘(i) prohibition to participate in any meeting or decision-making concerning a particular disclosed interest; (ii) resignation of a certain position; (iii) specific monitoring by the bank; (iv) specific reporting to the competent authority on a particular situation; (iv) cooling-off period for the appointee; (v) obligation on the bank to publish the conflict of interest; (vi) any application of the ‘at arm’s length’ principle; and (vii) specific approvals by the whole management body for a certain situation to continue.’95 Should measures of the bank or the conditions imposed by the ECB not be sufficient to manage the risks posed by the material conflict of interest, then the appointee will not be considered suitable.96

7.58 iii. Being Independent ‘Being independent’ is a requirement which is only rel-

evant in relation to the management board in its supervisory function. It means that the ‘independent members’ of the management body in its supervisory function should ‘not have any present or recent past relationships or links of any nature with the bank or its management that could influence the member’s

89 EBA Guidelines on suitability, 39 [86]. 90 EBA Guidelines on suitability, Annex III, section 5, 68. 91 ECB Guide, 15. 92 ECB Guide, 17. 93 ECB Guide, 16. 94 ECB Guide, 15. 95 ECB Guide, 16. 96 ECB Guide, 15–16.

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Fit and Proper Assessments within the Single Supervisory Mechanism objective and balanced judgment and reduce a member’s ability to take decisions independently’.97 According to the EBA Guidelines on suitability the independent members ‘should 7.59 play a key role in enhancing the effectiveness of checks and balances’ within the bank ‘by improving oversight of management decision-making’. They should ensure that: (i) ‘the interests of all stakeholders, including minority shareholders, are taken into account’; (ii) ‘no individual or small group of members dominates decision-making’; and (iii) ‘conflicts of interest within the bank or the group are adequately managed’.98 The EBA Guidelines on suitability provide details on the sufficient number of independent members.99 The requirement for having a sufficient number of independent members is not 7.60 one of the fit and proper assessment criteria. Therefore, the ECB will take into account this requirement in the context of a fit and proper assessment only when national substantive law includes specific formal independence criteria.100 E. Time Commitment A member of the management body must commit sufficient time to perform his/ 7.61 her function. The time commitment requirement consists of two elements: (i) a quantitative element, namely a limited number of directorships (Article 91(3) of CRD IV); and (ii) a qualitative element (Article 91(2) of CRD IV). i. Quantitative Assessment Combining a high number of directorships could 7.62 preclude a member of the management body from committing adequate time on the performance of each or several roles. Therefore Article 91(3) of CRD IV limits the number of directorships which a member of the management body of a significant institution may hold at the same time to: (1) one executive directorship with two non-executive directorships; (2) four non-executive directorships.101 The implicit assumption of this calculation rule is that an executive position takes up twice as much time as a non-executive position. Some argue that the workload entailed by a non-executive directorship will, in practice, often be much less than this ratio suggests.102 However, since the financial crisis the tasks and responsibilities of non-executives have increased and the accountability has become more important. So the counting rules of the CRD IV could be regarded as an indication of the increasing expectations towards the supervisory function. 97 EBA Guidelines on suitability, 37 [81]. 98 EBA Guidelines on suitability, 40 [90]. 99 EBA Guidelines on suitability, 39 [89], first paragraph. 100 ECB Guide, 17. 101 Competent authorities may authorize members of the management body to hold one additional non-executive directorship. See art 91(6) of CRD IV. 102 Cf E Wymeersch, Corporate Governance for Banks According to CRD IV in: P Gasós, E Gnan and M Balling (eds), Challenges in Securities Markets Regulation: Investor Protection and Corporate Governance (SUERF 2015/1) 69–90, § 7.

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Danny Busch and Annick Teubner 7.63 In certain situations, several mandates count as a single directorship.103 This is for

example the case when several directorships are held in a group. It is quite common for members of the management body of a top holding entity to be members of the management body of various group entities as well. On the one hand, one could argue that these could be counted as a single directorship, as there may be synergies. On the other hand, each mandate will require time, as each entity has its own specific interests, activities, and issues. In addition, in case of cross-border situations, the management body members should also have sufficient time to understand the national legal frameworks and compliance obligations.

7.64 Article 91(5) of CRD IV also stipulates that certain directorships are excluded

from counting, namely mandates in organizations which do not predominantly pursue commercial objectives. The EBA Guidelines on suitability include a few examples of such organizations.104 The ECB Guide provides a more extensive list.105 The background to the counting rule of Article 91(5) of CRD IV is that a management body member is assumed to be able to more easily free him/herself from the obligations of a mandate in a ‘non-commercial entity’, when the new directorship in the bank unexpectedly requires more time.

7.65 Even if the number of directorships of an appointee remains within the limits of

Article 91(3) of CRD IV, the appointee may be considered to not fulfil the qualitative requirement. For the quantitative element, CRD IV provides calculation rules, which could lead to a situation in which an appointee can still have ten or more directorships. Although there may be synergies (in particular when an appointee holds several mandates within one group), the combination of mandates could leave the management body member not sufficient time from a qualitative perspective to fulfil the responsibilities of the new mandate adequately.

7.66 ii. Qualitative Assessment Banks have to determine the expected time commit-

ment for a position and assess whether the appointee can commit sufficient time. Relevant qualitative aspects for the assessment of the banks themselves and of competent authorities include: (i) the bank’s size; (ii) the nature and complexity of its activities; (iii) the country/countries in which the bank is based; (iv) any travel time involved; (v) the appointee’s role or roles within the management body (eg a

See art 91(4) of CRD IV. 104 EBA Guidelines on suitability, 31 [57]. 105 The ECB Guide mentions the following examples: ‘(i) non- profit sports or cultural associations; (ii) charities; (iii) churches; (iv) chambers of commerce/trade unions/professional associations; (v) organisations for the sole purpose of managing the private economic interests of members of the management body and that do not require any day-to-day management by the member of the management body; and (vi) organisations which are presumed to pursue predominantly non-commercial activities based on national regulatory provisions.’ The Guide further clarifies that ‘other organisations could still be considered not to be pursuing predominantly commercial objectives after assessment by the competent authority of the nature of the organisation and the predominance of the non-commercial activities.’ See ECB Guide, 19. 103

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Fit and Proper Assessments within the Single Supervisory Mechanism role as CEO or Chair, memberships of committees etc); and (vi) other positions and commitments.106 In their assessment banks should also take into account the time needed for on- 7.67 going learning and development, and for unexpected circumstances, such as crisis situations and court cases that might come up during his/her membership of the management body.107 F. Collective Suitability The management body should collectively have the knowledge, skills and ex- 7.68 perience which is necessary to fulfil its tasks and responsibilities.108 The bank is primary responsible for ensuring that the management body has an adequate composition.109 When appointing a new member to the management body, the bank should not only assess the individual fitness and propriety, but also the collective suitability. Banks should assess the level of collective suitability in each area through a self- 7.69 assessment and identify the gaps by comparing the actual composition and collective suitability with the required one.110 The EBA Guidelines on suitability111 and the ECB Guide112 propose suitability matrices as an effective tool for the self-assessment, but banks can also develop their own methodology, as long as it achieves the same objectives. The outcomes of the self-assessment should be taken into account when determining the profile of the new management body member. They should also be transmitted to the competent authority together with the individual assessment of the appointee.113 The collective suitability of the management body is important for sound decision 7.70 making. Therefore, the collective suitability should cover all necessary areas of knowledge, which should be aligned with the current and future needs, activities, and challenges of the bank. This is well expressed in a speech of Danièle Nouy, Chair of the Supervisory Board of the ECB in 2018:

EBA Guidelines on suitability, 28 [43]; ECB Guide, 20. 107 EBA Guidelines on suitability, 28–30 [42]–[44]; ECB Guide, 20. 108 EBA Guidelines on suitability, 34 [71]. See art 91(7) of CRD IV. Please note that Directive (EU) 2019/878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253 will amend art 91(7) of CRD IV as follows (amendments are shown in italics): ‘The management body shall possess adequate collective knowledge, skills and experience to be able to understand the institution’s activities, including the main risks. The overall composition of the management body shall reflect an adequately broad range of experience.’ 109 ECB Guide, 22. 110 EBA Guidelines on suitability, 53 [150]. 111 EBA Guidelines on suitability, 53 [151]. 112 ECB Guide, 22. 113 EBA Guidelines on suitability, 51 [144]. 106

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Danny Busch and Annick Teubner The collective knowledge of boards can still be improved. In-depth knowledge is particularly important for challenging senior management on more technical topics such as digitalisation, IT, internal models and regulation.114 7.71 Currently, digitalization, and IT are important developments which are changing

the banking sector. Therefore, the management body should collectively have sufficient understanding of these topics and the risks involved. In a few years’ time, other issues or risks may arise, which will create new demands on the collective suitability of the management body members. Thus the collective suitability will change over time. This stresses the need for periodic re-assessments of the collective suitability and also for ongoing development and education.

7.72 The fact that the management body should be collectively suitable does not mean

that all members of the management body need to have the same level of understanding of each area. Depending on their role, members could have more or less knowledge of or experience in a certain topic. Overall, each area should be covered by a sufficient number of members to ensure adequate discussion and good decision-taking.115

7.73 As the roles of the management function and supervisory function differ, the col-

lective suitability of each function should be conducted separately. As explained in the EBA Guidelines on suitability, members of the management function should have the knowledge, skills, and experience to ensure sound decisions regarding the business model, risk appetite, strategy, and markets in which the bank operates, while the supervisory function should be able to effectively challenge the management function.116

7.74 Sometimes it is argued that there is no need for members to have sufficient knowl-

edge, skills and experience individually. The collective suitability would be sufficient in this view, as management body members take decisions collectively and are often collectively accountable (depending on national law). However, this would ignore the fact that members of the management body have their own individual tasks and responsibilities. In addition, members of the management function should be able to constructively challenge senior management and to discuss propositions and information in order to make sound decisions,117 while members of the supervisory function should be able to challenge the management function and should be able to fulfil their role in committees of which they are member.

114 Keynote speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, at the farewell seminar of Jan Sijbrand ‘From Lehman to Bitcoin—Trends and Cycles in Financial Supervision’, Amsterdam, 21 June 2018. 115 EBA Guidelines on suitability, 34 [70]. 116 EBA Guidelines on suitability, 34 [67]–[69 and 52 [150]. 117 EBA Guidelines on Internal Governance, 20 [30].

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Fit and Proper Assessments within the Single Supervisory Mechanism 3. Assessment of Key Function Holders Two of the assessment criteria applicable to members of the management body 7.75 also apply to key function holders, namely knowledge, skills and experience and honesty, integrity and reputation. Collective suitability is not relevant for key function holders as they only have individual responsibilities. Also, they are normally assumed to be able to commit sufficient time to their function, as their position is usually full-time. Should a key function holder occupy several positions within a group, then the time commitment criterion may become an issue. Although the EBA Guidelines on suitability do not mention independence of mind as a criterion, the EBA Guidelines on Internal Governance require key function holders to be independent of the business lines or units they control.118 4. Convergence of Assessment Process Currently, there is a wide variety of fit and proper assessment processes in the 7.76 Member States. Nevertheless, the EBA Guidelines on suitability have provided for convergence regarding several aspects of the assessment process, such as: • the time for notification by banks of a new appointment;119 • the requirement for competent authorities to set out the supervisory procedure applicable to the assessment of the suitability of the heads of the internal control functions and the CFO, where they are not part of the management body;120 • the maximum period for the suitability assessment (including the possibility to suspend) by the competent authority;121 and • documentation requirements for initial appointments.122 Important to mention is the use of fit and proper interviews as part of the assess- 7.77 ment procedure.123 In its 2016 peer review the EBA concluded that interviews are a useful tool for gathering information on the suitability of the appointee,124 in particular regarding aspects that are difficult to assess based on documents only (such as skills, integrity or reputational issues). The ECB also conducts fit and proper interviews, taking a proportionate and risk-based approach.125 The latter means that fit and proper interviews will as a principle always be conducted for new CEO’s and Chairmen of stand-alone banks and the top banks of groups, as

EBA Guidelines on Internal Governance, 46 [155] and 47 [158]. 119 EBA Guidelines on suitability, 58–9 [174]. 120 EBA Guidelines on suitability, 59 [177]. 121 EBA Guidelines on suitability, 58–9 [178]–[179]. 122 EBA Guidelines on suitability, 66–7, Annex III. 123 EBA Guidelines on suitability, 59 [182]–[183]. 124 EBA Report on the peer review of the Guidelines on the assessment of the suitability of members of the management body and key function holders (EBA/GL/2012/06), 18 and 20. 125 ECB Guide, 24. 118

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Danny Busch and Annick Teubner these entail the highest risk.126 In other cases the ECB may decide to interview an appointee. This will in particular be useful when a specific concern has arisen regarding the appointee’s fitness or integrity/propriety.127

VII. National Variations and Limits 1. General 7.78 As explained above, CRD IV and the EBA Guidelines on suitability aim to har-

monize fit and proper assessments across Europe, while the SSM policies reflected in the ECB Guide aim to achieve consistent application of the regulatory framework and common supervisory practices. Nevertheless, there is still a wide variety of national practices regarding fit and proper assessments, due to the fact that there are limits to convergence in this area.

7.79 Below we will discuss the reasons for these varying practices, which relate to

(1) the transposition of and the level of harmonization by CRD IV; (2) the limits to harmonization through the EBA Guidelines on suitability; and (3) the requirement for the ECB to apply national law. 2. Transposition of and Level of Harmonization by CRD IV

7.80 CRD IV fit and proper requirements do not apply directly within Member States,

but have to be transposed into national law. This has not always been done128 or at least not in the same way. This is due to the fact that regarding governance CRD IV only provides for minimum harmonization, leaving room for Member States to develop requirements regarding those aspects that have not been covered by CRD IV or when there is room for more detailed requirements.

7.81 One important area that has not been covered by CRD IV is the fit and proper

assessment process. The consequence is that Member States have taken varying approaches to these assessments. In some Member States candidates are assessed ex ante, ie prior to their appointment or to taking up their position (eg the Netherlands, Belgium, Spain, and Portugal), while in others the assessment is conducted ex post, ie after the candidate has been appointed or has already taken up his/her position (eg Germany, Austria, France, and Italy). Even between Member States with the same approach, there are differences regarding the duration of the assessment and the possibility to suspend or interrupt the deadline, the manner in which a decision is taken (explicit decision necessary, tacit approval

126 ECB Guide, 24. 127 ECB Guide, 24. 128 For example, the criterion of time commitment is not included in Italian law, which means that legally, it cannot be applied to candidates for Italian banks.

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Fit and Proper Assessments within the Single Supervisory Mechanism or rejection), and as to whether a candidate can take up the position when the deadline has passed. A good practice that has not been covered explicitly by CRD IV is the practice to 7.82 have a sufficient number of independent members in the management body in its supervisory function. Some Member States have included a provision on the number in their national law, requiring a sufficient number, a majority or a specific number of independent members; other Member States do not have such requirement. In the latter case, management bodies are not legally required to have independent members (see also ‘Limits to harmonization through the EBA Guidelines on suitability’ below). The assessment criteria are examples of aspects where CRD IV leaves room for inter- 7.83 pretation. When does a candidate possess sufficient knowledge, skills and experience and sufficient time? And when is a candidate considered to have independence of mind? The EBA Guidelines on suitability have provided some more detail. Another issue regarding the transposition of CRD IV is the implementation of 7.84 requirements in legislation that is not specific for banks, eg in company law or civil law. An example is the list of organizations which pursue predominantly non-commercial objectives. As explained above, mandates in these organizations do not have to be taken into account for the assessment of time commitment. In France this CRD IV provision has not been implemented in financial law, as there was already a list of such ‘non-commercial organizations’ included in civil law. In particular when this legislation already existed before CRD IV, it can be questioned whether it could be considered as an adequate basis for the transposition of the CRD IV fit and proper requirements. The original objectives of such national legal provisions may often relate to other considerations than suitability, such as tax reasons, supporting shared ownership or ensuring the provision of community services (eg garbage collection or water supply). 3. Limits to Harmonization Through the EBA Guidelines on Suitability A second reason for the national variety of practices on fit and proper assessments 7.85 relates to the limits of harmonization through the EBA Guidelines on suitability. One limit stems from the fact that competent authorities in their capacity of 7.86 members of the EBA Board of Supervisors have to agree on the guidelines. In the Consultation Paper on the EBA Guidelines on suitability a proposal to harmonize the assessment approach (ex ante assessments) was included, but there was not sufficient support for this proposal.129 Therefore, in the final guidelines a neutral

129 See for the initial proposal for an ex ante assessment: ‘Consultation Paper on the Joint ESMA and EBA Guidelines on the assessment of the suitability of members of the management body and key function holders under Directive 2013/36/EU and Directive 2014/65/EU’, EBA/CP/2016/17

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Danny Busch and Annick Teubner approach was taken. The EBA explains the reason for the neutral approach in the guidelines as follows: A higher level of harmonisation would be desirable within the banking union, but could not be achieved in the current circumstances due, amongst other, to the existing fragmented national frameworks.130 7.87 In addition, harmonization through EBA Guidelines on suitability is limited due

to the fact that Member States can choose not to comply with (a part of ) the guidelines, but explain their reasons for not complying. The table of compliance regarding the EBA Guidelines on suitability shows that nine out of the twenty- eight Member States will not fully comply. The main topics of divergence are the assessment of key function holders and independence (in particular ‘formal independence’). Some competent authorities mention that in their view there is no legal basis in CRD IV for these requirements.131 Thus the lack of harmonization in CRD IV cannot always be solved through guidelines. 4. Application of National Law by the ECB

7.88 Consistency of fit and proper assessments within the SSM is impacted by Article

4(3) of the SSM Regulation which requires the ECB to apply ‘all relevant Union law, and where this Union law is composed of Directives, the national legislation transposing those Directives’. As the fit and proper requirements are included in CRD IV (a directive), the ECB has to apply the relevant national law transposing CRD IV and all national specificities included therein. The outcome of the ECB fit and proper assessment should thus be fully in line with the applicable national laws.

7.89 As we have seen above, CRD IV and the EBA Guidelines on suitability leave

room for national legislators and competent authorities to interpret, specify or add to the Single rule book in their national laws, which hinders the creation of more consistency and a level playing field. The Chair of the Supervisory Board of the SSM described the problem as follows: The rules on these ‘fit and proper’ assessments were written a long time ago. They were written at a time when supervising banks was still a purely national task here in Europe. The result is that the rules are not as harmonised as they should be in a banking union. And on top of that, they are not tailored to the challenges of modern banking. It would be good to base future appointments of bank executives on rules

(28 October 2016), 53–4 [161]. See for a summary of the negative responses regarding the initial proposal for an ex ante assessment: EBA Guidelines on suitability, 118–19. See for the final neutral approach EBA Guidelines on suitability, 56 [170]. 130 See EBA guidelines on suitability, 118–19. 131 See online for the table of compliance regarding the Guidelines on suitability: .

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Fit and Proper Assessments within the Single Supervisory Mechanism that are the same across Europe and that fully take into account the lessons learned from the financial crisis.132

Some examples of varying national laws are described below. Regarding reputa- 7.90 tion, national laws provide different approaches to the assessment of pending or finalized proceedings. For example, in some Member States certain convictions result automatically in a rejection,133 while this is not the case in others. There are also differences regarding the impact of the time passed after proceedings or supervisory measures. In some Member States the period after which a person will be rehabilitated after a conviction varies between three and twenty years,134 while national law in other Member States does not foresee for a rehabilitation period for fit and proper assessments.135 The counting of the number of directorships is relevant for the assessment of 7.91 the quantitative time commitment. As described above, mandates in organizations which pursue predominantly non-commercial objectives do not have to be counted. Which organizations are considered to be ‘non-commercial’ differs among Member States. An example of varying national law regarding conflicts of interest are the different thresholds for loans which a director can take without impacting its independence of mind. The varying application of assessment criteria also leads to different measures. The 7.92 ECB can only oppose to the appointment of a candidate or remove him/her from the management body when the candidate does not fulfil the requirements set out in the national law which transposes CRD IV.136 In other Member States national law includes the requirement to have employee 7.93 representatives on the management body.137 These members do not always have the same level of banking knowledge and managerial experience as executives or non-executives at the moment of appointment. Finally, it should be noted that CRD IV itself includes a possibility to exceed 7.94 the maximum number of directorships as described in Article 91(3). According to Article 91(6) of CRD IV, competent authorities may authorize members of the management body to hold one additional non-executive directorship. These authorizations are granted on a case-by-case basis.138

132 Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, ‘Being good pays off: how ethical behaviour affects risk, reputation and returns’, The Communicators Conference, Frankfurt, 12 November 2018. 133 eg Belgium. 134 eg in France, Finland, and Belgium. The rehabilitation period will always depend on the specific situation, including the seriousness of the crime and the sentence. 135 See, eg, Ireland and Portugal. 136 Article 16(2)(m) of the SSM Regulation. 137 See, eg, Germany and Austria. 138 Article 91(6) of CRD IV.

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Danny Busch and Annick Teubner 7.95 The issue of varying national laws and practices could be solved by further harmo-

nization at EU level. However, in both cases Member States or competent authorities would need to agree on the changes and they would have to comply with the new rules or guidelines. As described above, the revised EBA Guidelines on suitability aim to provide more harmonization on topics which are not explicitly included in CRD IV (key function holders and formal independence). However, when Member States do not comply, but explain (as is legally allowed), the harmonization objective is not achieved.

VIII. Concluding Observations 7.96 Within the limits described above, the revised EBA Guidelines on suitability have

increased the level of harmonization, in particular regarding the assessment criteria, but also on procedural and other aspects. The ECB has achieved consistency of application through the development of policies and supervisory practices which the national competent authorities apply without prejudice to national law. With every step towards more harmonization and consistency, the existing national variations become more obvious. This will underline the need for more harmonization and inform revision of Union law in the longer term. For the SSM, the solution would be to revise the SSM Regulation requirement that the ECB has to apply national law implementing CRD IV and provide the ECB with specific rules for conducting fit and proper assessments. This would contribute significantly to more consistent application of union law throughout the SSM.

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8 THE EU FRAMEWORK DEALING WITH NON-P ERFORMING EXPOSURES Legal and Economic Analysis Emilios Avgouleas

I. Introduction II. Causes and Consequences of NPL Accumulations

8.01

8.14 1. The Causes of High NPL Ratios 8.14 2. The Consequences of High NPL Ratios 8.15

III. Structural Measures

8.21 1. Legal Measures to Facilitate Recovery 8.21 2. NPL Disclosure and Data Standardization 8.27

IV. Market-based Solutions: Asset Management Companies and NPL Platforms

1. Challenges Relating to the Operation of AMCs as an Effective Means of NPL Disposal 2. Building a Marketplace for Distressed Bank Debt

V. Prudential and Supervisory Policies for Tackling NPLs

8.31 8.35

1. Microprudential Measures 2. Macroprudential Backstops

8.38 8.38 8.54

VI. Conclusion

8.57

8.31

I. Introduction Broadly speaking non-performing loans (‘NPLs’) are bank loans that are subject 8.01 to late repayment (a minimum of 90 days delay) or are unlikely to be repaid by the borrower.1 While in economic terms NPLs are tantamount to borrower default, no legal notice of default is required for the relevant bank to recognize that a specific exposure is no longer serviced and the bank might incur losses out of The standardized EU definition of NPLs refers to: ‘[a]‌bank loan . . . when more than 90 days pass without the borrower (a company or a physical person) paying or unlikely to be paying the agreed instalments or interest.’ See EU Council Communique, 18 December 2018 (Non-performing loans: political agreement reached on capital requirements for banks' bad loans), available online at . Within EU law the 1

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Emilios Avgouleas it, depending also on the value of collateral. Once a bank asset is recognized as non-performing a number of options are open to the bank from renegotiating the exposure, to writing it off completely. Where possible, the lender will try to dispose of the NPL by selling the loan (or the collateral attached to it), possibly incurring a loss. 8.02 The true measure of bank losses from NPLs is eventually reflected on the bank’s

balance sheet. This is normally the difference between the asset’s net present value (NPV)2 and the amount that the bank will ultimately recover, also called loss given default (LGD). Recovery will take place either directly from the borrower by restructuring the debt contract or from the open market if the bank sells the asset or liquidates the requisite collateral, if the loan was secured. LGD is minimized where the legal system is functioning in a pro-creditor environment (including judicial and extra-judicial proceedings) and loan recovery or asset disposal procedures are not too burdensome. If the bank has adopted prudent loss provisioning policies prior to the disposal or the writing off of the exposure, the impact of any loss from the NPL on the bank’s capital base can be fully contained. Otherwise a bank with a high level of NPLs that has not been adequately provisioned will face a number of pressing problems. The profitability of banks with a high ratio of NPLs might suffer since a portion of the bank’s assets is not generating income while it also forces it to employ un-utilized attendant capital reserves. Therefore, high levels of NPLs can weigh on bank solvency, financial stability and economic growth.

broader term Non-performing exposures (NPEs) is used as an umbrella term to catch all bank exposures that are not serviced but for the purpose of analytical clarity this chapter prefers to use the older/narrower term NPLs. The ECB(SSM) notes in its 2017 Guidance that NPL are Loans other than held for trading that satisfy either or both of the following criteria: ‘(a) material loans which are more than 90 days past-due; (b) the debtor is assessed as unlikely to pay its credit obligations in full without realization of collateral, regardless of the existence of any past-due amount or of the number of days past due. Non-performing loans include defaulted and impaired loans. NPLs are part of NPEs. See also EBA Implementing Technical Standard (ITS) on Supervisory Reporting (Forbearance and non-performing exposures). However, it should be noted that this Guidance document generally refers to “NPLs” as this is an established term in daily interactions between banks and supervisors. In technical terms, the guidance addresses all Non-Performing Exposures (NPEs) following the EBA definition, as well as foreclosed assets. In parts it also touches on performing exposures with an elevated risk of turning non-performing, such as watch-list exposures and performing forborne exposures.’ See ECB Guidance, 99 (infra n 32). 2 In the simplest terms NPV refers to: ‘the present value of the cash flows at the required rate of return of [a]‌project compared to [the] initial investment [namely, it’s] a method of calculating . . . return on investment for a project or expenditure . . .’ Net Present Value

=∑

Year n Total Cash Flow n

(1+Discount Rate)

Where ‘n’ is the year whose cash flow is being discounted. See Amy Galo, ‘A Refresher on Net Present Value’, Harvard Business Review, 19 November 2014, available online at .

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The EU Framework Dealing with Non-Performing Exposures The European Union (EU) and especially the Eurozone banking sector were hit 8.03 by a debilitating NPL crisis between 2010–2017 for a number of reasons including the fact that the surpluses of the more competitive and richer members of the European Monetary Union (EMU) had been invested by the banks of surplus countries in the EU periphery including the Baltic economies and the real estate markets of Spain, Portugal, and Ireland. Adding to that the exposure of EMU banks to Member State bonds (eg, Greece, Italy) and the solvency crisis that some Member States faced (eg, Greece, Cyprus, and Ireland), NPL accumulation aggravated further the Eurozone banking crisis during that period. For example, between December 2007 and September 2015 NPLs in the Eurozone banking sector increased more than three-fold from €292bn to €928bn.3 The proportion of bank capital that NPLs absorbed up to that point (end-September 2015) had risen from 1.6% at the end-2007 to 8.1% of all bank lending.4 At the end of 2016 NPLs figures were stable and they amounted to nearly €1tn at the end of 2016, roughly 6.7% of the EU’s GDP and 5.1% of total bank loans. But this pressure on Eurozone bank balance sheets eased off considerably since 8.04 20175 under improved macroeconomic conditions for most of the EU economies and higher levels of liquidity within the EMU mostly due to the European Central Bank’s loose monetary policies which together led to an improvement in the investment climate. Today the highest levels of NPLs are observed in the EMU periphery (Greece, Cyprus, and Portugal).6 Given that the countries in the EU periphery were also worst hit by the eurozone debt crisis with most of them just coming out from a deep recession, the imbalance in the NPL ratios has hardly made the problem more palatable. Resolving the continuing NPL problem in those jurisdictions is of no less importance for the national economies affected even though the issue is no longer critical for the solvency of the EBU banking

3 European Stability Mechanism (ESM), ‘Annual Report: 2015’, 42. 4 Ibid. 5 The EU Commission notes in its latest NPL progress report: ‘NPL ratios continued to decline in the first-half of 2018. This followed and confirmed the overall trend of improvement over recent years. The latest figures show that the gross NPL ratio for all EU banks further declined to 3.4% (Q2-2018), down by 1.2 percentage points year-on-year . . . The NPL ratio of significant institutions also decreased over the same timeframe by almost one percentage point to 4.4%. The ratio has thus continued its downward trend since Q4-2014. Additional data sources with regard to the longer-term trend indicate that the NPL ratio is approaching pre-crisis levels again . . . The provisioning ratio has also further improved and has risen to 59% (Q2-2018).’ See EU Commission Communication, Third Progress Report on the Reduction of Non-Performing Loans and Further Risk Reduction in the Banking Union, 28.11.2018 COM(2018) 766 final. 6 ‘NPL ratios have fallen in nearly all Member States. However, the situation continues to differ significantly between Member States . . . At the end of Q2-2018, 12 Member States had low NPL ratios of below 3%, while there are still some with considerably higher ratios—3 Member States had ratios above 10%. Even in Member States with relatively high NPL ratios, there is encouraging and sustained progress in most cases due to a combination of policy actions and economic growth.’ See ibid.

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Emilios Avgouleas sector as a whole. In fact, the EU bodies and the European Banking Union (EBU) authorities have set out ambitious goals for further reduction of NPLs on a pan- European basis. The desire to achieve very ambitious NPL reduction goals within such a short time-horizon in the Member States that were worst hit by the NPL crisis is also motivated by concerns in Germany that the EBU could turn out to become a fiscal union and German taxpayers might be called to share in the costs of failure of banks located in another Member State. 8.05 Arguably, the 2008–2009 Global Financial Crisis was the moment of truth

for a European Union (EU) that previously had not built any institutional structures to deal with a cross-border banking crisis or the collapse of a Member State’s finances either due to bank bail-outs (Ireland, Cyprus, and Spain) or of the state’s solvency (Greece).7 But while the European Monetary Union has taken the painstaking road towards building a European Banking Union (EBU)8 and reduce the possibility of bail-outs through the EU Bank Recovery and Resolution Directive (BRRD),9 the problem legacy assets, which emerged at the same time the as so-called ‘doom loop’, required a different type of approach.

8.06 NPL reduction in the EU is inextricably linked with the problem of bank sol-

vency and BRRD’s criteria of bank viability.10 Thus, the adoption of the long-term structural approach that aims to reform the NPL recovery process and transform distressed debt markets in the EU without the utilization of state-backed AMCs, has raised the possibility that NPL reduction could give rise to concerns about resolution for some banks when progress is not drastic. Where European banks have to write off losses from NPLs and cannot identify private investors to buy bank equity to recapitalize the bank, then, given that the possibility of bail-outs is, prima facie, ruled out, the only apparent route would be to enter into BBRD resolution proceedings. These would, however, also entail a bail-in of bank creditors up to 8% of liabilities before any other funding is offered to the bank that is undergoing resolution proceedings.11 But as the recent recapitalization of the Italian

7 Emilios Avgouleas and Douglas Arner, ‘The Eurozone debt crisis and the European banking union: “Hard choices”, “intolerable dilemmas” and the question of sovereignty’ (2017) 50 1 The International Lawyer. 8 The first formal conception of the EBU was spelled out in the EU Commission Communication, ‘A Roadmap towards a Banking Union’ COM/2012/0510 final, and came about following inter- governmental agreement utilizing as a legal basis Articles 114 and 127(6) of the Treaty on the Functioning of the European Union (TFEU). On the history of the EBU and its main pillars, see Marcel Magnus, ‘Banking Union’, European Parliament Factshet 10-2017, available online at . 9 Directive 2014/59/EU 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms [2014] OJ L173/190, 12.6.2014. 10 Ibid, art 32. 11 Ibid, art 37(10).

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The EU Framework Dealing with Non-Performing Exposures banking sector and the transfer of Banco Popular to Banco Santander have shown, the prospect of a general creditor bail-in does not seem to create much enthusiasm to national governments and regulators in Europe possibly because it raises the prospect of contagion by means of an immediate collapse in creditor confidence.12 Arguably, the precautionary recapitalization of the Italian bank Banca Monte dei Paschi di Siena (MPS)13 and the winding up of two Veneto banks14 under domestic insolvency law were nothing else but an effort to avoid triggering the BRRD requirement to conduct a bail-in that would erode further market confidence in the Italian banking sector. Increasing hostility towards bail-outs in the EU and the tightening up of the 8.07 EU state aid framework through both the BRRD and Commission’s shift in its willingness to approve state aid packages requiring now that burden-sharing of the private sector becomes an inextricable part of the recapitalization of even solvent banks outside of the resolution framework.15 These largely rule out the possibility of implementing Swedish style state-backed Asset Management Companies (AMCs)16 to either assume the NPLs on their balance sheets freeing up banks from this burden or undertake this task in conjunction with direct state recapitalization of ailing banks to help them write off their bad assets.

12 A point made repeatedly in Emilios Avgouleas and Charles Goodhart, ‘An anatomy of Bank Bail-ins: Why the Eurozone needs a fiscal backstop for the banking sector’ (2016) European Economy—Banks Regulation and the Real Sector, 75–90; Emilios Avgouleas and Charles Goodhart, ‘Critical Reflections on Bank Bail-ins’ (2015) 1 Journal of Financial Regulation 3–29; Emilios Avgouleas and Charles Goodhart, ‘A Critical Evaluation of Bail-in as a Bank Recapitalisation Mechanism’, CEPR DP 10065/2014. The performance of Italian banking stocks after the precautionary recapitalization of MPS reinforces this view. As a relevant BIS study states: ‘Overall, the FTSE Italia All Share Banks index climbed by 10% from the beginning of June to the end of July, outperforming the STOXX Europe 600 Banks index, which returned nearly 5%.’ See Bilyana Bogdanova and Mathias Drehmann ‘How did markets react to bank distress in Europe?’ Extract from pp 4–5 of BIS Quarterly Review, September 2017, available online at . 13 European Commission, ‘State Aid SA.47677 (2017/N)—Italy New aid and amended restructuring plan of Banca Monte dei Paschi di Siena’ COM C (2017) 4690 final, 17–23. 14 SRB, ‘Decision of the Single Resolution Board concerning the assessment of the conditions for resolution in respect of Veneto Banca SpA’, SRB/EES/2017/11, 11–21; and SRB, ‘Decision of the SRB concerning the assessment of the conditions for resolution in respect of Banca Popolare di Vicenza SpA’, SRB/EES/2017/12, 11–21, 23 June 2017. 15 See EU Commission Communication on the application of State aid rules to support measures in favour of banks in the context of the financial crisis (‘Banking Communication’) [2013] OJ C216/1, 30.7.2013. See also EU Commission, Factsheet, ‘State aid: How the EU rules apply to banks with a capital shortfall’ (25 June 2017), available online at . 16 AMCs and state to banks debt-to-equity swaps were also used widely to rid banks from their NPLs in the aftermath of the Asian crisis. See Douglas W Arner, Emilios Avgouleas, and Evan Gibson, ‘Overstating Moral Hazard: Lessons from Two Decades of Banking Crises’ (2017) University of Hong Kong Faculty of Law Research Paper No 2017/003.

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Emilios Avgouleas State-backed AMCs have, on the other hand, already been tried in Ireland17 and Spain18 in conjunction with EU rescue packages with mixed success. 8.08 In general, once the EU and especially the EMU moved into a more centralized policy

for tackling NPLs, state-backed AMCs were abandoned in favour of other actions. The Council of finance ministers agreed in July 2017 an Action plan to tackle non- performing loans in Europe.19 The plan outlined the following action routes: • more intensive supervision for banks with high levels of NPLs; • the reform of domestic insolvency and debt recovery frameworks; • the development of secondary markets for NPLs (‘distressed assets’); • the use of private players like AMCs that can provide a structural solution to distressed debt markets.

8.09 The announcement of the Action Plan was followed by the announcement of spe-

cific measures to reduce NPL levels in the Commission Communication on completing the banking union of October 2017.20 In March 2018 the EU Commission submitted a package of concrete measures together with the Commission’s Second Progress Report on the Reduction of Non-Performing Loans (NPLs) in Europe.21

8.10 In June 2019 the European Parliament and the Council agreed upon the “banking

package” which passed inot European Law the new Capital Requirements Regulation (CRR II)22 and the Capital requirements Directive (CRD V) which enhances the standards for the regulation and supervision of EU banks. It also endorsed the proposals on NPLs put forward in March 2018. In parallel a Regulation that introduced the statutory prudential backstop’ amending the

17 Ireland’s National Asset Management Agency (NAMA) was established in 2009 as one of a number of initiatives taken by the Irish Government to address the crisis the country’s banking sector. NAMA’s core objective was to reduce Ireland’s €30bn NAMA contingent liability. This objective was achieved in October 2017. See online at . 18 Spain’s Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria (SAREB) was founded in November 2012 to help clean up the Spanish financial sector and, in particular, the banks that became financially distressed as a result of their excessive exposure to the real estate sector. The Memorandum of Understanding (MoU) signed by the Spanish Government in July 2012 with its European partners established the creation of Sareb as one of the conditions for receiving financial aid. See online at . 19 European Council, ‘Council sets out action plan for non-performing loans’ 11/07/2017, Press Release 456/17. 20 EU Commission, ‘Communication on Completing the Banking Union’, Brussels, 11.10.2017 COM(2017) 592 final 21 EU Commission Communication, ‘Second Progress Report on the Reduction of Non- Performing Loans in Europe’, Brussels, 14.3.2018 COM(2018) 133 final. 22 Regulation (EU) 2019/876 of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) No 648/2012; Directive (EU) 2019/878 of 20 May 2019 amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures.

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The EU Framework Dealing with Non-Performing Exposures Capital Requirements Regulation23 was adopted in April 2019. The ‘backstop’ is meant to prevent the risk of under-provisioning of future NPLs. As part of the package the Parliament and the Council also agreed upon the Directive on preventive restructuring frameworks and restructuring, insolvency and discharge procedures.24 The measures build on existing legal frameworks and insolvency practice in some Member States that was found to work effectively. It aims to encourage viable businesses to restructure early in order to preserve value and save more jobs.25 The new regime introduced by the Directive gives entrepreneurs who have found 8.11 themselves in financial difficulties while acting in good faith a second chance to start a new business instead of being penalised for business failure. Namely, it lowers the costs of bankruptcy by removing a certain portion of the stigma attached to it fostering risk-taking by honest entrepreneurs. Overall the ‘banking package’ purports to increase their resilience in order to improve their lending capacity which is an important challenge as EU banks have been consisntely deleveraging and losing market share in terms of asset base since 2010. The ‘restructuring’ Directive may prove to be a key part of the implementation of that objective as second chance entrprenurs may raise the level of demand for new loans which the EU banks claim has never recovered since the 2008 crisis. The combined objective of new EU measures for the reduction of NPLs and the 8.12 prevention of future high level NPL accumulations can be taxonomized as follows: (1) augmenting market-based solutions for the massive disposal of NPLs that would be buttressed by legal and regulatory reforms and the provision of EU- wide infrastructure for disclosure and pooling of buyer interest and liquidity, including initiatives to build pan-European platforms for NPLs;26 (2) measures to build a liquid market for distressed bank debt both at the domestic and the EU level and a number of recent initiatives by EU bodies including disclosure and transparency standardization27 aim at reinforcing this goal;

23 Regulation (EU) 2019/630 of the European Parliament and of the Council of 17 April 2019 amending Regulation (EU) No 575/2013 as regards minimum loss coverage for non-performing exposures. 24 Directive (EU) 2019/1023 of 20 June 2019 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (Directive on restructuring and insolvency) 25 Ibid. Rec. 3. 26 EU Commission, Staff Working Document, ‘European Platforms for Non- Performing Loans’ accompanying Commission communication, ‘Third Progress Report on the reduction of non-performing loans and further risk reduction in the Banking Union’, COM(2018) 766 final, 28.11.2018 SWD(2018) 472 final. 27 eg, EBA Final Report, ‘Guidelines on disclosure of non-performing and forborne exposures’ EBA/GL/2018/10 17/12/2018, available online at . EBA, ‘NPL transaction templates’, available online at . 28 ECB, Bank Supervision, ‘Guidance to Banks on Non-Performing Loans’, March 2017, 12–13. 29 In specific, the ECB notes: ‘Banks should ensure that their NPL strategy includes not just a single strategic option but rather combinations of strategies/options to best achieve their objectives over the short, medium and long term and explore which options are advantageous for different portfolios or segments.’ Ibid, 12. 30 Ibid, 2. For the full articulation of the NPL reduction, governance, and write off techniques into EU supervisory standards see EBA, Final Report, Guidelines on management of non-performing and forborne exposures, 31 October 2018, EBA/GL/2018/06, available online at . 31 The ECB notes that this strategy is much dependent on the existence of adequate prior provisioning, collateral valuations, quality exposure data and market liquidity (NPL investor demand) in the case of reduction through sales. 32 The most recent EU pronouncement of this policy is in EU Council, ‘Non-performing Loans: Political Agreement Reached on Capital Requirements for Banks’ Bad Loans’ 18/12/2018, Press Release 815/18. 33 Naturally by building up capital buffers ex ante banks will reduce the provision of credit raining in credit growth in the event of a bubble, but they might as well affect credit growth in other times which would turn prudential backstops into a very blunt instrument. To account for this problem and augment the macroprudential impact of such backstops the European systemic Risk Board has recently published a report making recommendations for targeted capital charges a nuanced approach that is starkly missing from the EU Council communique. The prudential backstops are discussed in Section 5 below.

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The EU Framework Dealing with Non-Performing Exposures incentive for banks to strengthen under-writing standards and as a disincentive against loose loan underwriting practices. This chapter provides critical analysis of the EU measures to tackle the NPL crisis 8.13 and to prevent the reoccurrence of the problem once the economic and financial stability consequences of NPL accumulation have been properly considered. Accordingly, the rest of this chapter is divided in five sections. The next section discusses the systemic and idiosyncratic reasons that give rise to high levels of NPLs as well as the macroeconomic consequences of a high level of NPLs (debt overhang). Section III discusses the nature and impact of structural measures to reduce NPLs in the eurozone with critical analysis of relevant EU initiatives. Section IV offers analytical discussion of the nature and impact of supervisory and prudential measures to deal with NPLs including those proposed by the EU commission and the EU council prudential backstops to prevent future accumulation of NPLs. Section V focuses on the nature and effectiveness of market-based solutions including the operation of private sector AMCs. Section VI concludes.

II. Causes and Consequences of NPL Accumulations 1. The Causes of High NPL Ratios The key reasons for the accumulation of high levels of NPLs in the banking sector 8.14 tend to be both idiosyncratic (bank specific) and systemic. Arguably, as idiosyncratic qualify the following forms of behaviour:34 (i) negligent lending due to lax management controls, lack of competence, or lack of pressure from competition in a highly concentrated and oligopolistic market; (ii) rent-seeking strategies purused by bank amangement and onwers who of course reap the rewards of increased lending activity and higher leverage or reckless senior management and shareholders. Arguably, as aggressive expansion of the bank balance sheet and leverage based profitability increase the bank’s return on equity (RoE) shareholder and managerial incentives have to rebalanced if regulators with to avoid a fuure accumulation of bad lonas (NPLs). In fact, bank management might sometimes respond to peer 34 A Berger and R DeYoung, ‘Problem Loans and Cost Efficiency in Commercial Banks’ (1997) 21 Journal of Banking and Finance 849–70; A Çifter, ‘Bank Concentration and Non-Performing Loans in Central and Eastern European Countries’ (2015) 16 Journal of Business Economics and Management 117–37; A Ghosh, ‘Banking-Industry Specific and Regional Economic Determinants of Non-Performing Loans: Evidence from US States’ (2015) 20 Journal of Financial Stability 93– 104; S Ghosh, ‘Does Leverage Influence Banks’ Non-Performing Loans? Evidence from India’ (2006) 12 Journal of Applied Economics Letters 913–18. For an overview of these studies, see D Anastasiou, H Louri, and M Tsionas, ‘Determinants of Non-Performing Loans: Evidence from Euro-Area Countries’ (2016) 18 Finance Research Letters 116–19.

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Emilios Avgouleas pressure or it might follow broader banking market trends that boost risky/ reckless lending as was the case with sub-prime lending the USA in the earlier 2000s or loans to the Spanish and Irish real estate sectors; (iii) crony lending where credit scoring and strict lending controls is sacrificed in favour of lending money to bank affiliates or government favoured operations to further the economic interests of controlling shareholders or the political ends of an incumbent government. Similarly, according to a host of recent empirical studies macroeconomic conditions can have a serious impact on the level of bank NPLs.35 8.15 As macroprudential/ systemic causes qualify, in summary, periods of excessive

credit growth at an earlier period that come to an end where an economy enters into recession experiencing adverse macroeconomic conditions including high level of unemployment which are followed by high levels of loan delinquencies.36 In these conditions the value of bank collateral is also depreciating due to either a collapse in demand for the relevant assets or due to behavioural causes such as widespread risk aversion.37 As collateral does not have a different price for different levels of leverage, which, as Geanakoplos plausibly argues,38 would be the best way to control leverage, earlier expansion of credit and leverage will trigger further falls in collateral value.

8.16 The best example of the first scenario is the way the banking crisis developed in

Greece, Italy, Cyprus, and Portugal. Also systemic are the causes for NPL accumulation when a systemic shock like the implosion of an asset bubble, with the

35 See R Beck, P Jakubik, and A Piloiu, ‘Non-Performing Loans: What Matters in Addition to the Economic Cycle?’ (2013) ECB Working Paper Series No 1515/February; M Bofondi and T Ropele, ‘Macroeconomic Determinants of Bad Loans: Evidence from Italian Banks, Bank of Italy’ (2011) Occasional Paper No 89; R Espinoza and A Prasad, ‘Non-Performing Loans in the GCC Banking System and their Macroeconomic effects’ (2010) IMF Working Paper, WP/10/224; N Klein, ‘Non- Performing Loans in CESEE: Determinants and Impact on Macroeconomic Performance’ (2013) IMF Working Paper, WP/13/72. 36 This assumption also tallies well with the findings of a recent ESRB report that summarizes the cause of NPLs as follows: ‘The report identifies business cycle and asset price shocks as two of the main drivers of system-wide increases in NPLs. A downturn of the business cycle and/or negative asset price shocks, particularly in sectors to which the banking sector is significantly exposed (eg residential real estate (RRE) and commercial real estate (CRE)), may trigger a system-wide increase in NPLs. In some cases, such increases may also be associated with instances of significant resource reallocation within the economy . . .’ European Systemic Risk Board (ESRB) Report, ‘Macroprudential Approaches to Non-Performing Loans, January 2019, 3. 37 First called the ‘financial instability hypothesis’ by Minsky and then termed the ‘leverage cycle’ by Geanakoplos this behaviour of the markets is one of the key reasons for the triggering of financial crises. Indicatively, see Hyman P Minsky, ‘The Financial Instability Hypothesis’ (1992) Jerome Levy Economics Institute of Bard College Working Paper No 74; John Geanakoplos, ‘Solving the Present Crisis and Managing the Leverage Cycle’ (2010) Federal Reserve Bank of New York Economic Policy Rev 101–31; Ross Buckley, Emilios Avgouleas, and Douglas W Arner, ‘Three Major Financial Crises: What Have We Learned?’ in D Arner, E Avgouleas, D Busch, and S Schwarcz (eds), Systemic Risk 10 Years after the GFC (McGill/CIGI Press 2019). 38 John Genakoplos in Schwarcz et al (eds), Systemic Risk (McGill/CIGI Press, 2019).

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The EU Framework Dealing with Non-Performing Exposures best example here being the housing market, affects the value of assets of banks’ balance sheet and the ability of borrowers to repay their loans in general. The best illustration of this second scenario is, again, the sub-prime mortgage crisis in the USA and the collapse of the real estate bubbles in Spain and Ireland. 2. The Consequences of High NPL Ratios There is a large number of conceptual and empirical studies which suggest that 8.17 the level of NPLs in the banking sector can be important for credit extension and growth.39 Weakened bank balance sheets can have an adverse impact on economic activity, especially for economies like eurozone’s, which are over-dependent on bank financing. Higher NPL levels tend to reduce the credit-to-GDP ratio and GDP growth and also have an adverse impact on employment. Also, because NPLs on bank balance sheets create uncertainty and weigh on their ability to resume lending they lead to reductions of aggregate demand and investment.40 Clearly, high NPL levels suppress economic activity especially the planning and investment of overextended borrowers41 and trap resources in unproductive uses in a classic debt overhang scenario. Thus, resolving impaired loans tackles debt overhang conditions stimulating demand for new loans for viable firms, while promoting the winding-down of unviable firms.42 An IMF study by Aiyar et al has shown that economic activity and employment in the Eurozone have suffered the consequences of bad bank lending and the subsequent accumulation of NPs.43 High NPL levels tie up bank capital that could otherwise be used to increase 8.18 lending. As a result, by limiting the productive part of the bank balance sheets, NPLs reduce bank profitability.44 In addition, NPLs force banks to raise funding costs dampening further credit supply.45 Naturally, all these consequences and 39 The literature on financial dependence and growth is well-established R Rajan and L Zingales, ‘Financial Dependence and Growth’ (1998) 88 American Economic Review 559–86; A Kashyap, O Lamont, and J Stein, ‘Credit Conditions and the Cyclical Behavior of Inventories’ (1994) 109 Quarterly Journal of Economics 565–92. Other studies have looked specifically at the feedback effects from NPLs to macroeconomic performance and have reached similar conclusions. See K Bergthaler, Y Liu, and D Monaghan, ‘Tackling Small and Medium Sized Enterprise Problem Loans in Europe’ (2015) IMF Staff Discussion Note No 15/04,; R Espinoza and A Prasad, ‘Non- Performing Loans in the GCC Banking System and their Macroeconomic Effects’ (2015) IMF Working Paper No 10/244; N Klein, ‘Non-Performing Loans in CESEE: Determinants and Impact on Macroeconomic Performance’ (2013) IMF Working Paper 13/72. 40 ESM, ‘Annual Report—2015’, 4. 41 eg, 80% of NPLs in Italy are loans to corporates. See IMF Working Paper WP/15/24, ‘A Strategy for Developing a Market for Nonperforming Loans in Italy’ February 2015, 6. 42 Ibid, 17; S Aiyar et al, ‘A Strategy for Resolving Europe’s Problem Loans’, (2015) IMF Staff Discussion Note No 15/19. 43 Ibid. 44 There is empirical evidence that the ratio of problem loans ratio and the cost-to-income ratio are key factors that influence bank profitability. See Teng Teng Xu, Kun Hu, and Udaibir S. Das, ‘Bank Profitability and Financial Stability’ (January 2019) IMF Working Paper WP/19/5 25–33. 45 S Aiyar et al, ‘How to Tackle Europe’s Non-Performing Loan Problem’ Voxeu.org, 5 November 2015, fig 2.

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Emilios Avgouleas especially reduced bank profitability have deleterious effects on financial stability perpetuating the cycle of financial instability.46 Furthermore, NPLs may concentrate on critical or dynamic parts of the economy creating excessive dead-weight, namely, unutilized economic capacity. A good example here is Portugal, where during 2016 at least 30% of small-and medium-sized enterprises had at a minimum one loan that was not performing.47 8.19 High NPL levels increase the fragility of the banking sector causing new financial

stability concerns. Reduced bank profitability due to NPLs makes banks an unattractive investment proposition for the capital markets. In addition, however well capitalized they may be, banks that experience very low profitability are normally assumed to be only a few steps away from trouble48 affecting market confidence in the solvency of the banks involved.49 Where banks have not written off the full loss of value resulting from NPLs the market will assume that the value of the capital that banks show on their books is overstated. The large stock of NPLs was found to be an important cause of anaemic economic activity in the eurozone during the earlier phase of economic recovery not just because of reduced lending but also due to a persistent impression of bank fragility.

8.20 Reducing NPLs expeditiously is, therefore, crucial for supporting economic

growth and restoring financial stability. Cleaning up the bank lending channel also enhances the transmission of monetary policy to the real economy. International organizations like the International Monetary Fund (IMF) have repeatedly stressed that lasting recovery following a financial crisis requires a sharp reduction in NPL levels.50 This, however, does not mean that there is an internationally acceptable or an optimal NPL ratio. Even the IMF that has made the ratio of NPLs key to its measurements of financial sector strength,51 has not expressed a firm view, which, in a sense, implies that the optimal NPL ratio is as low as possible.

46 A recent IMF study on the relationship between bank profitability and financial stability has found that profitability is negatively associated with both a bank’s contribution to systemic risk and its idiosyncratic risk and over-reliance on non-interest income, wholesale funding and leverage is associated with higher risks. See Xu et al (n 48). 47 Aiyar et al (n 46). 48 Indicatively, Acharya et al (2016) infra note that ‘[s]‌ince the start of the Banking Union in Nov. 2014, European banks lost nearly half their market capitalization’. See V Acharya et al, ‘Capital Shortfalls of European Banks since the Start of the Banking Union’ 28 July 2016, available online at . 49 Ibid. 50 IMF, EBRD et al, ‘European Banking Coordination “Vienna Initiative—Working Group on NPLs in Central, Eastern and Southeastern Europe’, March 2012. 51 The IMF employs a ‘nonperforming loans net of provisions to capital’ ratio as an indication of the extent to which losses can be absorbed before the sector becomes technically insolvent. IMF, ‘Financial Soundness Indicators Compilation Guide’, March 2006, last updated: November 2015, ch 6, para 6.15.

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III. Structural Measures 1. Legal Measures to Facilitate Recovery In the beginning of the NPL crisis EU Member States faced several structural 8.21 problems with regards to maximization of recovery rates and the creation of a liquid secondary market for distressed ban debt in Europe. Legal and judicial obstacles were among the most important. These were in summary: (1) bankruptcy regimes with a pro-debtor bias. This is a shortcoming that is gradually being remedied through the introduction of out-of-court procedures and a code of conduct for NPL settlement, aiding the recovery process; (2) long recovery times and high recovery costs, which differ on a country-to- country basis, due to both differing legal and judicial cultures and different degrees of restructuring skills on the business side and legal infrastructure effectiveness; (3) low and differing levels of transparency which, create a ‘market for lemons’52 conditions in the secondary market and intensify bid ask spread discrepancies;

Some of these problems will be remedied through the implementation of the Directive on collateral recovery and debt management,53 which requires each EU Member State to establish an ‘accelerated extrajud cial collateral enforcement procedure’. The Directive will facilitate the sale of the ‘bad’ credits to third parties and the enforcement of the collateral used to secure the credit. It also fosters the development of an EU-wide secondary market for NPLs by giving the EU passport to debt management companies licensed in one Member State.54 To achieve this objective, the Directive introduces a harmonised and less restric- 8.22 tive regime for credit purchasers and servicers and removes undue impediments to cross-border activity. In order to achieve the sppedy enforcement objective, the Commission proposed a supplementary mechanism for the accelerated extrajudicial recovery of collateral. The mechanism would allow banks and business borrowers (not consumers) to agree upfront by contract on a method of swift recovery of collateral by the creditor in case of the business borrower’s default. This mechanism would enhance secured creditors’ recovery and is designed to battle

52 George A. Akerlof, ‘The Market for “Lemons”: Quality Uncertainty and the Market Mechanism’ (1970) 84/3 The Quarterly Journal of Economics 488–500. 53 Directive (EU) 2019/1023 of 20 June 2019 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (Directive on restructuring and insolvency). See also Proposal for a Directive on credit servicers, credit purchasers and the recovery of collateral COM/2018/0135 final—2018/063 (COD), available online at . 54 Ibid, Explanatory Memorandum, 10.

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Emilios Avgouleas moral hazard, namely strategic default behaviour, to discourage the build-up of future NPLs. 8.23 The accelerated extrajudicial collateral enforcement procedure refers to an expe-

dited out-of-court enforcement mechanism that enables lenders to recover value from collateral granted in secured loans more efficiently rather than pushing the debtor into administration or liquidation to recover on the loan. In the majority of cases, banks address their NPLs themselves by recovering value through workout. A large share of loans that become NPLs are loans secured by collateral. While banks are able to enforce collateral under national insolvency and debt recovery frameworks, the process can often be slow and lack legal certainty. In the meantime, NPLs remain on banks’ balance sheets, keeping the bank exposed to prolonged uncertainty and tying up its resources. The extrajudicial procedure would be accessible when agreed upon in advance by both lender and borrower, in the loan agreement.55 It will not be available for consumer credits,56 and it is designed to not affect early restructuring or insolvency proceedings. It will not impact the insolvency laws of the Member States on issues such as the hierarchy of creditors in insolvency. Accelerating collateral recovery and liquidation does not just produce ex post effects (maximization of recovery), arguably, it is also a strategy that can prove instrumental in minimising moral hazard that leads to instances of strategic default. Under the new regime borrowers will face the prospect of early liquidation of collateral in the event of non-payment of the loan instalments.

8.24 In order to ensure full consistency and complementarity with the Directive, the

following principles will apply:57

(4) the extrajudicial enforcement of collateral would be possible only as long as a stay of individual enforcement actions, in accordance with applicable national laws, is not applicable; (5) the Restructuring Proposal already foresees that creditors, including secured creditors of a company or an entrepreneur that is undergoing restructuring proceedings, are subject to a stay of individual enforcement actions; (6) In this case, the debtor in difficulty can negotiate a restructuring plan with creditors and avoid insolvency. 8.25 Naturally, the Directive’s two tools are mutually reinforcing as thye can lead to

thortened work-out time-frames and and higher recovery rates raise the market prices for NPL transfers and boost transparency of pricing. For example, in the case of collateralised NPLs the value of the collateral sets a minimum price for the NPL that fully reflects the markets rational expectation vis-à-vis loan values. The impact on secondary market liquidity will, in fact, be even more accentuated

Ibid, Explanatory Memorandum, 3. 56 Ibid, Explanatory Memorandum, 4. 57 Ibid. 55

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The EU Framework Dealing with Non-Performing Exposures since the relative value certainty offered by the use the accelerated extrajudicial collateral enforcement procedures will allow investors to cmpare market prices for loans of roughly equivalent value of collateral allowing the emergence of a competitive secondary market for NPLs across the EU. Finally, since credit purchasers will prefer NPLs that allow for the use of the accelerated extrajudicial collateral enforcement procedure, credit institutions are bound to use loan templates that incorporate this feature at the origination stage. Finally, as debt recovery and insolvency regimes still differ widely across EU 8.26 Member States the EU cannot simply rely on EU-wide initiatives to resolve the problem. Apart from fostering drastic reform at the Member State level, a benchmarking exercise was initiated by the Commission to measure the efficiency of national loan enforcement (including insolvency) regimes from a bank creditor perspective.58 Relevant comparable metrics offer precise information about recovery rates, recovery times, and recovery costs across Member States. According to the Commission: ‘the objective is to obtain a reliable picture of the delays and value recovery rates that banks face in case of borrowers’ defaults.’ Naturally, as these outcomes are heavily dependent on judicial capacity in each Member State, the outcome fo the exercise will deliver reliable comparisons and idnciate areas where Member States’ judicial processes could be overhauled. To address some of these problems the European semester will focus on issues relating to the effectiveness of national insolvency regimes.59 The Commission first issued a call for advice to the EBA60 and subsequently the Commission services requested Member States to provide qualitative data on cornerstone characteristics of the national enforcement and insolvency regimes. 2. NPL Disclosure and Data Standardization In response to the calls of the European Commission and of the Council to 8.27 the European Banking Authority (EBA) to: (a) work further on reducing information asymmetries between potential buyers and sellers of NPLs which will help the development of a functioning secondary market for NPLs in the EU; and (b) issue, by the end of 2017, templates for banks for the monitoring

58 See Commission Staff Working document Accompanying Commission Communication, ‘First Progress Report on the Reduction of Non-Performing Loans in Europe’, COM(2018) 37 final, Brussels, 18.1.2018 SWD(2018) 33 final, 13, 19; available online at . 59 Commission Staff Working Document Accompanying Commission Communication, ‘First Progress Report’, 19. 60 See EBA, ‘Call for Advice to the EBA for the Purposes of a Benchmarking of National Loan Enforcement Frameworks (including Insolvency Frameworks) from a Bank Creditor Perspective’ available online at .

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Emilios Avgouleas of NPLs61 In addition, the EBA has recently published its NPL Disclosure Guidelines.62 8.28 The Guidelines include more specific disclosure requirements applicable to

significant credit institutions that have a gross NPL ratio of 5% or above. In issuing these guidelines, the EBA is implementing enhanced disclosure requirements that are consistent with the disclosure part of the NPL management cycle described in the SSM Guidance, following the Council’s requests on disclosure-related topics. The EBA is also developing new supervisory reporting requirements on NPEs, and there will be alignment between the disclosure templates included in these guidelines and the supervisory reporting data.

8.29 The EBA NPL templates require the disclosure of information at a high de-

gree of granularity and offers verification rules, a combination of which can facilitate NPL transfers and the efforts to develop a liquid market for distressed bank debt in the EU. The template includes the following data categories: Portfolio, Counterparty Group, Counterparty, Loan, Historical Collection and Repayment Schedule, External Collection, Forbearance, Property Collateral, Non-Property Collateral, Forbearance, Enforcement and Swap. Additional data and information may be required to be included on a case by case basis by interested parties.63 So the EBA template is a standardized baseline but not the legal maximum.

8.30 The EBA NPL transaction templates comprise Instructions, a Data Dictionary,

a data tape and validation rules.64 While all these components are critical for standardization of disclosure of NPL data to speed up investor due diligence and create conditions of comparability, the final facility: validation rules is the most critical for investor confidence. The validation rules in the EBA template provide guidance on how different data points can be validated against each other.

61 See EBA, ‘Instructions for the Usage of the EBA NPL Transaction Templates’, 3, available online at . 62 EBA Final Report, ‘Guidelines on Disclosure of Non-Performing and Forborne Exposures’ EBA/GL/2018/10 17/12/2018, available online at . 63 EBA, Instructions for the Usage of the EBA NPL Transaction Templates, 4. 64 Ibid: ‘The Instructions provide explanations for the usage of the EBA NPL transaction templates . . . The Data Dictionary provides a list of all data fields, which form part of the EBA NPL transaction templates . . . The data tape is the actual file to be filled in by an institution with data relating to the transacted NPL portfolio.’

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IV. Market-based Solutions: Asset Management Companies and NPL Platforms 1. Challenges Relating to the Operation of AMCs as an Effective Means of NPL Disposal Any asset transfers below book value mean that banks have to do further write offs 8.31 on losses materialising from the disposal of bad assets wiping out their capital base and requiring new injections of capital to remain solvent. Thus, with EU banks gradually raising their capital buffers to enable them to conduct extensive write offs and the improvement of macroeconomic and market liquidity conditions NPL disposals and write offs in the EU have proceeded at an accelerated pace.65 But where the problem has persisted the use of Asset Management Companies (AMCs) has been suggested on a domestic, or a Pan-European basis.66 The use of AMCs of NPL disposals and workouts carries a dual advantage in the sense that AMCs can both take a longer term view on asset disposal maximising recovery value and contribute to the creation of a liquid secondary market for distressed bank debt by serving as an interface between buyers and sellers of non-performing loans. Bank management’s and owners’ incentives are crucial. Bank management can be 8.32 incentivized to sell if the price is closer to net book value, book value ex provisions, rather than the normally much lower market price, a gap that may in fact worsen in the case of forced selling leading to firesales. On the other hand, any transfers to state backed AMCs above book value, namely above market price plus provisions raise the spectre of state subsidies to undeserving bank shareholders and creditors. Having said that the primary benefit of the use of AMCs in the past was the purchase of non-performing loans at prices higher than market prices. Characteristic example here is the Irish NAMA.67 Given the new rules that the EU has adopted in the meantime, it seems unlikely that it would set up structures similar to Ireland’s NAMA or Spain’s SAREB. The use of AMCs to facilitate the transfer of NPLs from bank balance sheets and 8.33 maximize workouts can face other important challenges beyond the structural obstacles discussed in Section III above which prevent maximization of loan recovery values. These additional challenges may be summarized as follows: (1) governance challenges—mostly relating to a fear of cherry picking, or that the AMC will be used to restructure loans to related parties at favourable terms, or

65 EU Commission, ‘Third Progress Report on the Reduction of Non-Performing Loans and Further Risk Reduction in the Banking Union’, 28.11.2018 COM(2018) 766 final. 66 See EU Commission Communication, ‘Second Progress Report on the Reduction of Non- Performing Loans in Europe’, Brussels, 14.3.2018 COM(2018) 133 final. 67 See n 17 above.

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Emilios Avgouleas to warehouse and hide worthless assets. Debt to equity swaps may encounter a similar problem resulting in the rescue of ‘zombie’ companies’ (IMF, 2016 on the challenges of Chinese scheme); (2) limited transparency and uncertainty about the quality of bank disclosures and due diligence can give rise to a ‘market for lemons’ situation; (3) asset valuation—the choice of measures to be employed to calculate NPL value, eg market value, book value, net book value, or long-term economic value is a matter of great importance both for the success of the scheme and the distribution of losses. Of course, this is no simple matter as the rate of NPL recovery, especially vis-à-vis corporate and real estate loans, is also dependent on the prevailing conditions of demand in the market and the state of the macroeconomic cycle; (4) ultimate loss absorption—which party will absorb any losses on liquidation and winding up. 8.34 As part of the Commission initiative to build a European approach to the devel-

opment of secondary markets for NPLs and in particular to remove impediments to the transfer of NPLs by banks to non-banks and to their ownership by non- banks, while safeguarding consumers’ rights,68 the Commission has developed a ‘blueprint’ for the potential set-up of national asset management companies (AMCs).69 This ‘blueprint’ sets out ‘common principles’ for the relevant asset and participation perimeters, asset-size thresholds, asset valuation rules, appropriate capital structures, the governance and operational features, both private and public building upon best practices from past experiences in Member States. The Commission blueprint specifies, amongst other things, the critical size that an AMC should reach to maximize its comparative advantage in the collection of non-performing loans, the type of assets it can hold (essentially real-estate related or backed loans) and the terms of financing, notably in the event of public fund injections. The blueprint clarifies that AMCs can be private or public with no need for State aid, if the State can be considered to act as any other economic agent. The Blueprint also describes the permissible design to make AMCs that may enjoy public support fully consistent with the EU legal framework, particularly the BRRD, the SRMR, and State aid rules.70 2. Building a Marketplace for Distressed Bank Debt

8.35 As part of the Council action plan to tackle non-performing loans, the European

Commission, the European Central Bank, and the EBA were invited to consider how such transaction platforms could be set up. The EU commission released

68 See European Council, ‘Council Conclusions on Action Plan to Tackle Non-Performing Loans in EUROPE’ 11/07/2017, Press Release 459/17. 69 See EU Commission, Staff Working Document, ‘AMC Blueprint Accompanying the document Second Progress Report on the Reduction of Non-Performing Loans in Europe’, SWD/ 2018/072 final, Brussels 14.3.2018, available online at . 70 Ibid.

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The EU Framework Dealing with Non-Performing Exposures in December 2018 its plan for an electronic pan-European platform for Non- performing loans (NPLs) which would serve both as a data warehouse and a marketplace.71 In general, the EU markets for distressed bank debt remain underdeveloped and largely illiquid with large bid-ask spreads that also lead to wide price discrepancies that are further accentuated by lack of price transparency.72 They are also dominated by large buy side investors.73 Thus, the rationale behind the commission’s initiative is to address the widely observed market failures. It is anticipated that a well-functioning platform could help create active, liquid, and efficient secondary markets for NPLs in Europe. This may be done by addressing information asymmetries, increasing creditor co-ordination and price transparency, and broadening the investor base. The combined impact of these improvements would also augment the competitive market pricing of NPLs maximising recovery rates per loan and per portfolio. Another long-term benefit arising from the establishment of the NPL platform is that it could provide permanent infrastructure through which NPLs could be efficiently disposed of in the future in a timely manner. More specifically the Commission’s plan describes the desirable properties of an 8.36 EU-wide multi-functional trading platform that is broad enough in scope to make all loan types eligible for inclusion. A pan-European platform can reduce market entry barriers especially for smaller banks on the sell side and interested parties would have the option of trading individual NPLs or entire NPL portfolios. To augment liquidity and the quality of pricing the Commission also suggests that the platform should act as an information depository to reduce transaction and search costs by ensuring widespread data sharing and a

71 EU Commission, Staff Working Document, ‘European Platforms for Non- Performing Loans’ accompanying Commission communication, ‘Third Progress Report on the reduction of non-performing loans and further risk reduction in the Banking Union’, COM(2018) 766 final, 28.11.2018 SWD(2018) 472 final. 72 Characteristically the Commission staff paper notes: ‘Price data are usually not disclosed. Industry sources estimate that prices vary strongly depending on the type of debt and the quality of the underlying collateral . . . Pricing is often an obstacle for transactions: if the prices offered are lower than the banks’ provision, banks make a loss, which reduces their capital and therefore inhibits their incentive to enter into a sales deal. These coverage ratios differ strongly across banks and Member States . . . They stand at around 46% at the EU aggregate level. Hence, for a price lower than 54% (100%–46%), the “average” bank would have to record a loss. ECB staff estimated that the gap between book value and market prices for NPLs could be sizeable, amounting to between 11 and 45% of gross book value (GBV), depending on the Member State.’ See ibid, 7–8. 73 For instance, the Commission Paper notes: ‘Between 2014 and 2017, transaction volumes in secondary markets for loans in the EU were estimated by industry sources to reach between EUR 100 billion and EUR 150 billion per annum’. See ibid, 6. ‘The NPL market has also been highly concentrated on the buy side. The 10 largest transactions in 2015/16 accounted for one third of the transaction volume, while the rest was spread over about 480 transactions. Very few transactions were recorded with a volume below EUR 100 million. Transactions have been strongly clustered in four countries: ES, IE, IT and the UK. In the first three, NPL sales have contributed substantially to reducing high NPL ratios. There have been few transactions in other countries with high NPL ratios.’ See ibid.

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Emilios Avgouleas high degree of data standardization.74 In a nutshell the Commission proposal broadly delineates a fully-fledged market platform which will have a price discovery mechanism and the functionality to intermediate between investors and third-party service providers such as appraisers, loan servicers, and transaction advisers. But an NPL platform would not own or service loans to avoid insurmountable legal problems. Similarly, settlement of transactions will take place bilaterally between the sellers and the buyers without involving the platform. More specifically, the Commission paper envisages the following functions for the platform:75 (1) a creditor co-ordination function, providing a forum for dialogue and decision- making by creditors with a claim on a common debtor to resolve co-ordination issues arising from multiple exposures (including exposure to the same borrowers; (2) a transaction-facilitating function which will offer access to five broad asset classes: commercial real estate (CRE) assets, residential real estate (RRE) assets, SME or other corporate loans, unsecured retail loans, asset-backed finance, car loans, other/specialized NPLs. The NPL platform could proactively offer matching and bundling of (small) similar loans that might interest specific investors from geographically diverse locations who may not be interested to buy the entire portfolio that is put up for sale by the banks. Aggregation of buy interest for partial disposals could create a more liquid and more competitively priced market for larger NPL portfolios that are also the most difficult to disposal at prices that maximize recovery value for the lender; (3) intermediation for further ancillary services, such as valuation76 and collateral appraisal, legal services, advisory services, and loan servicing, which would be offered by independent service providers to prospective buyers and sellers; (4) information standardization and improved data availability which would augment both transparency and liquidity and reduce information search costs and improving price formation. In specific, the platform will use harmonized data templates based on the discussed above EBA NPL templates. Investors would use such validated and standardized data to facilitate their due diligence and valuation efforts, allowing them to accurately perform portfolio valuations with significantly reduced costs. This approach also ensures comparability and consistency of valuation models. Moreover, data analysis could be highly focused, integrated, and granular offering information on specific portfolios/sectors/ borrowers across different sellers. This would allow buyers to target specific market segments or borrowers in their purchase strategies and adjust their existing portfolios of loans. Moreover, the Commission staff paper envisages that increased transparency and the ‘seal of approval’ procedure, given clear and

74 The Commission staff paper notes that relevant data and its use in context could be at a very high level of specificity including ‘data completeness and plausibility checks and defining standards for data validation that would be performed by banks.’ See ibid, 1 and 19. The centralization of this functionality would of course reduce the due diligence costs that NPL investors face today. See ibid. 75 See ibid, 1–2, 13–19. 76 Valuation and due diligence are of course the most important parts of NPL acquisition processes and increase, alongside tax, transaction costs, sometimes to prohibitive levels.

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The EU Framework Dealing with Non-Performing Exposures standardized rules and procedures for sellers and buyers, and the legal framework underpinning the platform would also act as an incentive for investors offering them additional reassurance.

As per the 2017 proposal by Avgouleas and Goodhart (in the context of a 8.37 pan-European AMC),77 the EU Commission staff contemplate pan-European public ownership, since it would fit better with the European scope of the platform. However, they find the challenges raised by such a solution, including identification or establishment of an appropriate EU agency to discharge this duty and certain state aid concerns that will arise in the future, as insurmountable. Thus, they reject a public ownership solution in favour of private sector solutions, which, however, will have to charge a high fee for the use of the platform to cover the substantial sunk costs that the building up of the platform would entail.78

V. Prudential and Supervisory Policies for Tackling NPLs 1. Microprudential Measures A. Supervisory Policies to Tackle NPLs As mentioned in Section I the SSM has required eurozone banks to establish time- 8.38 bound quantitative targets for NPL reduction. The ECB Guidance specifies that relevant targets should be established at a minimum along the following lines: (i) by time horizons: short-term (eg, 1 year), medium-term (eg, 3 years) and where possible long-term; (ii) by main portfolios (eg retail mortgage, retail consumer, retail small businesses and professionals, SME corporate, large corporate, commercial real estate); (iii) by implementation option chosen to drive the planned NPL reduction, eg cash recoveries from hold strategies, collateral repossessions, recoveries from legal proceedings, revenues from sale of NPLs or write-offs.

Required reduction targets ought to be both granular and more specific especially for banks that have accumulated a high level of NPLs. In the latter case NPL reduction targets are not merely a projected reduction of NPLs, both gross and net of provisions, but also targets for reduction of their main NPL portfolios. Operation targets might refer to: coverage, cash recoveries, the quality of forbearance measures (eg redefault rates), the status of legal actions or the identification of non-viable (denounced) exposures and the flow of new NPLs including repeat delinquencies.

77 Emilios Avgouleas and Charles Goodhart, ‘Utilizing AMCs to Tackle Eurozone’s Legacy Non- Performing Loans’ (2017) European Economy—Banks Regulation and the Real Sector 97–112. 78 EU Commission, Staff Working Document, ‘European Platforms for Non-Performing Loans’, 2,  11–13.

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Emilios Avgouleas 8.39 Moreover, the ECB has compelled eurozone banks to operationalize the achieve-

ment of NPL reduction targets which were overhauled when the EBA published its final Guidelines on management of non-performing and forborne exposures for the entire EU in October 2018.79 These Guidelines provide supervisory guidance and set out rules for suitable NPE management to achieve a sustainable reduction in NPEs in credit institutions’ balance sheets.80

B. NPL Reduction Strategy 8.40 Under EBA Guidelines, which also reflect the SSM Guidance, EU Credit institutions should establish an NPE strategy to target a time-bound reduction of NPEs over a realistic but sufficiently ambitious time horizon (NPE reduction targets). The NPE strategy should be two-fold: first it should lay out the credit institution’s approach and objectives regarding NPE management to maximize recovery; secondly, it must set out reduction targets in NPE stocks per NPE portfolio. The NPE strategy must cover short-, medium-and long-term time horizons and be fully embedded into the institution’s management processes. For the development and implementation of the NPE strategy credit institutions must assess their operating environment and external conditions,81 including an assessment of internal capabilities to effectively manage and reduce NPEs82 and the capital implications of the NPE strategy. Critically, the EBA Guidance provides that credit institutions must as part of their NPE strategy ‘ensure the fair treatment of borrowers’. C. Augmenting Bank Governance and NPL Management Capability 8.41 i. Building Organizational Capacity to Tackle NPLs EBA Guidelines (Section IV.4) require EU banks to implement an operational plan to meet the objectives

79 EBA Final Report, ‘Guidelines on management of non- performing and forborne exposures’ 31 October 2018, EBA/ GL/ 2018/ 06, available online at . 80 In addition, in order to enhance supervisory guidance, the EBA will issue guidelines on banks’ loan origination, monitoring, and internal governance. 81 Section 4.2 of the EBA Guidelines. External conditions mostly refer to the macroeconomic environment and structural factors as well as the tax implications of NPE write offs. Macroeconomic factors have included the dynamics of the real estate market and NPE investor demand, including trends in and the dynamics of the domestic and international NPE markets for portfolio sales. Structural factors include: ‘The maturity of the NPE servicing industry and the availability and coverage of specialised servicers . . . [and] the regulatory, legal and judicial framework the average total costs associated with legal proceedings’. See ibid, Section 4.2.2. 82 The term ‘internal capabilities’ (and environment) refers to the magnitude and drivers of their NPEs and operational capacities such as processes, tools, data quality, IT/automation, staff/expertise, decision-making, internal policies, and any other relevant area for the implementation of the strategy in relation to the various steps involved in the process, including but not limited to: early identification of NPEs; forbearance activities; impairments and write-offs; collateral valuations; recovery, legal process and foreclosure; reporting and monitoring of NPEs and of the effectiveness of NPE workout solutions. See ibid, Section 4.2.1.

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The EU Framework Dealing with Non-Performing Exposures of the NPE strategy. This should be subject to regular reviews and independent monitoring. According to the EBA Guidelines:83 The implementation of the NPE strategy operational plan should rely on suitable policies and procedures, clear ownership and appropriate governance structures, including escalation procedures, and the operational plan should incorporate wide-ranging change management measures in order to embed the NPE workout framework as a key element in the corporate culture. Credit institutions should report material deviations from the plan to the management body and to the competent authority in a timely manner, with appropriate remediation actions to be put in place.

Under the ECB (SSM) Guidance for banks with a high level of NPLs, the NPL 8.42 strategy and operational plan are a vital part of the bank’s strategy and they should be approved and steered by the organization management body.84 In specific, the bank’s management body must:85 (1) approve annually and regularly review the NPL strategy including the operational plan; (2) oversee the implementation of the NPL strategy; (3) define management objectives (including a sufficient number of quantitative ones) and incentives for NPL workout activities; (4) periodically (at least quarterly) monitor progress made in comparison with the targets and milestones defined in the NPL strategy, including the operational plan; (5) define adequate approval processes for NPL workout decisions; for certain large NPL exposures this should involve management body approval; (6) approve NPL-related policies and ensure that they are understood by the bank’s staff; (7) ensure sufficient internal controls over NPL management processes (with a special focus on provisioning, collateral valuations and sustainability of forbearance solutions);

Furthermore, based on International experience the ECB Guidance requires 8.43 banks to form, as part of their NPL operating model, NPL workout units (WUs) which are separate from units responsible for loan origination to eliminate potential conflicts of interest with the bank’s business origination units and to secure the use of staff with dedicated NPL expertise.86 The separation of duties includes both the handling of client relationships, especially negotiation of forbearance solutions with clients), but also the decision-making process. Where dedicated NPL decision-making bodies are not possible and overlaps with the bodies,

See ibid, Section 4.4. 84 ECB Guidance, 9. 85 See ibid, 12 and 15. 86 See ibid, 18 and 99; EBA Guidance, Section 5. The ECB Guidance clarifies that ‘[w]‌here it is not possible or efficient to build in-house expertise and infrastructure, the NPL WUs should have easy access to qualified independent external resources or dedicated NPL servicing companies’. See ECB Guidance, 24. 83

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Emilios Avgouleas managers or experts involved in the loan origination process are not avoidable, the institutional framework should ensure that any potential conflicts of interest are sufficiently mitigated. 8.44 A suitable operating model is based on analysing the bank’s NPL portfolio with

a high degree of granularity, resulting in clearly defined borrower segments. Portfolio segmentation enables the bank to group borrowers with similar characteristics requiring similar treatments, eg restructuring solutions or liquidation approaches.87

8.45 The performance of WU staff is monitored on a regular basis with the relevant

appraisal system tailored to the requirements of the NPL WUs. Further to quantitative elements linked to the bank’s NPL targets and milestones (probably with a strong focus on the effectiveness of workout activities), the appraisal system may include qualitative measurements such as negotiations competence, technical abilities relating to financial analysis, structuring of proposals, quality of recommendations, or monitoring of restructured cases.

8.46 The performance measurement framework for high NPL banks’ management

bodies and relevant managers includes specific indicators linked to the targets defined in the NPL strategy and operational plan. The importance of the respective weight given to these indicators within the overall performance measurement frameworks should be proportionate to the severity of the NPL issues faced by the bank. One of the key success factors for the successful implementation of any NPL strategy option is an adequate technical infrastructure to track multiple NPL aspects.88

8.47 ii. NPL Governance Processes within the Organization The EBA Guidance

provides that the NPE strategy should be fully embedded in the risk management framework under which the institution operates. Thus, credit institutions should ensure high level monitoring by the risk management functions with respect to the formulation and implementation of both the NPE strategy and the operational plan.89 Moreover, staff and management involved in NPE workout activities should be provided with clear individual (or team) goals and incentives ‘geared towards reaching the targets agreed in the NPE strategy and operational plan’.90

87 ECB Guidance, 24 and following. 88 These are, inter alia, information about current NPLs and early arrears; exposure and collateral/ guarantee information linked to a borrower; monitoring/documentation tools with the IT capabilities to track forbearance performance and effectiveness; status of workout activities and borrower interaction as well as details on forbearance measures agreed etc: foreclosed assets (where relevant); cash flows relating to the loan and collateral; data from central credit registers, land registers, and other relevant external data sources where technically possible. See EBA Guidelines, Section 4.2.1. 89 Ibid, Section 4.4. 90 Ibid, Section 4.5.

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The EU Framework Dealing with Non-Performing Exposures These should include remuneration policies, career development objectives and performance monitoring frameworks that ensure the full engagement of staff and management with NPE reduction.91 The SSM guidance clarifies that that the execution and delivery of the NPL 8.48 strategy should attract the engagement of different departments and the monitoring and control of the execution of the strategy should be embedded in the entire organizational edifice of the relevant bank organization within the bank involves and depends on many different areas within the bank. This should be based on ‘three lines of defence’.92 The first ‘line of defence’ requires banks, especially high NPL banks, to implement effective and efficient control processes for the NPL workout framework, ‘in order to ensure full alignment between the NPL strategy and operational plan on the one hand, and the bank’s overall business strategy’ and risk appetite on the other.93 In addition, a review process must be laid out to detect and deal with any weaknesses. Where periodic controls detect weaknesses, procedures should be in place in order to address them in a timely and effective manner. Namely, the first line of defence refers to control mechanisms within the operational units that actually ‘own’ and manage the bank’s risks in specific the NPL WUs (depending on the NPL operating model). Responsible for carrying out the first-line controls are the managers of the operational units. The ‘second line of defence’ refers to functions established to ensure on a con- 8.49 tinuous basis that the first line of defence is operating as intended. It usually comprises risk control, compliance and other quality assurance functions. To adequately perform their control tasks, second-line functions require a strong degree of independence from the NPL WUs. Risk control and compliance functions should also provide strong guidance in the process of designing and reviewing NPL-related policies, especially with a view to incorporating best practices. Checking the quality and adequacy of early warning indications for NPLs is also part of this process. The ‘third line of defence’ usually comprises the internal audit function since this is normally independent of the bank’s business units and units carrying operational functions. In the case of high NPL banks, those carrying out the audit function should have sufficient NPL workout expertise. To strengthen the NPL governance and accountability framework the ECB guidance provides that ‘key outcomes of second and third-line’ of defence activities and mitigating actions and progress ‘should be reported to the management body regularly’.94

Ibid. 92 ECB Guidance, 27–9. 93 Ibid,  27–8. 94 Ibid,  28–9. 91

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Emilios Avgouleas D. Microprudential Backstops 8.50 Arguably the first line for building ex ante defences against NPL losses in the banking sector is the full implementation of the IFRS 9. In addition to the IFRS 9 standard95 implemented via the EU CRR II,96 new Regulation97 provides for a so-called prudential “backstop”.98 It requires banks to set aside capital when customers do not meet their agreed repayment arrangements on the assumption that the loan will not be paid back’99 to increase the bank’s resilience to adverse shocks. Namely, the Regulation requires banks to have sufficient loan loss coverage (common minimum coverage levels) for newly originated loans once these become non-performing exposures (NPEs). The Regulation defines as NPEs100: (a) an exposure in respect of which a default is considered to have occurred (in accordance with Article 178); (b) an exposure which is considered to be impaired in accordance with the applicable accounting framework; (c) an exposure under probation, where additional forbearance measures101 are granted or where the exposure becomes more than 30 days past due;

95 ‘IFRS 9 specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy or sell non-financial items. IFRS 9 requires an entity to recognise a financial asset or a financial liability in its statement of financial position when it becomes party to the contractual provisions of the instrument. At initial recognition, an entity measures a financial asset or a financial liability at its fair value plus or minus, in the case of a financial asset or a financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or the financial liability.’ See IFRS 9 Financial Instruments, available online at . 96 Regulation (EU) 2019/876 of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) No 648/2012. 97 Regulation (EU) 2019/630 of the European Parliament and of the Council of 17 April 2019 amending Regulation (EU) No 575/2013 as regards minimum loss coverage for non-performing exposures. 98 The EU Council in its December 2018 communique defined the prudential backstop as the ‘common minimum loss coverage for the amount of money banks need to set aside to cover losses caused by future loans that turn non-performing’. See infra. 99 See EP Press Announcement, ‘Banking Package: Parliament and Council Reach An Agreement’ 4 December 2018. 100 Art. 1(2) Regulation (EU) 2019/630 inserting Art.47(a) into Regulation (EU) No 575/2013. 101 The Regulation defines as forbearance measure: “a concession by an institution towards an obligor that is experiencing or is likely to experience difficulties in meeting its financial commitments. A concession may entail a loss for the lender” and means “(a) a modification of the terms and conditions of a debt obligation, where such modification would not have been granted had the obligor not experienced difficulties in meeting its financial commitments”. It includes a more favourable change in the contractual terms or a partial debt write off. And “(b) a total or partial refinancing of a debt obligation, where such refinancing would not have been granted had the obligor not experienced difficulties in meeting its financial commitments.” Art. 1(2) Regulation (EU) 2019/630 inserting Art.47b into Regulation (EU) No 575/2013.

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The EU Framework Dealing with Non-Performing Exposures (d) an exposure in the form of a commitment that, were it drawn down or otherwise used, would likely not be paid back in full without realisation of collateral; (e) an exposure in form of a financial guarantee that is likely to be called by the guaranteed party, including where the underlying guaranteed exposure meets the criteria to be considered as non-performing In case a bank does not meet the applicable minimum coverage level, it has to deduct the shortfall from its own funds. This means that where accounting provisions are esteemed to fall short of the minimum coverage requirement, the bank in question would have to deduct the difference between the level of the actual coverage and the minimum coverage from its Common Equity Tier 1 (CET1) capital, forcing it to act to top up its regulatory capital or face the prospect of resolution. These minimum levels apply to provisions covering potential losses on all new loans issued after 26 April 2019 and that would become non- performing (modification of CRR Article 469a). The minimum coverage levels would increase gradually to 100% after eight years for secured loans and after two years for unsecured loans. According to the Regulation the “prudential backstop” minimum coverage re- 8.51 quirement depend on two main variables: • whether part or all of an NPE is secured by eligible credit protection (as defined in the CRR); and • the time period for which an exposure has been classified as non-performing. The coverage requirements for banks increase progressively up to 100%, after 3 years for unsecured NPEs, and after 9 and 7 years for NPEs secured by immovable property and for NPEs secured by other eligible credit protection.102 In turn, this means that he full coverage of NPLs secured by movable and other CRR eligible collateral will have to be built up after seven years. On the other hand, for unsecured NPLs not backed by collateral, the maximum coverage requirement would apply fully after three year to reflect the high risk of partial or non-recovery of loan value. Moreover, the “backstop” fully accounts for the fact that “aged” NPEs are riskier even if they are secured. It is a common assumption that the longer NPEs remain on banks’ balance sheets, the less banks tend to succeed in recovering their money. To ensure legal certainty and consistency in the prudential framework, the Regulation also introduces a common definition of ‘non-performing exposures’ (NPE), in line with the one already used for supervisory reporting purposes. The EU council has explained that the ‘prudential backstop’ will serve multiple 8.52 purposes: (a) it will facilitate private risk-sharing; (b) it will reduce the need for public intervention; (c) it will strengthen the Banking Union as possible future Art. 1(2) Regulation (EU) 2019/630 inserting Art.47c into Regulation (EU) No 575/2013. 102

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Emilios Avgouleas NPLs will not become a burden on EBU member sates’ fiscal resources; and (d) it will boost credit supply in adverse economic times boosting economic growth. The Commission has added that the prudential backstop is also meant to “reduce risks to financial stability arising from high levels of insufficiently covered NPEs, by preventing the build-up or increase of such NPEs . . . particularly in stressed market conditions . . . [and] will help ensure that institutions have sufficient loss coverage for NPEs, therefore protecting their profitability, capital and funding costs in stressed times. In turn, this would contribute to the provision of stable, less pro-cyclical financing to households and businesses.” 8.53 These are indeed very high hopes pinned on a simple piece of capital regulation

and seem to ignore that credit quality problems are no longer cyclical but rather structural given the intense search for yield of all big financial institutons in the EU and globally in the face of negative interest rates and ultra-loose monetary policies. Similarly, the attainment of the last goal (credit growth) depends on how well the backstop is calibrated. Thus, I discuss below the suggestions of the ESRB about the macroprudential impact of the backstop and how that could be best calibrated. 2. Macroprudential Backstops

8.54 A recent ESRB report on NPLs has suggested that macroprudential authori-

ties should not just use the countercyclical capital buffer (CCYB) to prevent the systemic build-up of macrofinancial imbalances, but also to increase banks’ resilience when dealing with NPL-related vulnerabilities. In ESRB’s view that is also consistent with the initial conception of the use of the buffer to generate credit growth in a downturn since if banks have ‘excess’ capital they can take measures to write off NPLs at an early stage, allowing them to resume lending and boost liquidity during a downturn. In this context, the ESRB suggests that the borrower-based instruments (assuming them to be similar to Loan-To-Income (LTI) and Loan-To-Value (LTV) ratios should be used early in the cycle to prevent origination of high-risk loans, with the CCYB activated earlier in the cycle. This approach would create reserves that can be used to write off bank losses from NPLs.103

8.55 Furthermore, the ESRB suggests that macroprudential authorities should use the

systemic risk buffer (SyRB) in a more targeted way to specifically deal with potential increase of systemic risk associated with NPL growth that is centred around specific debtors or market sectors rather than situations of generalized credit growth.104 Finally, the ESRB has suggested that macroprudential authorities could

103 European Systemic Risk Board (ESRB) Report, ‘Macroprudential Approaches to Non- Performing Loans, January 2019, 3. 104 Ibid, 4.

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The EU Framework Dealing with Non-Performing Exposures use capital measures to target excessive concentration of credit exposures when systemic risk appears to be building up in specific sectors/asset classes. This would tighten provisions for large exposures alleviating concentration risk and thus reducing the flashpoints through risks can be propagated to the rest of the financial sector. Also if one takes into account the fact that the two most recent bank crises in the eurozone were triggered by over-concentration on real estate loans and sovereign bonds it is easy to realize that by stifling lending to a specific sector authorities can altogether prevent a crisis, since they reduce credit growth in the areas where signs of overheating (bubbles) are evident and not just vis-à-vis building up bank defences to face a crisis. Such restrictions can also have an indirect impact on financial stability by mitigating and preventing excessive credit growth. To this effect, the ESRB is suggesting that ‘higher own funds requirements can be applied by the designated authority in order to target asset bubbles in the residential and commercial property sector’.105 It is unknown if this could control the formation of real estate bubbles when interest rates are ultra-low but it will certainly make banks think twice before they lend to that sector given the extra (penal) capital charge. Given, that, unlike corporate lending, most real estate lending is still sourced from the banking sector it should be plausibly assumed that the impact of such capital break would be appreciable. Finally, the ESRB suggests that authorities should put in place an early warning 8.56 system (EWS) for NPLs,106 which should be seen as a critical element of prudential supervision. This EWS should be a macroprudential rather than a microprudential mechanism measuring risks related to an increase of NPLs on a system-wide basis and is supplementary to the microprudential tools provided in the SSM Guidance, discussed in Section IV above. As the EWS already developed by macroprudential authorities in the EU do not specifically capture a potential system-wide increase in NPLs a new set of data (and indicators) must be developed that is also linked to existing microprudential (institution specific) MPL reporting processes and data.107

VI. Conclusion The size of NPLs in the EU and the eurozone has gradually become much less 8.57 important than it was at the height of the crisis, with the exception of a small number of jurisdictions in the EU periphery, at the same time EU institutions have built a new policy toolkit to both deal with legacy assets and prevent a future

105 Ibid,  4–5. 106 See ESRB, ‘Macroprudential Approaches to Non- Performing Loans/ The Role of Macroprudential Policy’, 23–4. 107 Ibid, 24.

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Emilios Avgouleas NPL crisis. These policies focus on market-based solutions, aided by legislative initiatives to remove structural obstacles to the creation of a liquid EU market for distressed market debt, and the creation of a new micro and macroprudential surveillance framework as well as attendant capital backstops. The improvement of the general macroeconomic environment and market liquidity conditions in the eurozone have greatly facilitated the reduction of the earlier piles of NPLs, thus the effectiveness of the recent and forthcoming measures is still unproven.108 8.58 What is clear in contrast is that the deep-seated fear of having to share the cost

of bank bail-outs that could eventually turn the European Banking Union to a fiscal union has mostly ruled out the most effective means of NPL reduction in the previous crises, which was AMCs enjoying a fiscal backstop.109 Either way what could be predicted with some certainty is that this new set of measures will shorten recovery times across the EU and make recovery of loan value easier for the banks, especially for loans that were given against good collateral. Moreover, the new prudential backstops will make bank lending much more cautious and would augment loan underwriting standards in banks. The backstop might also be well calibrated and strong enough to prevent over-concentration of bank assets in a single sector, which was an important factor behind the troubles of Irish and Spanish banks. It remains, however, uncertain whether the new framework will prove effective enough to prevent the concentration of NPLs on bank balance sheets due to systemic causes. This is, in fact, the key question for the European banking sector going forward as structural measure such as a liquid secondary market for NPLs in the EU and faster recovery are ex post remedies (unlike the backstops). Namely, they do not prevent, in the first place, the genesis of the problem. Therefore, the possible potency of the new framework should not divert attention from the fact that the best deterrent against NPLs are robust pro-growth policies. In addition to pro-growth policies, the backstop, SSM’s patient and diligent exercise of its prudential framework for NPL reporting and governance, and a tailor-made EWS are the key tools for securing against a re-occurrence of the European NPL crisis.

108 See also Javier Suárez and Antonio Sánchez Serrano, Reports of the ESRB Advisory Scientific Committee, ‘Approaching Non-Performing Loans from a Macroprudential Angle” (No 7/September 2018) 38, available online at . 109 Douglas W Arner, Emilios Avgouleas, and Evan Gibson, ‘Overstating Moral Hazard: Lessons from Two Decades of Banking Crises’ (2017) University of Hong Kong Faculty of Law Research Paper No 2017/003.

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Part III SINGLE RESOLUTION AND THE BRRD

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9 GOVERNANCE OF THE SINGLE RESOLUTION MECHANISM Danny Busch*

I. Introduction II. General Aspects

9.01

1. The Broader Context 2. Scope of the SRM 3. Division of Tasks within the SRM 4. Co-operation within the SRM 5. The Single Resolution Board 6. The Single Bank Resolution Fund

III. Financing of the Fund

9.04 9.04 9.08 9.09 9.15 9.17 9.41

9.46 1. General 9.46 2. Ex Ante Contributions 9.47 3. Extraordinary Ex Post Contributions 9.55 4. Intergovernmental Agreement: Transfer and Mutualization of Contributions 9.58

5. Alternative Funding Means: Common Backstop 6. Voluntary Borrowing between Financing Arrangements

9.64 9.71

IV. Resolution

9.75 1. General 9.75 2. Objectives and Principles 9.76 3. Content Resolution Scheme 9.81 4. Adoption of a Resolution Scheme 9.97 5. Execution Resolution Scheme 9.120

V. Conclusion

9.121

I. Introduction In the early morning of 20 March 2014, after lengthy and heavy negotiations, an 9.01 important step towards completion of the European Banking Union (EBU) was taken.1 In a so-called ‘trilogue’ between the European Commission, the European Parliament, and the Council, political agreement was reached on the uniform and centralized resolution of ailing banks within the Eurozone, the so-called

I am indebted to Marije Louisse and Mirik van Rijn for their valuable comments on a previous * version of this chapter. 1 For an informal report on the negotiations see Bulletin Quotidien Europe No 2581, 15 April 2014.

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Danny Busch ‘Single Resolution Mechanism’ (SRM).2 The SRM’s aim is to ensure an effective European reaction when a bank—despite stricter capital requirements and stricter supervision—gets into serious trouble. The basic principle is that no longer the taxpayer, but the private sector, will bear the costs of bank resolutions. 9.02 This chapter analyzes the governance or decision-making structure of the SRM.

In this chapter, ‘governance’ or ‘decision- making’ is understood in a broad sense. It does not only refer to individual decision-making, but also includes decision-making of a more general nature, such as the adoption of delegated or implementing acts.3 In particular, the SRM’s governance structure with respect to the following two key topics will be discussed: the financing of the Single Bank Resolution Fund (the Fund) and the adoption of a resolution scheme.

9.03 Before discussing the governance with respect to financing of the Fund (Section III)

and the adoption of resolution schemes (Section IV) some general aspects, including general governance aspects, of the SRM will be outlined (Section II). The chapter ends with some concluding remarks (Section V).

II. General Aspects 1. The Broader Context 9.04 The SRM must be viewed against the background of another important pillar of

the EBU, the Single Supervisory Mechanism (SSM)4 as well as against the background of the Bank Recovery and Resolution Directive (BRRD).5 2 Regulation (EU) 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) 1093/2010 [2014] OJ L225/1 (SRM Regulation). Please note that Regulation (EU) 2019/877, amending Regulation (EU) 806/2014 as regards the loss- absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/ 226 will amend the SRM Regulation in various respects. To the extent relevant to the topic of this chapter, these changes will be highlighted in the footnotes. 3 Judicial protection against decisions taken within the context of the SRM can also be considered as being part of the SRM’s governance structure. However, also in view of the fact that the topic of judicial protection against decisions taken within the context of the SRM (and the Single Supervisory Mechanism (SSM)) is the subject of Chapter 3 in this volume, this aspect of the SRM’s governance is not addressed in this chapter. 4 Council Regulation (EU) 1024/ 2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2013] OJ L287/63 (SSM Regulation). See, on the SSM, ECB, ‘Guide to Banking Supervision’, November 2014 (available online at ). 5 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/ 25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) 1093/2010 and (EU) 648/2012 of the European Parliament and of the Council [2014] OJ

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Governance of the Single Resolution Mechanism On 4 November 2014, the European Central Bank (ECB) assumed its task as a pru- 9.05 dential supervisor of the largest and most internationally active banks (including some other entities) within the Eurozone (termed ‘significant’6).7 The other banks (including some other entities) within the Eurozone (termed ‘less significant’8) continue to be supervised at national level with bank supervisors applying a ‘single rulebook’ of prudential rules (the Capital Requirements Directive IV (CRD IV) and the Capital Requirements Regulation (CRR)9). However, the ECB can always ‘call up’ direct supervision for such other Eurozone banks when necessary to ensure consistent application of high supervisory standards.10 Other Member States than Eurozone Member States11 can decide to establish a close co-operation arrangement with the ECB for supervision purposes. In that case, such other Member State joins the SSM, with the result that the largest and most international banks in such Member State will be directly supervised by the ECB as well.

L173/190 (Bank Recovery and Resolution Directive (BRRD)). Please note that Directive (EU) 2019/879, amending Directive 2014/59/EU as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296 will amend the BRRD in various respects. To the extent relevant to the topic of this chapter, these changes will be highlighted in the footnotes. 6 SSM Regulation, art 6(4). However, the ECB is responsible, regardless of size or systemic significance of the institution, for the granting and withdrawal of banking licences, and for assessing the suitability of bank owners. See SSM Regulation, art 4(1)(a) and (c) and 6(4). See for the list of significant and less significant entities as of 1 January 2018: ECB, ‘List of supervised entities’, 1 January 2018 (available online at ). As of 1 January 2018, there are 118 significant entities. 7 After having completed its ‘comprehensive assessment’ in question in October 2014 (asset quality review (AQR) and stress test) the ECB published the results: see ECB, ‘Aggregate Report on the Comprehensive Assessment’, 26 October 2014 (available online at ). 8 SSM Regulation, art 6(4). 9 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC [2013] OJ L176/338 (CRD IV) and Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) 648/2012 [2013] OJ L176/1 (CRR). Please note that: (i) Directive (EU) 2019/878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253; and (ii) Regulation (EU) 2019/876, amending Regulation (EU) 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) 648/2012 [2019] OJ L150/ 1 will amend CRD IV and CRR in various respects. To the extent relevant to the topic of this chapter, these changes will be highlighted in the footnotes. 10 SSM Regulation, art 6(5)(b). 11 There are currently 19 Eurozone Member States: (1) Austria, (2) Belgium, (3) Cyprus, (4) Estonia, (5) Finland, (6) France, (7) Germany, (8) Greece, (9) Ireland, (10) Italy, (11) Latvia, (12) Lithuania, (13) Luxembourg, (14) Malta, (15) the Netherlands, (16) Portugal, (17) Slovakia, (18) Slovenia, and (19) Spain.

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Danny Busch In the SSM Regulation, Member States participating in the SSM are termed ‘participating Member States’.12 9.06 By 1 January 2015, the BRRD should have been transposed into the national

laws of the EU Member States, including non-Eurozone Member States. The BRRD harmonized the rules for how EU banks in serious financial difficulties are restructured, how vital functions for the real economy are maintained, and how losses and costs are allocated to the banks’ shareholders, creditors and uninsured depositors, minimizing taxpayers’ exposure to losses. Bail-in, a key instrument in the BRRD that has been applicable since 1 January 2016,13 sequentially allocates losses and writes–down the claims of shareholders, subordinated creditors, and senior creditors. Depositors below €100,000 are in any case excluded from suffering losses, their claims being protected by national Deposit Guarantee Schemes (DGSs). The BRRD14 includes the establishment of national resolution funds (termed ‘national financing arrangements’).15

9.07 The BRRD relies on a network of national authorities and national resolu-

tion funds to resolve banks. The BRRD is a major step forward in minimizing differing national approaches and protecting the integrity of the internal market, but it was thought insufficient for participating Member States which share the supervision of credit institutions within the SSM. The SRM is widely perceived as a necessary complement to the SSM as the levels of responsibility and decision- making for resolution and supervision have to be aligned. Otherwise tensions between the European supervisor (ECB) and national resolution authorities may emerge over how to deal with ailing banks. Furthermore, co-ordination between national resolution systems has not proved sufficient to achieve the most timely and cost-effective resolution decisions, especially in a cross-border context. Also, market expectations about Member States’ (in)ability to deal with bank failures nationally may well continue reinforcing feedback loops between sovereigns and banks, as well as fragmentations and competitive distortions across the internal

12 See SSM Regulation, art 2(1) which provides the following definition of ‘participating Member State’: ‘a Member State whose currency is the euro or a Member State whose currency is not the euro which has established a close co-operation in accordance with Article 7 [Close co-operation with the competent authorities of participating Member States whose currency is not the euro]’. 13 See BRRD, art 130(1), 3rd para, read in conjunction with arts 43 and 44. The bail-in tool has been applicable since 1 January 2016 to give banks enough time to prepare themselves for bail-in. Please note that Directive (EU) 2019/879, amending Directive 2014/59/EU as regards the loss- absorbing and recapitalization capacity of credit institutions and investment firms; and Directive 98/26/EC [2019] OJ L150/296 will amend BRRD, art 44(2) in certain respects. See also the new art 44a BRRD on the selling of subordinated eligible liabilities to retail clients. 14 See BRRD, art 100. 15 Regulation (EU) No 806/2014 of the European Parliament and of the Council establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Bank Resolution Fund and amending Regulation (EU) 1093/2010 of the European Parliament and of the Council, COM(2013) 520 Final, Explanatory Memorandum, 3.

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Governance of the Single Resolution Mechanism market.16 In view of all this the SSM was complemented by the SRM for participating Member States.17 Key elements of the SRM are a central decision-making body, the Single Resolution Board (SRB) and a Single Bank Resolution Fund (the Fund). The bulk of the SRM has entered into force on 1 January 2016.18 2. Scope of the SRM The SRM applies to the following entities established in participating Member 9.08 States: (1) credit institutions; (2) parent undertakings, including financial holding companies and mixed financial holding companies when subject to consolidated supervision carried out by the ECB in accordance with Article 4(1)(i) of the SSM Regulation; and investment firms and financial institutions when they are covered by the consolidated supervision of the parent undertaking carried out by the ECB in accordance with Article 4(1)(g) of the SSM Regulation.19 Thus, the SRM applies to all credit institutions established in participating Member States, irrespective of size or interconnectedness. Furthermore, the SRM also applies to entities which the ECB does not, on a solo basis, supervise under the SSM but which parent’s undertaking is subject to consolidated supervision by the ECB.20 This must be understood against the backdrop that the ECB is the only supervisor that has a global perception of the risk which a group, and indirectly its individual members, are exposed to.21 Accordingly, due to the significant level to which bank supervision is interwoven with resolution, the scope of the SRM is linked to the scope of the SSM.22 3. Division of Tasks Within the SRM The SRM is based on a division of tasks between the SRB and national resolution 9.09 authorities in participating Member States. This division of labor is similar to the division of tasks between the ECB and the national supervisors within the context

16 Ibid; SRM Regulation, Recital 14; Opinion of the European Central Bank of 6 November 2013 on a proposal for a Regulation of the European Parliament and of the Council establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Bank Resolution Fund and amending Regulation (EU) 1093/2010 of the European Parliament and of the Council [2014] OJ C109/2,  2–3. 17 See SRM Regulation, art 4(1) stating that ‘Participating Member States within the meaning of Article 2 of [the SSM Regulation] shall also be participating Member States for the purposes of [the SRM Regulation]’. 18 SRM Regulation, art 99. 19 SRM Regulation, art 2. 20 According to art 4(1)(g) of the SSM Regulation. 21 SRM Regulation, Recital 22. 22 SRM Regulation, Recital 15.

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Danny Busch of the SSM, the result being that the levels of responsibility and decision-making for resolution and supervision are aligned. 9.10 The SRB has overall responsibility for the effective and consistent functioning

of the SRM.23 The SRB is also responsible for drawing up resolution plans and adopting all decisions relating to resolution for the following entities or groups covered by the SRM24:

(1) entities and groups which are considered ‘significant’,25 ie the largest entities and groups established in participating Member States; (2) entities and groups which are considered ‘less significant’, but in relation to which the ECB has decided to ‘call up’ direct supervision because this is viewed necessary to ensure consistent application of high supervisory standards;26 and (3) other cross-border groups.27 However, if the resolution action requires use of the Fund, the SRB must always adopt the resolution scheme.28 9.11 In relation to other entities and groups covered by the SRM,29 without preju-

dice to the responsibilities of the SRB for the tasks conferred on it by the SRM Regulation, the national resolution authorities must perform and be responsible for the following tasks: (1) adopting resolution plans and carrying out an assessment of resolvability;30 (2) adopting measures during early intervention;31 (3) applying simplified obligations or waiving the obligation to draft resolution plans;32 (4) setting the level of minimum requirement for own funds and eligible liabilities;33 (5) adopting resolution decisions and applying resolution tools, in accordance with the relevant procedures and safeguards, provided that the resolution action does not require any use of the Fund and is financed exclusively by: (a) write-down and conversion of capital instruments;

23 SRM Regulation, art 7(1). 24 See Section II(2). 25 In accordance with SSM Regulation, art 6(4). 26 SSM Regulation, art 6(5)(b). 27 SRM Regulation, art 7(2). 28 SRM Regulation, art 7(3), 2nd para. 29 See Section II(2). 30 In accordance with arts 8 and 9 and with the procedure laid down in SRM Regulation, art 9: see SRM Regulation, art 7(3)(a). 31 In accordance with SRM Regulation, art 13(3): see SRM Regulation, art 7(3)(b). 32 In accordance with SRM Regulation, art 11: see SRM Regulation, art 7(3)(c). 33 In accordance with SRM Regulation, art 12: see SRM Regulation, art 7(3)(d).

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Governance of the Single Resolution Mechanism (b) the sale of business tool; (c) the bridge institution tool; (d) the asset separation tool; and (e) the bail-in tool, and/or the deposit guarantee scheme;34 and (6) writing down or converting capital instruments.35 When performing the tasks referred to in (1)–(6) above, the national resolution 9.12 authorities must apply the relevant provisions of the SRM Regulation. References to the SRB must be read as references to the national resolution authorities.36 For that purpose they must exercise the powers conferred on them under national law transposing the BRRD in accordance with the conditions laid down in national law.37 The national resolution authorities must inform the SRB of the measures to be taken, referred to in (1)–(6) above, and must closely co-ordinate with the SRB when taking those measures.38 They must submit to the SRB the resolution plans,39 as well as any updates, accompanied by a reasoned assessment of the resolvability of the entity or group concerned.40, 41 However, in relation to such other entities and groups covered by the SRM42 for 9.13 which the national resolution authorities are responsible (see above) the SRB may at any time decide, on its own initiative after consulting the national resolution authority concerned or upon request from the national resolution authority concerned, to exercise directly all of the relevant powers under the SRM Regulation.43 This is in particular the case if the SRB has issued a warning to a national resolution

34 Set out in arts 21 and 24–27 and in accordance with art 79, and with the procedure laid down in SRM Regulation, art 31: see SRM Regulation, art 7(3)(e). See further, on resolution tools, Section IV(3). 35 Pursuant to art 21, in accordance with the procedure set out in SRM Regulation, art 31: see SRM Regulation, art 7(3)(f ). Write-down and conversion of capital is not only a resolution action, but also an instrument which may be applied prior to the resolution stage, which explains that it is mentioned twice (in SRM Regulation, art 7(3)(e) and (f )). See Section IV(1). Please note that Regulation (EU) 2019/877, amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226 will amend art 21 of the SRM Regulation in certain respects, including a change of the title from ‘Write- down and conversion of capital instruments’ to ‘Write-down or conversion of capital instruments and eligible liabilities’ [emphasis added]. 36 SRM Regulation, art 7(3), 4th para. More specifically, SRM Regulation, art 7(3) provides that any references to the SRB in arts 5(2), 6(5), 8(6), 8(8), 8(12), 8(13), 10(1)–(10), 11–14, 15(1)–(3), 16, 18(1) 1st subpara, (2), (6), 20, 21(1)–(7), 21(8) 2nd subpara, 21(9), 21(10), 22(1), 22(3), 22(6), 23, 24, 25(3), 27(1)–(15), 27(16) 2nd sentence of the 2nd subpara, the 3rd subpara, and the 1st, 3rd and 4th sentences of the 4th subpara, and 32 must be read as references to the national resolution authorities. 37 SRM Regulation, art 7(3), 4th para, in fine. 38 SRM Regulation, art 7(3), 5th para. 39 Referred to in SRM Regulation, art 9. 40 In accordance with SRM Regulation, art 10. 41 SRM Regulation, art 7(3), 6th para. 42 See Section II(2). 43 SRM Regulation, art 7(4)(b).

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Danny Busch authority because it considers that a draft decision with respect to measures referred to in (1)–(6) above does not comply with the SRM Regulation or with its general instructions referred to in Article 31(1)(a) of the SRM Regulation (see Section II(4)) and that warning is not appropriately addressed by the relevant national resolution authority.44 9.14 In addition, participating Member States may decide, with respect to such other

entities and groups established in their territory, that the SRB must exercise all relevant powers and responsibilities which the SRM Regulation confers to national resolution authorities. Member States that intend to make use of this option must notify the SRB and the Commission. The notification takes effect from the day of its publication in the Official Journal of the European Union.45 4. Co-operation within the SRM

9.15 Notwithstanding the fact that there is a fairly clear division of tasks between the

SRB and the national resolution authorities (see Section II(3)) co-operation between the SRB and the national resolution authorities remains absolutely crucial. In view of this, Article 31 of the SRM Regulation stipulates that the SRB must perform its tasks in close co-operation with national resolution authorities. The SRB must, in co-operation with national resolution authorities, approve and make public a framework to organize the practical arrangements for the implementation of this co-operation.46

9.16 In order to ensure effective and consistent application of the co-operation:

(1) the SRB must issue guidelines and general instructions to national resolution authorities according to which the tasks are performed and resolution decisions are adopted by national resolution authorities;47 (2) the SRB may at any time make use of its investigatory powers;48 (3) the SRB may request, on an ad hoc or continuous basis, information from national resolution authorities on the performance of the tasks carried out by the national resolution authorities under Article 7(3) of the SRM Regulation (see Section II(3));49 and

44 SRM Regulation, art 7(4)(b), read in conjunction with (a). 45 SRM Regulation, art 7(5). In this case, SRM Regulation, arts 7(3), 7(4), 9, 12(2), and 31(1) do not apply. 46 SRM Regulation, art 31(1), 1st para. See for this framework: ‘Decision of the plenary session of the [SRB] of 28 June 2016 establishing the framework for the practical arrangements for the co- operation within the [SRM] between the [SRB] and national resolution authorities’ (SRB/PS/2017/ 07) (available online at ). 47 SRM Regulation, art 31(1)(a). 48 SRM Regulation, art 31(1)(b). See SRM Regulation, Pt II, chap 5 (Investigatory Powers); SRM Regulation, arts 34–37: (1) requests for information, (2) general investigations, (3) on-site inspections, and (4) authorization by a judicial authority. 49 SRM Regulation, art 31(1)(c).

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Governance of the Single Resolution Mechanism (4) the SRB must receive from national resolution authorities draft decisions on which it may express its views and, in particular, indicate the elements of the draft decision that do not comply with the SRM Regulation or the SRB’s general instructions.50 Furthermore, for the purposes of evaluating resolution plans, the SRB may request national resolution authorities to forward to the SRB all information necessary.51 5. The Single Resolution Board A. General As previously mentioned,52 the central decision-making body of the SRM is the 9.17 SRB which has its seat in Brussels.53 The SRB became fully operational on 1 January 2015.54 The SRB is a European Union agency with legal personality55 and may, in particular, acquire or dispose of movable and immovable property and be party to legal proceedings.56 The SRB is represented by its Chair.57 The SRB has overall responsibility for the effective and consistent functioning of the SRM.58 B. Composition The SRB is composed of the Chair and four further full-time members.59 These 9.18 independent members are appointed on the basis of merit, skills, knowledge of banking and financial matters, and of experience relevant to financial supervision

50 SRM Regulation, art 31(1)(d). 51 As obtained by them in accordance with BRRD, arts 11 and 13(1) and without prejudice to SRM Regulation, Pt II, chap 5 (Investigatory Powers); see SRM Regulation, art 31(1) in fine. 52 See Section II(1). 53 SRM Regulation, art 48. 54 SRM Regulation, art 98(1). 55 SRM Regulation, art 42(1). 56 SRM Regulation, art 42(2), 2nd sentence. 57 SRM Regulation, art 42(3). 58 SRM Regulation, art 7(1). 59 SRM Regulation, art 43(1)(a) and (b). The status of the Vice-Chair mentioned in SRM Regulation, art 56(3) is not entirely clear. SRM Regulation, arts 56(4) and 47(2) suggest that the Vice-Chair is not one of the ‘four further full-time members’ referred to in SRM Regulation, art 43(1)(b) as SRM Regulation, arts 56(4) and 47(2) refer to ‘[t]‌he Chair, the Vice-Chair and the members referred to in Article 43(1)(b)’ [italics added]. Compare also SRM Regulation, art 47(3). In view of this, it is submitted that the Vice-Chair is not a member of the SRB. He only becomes a member of the SRB as soon as he carries out the functions of the Chair in his absence or reasonable impediment (SRM Regulation, art 56(3), 2nd sentence). However, in order to step in smoothly he should be able to attend the plenary and executive sessions of the SRB, without, however, the autonomous right to vote, unless he replaces the Chair. It is rather confusing that the Dutch version of the SRM Regulation assumes that the Vice-Chair is a member of the SRB, as SRM Regulation, art 43(1)(a) explicitly mentions the Vice-Chair as member of the SRB. This has the paradoxical effect that the Vice-Chair cannot be a member of the SRB in its executive session, as the Dutch version of SRM Regulation, art 53(1), 1st para (in line with the English version) states that the SRB in its executive session is composed of the Chair and the members mentioned in SRM Regulation, art 43(1)(b). I assume this is a slip of the pen.

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Danny Busch and regulation as well as bank resolution. They are chosen on the basis of an open selection procedure, respecting the principles of gender balance, experience, and qualification, of which the European Parliament and the Council are kept duly informed at every stage of the procedure in a timely manner.60 9.19 In addition, the participating Member States representing the national resolution

authorities each appoint a member of the SRB.61 Currently, only the Eurozone Member States participate, which means that the SRB is composed of five independent members and nineteen members representing the national resolution authorities within the Eurozone, that is twenty-four members in total. Each member, including the Chair, has one vote.62

9.20 Furthermore, the ECB and the Commission each designate a representative en-

titled to participate in meetings of executive and plenary sessions of the SRB as a permanent observer. The representatives of the Commission and the ECB are entitled to participate in the debates and have access to all documents.63 They do not have any voting rights. In draft versions of the SRM Regulation they did have voting rights,64 but with respect to the ECB this has been amended at the request of the ECB in order to more accurately reflect the difference between the ECB’s role pursuant to the SSM Regulation, and its role as a participant in the SRB pursuant to the SRM Regulation, and to avoid potential conflicts of interests for the member appointed by the ECB.65 Similar arguments apply with respect to the Commission, which has its own role to play within the governance framework of the SRM.

9.21 The SRB may convene in a plenary or executive session. In plenary sessions, all

members of the SRB participate.66

9.22 In executive sessions, the SRB is composed of the Chair and the four further full-

time members.67 When deliberating on an entity or a group of entities covered by the SRM68 established only in one participating Member State, the member appointed by that participating Member State also participates in the deliberations and in the decision-making process.69 Furthermore, when deliberating on a cross- border group, the member appointed by the participating Member State in which

60 SRM Regulation, art 56(4). 61 SRM Regulation, art 43(1)(c). In the event of more than one national resolution authority in a participating Member State, a second representative is allowed to participate as observer without voting rights: see SRM Regulation, art 43(4). 62 SRM Regulation, art 43(2). 63 SRM Regulation, art 43(3). 64 See, eg SRM Regulation, art 39(1)(c) and (d) (version of 6 February 2014). 65 See ECB Opinion (n 15), 21–2. 66 SRM Regulation, art 49. 67 SRM Regulation, art 53(1), 1st para, read in conjunction with art 43(1)(b). 68 See Section II(2). 69 SRM Regulation, art 53(3).

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Governance of the Single Resolution Mechanism the group level resolution authority is situated, as well as the members appointed by the participating Member States in which a subsidiary or entity covered by consolidated supervision is established, such members will also participate in the decision-making process.70 The SRB in its executive session may invite, in addition to the permanent observers 9.23 of the Commission and the ECB, other observers, including a representative of the EBA.71 Recital 35 of the SRM Regulation explains that ‘as a general rule, the [SRB] should always invite the EBA when matters are discussed for which, in accordance with [the BRRD], EBA is required to develop technical standards or to issue guidelines’. Recital 35 also mentions the possibility of inviting, where appropriate, an observer representing the European Stability Mechanism (ESM). Although not specifically mentioned in the text or the recitals, a representative of the Council may be invited as well. Inviting someone from the Council may sometimes be a good idea, as the Council (like the Commission) has a role to play in eg the adoption of resolution plans by the SRB.72 In any event, the SRB must also invite national resolution authorities of non- 9.24 participating Member States, when deliberating on a group that has subsidiaries or significant branches in those non-participating Member States, to participate at its meetings. The participation of representatives of EBA, of the ESM, of the Council, and of national resolution authorities of non-participating Member States (and possibly others) will be on an ad hoc basis.73 Since the participants in the decision-making process of the SRB in its executive sessions would change depending on the participating Member State(s) where the relevant institution or group operates, the permanent members (the Chair and the four further full-time members) must ensure that the resolution decisions and actions, in particular with regard to the use of the Fund, across the different formations of the executive sessions of the SRB are coherent, appropriate and proportionate.74 C. Duty to Act Independently and in the General Interest The SRB and the national resolution authorities must act independently and in 9.25 the general interest.75 The Chair, the Vice-Chair, and the four full-time members must perform their tasks in conformity with the decisions of SRB, the Council, and the Commission. They must act independently and objectively in the interest

70 SRM Regulation, art 53(3). The provision merely refers to ‘Member State’, but obviously it is meant to refer to ‘participating Member State’. 71 SRM Regulation, art 53(1), 3rd para, read in conjunction with art 43(3). 72 See Section IV(4)(E). 73 SRM Regulation, art 53(1), 3rd para. 74 SRM Regulation, art 53(5) and Recital 34. 75 SRM Regulation, art 47(1).

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Danny Busch of the Union as a whole and may not seek or take instructions from the Union’s institutions or bodies, from any government of a Member State, or from any other public or private body. In the deliberations and decision-making process within the SRB, they must express their own views and vote independently.76 Neither the Member States, the Union’s institutions or bodies, nor any other public or private body may seek to influence the Chair, the other members of the SRB, or the Vice-Chair.77 9.26 Unfortunately, it is not made clear whether there is any difference in meaning

between ‘general interest’ (to be pursued by the SRB and national resolution authorities) and ‘the interest of the Union as a whole’ (to be pursued by the Chair, the Vice-Chair and the four full-time members of the SRB). In any event, the members appointed by the participating Member States, representing national resolution authorities, observers of the ECB and the Commission, and ad hoc observers such as EBA, are apparently not under a duty to pursue the general interest/the interest of the Union as a whole. This seems inconsistent. The national resolution authorities themselves must act independently and in the general interest, so it is difficult to see why the members representing them in the SRB should not act in such a manner.

D. Division of Tasks Between Executive and Plenary Sessions of the SRB 9.27 i. Executive Sessions The SRB in its executive session prepares all of the decisions to be adopted in its plenary session.78 Furthermore, the SRB in its executive session takes all of the decisions to implement the SRM Regulation, unless the SRM Regulation provides otherwise.79 So apparently the rule is that the SRB in its plenary session only takes decisions to implement the SRM Regulation if this is explicitly provided in the SRM Regulation (see under Section II(5)(D)(ii)). In any event, the SRM Regulation clarifies that this approach includes that the SRB in its executive session decides on the following matters: (1) preparing, assessing, and approving resolution plans for the entities and groups for which the SRB (and not a national resolution authority) is responsible;80,81 (2) applying simplified obligations to certain entities and groups for which the SRB (and not a national resolution authority) is responsible82 when the conditions for application are met;83 SRM Regulation, art 47(2). 77 SRM Regulation, art 47(3). SRM Regulation, art 47(3) in fact refers to ‘the Chair, the Vice- Chair or the members of the [SRB]’. This wording incorrectly suggests that the Chair is not a member of the SRB. This wording also suggests that the Vice-Chair is not a member of the SRB, which seems correct. See the discussion in n 59. 78 SRM Regulation, art 54(1)(a). 79 SRM Regulation, art 54(1)(b). 80 See Section II(3). 81 SRM Regulation, art 54(2)(a). 82 See Section II(3). 83 SRM Regulation, art 54(2)(b). 76

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Governance of the Single Resolution Mechanism (3) determining the minimum requirement for own funds and eligible liabilities that entities and groups for which the SRB (and not a national resolution authority) is responsible84 need to meet at all times;85 (4) providing the Commission, as early as possible, with a resolution scheme accompanied by all relevant information allowing in due time the Commission to assess and decide or, where appropriate, propose a decision to the Council pursuant to Article 18(7) of the SRM Regulation;86,87 and (5) deciding upon the SRB’s Part II of the budget on the Fund.88 The revenues of Part II of the budget consist, in particular, of the following: (a) ex ante contributions and extraordinary ex post contributions, both paid by institutions established in participating Member States; (b) loans received from other resolution financing arrangements in non- participating Member States; (c) loans from financial institutions or other third parties; (d) returns on the investments of the amounts held in the Fund; and (e) any part of the expenses incurred which are recovered in the resolution proceedings.89

The expenditure of Part II of the budget consists of the following: ( a) expenses for the purposes for which the Fund is established; (b) investments; (c) interest paid on loans received from other resolution financing arrangements in non-participating Member States; and (d) interest paid on loans received from financial institutions or other third parties.90

In addition, where necessary because of urgency, the SRB in its executive session 9.28 may take certain provisional decisions on behalf of the SRB in its plenary session, in particular on administrative management matters, including budgetary matters.91 The SRB, in its executive session, must keep the SRB in its plenary session in- 9.29 formed of the decisions it takes on resolution.92 ii. Plenary Sessions In the SRM Regulation it is explicitly provided that the SRB 9.30 in its plenary session has the following tasks: (1) It must adopt, by 30 November each year, the SRB’s annual work programme for the following year, based on a draft put forward by the Chair and must transmit it for information to the European Parliament, the Council, the Commission and the ECB.93 84 See Section II(3). 85 SRM Regulation, art 54(2)(c). 86 See Section IV(4)(E) for a discussion of SRM Regulation, art 18(7). 87 SRM Regulation, art 54(2)(d). 88 SRM Regulation, art 54(2)(e). 89 SRM Regulation, art 60(1). 90 SRM Regulation, art 60(2). 91 SRM Regulation, art 54(3). 92 SRM Regulation, art 54(4). 93 SRM Regulation, art 50(1)(a).

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Danny Busch (2) It must adopt and monitor the annual budget of the SRB94 and approve the SRB’s final accounts and give discharge to the Chair.95,96 (3) It must97 decide on the use of the Fund, if the support of the Fund in that specific resolution action is required above the threshold of €5bn for which the weighting of liquidity support is 0.5.98 (4) It must, once the net accumulated use of the Fund in the last consecutive twelve months reaches the threshold of €5bn, evaluate the application of the resolution tools, in particular the use of the Fund, and provide guidance which the executive session must follow in subsequent resolution decisions, in particular, if appropriate, differentiating between liquidity and other forms of support.99 (5) It must decide on: (a) the necessity of raising extraordinary ex post contributions;100 (b) the voluntary borrowing between financing arrangements;101 (c) alternative financing means;102 and (d) the mutualization of national financing arrangements in the case of group resolution involving institutions in non-participating Member States,103 in case of support of the Fund above the threshold of €5bn for which the weighting of liquidity support is 0.5.104 (6) It must decide on the investments of the Fund.105,106 (7) It must adopt the annual activity report on the SRB’s activities,107 which must present detailed explanations on the implementation of the budget.108 (8) It must adopt the financial rules applicable to the SRB.109,110 (9) It must adopt an anti-fraud strategy, proportionate to fraud risks taking into account the costs and benefits of the measures to be implemented.111 (10) It must adopt rules for the prevention and management of conflicts of interest in respect of its members.112

94 In accordance with SRM Regulation, art 61(2). 95 In accordance with SRM Regulation, art 63(4) and (8). 96 SRM Regulation, art 50(1)(b). 97 Subject to the procedure referred to in SRM Regulation, art 50(2). 98 SRM Regulation, art 50(1)(c). See further Sections II(5)(E) and IV(4)(C). 99 SRM Regulation, art 50(1)(d). See further Sections II(5)(E) and IV(4)(C). 100 In accordance with SRM Regulation, art 71. 101 In accordance with SRM Regulation, art 72. 102 In accordance with SRM Regulation, arts 73 and 74. 103 In accordance with SRM Regulation, art 78. 104 SRM Regulation, art 50(1)(e). See further Section II(5)(E)(ii). See also Section III(3) (extraordinary ex post contributions), Section III(6) (voluntary borrowing), Section III(5) (alternative financing means), and Section IV(3)(F)(ii) (mutualization of national financing arrangements in the case of group resolution involving institutions in non-participating Member States). 105 In accordance with SRM Regulation, art 75. 106 SRM Regulation, art 50(1)(f ). 107 Referred to in SRM Regulation, art 45. 108 SRM Regulation, art 50(1)(g). 109 In accordance with SRM Regulation, art 64. 110 SRM Regulation, art 50(1)(h). 111 SRM Regulation, art 50(1)(i). 112 SRM Regulation, art 50(1)(j).

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Governance of the Single Resolution Mechanism (11) It must adopt its rules of procedure and those of the SRB in its executive session.113 (12) It must exercise,114 with respect to the staff of the SRB, the powers conferred by the Staff Regulations on the Appointing Authority and by the Conditions of Employment of Other Servants of the European Union as laid down by Council Regulation (EEC, Euratom, ECSC) 259/68115 (‘Conditions of Employment’) on the Authority Empowered to Conclude a Contract of Employment (‘the appointing authority powers’).116 (13) It must adopt appropriate implementing rules for giving effect to the Staff Regulations and the Conditions of Employment.117, 118 (14) It must appoint an Accounting Officer, subject to the Staff Regulations and the Conditions of Employment, who will be functionally independent in the performance of his or her duties.119 (15) It must ensure adequate follow-up to findings and recommendations stemming from the internal or external audit reports and evaluations, as well as from investigations of the European Anti-Fraud Office (OLAF).120 (16) It must take all decisions on the establishment of the SRB’s internal structures and, where necessary, their modification.121 (17) It must approve the framework122 to organize the practical arrangements for the co-operation with the national resolution authorities.123

E. Decision-making i. Executive Sessions The SRB, in its executive session, when deliberating on 9.31 an individual entity or a group established only in one participating Member State, if the members124 are not able to reach a joint agreement by consensus within a deadline set by the Chair, the Chair and the four further full-time members must take a decision by a simple majority.125 This means that the member appointed by the participating Member State in which the relevant entity or group of entities is established, does not have a voting right in the absence of consensus.

SRM Regulation, art 50(1)(k). 114 In accordance with SRM Regulation, art 50(3). 115 Council Regulation (EEC, Euratom, ECSC) 259/68 of 29 February 1968 [1968] OJ L56. 116 SRM Regulation, art 50(1)(l). 117 In accordance with Staff Regulation, art 110. 118 SRM Regulation, art 50(1)(m). 119 SRM Regulation, art 50(1)(n). 120 SRM Regulation, art 50(1)(o). 121 SRM Regulation, art 50(1)(p). 122 Referred to in SRM Regulation, art 31(1). 123 SRM Regulation, art 50(1)(q). 124 Those members are: the Chair and the four further full-time members (SRM Regulation, art 53(1), 1st para, read in conjunction with art 43(1)(b)), and the member appointed by the participating Member State in which the relevant entity or group of entities is established (SRM Regulation, art 53(3)). 125 SRM Regulation, art 55(1). 113

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Danny Busch 9.32 The SRB, in its executive session, when deliberating on a cross-border group, if

the members126 are not able to reach a joint agreement by consensus within a deadline set by the Chair, the Chair and the four further full-time members must likewise take a decision by a simple majority.127 This means that the members appointed by the participating Member State in which a subsidiary or entity covered by consolidated supervision is established, do not have voting rights in the absence of consensus.

9.33 There are also decisions taken by the SRB’s executive session which do not involve

deliberation on an individual entity or (cross-border) group such as deciding on the SRB’s Part II of the budget of the Fund.128 This modality is not explicitly addressed in the SRM Regulation, but it may be assumed that, if the members129 are not able to reach a joint agreement by consensus within a deadline set by the Chair, the Chair and the four further full-time members must take a decision by a simple majority.

9.34 In all the modalities set out above, the Chair has a casting vote in the event of a

tie.130 However, since there are five members voting in these cases, the case of a tie will not likely occur, although it seems conceivable that a member with a voting right may not be present or may abstain from voting.

9.35 ii. Plenary Sessions As a general rule, the SRB in its plenary session takes

decisions by a simple majority of its members. Each voting member has one vote. In the event of a tie, the Chair has a casting vote.131 There are however important exceptions to the rule that decisions in the SRB’s plenary session are taken by simple majority.

9.36 First, the following decisions of the SRB in its plenary session are taken by a

simple majority of the SRB members (in line with the general rule) but (in derogation from the general rule) representing at least 30% of the contributions to the Fund. Each voting member has one vote. In case of a tie, the Chair has a casting vote (which is all in line with the general rule). (1) Decisions on the use of the Fund, if the support of the Fund in that specific resolution action is required above the threshold of €5bn for which the weighting of liquidity support is 0.5.132

126 Those members are: the Chair and the four further full-time members (SRM Regulation, art 53(1), 1st para read in conjunction with art 43(1)(b)) and the member appointed by the participating Member State in which the group-level resolution authority is situated, as well as the members appointed by the participating Member State in which a subsidiary or entity covered by consolidated supervision is established (SRM Regulation, art 53(4)). 127 SRM Regulation, art 55(2). 128 SRM Regulation, art 54(2)(e). 129 Those members are the Chair and the four further full-time members. 130 SRM Regulation, art 55(3). 131 SRM Regulation, art 52(1). 132 SRM Regulation, art 52(2) read in conjunction with art 50(1)(c).

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Governance of the Single Resolution Mechanism (2) Once the net accumulated use of the Fund in the last consecutive 12 months reaches the threshold of €5bn, decisions regarding the evaluation of the application of the resolution tools, in particular the use of the Fund, and decisions regarding the provision of guidance which the executive session must follow in subsequent resolution decisions in particular, if appropriate, differentiating between liquidity and other forms of support.133 (3) Decisions on the mutualization of national financing arrangements in the case of group resolution involving institutions in non-participating Member States, limited to the use of the financial means available in the Fund.134 In view of Articles 50(1)(e) (which, inter alia, refers to mutualization of national financing arrangements in the case of group resolution involving institutions in non-participating Member States) and 50(1)(c) of the SRM Regulation (stating that the plenary session only decides in case of support of the Fund above the threshold of €5–10bn) it seems that the words ‘limited to the use of the financial means available in the Fund’ in Article 52(2) of the SRM Regulation, should be taken to mean ‘limited to the use of the financial means available in the Fund, but above the threshold of 5/10 billion euro’.

Secondly, the following decisions of the SRB in its plenary session are taken: (a) 9.37 by a majority of two-thirds of the SRB members, representing at least 50% of contributions to the Fund during the eight-year transitional period until the Fund is fully mutualized; and (b) by a majority of two-thirds of the SRB members, representing at least 30% of contributions from then on. Each voting member has one vote. In case of a tie, the Chair has a casting vote. (1) Decisions which involve the raising of extraordinary ex post contributions;135 (2) Decisions which involve voluntary borrowing between financing arrangements.136 (3) Decisions which involve alternative financing means.137 (4) Decisions which involve the mutualization of national financing arrangements in the case of group resolution involving institutions in non-participating Member States, exceeding the use of the financial means available in the Fund.138 In view of Articles 50(1)(e) (which, inter alia, refers to mutualization of national financing arrangements in the case of group resolution involving institutions in non-participating Member States) and 50(1)(c) of the SRM Regulation (stating that the plenary session only decides in case of support of the Fund above the threshold of €5–10bn) it seems that the words ‘exceeding the use of the financial means available in the Fund’ in Article 52(3) of the SRM Regulation, should be taken to mean ‘exceeding the use of the financial means available in the Fund, and above the threshold of 5/10 billion euro’.

iii. Rules of Procedure The SRB must adopt and make public its rules of pro- 9.38 cedure. The rules of procedure must establish more detailed voting arrangements

133 SRM Regulation, art 52(2) read in conjunction with art 50(1)(d). 134 SRM Regulation, art 52(2) read in conjunction with art 78. 135 SRM Regulation, art 52(3) read in conjunction with art 71. 136 SRM Regulation, art 52(3) read in conjunction with art 72. 137 SRM Regulation, art 52(3) read in conjunction with arts 73 and 74. 138 SRM Regulation, art 52(3) read in conjunction with art 78.

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Danny Busch in particular the circumstances in which a member may act on behalf of another member and including, where appropriate, the rules governing quorums.139 F. Accountability and Liability 9.39 The SRB is accountable to the European Parliament, the Council, and the Commission.140 To that end, the SRB submits an annual report to the European Parliament, the national Parliaments of participating Member States, the Council, the Commission, and the European Court of Auditors on the performance of its tasks conferred on it by the SRM Regulation. Subject to the requirements of professional secrecy, that report will be published on the SRB’s website.141 9.40 In addition, the SRB can be held liable in private law. Its contractual liability

is governed by the law applicable to the contract in question.142 In the case of non-contractual liability, the SRB must, in accordance with the general principles common to the laws concerning the liability of public authorities of the Member States, make good any damage caused by it or by its staff in the performance of their duties, in particular their resolution functions, including acts and omissions in support of foreign resolution proceedings.143 6. The Single Bank Resolution Fund

A. General 9.41 Another key element of the SRM, alongside with the SRB, is the Single Bank Resolution Fund (the Fund). The Fund is owned by the SRB.144 The SRB may 139 SRM Regulation, art 52(4). See: Decision of the Plenary Session of 29 April 2015 adopting the Rules of Procedure of the [SRB] in its Executive Session’ (SRB/PS/2015/8) (available online at ); ‘Decision of the Plenary Session of 29 April 2015 adopting the Rules of Procedure of the [SRB] in its Plenary Session’ (SRB/PS/2015/9) (available online at ). 140 SRM Regulation, art 45(1). 141 SRM Regulation, art 45(2). 142 SRM Regulation, art 87(1). The Court of Justice has jurisdiction to give judgment pursuant to any arbitration clause contained in a contract concluded by the SRB: see SRM Regulation, art 87(2). 143 SRM Regulation, art 87. The SRB must compensate a national resolution authority for the damages which it has been ordered to pay by a national court or which it has, in agreement with the SRB, undertaken to pay pursuant to an amicable settlement, which are the consequences of an act or omission committed by that national resolution authority in the course of any resolution under the SRM Regulation. That obligation does not apply where that act or omission constituted an infringement of the SRM Regulation, of another provision of Union law, of a decision of the SRB, of the Council, or of the Commission, committed intentionally or with manifest and serious error of judgment. See SRM Regulation, art 87(4). The Court of Justice has jurisdiction in any dispute regarding contractual or non-contractual liability of the SRB. Proceedings in matters arising from non-contractual liability are barred after a period of five years from the occurrence of the event giving rise thereto. See SRM Regulation, art 87(5). The personal liability of its staff towards the SRB is governed by the provisions laid down in the Staff Regulations or Conditions of Employment applicable to them: see SRM Regulation, art 87(6). 144 SRM Regulation, art 67(3).

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Governance of the Single Resolution Mechanism use the Fund only for the purpose of ensuring the efficient application of the resolution tools and exercise of resolution powers145 and in accordance with the resolution objectives and the principles governing resolution.146 Under no circumstances are the Union budget or the national budgets of Member States liable for expenses or losses of the Fund.147, 148 As of 2016, all Eurozone MS have entered into a harmonized Loan Facility Agreement with the SRB, providing a national individual credit line to the SRB to back their national compartments in the SRF in case of possible funding shortfalls following resolution cases of banks in the Eurozone. The banking sector of the Member State concerned will however be liable for repayment of the amounts drawn under the credit line.149 B. Objectives The primary objective of the Fund is to ensure financial stability, rather than 9.42 to absorb losses or provide capital to an institution under resolution. The Fund should not be considered a bail-out fund. There might however be exceptional circumstances where, after sufficiently having exhausted the internal resources (at least eight per cent of the liabilities and own funds of the institution under resolution150) the primary objective (financial stability) could not be achieved without allowing the Fund to absorb those losses or provide the capital. It is only in these circumstances when the Fund could act as a backstop to the private resources.151 The contribution from the Fund does not exceed 5% of the total liabilities including own funds of the institution under resolution unless all unsecured, non-preferred liabilities, other than eligible deposits, have been written-down or converted in full.152 C. Target Level In order to reach a critical mass and to avoid pro-cyclical effects which would 9.43 arise if the Fund had to rely solely on ex post contributions in a systemic crisis, the ex ante available means of the Fund must amount at least to a certain target level.153 In an initial period, in principle no longer than eight years after entry into force of the SRM (2016–2023) the available financial means of the Fund must reach at least one per cent of the amount of deposits of all credit institutions authorized in all of the participating Member States which are guaranteed under

145 Referred to in SRM Regulation, Pt II, Title I. 146 Referred to in SRM Regulation, arts 14 and 15. 147 SRM Regulation, art 67(2), 1st sentence. See further SRM Regulation, arts 76, 77, and 78. 148 SRM Regulation, art 67(2), 2nd sentence. 149 See online at . 150 SRM Regulation, art 27(7)(a). 151 Explanatory Memorandum (n 15), 13. 152 SRM Regulation, art 27(7)(b) and (9). See also IGA, Recital 16. 153 SRM Regulation, Recital 104.

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Danny Busch the DGS (target funding level).154 On the basis of 2011 data on banks and an estimated amount of covered deposits held in banks in the Eurozone, the one per cent target level for the Fund would correspond to around €55bn. Of course, the target size of the Fund in absolute amounts (euros) will remain dynamic and will increase automatically if the banking industry grows.155 D. Extension of Initial Period of Time 9.44 The SRB must extend the initial period of time of eight years for a maximum of four years (until 1 January 2027) in the event that the Fund has made cumulative disbursements in excess of half a per cent of the total amount of covered deposits.156 This decision is taken by the SRB in its executive session.157 The decision will normally be taken by the Chair and the four further full-time members. In other words, this decision will normally be taken by the independent members of the SRB only, without the members representing national resolution authorities participating in the decision-making. As previously mentioned, this modality is not explicitly addressed in the SRM Regulation, but it may be assumed that, if the members are not able to reach a joint agreement by consensus within a deadline set by the Chair, the Chair and the four further permanent members must take a decision by a simple majority. Since there are five members voting in such a case, the case of a tie (in which case the Chair has a casting vote)158 will not likely occur, although it seems conceivable that a member with a voting right may not be present or may abstain from voting. 9.45 The above decision-making procedure with respect to an extension of the initial

period of time does not necessarily mean that the Member States do not have any influence. The Commission is empowered to adopt delegated acts by simple

154 SRM Regulation, art 69(1). In ECB Opinion (n 15), 23, the ECB expressed the view that covered deposits are not the most appropriate benchmark for the target funding level of the Fund, given that they do not entirely reflect possible funding costs in resolution. Covered deposits remain stable, while overall liabilities considerably increase, or may increase while overall liabilities remain stable. In both cases, the Fund’s potential exposure would not be adequately reflected. The fact that covered deposits are already insured via the DGS should also be considered, since the DGS may contribute to resolution financing if the (preferred) covered deposits suffer a loss. This benchmark should therefore be complemented by a reference value relating to total liabilities, which should be adequately calibrated by the SRB, while keeping the 1% covered deposits as a floor. This suggestion has unfortunately not been adopted. Instead, the SRM Regulation merely acknowledges that the amount of the total liabilities of those institutions would be a more adequate benchmark and that the Commission should have assessed by 31 December 2018 if a reference value relating to total liabilities is a more appropriate basis and if a minimum absolute amount for the Fund should be introduced in order to avoid volatility in the flow of financial means to the fund and to ensure the stability and adequacy of the financing of the Fund over time, while maintaining the level playing field with the BRRD. See SRM Regulation, Recital 105 and art 94(1)(a)(vi) and (vii). Apparently, the Commission did not manage to comply with the 31 December 2018 deadline. 155 See Explanatory Memorandum (n 15), 14–15. 156 See SRM Regulation, art 69(3). 157 See SRM Regulation, art 54(1)(b). 158 SRM Regulation, art 55(3).

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Governance of the Single Resolution Mechanism majority159 to specify the criteria for determining the number of years by which the initial period can be extended.160 Such delegated acts must be adopted in accordance with the procedure set out in Article 93 of the SRM Regulation. This means, that the delegated act enters into force only: (1) if no objection has been expressed either by the European Parliament or the Council within a period of three months of notification of the act to the European Parliament and the Council; or (2) if, before the expiry of that period, the European Parliament and the Council have both informed the Commission that they will not object.

The period of three months is extended by three months at the initiative of the European Parliament or the Council.161 So, through the right of objection of the Council, acting by qualified majority,162 the Member States, apparently including non-participating Member States, can exercise their influence.163

III. Financing of the Fund 1. General The Fund is, first of all, financed by ex ante and extraordinary ex post contributions 9.46 raised from the institutions covered by the SRM.164 Not the SRB, but the participating Member States raise the ex ante and extraordinary ex post contributions from the institutions covered by the SRM which are located in their respective territories. The participating Member States remain competent to transfer them to the Fund. In view of this, the obligation to transfer the contributions raised at national level to the Fund was established by the Intergovernmental Agreement on the Transfer and Mutualization of Contributions to the Fund among the participating Member States (IGA). The IGA also addresses the gradual mutualization of the Fund.165 The SRB may also seek alternative funding in certain cases, inter

159 According to the general rule of the Treaty on the Functioning of the European Union (TFEU), art 250. 160 SRM Regulation, art 69(5)(b). 161 SRM Regulation, art 93(6). It should also be noted that the delegation of powers may be revoked at any time by the European Parliament or by the Council. A decision of revocation puts an end to the delegation of the power specified in the decision. It takes effect the day following the publication of the decision in the Official Journal of the European Union or at a later date specified therein. However, such revocation does not affect the validity of any delegated acts already in force: see SRM Regulation, art 93(4). 162 TFEU, art 290(2). The European Parliament must object by simple majority of its members: see TFEU, art 290(2). 163 It is probably not possible to apply TFEU, art 136(2) (on decision-making concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights. 164 See further Sections III(2) and III(3). 165 See further Section III(4).

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Danny Busch alia, from participating Member States and the European Stability Mechanism (ESM) and may sometimes request to voluntarily borrow for the Fund from resolution financing arrangements (resolution funds) within non-participating Member States.166 2. Ex Ante Contributions 9.47 The institutions covered by the SRM must contribute to the Fund on the basis

of annual ex ante contributions necessary to reach the target funding level of at least one per cent of the amount of deposits of all credit institutions authorized in the participating member States which are guaranteed under the DGS.167 The individual contribution of each institution must be raised at least annually and is calculated pro rata to the amount of its liabilities excluding own funds and covered deposits, with respect to the aggregate liabilities excluding own funds and covered deposits of all the institutions covered by the SRM.168 This means that banks which are financed almost exclusively by deposits will in practice have very low contributions. Of course, these banks will contribute to national DGS.169

9.48 Each year the SRB, after consulting the ECB or the national competent authority

and in close co-operation with the national resolution authorities, must calculate the individual contributions to ensure that the contributions due by all the institutions authorized in the territories of all the participating Member States will not exceed 12.5% of the target level.170 It seems that such calculation is made by the SRB in its executive session.171 It may be argued that such calculation does not actually involve deliberation on an individual entity or a (cross-border) group. As previously mentioned, this modality is not explicitly addressed in the SRM Regulation, but it may be assumed that, if the members are not able to reach a joint agreement by consensus within a deadline set by the Chair, the Chair, and the four further full-time members must take a decision by a simple majority. The Chair has a casting vote in the event of a tie.172 However, since there are five members voting in these cases the case of a tie will not likely occur, although it seems conceivable that a member with a voting right may not be present or may abstain from voting.

9.49 Each year the calculation of the contributions for individual institutions is

based on:

See further Sections III(5) and (6). 167 SRM Regulation, art 69(1). 168 SRM Regulation, art 70(1). 169 Explanatory Memorandum (n 15), 15. 170 SRM Regulation, art 70(2), 1st para. 171 This seems to follow from the general rule that the executive session takes all decisions to implement the SRM Regulation, unless the SRM Regulation provides otherwise (art 54(1) opening words and 54(1)(b)). 172 SRM Regulation, art 55(3). 166

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Governance of the Single Resolution Mechanism (1) a flat contribution, that is pro-rata based on the amount of an institution’s liabilities excluding own funds and covered deposits, with respect to the total liabilities, excluding own funds and covered deposits, of all of the institutions authorized in the territories of the participating Member States; and (2) a risk-adjusted contribution, that is based on the criteria set out in Article 103(7) of the BRRD, taking into account the principle of proportionality, without creating distortions between banking sector structures of the Member States. This apparently includes non-participating Member States. The relation between the flat contribution and the risk-adjusted contributions 9.50 must take into account a balanced distribution of contributions across different types of banks. In any case, the aggregate amount of individual contributions by all of the institutions authorized in the territories of all of the participating Member States, calculated under points (1) and (2) above, must not exceed annually 12.5% of the target level.173 The delegated acts specifying the notion of adjusting contributions in propor- 9.51 tion to the risk profile of institutions, adopted by the Commission by simple majority174 under Article 103(7) of the BRRD, apply.175 The Council, acting on a proposal from the Commission, must, within the framework of the delegated acts adopted pursuant to the BRRD, adopt implementing acts particularly relating to: (a) the application of the methodology for the calculation of individual contributions; and (b) the practical modalities for allocating to institutions the risk factors specified in the delegated act.176 This procedure means that the Council ultimately decides on the methodology of the banking sector’s contribution to the Fund. Thus, even though the SRB in its executive session calculates the individual ex ante contributions (without the involvement of the members representing national resolution authorities) the methodology, through the adoption by the Council acting by qualified majority,177 remains in the hands of the

173 SRM Regulation, art 70(2), 2nd and 3rd paras. The available financial means to be taken into account in order to reach the target funding level may include irrevocable payment commitments which are fully backed by collateral of low-risk assets unencumbered by any third-party rights, at the free disposal of and earmarked for the exclusive use by the SRB for the purposes of the Fund. The share of those irrevocable payment commitments may not exceed 30% of the total amount of ex ante contributions raised: see SRM Regulation, art 70(3). 174 According to the general rule of TFEU, art 250. 175 SRM Regulation, art 70(6), BRRD, art 103(7) and Commission Delegated Regulation (EU) 2015/63 of 21 October 2014 supplementing Directive 2014/59/EU of the European Parliament and of the Council with regard to ex ante contributions to resolution financing arrangements [2015] OJ L11/44. 176 SRM Regulation, art 70(7) and Council Implementing Regulation (EU) 2015/81 of 19 December 2014 specifying uniform conditions of application of Regulation (EU) 806/2014 of the European Parliament and of the Council with regard to ex ante contributions to the Single Resolution Fund [2015] OJ L15/1. 177 TFEU, art 290(2).

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Danny Busch Member States alone, apparently including non-participating Member States.178 The adoption of this procedure was an important issue for France which feared that its universal banks would otherwise have to pay more than their fair share.179 9.52 During the initial period of time of eight years from, in principle, 1 January 2016,

the ex ante contributions will be spread out in time as evenly as possible until the target level is reached, but with due account of the phase of the business cycle and the impact that pro-cyclical contributions may have on the financial position of contributing institutions.180 The Commission is empowered to adopt delegated acts specifying the criteria for the spreading out in time of the contributions to the Fund.181 Such delegated acts must be adopted in accordance with the procedure set out in Article 93 of the SRM Regulation. This means that the delegated act enters into force only: (1) if no objection has been expressed either by the European Parliament or the Council within a period of three months of notification of the act to the European Parliament and the Council; or (2) if, before expiry of that period, the European Parliament and the Council have both informed the Commission that they will not object.

That period is extended by three months at the initiative of the European Parliament or the Council.182 So, through the right of objection of the Council, acting by qualified majority,183 the Member States, apparently including non-participating Member States, can exercise their influence.184 9.53 If, after the initial period of time, the available financial means diminish below

the target level, ex ante contributions will be raised until the target level is reached. After the target level has been reached for the first time and where the available financial means have subsequently been reduced to less than two-thirds of the target level, those contributions will be set at a level allowing for reaching the target level within six years. The ex ante contributions must take due account of

178 It is probably not possible to apply TFEU, art 136(2) (on decision-making concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights. 179 See Bulletin Quotidien Europe (n 1), 5. 180 SRM Regulation, art 69(2) read in conjunction with art 69(1). 181 SRM Regulation, art 69(5)(a). 182 SRM Regulation, art 82(5). It should also be noted that the delegation of powers may be revoked at any time by the European Parliament and the Council. A decision of revocation puts an end to the delegation of the power specified in the decision. It takes effect the day following the publication of the decision in the Official Journal of the European Union or at a later date specified therein. However, such revocation does not affect the validity of any delegated acts already in force: see SRM Regulation, art 82(3). 183 TFEU, art 290(2). The European Parliament must object by simple majority of its members: see TFEU, art 290(2). 184 It is probably not possible to apply TFEU, art 136(2) (on decision-making concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights.

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Governance of the Single Resolution Mechanism the phase of the business cycle, and the impact pro-cyclical contributions may have when setting annual contributions.185 The Commission is empowered to adopt delegated acts specifying the annual 9.54 contributions after the initial period of time.186 Such delegated acts must be adopted in accordance with the procedure set out in Article 93 of the SRM Regulation. This means, that the delegated act enters into force only: (1) if no objection has been expressed either by the European Parliament or the Council within a period of three months of notification of the act to the European Parliament and the Council; or (2) if, before expiry of that period, the European Parliament and the Council have both informed the Commission that they will not object.

That period is extended by three months at the initiative of the European Parliament or the Council.187 So, through the right of objection of the Council, acting by qualified majority,188 the Member States, apparently including non-participating Member States, can exercise their influence.189 Nevertheless, actions have been brought by discontented individual banks before the EU Courts against the SRB mainly in relation to the payment of the ex ante contributions to the SRF.190 3. Extraordinary Ex Post Contributions Where the available financial means are not sufficient to cover the losses, costs, or 9.55 other expenses incurred by the use of the Fund in resolution actions, extraordinary ex post contributions from the institutions covered by the SRM will be raised, in order to cover the additional amounts. The individual extraordinary ex post contribution of each institution is, like the individual ex ante contribution, calculated pro-rata to the amount of its liabilities excluding own funds and covered deposits

185 SRM Regulation, art 69(4). 186 SRM Regulation, art 69(5)(c). 187 SRM Regulation, art 82(5). It should also be noted that the delegation of powers may be revoked at any time by the European Parliament and the Council. A decision of revocation puts an end to the delegation of the power specified in the decision. It takes effect the day following the publication of the decision in the Official Journal of the European Union or at a later date specified therein. However, such revocation does not affect the validity of any delegated acts already in force: see SRM Regulation, art 82(3). 188 TFEU, art 290(2). The European Parliament must object by simple majority of its members: see TFEU, art 290(2). 189 It is probably not possible to apply TFEU, art 136(2) (on decision-myaking concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights. 190 See, eg, Landesbank Baden Württemberg v SRB (Case T-14/17); Credito Fondiario v CRU (Case T-661/16); NRW Bank v SRB (Case T-466/16); Portigon v SRB (Case T-365/16); and Banco Cooperativo Español v SRB (Case T-323/16). The European Banking Institute (EBI) maintains a regularly updated overview of all cases pending against the SRB on its website at .

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Danny Busch adjusted in proportion to the risk profile of each institution. Extraordinary ex post contributions must not exceed three times the annual amount of ex ante contributions.191 9.56 As previously discussed,192 the SRB in its plenary session decides on the necessity

of raising extraordinary ex post contributions.193 Normally, the SRB in its plenary session takes decisions by a simple majority of its members194 but in the case of a decision to raise extraordinary ex post contributions this is otherwise. In such a case, a decision is taken: (a) by a majority of two-thirds of the SRB members, representing at least 50% of the contributions during the eight-year transitional period until the Fund is fully mutualized; and (b) by a majority of two-thirds of the SRB members, representing at least 30% of the contributions from then on. Each voting member has one vote. In case of a tie, the Chair has a casting vote.195 The foregoing means that the participating Member States representing the national resolution authorities which have the largest banking sector have the most influence, although this influence will diminish somewhat after the eight-year transitional period.

9.57 In addition, the SRB will, on its own initiative after consulting the national res-

olution authority or upon proposal of a national resolution authority, defer, in whole or in part, an institution’s payment of extraordinary ex post contributions if it is necessary to protect its financial position. Such a deferral is not granted for a period of longer than six months but may be renewed on request of the institution. The contributions deferred will be made later at a point in time when the payment no longer jeopardizes the institution’s financial position.196 It seems that such decision is also taken in its plenary session and that the same decision- making procedure as set out earlier applies. This would mean that participating Member States other than the Member State in which the relevant institution is based, have a say as well. Again, the Commission is empowered to adopt delegated acts to specify the circumstances and conditions under which the payment of ex post contributions may be partially or entirely deferred.197 Such delegated acts must also be adopted in accordance with the procedure set out in Article 93 of the SRM Regulation. This means, that the delegated act enters into force only: (1) if no objection has been expressed either by the European Parliament or the Council within a period of three months of notification of the act to the European parliament and the Council; or

SRM Regulation, art 71(1) read in conjunction with arts 69 and 70. 192 See Section II(5)(E)(ii). 193 SRM Regulation, art 50(1)(e). 194 See SRM Regulation, art 52(1). 195 SRM Regulation, art 52(3). 196 SRM Regulation, art 71(2). 197 SRM Regulation, art 71(3). 191

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Governance of the Single Resolution Mechanism (2) if, before expiry of that period, the European Parliament and the Council have both informed the Commission that they will not object.

That period is extended by three months at the initiative of the European Parliament or the Council.198 So, through the right of objection of the Council, acting by qualified majority,199 the Member States, apparently including non-participating Member States, can exercise their influence.200 4. Intergovernmental Agreement: Transfer and Mutualization of Contributions A. General The participating Member States raise the ex ante and ex post contributions on 9.58 the institutions covered by the SRM which are located in their respective territories. The participating Member States remain competent to transfer them to the Fund. There was no consensus among the participating Member States that the obligation to transfer the contributions raised at national level to the Fund could be based on Union law. It was Germany that insisted on the intergovernmental approach primarily for constitutional reasons. The European Parliament, standing firm behind the Community method, always rejected the intergovernmental approach201 over which it has no influence. On the night of 19–20 March 2014, the European Parliament finally accepted it in order to make an overall agreement possible.202 In view of this, the obligation to transfer the contributions raised at national level to the Fund, as well as the gradual mutualization of the Fund, was established by the Intergovernmental Agreement on the Transfer and Mutualization of Contributions to the Fund among the participating Member States (IGA) at least for the time being.203 In the future, primary EU law may well be amended to make it possible to address these topics in the SRM Regulation. In any event, for now, the IGA lays down the conditions upon which the parties,

198 SRM Regulation, art 82(5). It should also be noted that the delegation of powers may be revoked at any time by the European Parliament and the Council. A decision of revocation puts an end to the delegation of the power specified in the decision. It takes effect the day following the publication of the decision in the Official Journal of the European Union or at a later date specified therein. However, such revocation does not affect the validity of any delegated acts already in force: see SRM Regulation, art 82(3). 199 TFEU, art 290(2). The European Parliament must object by simple majority of its members: see TFEU, art 290(2). 200 It is probably not possible to apply TFEU, art 136(2) (on decision-making concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights. 201 See ‘Letter from the Committee on Economic and Monetary Affairs to the Greek Presidency’, 15 January 2014 (available online at ). 202 See Bulletin Quotidien Europe (n 1), 3, 4, and 8. 203 The text of the IGA is available online at .

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Danny Busch in accordance with their respective constitutional requirements, jointly agree to transfer the contributions that they raise at national level to the Fund, and also addresses the gradual mutualization of the Fund.204 9.59 On 21 May 2014, representatives of twenty- six EU Member States (all EU

members excluding the United Kingdom and Sweden) signed the IGA. The IGA entered into force in time to permit that the SRM became fully operational on 1 January 2016.205 Member States that have signed the IGA but are not yet participating Member States will only be subject to the rights and obligations stemming from the agreement once they become participating Member States (ie become part of the SSM and SRM).206

B. Transfer and Mutualization of Contributions 9.60 The IGA establishes the obligation to transfer the contributions raised at national level towards the Fund, pursuant to uniform criteria, modalities, and conditions, notably, the allocation during an eight-year transitional period of the contributions they raise at national level to different compartments corresponding to each of them as well as the progressive mutualization of the use of the compartments in a manner such that the compartments will cease to exist at the end of that transitional period.207 9.61 During the transitional period contributions raised at national level are trans-

ferred to the Fund in such a manner that they are allocated to compartments corresponding to each participating Member State.208 The size of the compartments of each participating Member State must be equal to the totality of contributions payable by the institutions authorized in each of their territories.209 During the transitional period, the national compartments are progressively mutualized in the following manner. In the first year after the entry into force of the Fund (2016) 40% of the financial means available within the national compartments have been ‘mutualized’. In the second year (2017) an additional 20% of the financial means available within the national compartments of the Fund have been mutualized.

204 IGA, Recital 7 and art 3 (transfer of contributions to the Fund), Recital 9 and arts 4 and 5 (gradual mutualization). 205 The IGA enters into force on the first day of the second month following the date when instruments of ratification, approval, or acceptance have been deposited by signatories of the participating Member States that represent no less than 90% of the aggregate of the weighted votes of all participating Member States as determined by Protocol (No 36) on transitional provisions annexed to the TEU and the TFEU: see IGA, art 11(2). 206 IGA, art 12(4). See also Press Release, ‘Member States Sign Agreement on Bank Resolution Fund’, Brussels, 21 May 2014, (available online at ). 207 IGA, Recital 7 and art 3 (transfer of contributions to the Fund), Recital 9 and arts 4 and 5 (gradual mutualization). 208 IGA, art 4(1). 209 IGA, art 4(2).

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Governance of the Single Resolution Mechanism In the third until the eighth year (2018–2023) each year an additional number of percentage points equal to 40 divided by six (ie six and two-thirds per cent) has been/will be mutualized.210 The participating Member States may, during the transitional period, request the 9.62 SRB to temporarily make use of the part of the financial means available in the compartments of the Fund not yet mutualized. In such a case, the participating Member States concerned must subsequently transfer to the Fund, before the transitional period has elapsed, extraordinary ex post contributions in an amount equivalent to the one received by their compartments, plus the interest accrued, so that the other compartments are refunded.211 The amount temporarily transferred from each of the compartments to the recipient ones is pro rata to their size, and may not exceed 50% of the available financial means under each compartment not yet subject to mutualization.212 Decisions of the SRB on the request for the temporary transfer of financial means 9.63 between compartments are taken by simple majority of the members of its plenary session, as specified in Article 52(1) of the SRM.213 Participating Member States from which compartments the transfer has been made may object against a decision of the SRB to temporary transfer financial means within a period of four calendar days of the date of adoption of the decision. Such objection may only be exercised if any of the following circumstances occurs: (1) it may require the financial means from the national compartment that corresponds to it to finance a resolution operation in the near term or if the temporary transfer would jeopardize the conduct of an on-going resolution action within its territory; (2) the temporary transfer would take more than the 25% of its part of the national compartment not yet subject to mutualization; or (3) it considers that the participating Member State whose compartment benefits from the temporary transfer is not providing guarantees of refunding from national sources or support from the ESM in line with agreed procedures.

The participating Member State intending to object must duly substantiate the occurrence of any of the above circumstances. In case objections are raised in accordance with the above, the decision on temporary transfer of the SRB is adopted excluding the financial means of the compartments of the objecting participating Member States.214 The SRB will specify general criteria determining the conditions upon which the temporary transfer of financial means among compartments will take place.215 Although this is not expressly stipulated in the 210 IGA, art 5(1)(b), in fine. 211 IGA, art 7(1). 212 IGA, art 7(2). 213 IGA, art 7(3). 214 IGA, art 7(4). 215 IGA, art 7(6).

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Danny Busch IGA, it seems that such general criteria are also determined by simple majority of the members of its plenary session, as specified in Article 52(1) of the SRM. 5. Alternative Funding Means: Common Backstop 9.64 The SRB ‘may’ contract for the Fund borrowings or other forms of support

from those institutions, financial institutions or other third parties, which offer better financial terms and at the most appropriate time so as to optimize the cost of funding and preserve its reputation, in the event that: (1) the ex ante contributions; and (2) the extraordinary ex post contributions are not immediately accessible or do not cover the expenses incurred by the use of the Fund in relation to resolution actions.216 The borrowing or other forms of support must be fully recouped within the maturity period of the loan from the institutions covered by the SRM through: (1) annual ex ante contributions; and (2) extraordinary ex post contributions.217

9.65 The SRB ‘shall’ contract for the Fund financial arrangements, including, ‘where

possible’, public financial arrangements, regarding the immediate availability of additional financial means, where the amounts raised or available through: (1) ex ante contributions; and (2) extraordinary ex post contributions are not sufficient to meet the Funds’ obligations.218

9.66 The SRB in its plenary session decides on the contracting of alternative financing

means in accordance with Articles 73 and 74 of the SRM Regulation.219 Normally, the SRB in its plenary session takes decisions by a simple majority of its members, but in the case of a decision to contract alternative finance means this is otherwise. In such a case, a decision is taken by a majority of two-thirds of the SRB members, representing at least 50% of the contributions during the eight-year transitional period until the Fund is fully mutualized and by a majority of two- thirds of the SRB Members, representing at least 30% of the contributions from then on. Each voting member has one vote. In case of a tie, the Chair has a casting vote.220 The foregoing means that the participating Member States representing the national resolution authorities which have the largest banking sector have the most influence, although this influence will diminish somewhat after the eight- year transitional period.

9.67 In its Opinion of 6 November 2013, the ECB stated that access to fiscal resources

is an essential element of the SRM’s backstop arrangements. This is the case because private resources of funding may, especially at the start of the SRM, be

SRM Regulation, art 73(1). 217 SRM Regulation, art 73(2). 218 SRM Regulation, art 74. 219 SRM Regulation, art 50(1)(e). 220 SRM Regulation, art 52(3). 216

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Governance of the Single Resolution Mechanism scarce and temporarily dry up under acute financial market turmoil. In its proposal of the SRM Regulation, the Commission did not include an obligation on participating Member States to grant access to public funds, because this could interfere with Member States’ fiscal sovereignty which cannot be encroached upon under the legal basis of the SRM Regulation.221 And indeed, as seen earlier, such obligation on the side of the participating Member States is not included in the SRM Regulation. The SRM Regulation merely stipulates that the SRB ‘shall’ contract ‘where possible’ public financial arrangements.222 In its Opinion of 6 November 2013, the ECB had to accept the legal basis of the 9.68 SRM Regulation as a fact. As already mentioned, it follows from the legal basis that the SRM Regulation cannot guarantee access of the Fund to fiscal resources. The SRM can at most rely on the obligation of the SRB to actively seek access to fiscal resources for the Fund. Against this background the ECB, in its Opinion of 6 November 2013, suggested stipulating in the SRM Regulation that ‘[t]‌he SRB may contract for the Fund borrowings or other forms of support from financial institutions or other third parties, notably joint fiscal resources from the participating Member States’. So as to guarantee fiscal neutrality, the ECB also suggested stipulating that ‘[t]hese borrowings or other forms of financial support would have to be fully recouped in case such measures were to be activated’. The ECB remarked that such a credit line arrangement would be consistent with similar resolution frameworks in other countries such as the credit line to the Federal Deposit Insurance Corporation from the US Treasury. And, of course, it would be important to carefully calibrate the time horizon for recouping these funds from the financial sector so as to avoid overly pro-cyclical levies. As seen earlier, the suggestions of the ECB have been followed in the SRM Regulation (Articles 73 and 74).223 So, access of the Fund to fiscal resources is not guaranteed and is left to the partic- 9.69 ipating Member States. This constitutes a risk factor which can potentially jeopardize the functioning of the Fund, especially at the start of the SRM.224 In view of this, pursuant to the statement of the Eurogroup and of the Council of 18 December 2013, in order to ensure continuous sufficient financing during the transitional period the participating Member States concerned by a particular

221 ECB Opinion (n 15), 8. 222 SRM Regulation, art 74. See also SRM Regulation, art 6(6): ‘[d]‌ecisions or actions of the Board, the Commission, or the Council shall neither require Member States to provide extraordinary public financial support nor impinge on the budgetary sovereignty and fiscal responsibilities of the Member States’. 223 ECB Opinion (n 15), 9, 24. 224 Of course, fund aid is the last resort and there are other lines of defence, including stricter capital rules and stricter supervision, the ‘comprehensive assessment’ (AQR and stress test) by the ECB, drawing up and maintaining recovery and resolution plans, early intervention measures, and bail-in.

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Danny Busch resolution action should provide bridge financing from national sources or the ESM in line with agreed procedures (including the setting up of possibilities for temporary transfers between national compartments (see Section III(4)(2)). The participating Member States should have in place procedures allowing them to address any request for bridge financing in a timely manner. Furthermore, a common backstop will be developed during the transitional period. Such a backstop will facilitate borrowings by the Fund. The banking sector will ultimately be liable for repayment by means of contributions in all participating Member States, including ex post contributions. Those arrangements will ensure equivalent treatment across all the participating Member States, in terms of rights and obligations and both in the transition period and in the steady state. Those arrangements will respect a level playing field with non-participating Member States.225 9.70 Finally and in addition to the measures mentioned earlier, on 8 December 2014,

the Board of Governors of the ESM226 adopted the ESM Direct Recapitalization Instrument (DRI) for euro area financial institutions. The adoption marked the final step in the ratification process and DRI became operational on 8 December 2014. The new instrument allows the ESM to recapitalize a systemic and viable euro area financial institution directly under specific circumstances as a last resort measure. The ESM can recapitalize banks directly only if private investors have been bailed-in, in accordance with the BRRD. In addition, the national resolution funds or, from 2016 onwards, the Fund must contribute. In order to preserve the ESM’s high creditworthiness and lending capacity for other instruments, the total amount of ESM resources available for the new instrument is limited to €60bn.227 In an important further development, the Euro area leaders agreed that the ESM will provide the common backstop to the Fund (June 2018).228 On the basis of this

225 IGA, Recital 13; ‘Statement of Eurogroup and ECOFIN Ministers on the SRM Backstop’, 18 December 2013 (available online at ). 226 The ESM Board of Governors comprises the 19 euro area finance ministers. 227 ESM Press Release, ‘ECM Direct Bank Recapitalization Instrument Adopted’, 8 December 2014 (available online at ). Until the creation of DRI, the ESM could only recapitalize financial institutions indirectly. In this case, the ESM provides a loan to the government of a euro area Member State. With these funds the government then recapitalizes the financial institutions, which is how the ESM provided assistance to Spain. However, such assistance adds to the beneficiary country’s public debt which could have a negative impact on market sentiment. The link between governments and banks (described as a ‘vicious circle’) has been widely regarded as a crucial destabilizing factor for some euro area countries. As a result, the leaders of euro area countries decided, in June 2012, to develop an instrument that would allow certain institutions to strengthen their capital position without placing a large burden on the country where the institution is incorporated. See ESM, ‘FAQ on the ESM Direct Recapitalisation Instrument’, sub-para 1 (available from the link at ). 228 See Euro summit statement of 29 June 2018 (available online at ).

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Governance of the Single Resolution Mechanism mandate the Eurogroup has agreed on the main details for the operationalization of the common backstop.229 It proposed that the ESM will provide a backstop to the Fund in the form of a revolving credit line. The size of the credit line will be aligned with the target level of the Fund and will have a nominal cap set above the initial size. According to the Eurogroup, the common backstop will be established at the latest by the end of the transition period. It will be introduced earlier if sufficient progress is made in risk reduction, which will be assessed in 2020. The common backstop will then replace the DRI of the ESM. 6. Voluntary Borrowing between Financing Arrangements The SRB ‘shall’ decide to make a request to voluntarily borrow for the Fund from 9.71 resolution financing arrangements within non-participating Member States, in the event that: (1) the ex ante contributions do not cover the losses, costs, or other expenses incurred by the use of the Fund in relation to resolution actions; (2) the extraordinary ex post contributions are not immediately accessible; and (3) the alternative funding means are not immediately accessible on reasonable terms.230 The SRB in its plenary session decides on voluntary borrowing between financing 9.72 arrangements.231 Normally, the SRB in its plenary session takes decisions by a simple majority of its Members, but in the case of a decision on voluntary borrowing between financing arrangements this is otherwise. In such a case, a decision is taken: (a) by a majority of two-thirds of the SRB Members, representing at least 50% of the contributions during the eight-year transitional period until the Fund is fully mutualized; and (b) by a majority of two-thirds of the SRB Members, representing at least 30% of the contributions from then on. Each voting member has one vote. In case of a tie, the Chair has a casting vote.232 The foregoing means that the participating Member States representing the national resolution authorities which have the largest banking sector have the most influence, although this influence will diminish somewhat after the eight-year transitional period. Following a request from the SRB, each resolution financing arrangement within 9.73 a non-participating Member State must decide whether to lend to the SRB for the purpose of the Fund. Non-participating Member States may require that such

229 See Eurogroup, ‘Term sheet on the European Stability Mechanism reform’, 4 December 2018 (available online at ); ‘Terms of reference of the common backstop to the Single Resolution Fund’, 4 December 2018 (available online at ). 230 SRM Regulation, art 72(1). 231 SRM Regulation, art 50(1)(e). 232 SRM Regulation, art 52(3).

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Danny Busch decision is taken after consultation with, or with the consent of, the competent ministry or the government. The decision must be taken with due urgency.233 Unfortunately, no quantitative time limit is given. 9.74 The rate of interest, repayment period, and other terms and conditions of the

loans must be agreed between the SRB and the resolution financing arrangements within non- participating Member States which have decided to participate. The loan of every participating financing arrangement must have the same interest rate, repayment period, and other terms and conditions unless the SRB and all participating resolution financing arrangements within non-participating Member States agree otherwise.234 The amount lent by each participating resolution financing arrangement within a non-participating Member State must be pro rata to the amount of covered deposits in the Member State of that resolution financing arrangement with respect to the aggregate amount of covered deposits in the Member States of participating resolution financing arrangements. The rates of contribution may vary upon agreement of all participating resolution financing arrangements.235

IV. Resolution 1. General 9.75 The BRRD and the SRM Regulation organize bank intervention in four stages.

The first stage consists of preparatory and preventive measures, ie drawing up and maintaining recovery and resolution plans.236 In the second stage, certain early intervention measures can be taken.237 In the third stage it is possible to write-down

SRM Regulation, art 72(2) read in conjunction with BRRD, art 106(3). 234 SRM Regulation, art 72(2) read in conjunction with BRRD, art 106(4). 235 SRM Regulation, art 72(2) read in conjunction with BRRD, art 106(5). 236 BRRD, arts 4–26 (recovery and resolution planning); SRM Regulation, arts 8–12 (resolution planning). See also CRD IV, art 74(4) (recovery and resolution planning). Please note that Directive (EU) 2019/879, amending Directive 2014/59/EU as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296 will: (i) amend BRRD, arts 4–16 in various respects; and (ii) introduce a new BRRD, art 16a (Power to prohibit certain distributions). Please also note that the Regulation (EU) 2019/ 877, amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226 will: (i) amend art 12 of the SRM Regulation (on minimum requirement for own funds and eligible liabilities); and (ii) add several arts to the chapter on resolution planning, ie arts 12a–12k of the SRM Regulation (all concerned with aspects of minimum requirements for own funds and eligible liabilities). Finally, please note that Directive (EU) 2019/878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/253 will amend CRD IV, art 74(4) in certain respects. 237 SRM Regulation, art 13. Based on the SSM Regulation, the ECB or national competent authorities may take, amongst others, the following early intervention measures: (1) to require institutions to hold own funds in excess of the capital requirements laid down in CRD IV and 233

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Governance of the Single Resolution Mechanism or convert capital instruments.238 The fourth and final—most serious—stage is the resolution stage.239 In this final stage a resolution scheme must be drawn up if the conditions for resolution are to be fulfilled and resolution tools must be applied. In this chapter, we will focus on decision-making within the context of the final stage, ie with respect to the adoption of a resolution scheme. Before moving on to decision-making with respect to the adoption of resolution

CRR; (2) to restrict or limit the business, operations, or network of institutions or to request the divestment of activities that pose excessive risks to the soundness of an institution; (3) to require institutions to limit variable remuneration as a percentage of net revenues when it is inconsistent with the maintenance of a sound capital base; (4) to require institutions to use net profits to strengthen own funds; and (5) to remove at any time members from the management body of credit institutions who do not fulfil the requirements of applicable Union law. See SRM Regulation, art 13(1) read in conjunction with art 16 of the SSM Regulation. The measures set out in CRD IV, art 104 are similar to the measures set out in the SSM Regulation and may likewise be exercised by the ECB or a national competent authority. See SRM Regulation, art 13(1) read in conjunction with CRD IV, art 104. Please note that Directive (EU) 2019/878, amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers, and capital conservation measures [2019] OJ L150/ 253 will amend CRD IV, art 104 in certain respects. The early intervention measures set out in the BRRD, to be exercised by the ECB or national competent authorities include, amongst others, the following measures: (1) to require the management body of the relevant institution to implement one or more arrangements and measures set out in the recovery plan; (2) to require one or more members of the management body or senior management to be removed or replaced if these persons are found unfit to perform their duties; (3) to require the management body of the institution to draw up a plan for negotiation on restructuring of debt with some or all of its creditors according to the recovery plan where applicable; (4) require changes to the institution’s business strategy; and (5) require changes to the legal or operational structures of the institution. See SRM Regulation, art 13(1) read in conjunction with BRRD, art 27(1). Furthermore, as set out in the BRRD, where there is a significant deterioration in the financial situation of an institution or where there are serious violations of law, regulations or bylaws or serious administrative irregularities, and other measures taken in accordance with BRRD, art 27 are not sufficient to reverse the deterioration, the ECB or a national competent authority may require the removal of the senior management and/or management body of the institution. See SRM Regulation, art 13(1) read in conjunction with BRRD, art 28. Finally, as is set out in the BRRD as well, where replacement of the senior management and/or management body is deemed insufficient by the ECB or a national competent authority to remedy the situation, it may appoint one or more temporary administrators to the institution. The ECB or a national competent authority specifies the powers of the temporary administrator at the time of appointment based on what is proportionate in the circumstances. Such powers may include some or all of the powers of the management of the institution under the statutes of the institution and under national law, including the power to exercise some or all of the administrative functions of the management of the institution. The powers of the temporary administrator in relation to the institution must be in conformity with the applicable company law: see SRM Regulation, art 13(1) read in conjunction with BRRD, art 29. 238 SRM Regulation, art 21; BRRD, arts 59–62. Please note that Directive (EU) 2019/879, amending Directive 2014/59/EU as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296 will: (i) amend BRRD, arts 59–62 in various respects. The title of the relevant Chapter (Ch V of Title IV) will be changed from ‘Write down of capital instruments’ to ‘Write down or conversion of capital instruments and eligible liabilities’. 239 SRM Regulation, arts 14–28; BRRD, arts 31–92. Please note that Directive (EU) 2019/ 879, amending Directive 2014/59/EU as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296 will: (i) amend BRRD, arts 31–92 in various respects; and (ii) include several new articles.

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Danny Busch schemes, for a better understanding of the concept of resolution and resolution schemes, some remarks will be made on the objectives and principles of resolution within the SRM framework (Section IV(2)) as well as on the content of the resolution scheme (Section IV(3)). Then we move on to decision-making with respect to adoption of a resolution scheme (Section IV(4)). Finally, again for a better understanding, a few remarks will be made on the manner of execution of resolution schemes (Section IV(5)). 2. Objectives and Principles 9.76 The resolution objectives are:

(1) to ensure the continuity of critical functions; (2) to avoid significant adverse effects on financial stability, in particular by preventing contagion, including to market infrastructures, and by maintaining market discipline; (3) to protect public funds by minimizing reliance on extraordinary public financial support; (4) to protect depositors covered by Directive 94/19/EC240 and investors covered by Directive 97/9/EC;241 and (5) to protect client funds and client assets.242

When pursuing these objectives, the SRB, the Council, the Commission and, where relevant, the national resolution authorities, must seek to minimize the cost of resolution and avoid destruction of value unless necessary to achieve the resolution objectives.243 9.77 The SRB, the Council, the Commission and, where relevant, the national reso-

lution authorities, must take all appropriate measures to ensure that resolution actions are taken in accordance with the following principles: (1) the shareholders of the institution under resolution bear first losses;244 (2) creditors of the institution under resolution bear losses after the shareholders in accordance with the priority of their claims,245 unless expressly provided otherwise in the SRM Regulation;246 (3) except where otherwise provided in the SRM Regulation, creditors of the same class are treated in an equitable manner;247

240 Directive 1994/19/EU of the European Parliament and of the Council of 30 May 1994 on deposit guarantee schemes [1994] OJ L135. 241 Directive 97/9/EC of the European Parliament and of the Council of 3 March 1997 on investor-compensation schemes [1997] OJ L84. 242 SRM Regulation, art 14(2). 243 SRM Regulation, art 14(2). 244 SRM Regulation, art 15(1)(a). 245 Pursuant to SRM Regulation, art 17. 246 SRM Regulation, art 15(1)(b). 247 SRM Regulation, art 15(1)(f ).

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Governance of the Single Resolution Mechanism (4) no creditor will incur greater losses than would have been incurred if the entity had been wound up under normal insolvency proceedings (no creditor worse off or NCWO principle);248,249 (5) covered deposits are fully protected;250 and (6) where the sale of business tool, the bridge institution tool or the asset separation tool is applied to an entity, that entity is considered to be the subject of bankruptcy proceedings or analogous insolvency proceedings for the purposes of Article 5(1) of Directive 2001/23/EC.251

Also, the following principles apply:

9.78

(1) resolution action must be taken in accordance with the safeguards in the SRM Regulation;252 (2) management body and senior management of the institution under resolution are replaced, except in those cases when the retention of the management body and senior management (in whole or in part as appropriate in the circumstances) is considered necessary for the achievement of the resolution objectives;253 (3) the management body and senior management of the institution under resolution must provide all necessary assistance for the achievement of the resolution objectives;254 and (4) natural and legal persons are made liable, subject to national law, under civil or criminal law for their responsibility for the failure of the institution under resolution.255

Furthermore, where an institution is a group entity,256 the SRB, the Council, and 9.79 the Commission, when deciding on the application of the resolution tools and the exercise of resolution powers, must act in a way that minimizes the impact on other group entities and on the group as a whole and minimizes the adverse effect on financial stability in the Union and its Member States, in particular in the countries where the group operates.257 Finally, when deciding on the application of the resolution tools and the exercise 9.80 of resolution powers, the SRB must instruct national resolution authorities to inform and consult employee representatives where appropriate. This is without

In accordance with the safeguards provided for in SRM Regulation, art 29. 249 SRM Regulation, art 15(1)(g). 250 SRM Regulation, art 15(1)(h). 251 Council Directive 2001/23/EC of 12 March 2001 on the approximation of the laws of the Member States relating to the safeguarding of employees’ rights in the event of transfers of undertakings, businesses or parts of undertakings or businesses [2001] OJ L82; SRM Regulation, art 15(3). 252 SRM Regulation, art 15(1)(i). 253 SRM Regulation, art 15(1)(c). 254 SRM Regulation, art 15(1)(d). 255 SRM Regulation, art 15(1)(e). 256 Without prejudice to SRM Regulation, art 14. 257 See SRM Regulation, art 15(2). 248

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Danny Busch prejudice to provisions on the representation of employees in management bodies as provided for by national law or practice.258 3. Content Resolution Scheme A. General 9.81 The resolution scheme places the relevant entity under resolution259 and determines the application of the resolution tools260 to the institution under resolution. It particularly determines any exclusions from the application of bail-in.261,262 The scheme also determines the use of the Fund to support the resolution action.263 In addition, the resolution provides, where appropriate, for the appointment by the national resolution authorities of a special manager for the institution under resolution.264 The SRB or, as the case may be a national resolution authority, may establish that the same special manager is appointed for all of the entities affiliated to a group where that is necessary in order to facilitate solutions redressing the financial soundness of the entities concerned.265 9.82 When adopting the resolution scheme, the SRB or, as the case may be, a national

resolution authority, must take into consideration the following factors:

(1) the assets and liabilities of the institution under resolution on the basis of the valuation;266 (2) the liquidity position of the institution under resolution; (3) the marketability of the franchise value of the institution under resolution in the light of the competitive and economic conditions of the market; and (4) the time available.267

SRM Regulation, art 15(4). 259 SRM Regulation, art 18(6)(a). See, on the resolution scheme, SRM Regulation, art 23. 260 Referred to in SRM Regulation, art 22(2) on which see Sections IV(3)(B)–(E). 261 In accordance with SRM Regulation, art 27(5) and (14). See Section IV(3)(E)(iii). 262 SRM Regulation, art 18(6)(b). 263 SRM Regulation, art 18(6)(c) read in conjunction with arts 76 (mission of the Fund), 19 (state aid and fund aid), art 7(3), 4th para (national resolution authority). 264 Pursuant to BRRD, art 35. 265 SRM Regulation, art 23, 5th para (SRB); SRM Regulation, art 23, 5th para read in conjunction with art 7(3), 4th para (national resolution authority). 266 See, on valuation, SRM Regulation, art 20 (SRB) (please note that Regulation (EU) 2019/ 877, amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226 amends art 20 of the SRM Regulation in some respects); SRM Regulation, art 20 read in conjunction with art 7(3), 4th para (national resolution authority). Before deciding on resolution action or the exercise of the power to write down or convert relevant capital instruments the SRB or, as the case may be, a national resolution authority, must ensure that a fair, prudent, and realistic valuation of the assets and liabilities of the entity concerned is carried out by a person independent from any public authority, including the SRB/the national resolution authority, and from the entity concerned (SRM Regulation, art 20(1)). 267 SRM Regulation, art 22(3) (SRB); SRM Regulation, art 20(3) read in conjunction with art 7(3), 4th para (national resolution authority). 258

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Governance of the Single Resolution Mechanism Where the SRB decides to apply a resolution tool which would result in losses 9.83 being borne by creditors or their claims being converted, the SRB must instruct the national resolution authorities to exercise the power to write-down and convert relevant capital instruments immediately before or together with the application of the resolution tool.268 B. Resolution Tools—General The resolution tools of which the application can be determined in the resolution 9.84 scheme are: (1) the bridge institution tool; (2) the sale of business tool; (3) the asset separation tool; and (4) the bail-in tool.269 C. Bridge Institution Tool and Sale of Business Tool The bridge institution tool is defined as the mechanism for transferring: (a) shares 9.85 or other instruments of ownership issued by an institution under resolution; or (b) assets, rights, or liabilities of an institution under resolution to a bridge institution.270 A bridge institution is a legal person that is wholly or partially owned by one or more public authorities which may include the resolution authority, or the resolution financing arrangement, and is controlled by the resolution authority. Furthermore, it must be created for the purpose of receiving and holding shares or other instruments issued by an institution under resolution or hold assets, rights, and liabilities of such an institution, with a view to maintaining access to critical functions and selling the institution.271 The sale of business tool is similar to the bridge institution tool but entails a transfer to a purchaser that is not a bridge institution.272 Where the sale of business tool or the bridge institution tool is used to transfer only part of the assets, rights, or liabilities of the institution under resolution, the residual entity must be wound up under normal insolvency proceedings.273 268 SRM Regulation, art 22(1). It follows from art 7(3), 4th para that in the cases set out in art 7(3), 4th para references in SRM Regulation, art 22(1) to the SRB must be read as references to the national resolution authorities. In the case of SRM Regulation, art 22(1) this would have an odd result: ‘[w]‌here a national resolution authority decides to apply a resolution tool . . . and that resolution action would result in losses being borne by creditors or their claims being converted, the national resolution authority shall instruct the national resolution authorities to exercise the power to write down and convert capital instruments . . . immediately before or together with the application of the resolution tool’. Of course, in the case that a national resolution authority is competent, it may act without instructions from the SRB. 269 SRM Regulation, art 18(6)(b) read in conjunction with art 22(2). 270 See SRM Regulation, art 3(2) read in conjunction with BRRD, arts 2(59), 2(60), and 40. 271 SRM Regulation, art 40(2). See also SRM Regulation, art 25. 272 SRM Regulation, art 3(2) read in conjunction with BRRD arts 2(58) and 38. 273 SRM Regulation, art 22(5). See also SRM Regulation, art 24.

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Danny Busch D. Asset Separation Tool 9.86 The asset separation tool is defined as the mechanism for effecting a transfer by a resolution authority of assets, rights, or liabilities of an institution under resolution (or a bridge institution) to one or more asset management vehicles.274 The main difference between the bridge institution tool and the sale of business tool on the one hand, and the asset separation tool on the other, is that the bridge institution tool and the sale of business tool are designed to continue some or all of the activities of the institution under resolution, whereas in the case of the asset separation tool the relevant asset management vehicle merely manages the assets, rights and liabilities received from an institution under resolution (or a bridge institution) with a view to maximizing their value through eventual sale or orderly wind-down.275 The asset separation tool may only be applied together with another resolution tool.276 E. Bail-in Tool 9.87 i. General The bail-in tool is defined as the mechanism for effecting the exercise by a resolution authority of the write-down and conversion powers in relation to liabilities of an institution under resolution.277 The bail-in tool may be used for either of the following two purposes: (1) To recapitalize an entity under 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 under CRD IV or the Markets in Financial Instruments Directive II,278 where the entity is authorized under those directives, and to sustain sufficient market confidence in the institution or entity.279 The bail-in tool may only be used in this manner if there is a reasonable prospect that its application (together with other measures) will restore the entity to financial soundness and long-term viability.280 (2) To convert to equity or reduce the principal amount of claims or debt instruments that are transferred: (a) to a bridge institution with a view to providing capital for that bridge institution; or (b) under the sale of business tool or the asset separation tool.281 274 SRM Regulation, art 3(2) read in conjunction with BRRD, arts 2(55), (56), and 42. See also SRM Regulation, art 26. 275 BRRD, art 42(3). 276 SRM Regulation, art 22(4). 277 SRM Regulation, art 3(2) read in conjunction with BRRD, arts 2(57) and 43. See also SRM Regulation, art 27. 278 Directive 2014/65/EU of 15 May 2014 [2014] OJ L173/349. 279 SRM Regulation, art 27(1)(a). 280 SRM Regulation, art 27(2). 281 SRM Regulation, art 27(1)(b).

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Governance of the Single Resolution Mechanism ii. Liabilities which are, per Definition, Excluded from Write- down or Conversion For several categories of liabilities it is specifically provided that 9.88 they are, per definition, not subject to write-down or conversion: (1) covered deposits; (2) secured liabilities, including covered bonds and financial instruments similar to covered bonds; (3) liabilities in relation to client assets and client money held by a relevant entity or on behalf of UCITS or AIFs always provided that such client is protected under the applicable insolvency law; (4) any liability arising by virtue of a fiduciary relationship between the relevant entity (as fiduciary) and another person (as beneficiary), provided that such beneficiary is protected under the applicable insolvency or civil law; (5) liabilities to institutions, excluding entities that are part of the same group, with an original maturity of less than seven days; (6) liabilities with a remaining maturity of less than seven days, owed to systems or operators of systems designated in accordance with Directive 98/26/EC or their participants and arising from the participation in such a system; (7) liabilities to an employee in relation to accrued salary pension benefits or other fixed remuneration (except for the variable component of remuneration that is not regulated by a collective bargaining agreement and except for the variable component of the remuneration of material risk takers); (8) liabilities to a commercial or trade creditor arising from the provision of goods and services that are critical to the daily functioning of its operations including IT services, utilities, and the rental, servicing, and upkeep of premises; (9) liabilities to tax and social security authorities provided that they are preferred under the applicable law; and (10) liabilities to Deposit Guarantee Schemes (DGS) arising from contributions due in accordance with the DGS Directive.282 282 SRM Regulation, art 27(3). Please note that Regulation (EU) 2019/877, amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226 replaces the text relating to the category mentioned under point (6) in the main text as follows (amendments are shown in italics): ‘liabilities with a remaining maturity of less than seven days, owed to systems or operators of systems designated in accordance with Directive 98/26/EC or to their participants and arising from the participation in such a system, or to CCPs authorized in the Union pursuant to Article 14 of Regulation (EU) No 648/2012 and third-country CCPs recognized by ESMA pursuant to Article 25 of that Regulation’ (SRM Regulation, art 27(3)(f )). Also, a new category will be added in art 27(3)(h) of the SRM Regulation: ‘liabilities to entities referred to in point (a), (b), (c) or (d) of Article 1(1) of [BRRD] that are part of the same resolution group without being themselves resolution entities, regardless of their maturities, except where those liabilities rank below ordinary unsecured liabilities under the relevant national law of the participating Member State governing normal insolvency proceedings applicable on 28 December 2020; in cases where that exception applies, the Board shall assess whether the amount of items complying with Article 12g(2) is sufficient to support the implementation of the preferred resolution strategy.’

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Danny Busch 9.89 iii. Liabilities which may be Excluded from Write-down or Conversion In ad-

dition to liabilities that are, per definition, excluded from the application of write down and conversion (see earlier) in exceptional circumstances other liabilities (so-called ‘eligible liabilities’) may be (partially) excluded from the application of the write-down and conversion powers. These exceptional circumstances are any of the following: (1) it is not possible to bail-in the relevant liability within a reasonable time notwithstanding the good faith efforts of the relevant national resolution authority; (2) the exclusion is strictly necessary and proportionate to achieve the continuity of critical functions and core business lines in a manner that maintains the ability of the institution under resolution to continue key operations, services, and transactions; (3) 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; and (4) the application of the bail-in tool to the relevant liabilities would cause a destruction in value such that the losses borne by other creditors would be higher than if these liabilities were excluded from bail-in.283 These exclusions may be applied either to completely exclude a liability from write-down or to limit the extent of the write-down applied to that liability.284

9.90 Where an eligible liability or class of eligible liabilities is in exceptional

circumstances (partially) excluded, the level of write-down or conversion applied to other eligible liabilities may be increased to take account of such exclusions provided that the level of write-down and conversion applied to other eligible liabilities complies with the principle that no creditor incurs greater loss than would have been incurred if the relevant entity had been wound up under normal insolvency proceedings.285

SRM Regulation, art 27(5), 1st para. 284 SRM Regulation, art 27(14). 285 SRM Regulation, art 27(5), 2nd para, read in conjunction with art 15(1)(g). Please note that Regulation (EU) 2019/877, amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226 replaces art 27(5), 2nd para of the SRM regulation with the following text: ‘The [SRB] shall carefully assess whether liabilities to institutions or entities that are part of the same resolution group without themselves being resolution entities and that are not excluded from the application of write-down and conversion powers under point (h) of paragraph (3) should be excluded or partially excluded under points (a) to (d) of the first subparagraph to ensure the effective implementation of the resolution strategy. Where a bail-inable liability or class of bail-inable liabilities is excluded or partially excluded under this paragraph, the level of write-down or conversion applied to other bail-inable liabilities may be increased to take account of such exclusions, provided that the level of write-down 283

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Governance of the Single Resolution Mechanism When taking the decision to (partially) exclude eligible liabilities from write- 9.91 down and conversion, due consideration must be given to: (1) the principle that losses should be borne first by shareholders and next, in general, by creditors of the institution under resolution in order of preference; (2) the level of loss absorbing capacity that would remain in the institution under resolution if the liability or class of liabilities were excluded; and (3) the need to maintain adequate resources for resolution financing.286 F. Use of the Fund i. General Within the resolution scheme, when applying the resolution tools to 9.92 entities covered by the SRM, the SRB may use the Fund only to the extent necessary to ensure the effective application of the resolution tools for the following purposes: (1) to guarantee the assets or the liabilities of the institution under resolution, its subsidiaries, a bridge institution or an asset management vehicle; (2) to make loans to the institution under resolution, its subsidiaries, a bridge institution, or an asset management vehicle; (3) to purchase assets of the institution under resolution; (4) to make contributions to a bridge institution and an asset management vehicle; (5) to pay compensation to shareholders or creditors if, following an evaluation pursuant to Article 20(5) of the SRM Regulation they have incurred greater losses than they would have incurred, following a valuation pursuant to Article 20(16) of the SRM Regulation, in a winding-up under normal insolvency proceedings; (6) to make a contribution to the institution under resolution in lieu of the write- down or conversion of liabilities of certain creditors, when the bail-in tool is applied and the decision is made to exclude certain creditors from the scope of bail-in in accordance with Article 27(5) of the SRM Regulation;287 and (7) to take any combination of the actions referred to in (1)–(6) above.288 The use of the Fund is contingent upon the IGA, by which the participating 9.93 Member States agree to transfer to the Fund the contributions that they raise at national level in accordance with the SRM Regulation and the BRRD and comply with the principles laid down in the IGA.289 Accordingly, until the Fund

and conversion applied to other bail-inable liabilities complies with the principle laid down in point (g) of Article 15(1).’ 286 SRM Regulation, art 27(12). 287 See further, Section IV(3)(E)(iii). 288 SRM Regulation, art 76(1). See further SRM Regulation, art 76(2)–(4). 289 SRM Regulation, art 77, 1st para.

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Danny Busch reaches the target funding level, but until no later than eight years after 1 January 2016, the SRB must use the Fund in accordance with principles founded on a division of the Fund into national compartments corresponding to each participating Member State as well as on a progressive merger of the different funds raised at national level to be allocated to national compartments of the Fund as laid down in the IGA.290 ii. Mutualization of National Financing Arrangements in the Case of Group 9.94 Resolution Involving Institutions in Non-Participating Member States In the case of a group resolution involving institutions established in one or more participating Member States on the one hand, and institutions established in one or more non-participating Member States on the other, the Fund must contribute to the financing of the group resolution in accordance with the BRRD.291,292 9.95 iii. Use of the Fund and Bail-in The use of the Fund in the context of bail-in293

deserves some further attention. Where an eligible liability or class of eligible liabilities is in exceptional circumstances (partially) excluded, and the losses that would have been borne by those liabilities have not been passed on fully to other creditors, a contribution from the Fund may be made to the institution under resolution. Such contribution: (1) covers any losses which have not been absorbed by eligible liabilities and restore the net asset value of the institution to zero; and/or (2) is used to purchase shares or other instruments of ownership or capital instruments in the institution under resolution, in order to recapitalize the institution.294

9.96 The Fund may only make such contribution where:

(1) a contribution to loss absorption and recapitalization equal to an amount of at least eight per cent of the total liabilities including own funds of the institution under resolution has been made by shareholders and creditors through write-down, conversion or otherwise; and (2) the contribution from the Fund does not exceed five per cent of the total liabilities including own funds of the institution under resolution, in each case measured at the time of the resolution action in accordance with the valuation made.295

290 SRM Regulation, art 77, 2nd para. 291 BRRD, art 107(2)–(5). 292 SRM Regulation, art 78. 293 See Section IV(3)(F)(i) under item (6) in the list. 294 SRM Regulation, art 27(6). 295 SRM Regulation, art 27(7). See also IGA, Recital 17.

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Governance of the Single Resolution Mechanism In extraordinary circumstances, further funding may be sought from alternative financing sources after: (a) the 5% limit specified under (2) above has been reached; and (b) all unsecured, non-preferred liabilities, other than eligible deposits, have been written down or converted in full.296 4. Adoption of a Resolution Scheme A. General A resolution scheme must be adopted by the SRB or a national resolution au- 9.97 thority, in principle depending on the significance of the relevant entity or group covered by the SRM.297 If a resolution action requires use of the Fund, the SRB must always adopt the resolution scheme, irrespective of the significance of the relevant entity or group covered by the SRM.298 B. Normal Decision-making Procedure If the SRB adopts the resolution scheme it will normally do so in its executive 9.98 session including representatives of the relevant national resolution authorities.299 The competence of the executive session with respect to decisions concerning resolution is justified by the highly sensitive, institution-specific information involved in resolution decisions. See Recital 33 of the SRM Regulation: The Board, in its executive session, should prepare all decisions concerning resolution procedure and, to the fullest extent possible, adopt those decisions. Because of the institution-specific nature of the information contained in the resolution plans, decisions concerning the drawing up, assessment, and approval of the resolution plans should be taken by the Board in its executive session.

In any event, if the members300 of the executive session of the SRB are not able to reach a joint agreement by consensus within a deadline set by the Chair, a decision must be taken by simple majority of the Chair and the four further full-time members.301 This means that the members appointed by relevant participating

296 SRM Regulation, art 27(9). 297 SRM Regulation, art 18(1) and (6) (SRB); SRM Regulation, art 16(1) and (6) read in conjunction with art 7(3), 4th para (national resolution authority). See, on the division of tasks between the SRB and the national resolution authorities, in more detail Section II(3). 298 SRM Regulation, art 7(3), 2nd para. 299 See SRM Regulation, art 54(2)(d). 300 Those members are the Chair and the four further full-time members (SRM Regulation, art 53(1), 1st para read in conjunction with art 43(1)(b)), and: (a) the member appointed by the participating Member State in which the relevant entity or group of entities is established (SRM Regulation, art 53(3)); or (b) the member appointed by the participating Member State in which the group-level resolution authority is situated, as well as the members appointed by the participating Member State in which a subsidiary or entity covered by consolidated supervision is established (SRM Regulation, art 53(4)). 301 SRM Regulation, art 55(1) and (2).

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Danny Busch Member States do not have voting rights in the absence of consensus. The Chair has a casting vote in the event of a tie.302 However, since there are five members voting in these cases, the case of a tie will not likely occur, although it seems conceivable that a member with a voting right may not be present or may abstain from voting. C. Special Decision-making Procedure in Case of Use of the Fund above Threshold of €5–10bn 9.99 If in a specific resolution action the use of the Fund is required above the threshold of €5bn, the following special decision-making procedure applies. The resolution scheme prepared by the executive session of the SRB is deemed to be adopted unless, within three hours from the submission of the draft by the executive session of the SRB to the plenary session of the SRB, at least one member of the plenary session has called a meeting of the plenary session. In the latter case, a decision on the resolution scheme must be taken by the plenary session.303 In such a case, a decision is taken by the SRB in its plenary session by simple majority, but (in derogation from the normal procedure304) such simple majority must represent at least 30% of the contributions to the Fund. Each voting member has one vote. In case of a tie, the Chair has a casting vote.305 Unfortunately, there is no time limit within which the plenary session must adopt the resolution plan. 9.100 It should be noted that a differentiation is made between aid in the form of cash

and aid in the form of capital. The €5bn can be liquidity, capital, or a mixture of the two. For calculating the €5bn, there are different weightings: for capital it is 100% but liquidity is valued at 50%.306 This means that for liquidity support the threshold is in fact €10bn. The differentiated treatment was suggested by the Commission based on a Finnish proposal previously rejected by Germany at the ECOFIN Council. It is justified by the fact that beneficiaries pay cash back faster than capital which is a longer-term investment. It is a compromise. At the beginning, the European Parliament did not want to accept the €5bn cap, wanting the SRB in its executive session to have decision-making powers in all circumstances. Faced with the fact that the Council refused to budge, the European Parliament went along with the idea but wanted the granting of cash not to be taken into account. The question was split down in the middle: €2 of aid from the Fund in the form of cash will be counted as €1.307 See also Recital 33 of the SRM Regulation: Where liquidity support involves no or significantly less risk than other forms of support, in particular in the case of short-term, one-off extension of credit to solvent

302 SRM Regulation, art 55(3). 303 SRM Regulation, art 50(2), 2nd para. 304 See, for the normal procedure, SRM Regulation, art 52(1). 305 SRM Regulation, art 50(1)(c) read in conjunction with art 52(2). 306 SRM Regulation, art 50(1)(c). 307 See Bulletin Quotidien Europe (n 1), 6.

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Governance of the Single Resolution Mechanism institutions against adequate collateral of high quality, it is justified to give such a form of support a lower weight of only 0.5.

If in a specific resolution action the use of the Fund is required of €5bn or less, the normal decision-making procedure for the adoption of resolution plans applies, ie the decision is taken by the SRB in its executive session, including representatives of the relevant national resolution authorities.308 D. Conditions for Adoption A resolution scheme must be adopted if the following three conditions are met.309 9.101 i. Condition 1: Failing or Likely to Fail First, the entity is failing or likely to 9.102 fail.310 This is deemed to be the case in one or more of the following circumstances: (1) the entity infringes, or there are objective elements to support a determination that the institution will, in the near future, infringe the requirements for continuing authorization in a way that would justify the withdrawal of the authorization by the ECB, including but not limited to the fact that the institution has incurred or is likely to incur losses that will deplete all or a significant amount of its own funds; (2) the assets of the entity are, or there are objective elements to support a determination that the assets of the entity will in the near future be, less than its liabilities; (3) the entity is, or there are objective elements to support a determination that the entity will in the near future be, unable to pay its debts or other liabilities as they fall due; or (4) extraordinary public financial support is required.311

See SRM Regulation, art 54(2)(d). See further, Section IV(4)(B). 309 SRM Regulation, art 18(1). 310 SRM Regulation, art 18(1)(a). 311 SRM Regulation, art 18(4). Except where, in the case of extraordinary public financial support, in order to remedy a serious disturbance in the economy of a Member State and preserve financial stability that extraordinary public financial support takes any of the following forms: (i) a state guarantee to back liquidity facilities provided by central banks in accordance with the central banks’ conditions; (ii) a state guarantee of newly issued liabilities; or (iii) an injection of own funds or purchase of capital instruments at prices and on terms that do not confer an advantage upon the entity, where neither the circumstances referred to in art 18(4) points (a), (b), and (c) (conditions for adopting a resolution scheme (see main text)), nor the circumstances referred to in SRM Regulation, art 21(1) are present at the time the public support is granted. In each of the cases mentioned in points (i)–(iii) above, the guarantee or equivalent measures referred to therein must be confined to solvent entities and must be conditional on final approval under the Union State aid framework. Those measures must be of a precautionary and temporary nature and must be proportionate to remedy the consequences of the serious disturbance and may not be used to offset losses that the entity has incurred or is likely to incur in the near future. Support measures under point (iii) must be limited to injections necessary to address capital shortfall established in the national, Union, or SSM-wide stress tests, AQRs or equivalent exercises conducted by the ECB, EBA, or national authorities, where applicable, confirmed by the competent authority: see SRM Regulation, art 18(4)(d). 308

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Danny Busch 9.103 An assessment of the condition that an entity is failing, or likely to fail, is made

by the ECB, after consulting the SRB or, as the case may be, a national resolution authority, to be communicated without delay to the Commission and the SRB or, as the case may be, a national resolution authority.312 However, the SRB may also make such determination in its executive session or, as the case may be, a national resolution authority. If the members313 of the executive session of the SRB are not able to reach a joint agreement by consensus within a deadline set by the Chair, a decision must be taken by simple majority of the Chair and the four further full-time members.314 This means that the members appointed by relevant participating Member States do not have voting rights in the absence of consensus. The Chair has a casting vote in the event of a tie.315 However, since there are five members voting in these cases, the case of a tie will not likely occur, although it seems conceivable that a member with a voting right may not be present or may abstain from voting. The executive session of the SRB or, as the case may be, a national resolution authority, may only make such determination, if: (a) the SRB or a national resolution authority previously informs the ECB about its intention; and (b) the ECB, within three calendar days of receipt of that information, does not make such assessment. The ECB must, without delay, provide the SRB or a national resolution authority with any relevant information which the SRB or national resolution authority requests in order to inform its assessment.316 The competence of the determination of whether an entity is failing or likely to fail was a sensitive issue during the negotiations on the SRM on 19 and 20 March 2014. The Member States wanted the ECB and the SRB (including representatives of relevant national resolution authorities) or a national resolution authority to be on equal footing but the European Parliament wanted a true hierarchy between the ECB and the SRB or a national resolution authority. In the end, the European Parliament got its way.317

9.104 ii. Condition 2: No Reasonable Prospect Secondly, having regard to timing and

other relevant circumstances, there is no reasonable prospect that any alternative private sector measures, including measures by an institutional protection scheme

312 SRM Regulation, art 18(1), 2nd and 3rd paras (SRB) and art 18(1), 2nd and 3rd paras read in conjunction with art 7(3), 4th para (national resolution authority). 313 Those members are the Chair and the four further full-time members (SRM Regulation, art 53(1), 1st para, read in conjunction with art 43(1)(b)) and (a) the member appointed by the participating Member State in which the relevant entity or group of entities is established (SRM Regulation, art 53(3)) or (b) the member appointed by the participating Member State in which the group-level resolution authority is situated, as well as the members appointed by the participating Member State in which a subsidiary or entity covered by consolidated supervision is established (SRM Regulation, art 53(4)). 314 SRM Regulation, art 55(1) and (2) read in conjunction with art 18(1), 2nd para. 315 SRM Regulation, art 55(3). 316 SRM Regulation, art 18(1), 2nd para (SRB) and art 18(1), 2nd para, read in conjunction with art 7(3), 4th para (national resolution authority). 317 See Bulletin Quotidien Europe (n 1), 3.

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Governance of the Single Resolution Mechanism (IPS),318 or supervisory action, including early intervention measures or the write- down or conversion of capital instruments, would prevent its failure within a reasonable timeframe.319 An assessment of the condition that there are no reasonable alternatives, is made 9.105 by the SRB in its executive session or, where applicable, by the national resolution authorities, each time in close co-operation with the ECB. The ECB may also inform the SRB or the national resolution authorities concerned that it considers that this condition is met.320 If the members321 of the executive session of the SRB are not able to reach a joint agreement by consensus within a deadline set by the Chair, a decision must be taken by simple majority of the Chair and the four further full-time members.322 Again, this means that the members appointed by relevant participating Member States do not have voting rights in the absence of

318 IPS means an arrangement that meets the requirements laid down in CRR, art 113(7) CRR: see SRM Regulation, art 3(1)(28). 319 SRM Regulation, art 18(1)(b). Please note that Regulation (EU) 2019/877, amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226 will amend art 18(1)(b) of the SRM Regulation as follows (amendments shown in italics): ‘having regard to timing and other relevant circumstances, there is no reasonable prospect that any alternative private sector measures, including measures by an IPS, or supervisory action, including early intervention measures or the write-down or conversion of relevant capital instruments and eligible liabilities in accordance with Article 21(1) taken in respect of the entity, would prevent the failure of the entity within a reasonable timeframe.’ Please note that Regulation (EU) 2019/877, amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226 will add a new para 1a to art 18 of the SRM Regulation: ‘The [SRB] may adopt a resolution scheme in accordance with paragraph 1 in relation to a central body and all credit institutions permanently affiliated to it that are part of the same resolution group when that resolution group complies as a whole with the conditions provided in the first paragraph of paragraph 1.’ ‘Resolution group’ is a new concept introduced by Regulation (EU) 2019/877, amending Regulation (EU) 806/ 2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226, which is defined in the new art 3(1)(24b) of the SRM Regulation as: ‘(a) a resolution authority, together with its subsidiaries that are not (i) resolution entities themselves; (ii) subsidiaries of other resolution entities; or (iii) entities established in a third country that are not included in the resolution group under the resolution plan, and their subsidiaries; or (b) credit institutions that are permanently affiliated to a central body, and the central body is a resolution entity, and their respective subsidiaries.’ Regulation (EU) 2019/877, amending Regulation (EU) 806/2014 as regards the loss-absorbing and recapitalization capacity of credit institutions and investment firms [2019] OJ L150/226 also changes the definition of ‘subsidiary’ in art 3(1)(21) of the SRM Regulation, and introduces and defines the concept of: (i) ‘material subsidiary’ in art 3(1) (21a) of the SRM Regulation; and (b) ‘resolution entity’ in art 3(1)(24a) of the SRM Regulation. 320 SRM Regulation, art 18(1), 4th para (as this para stipulates ‘the national resolution authorities’ it is strictly speaking not necessary to read the provision in conjunction with art 7(3), 4th para). 321 Those members are the Chair and the four further full-time members (SRM Regulation, art 53(1), 1st para read in conjunction with art 43(1)(b)), and: (a) the member appointed by the participating Member State in which the relevant entity or group of entities is established (SRM Regulation, art 53(3)); or (b) the member appointed by the participating Member State in which the group-level resolution authority is situated, as well as the members appointed by the participating Member State in which a subsidiary or entity covered by consolidated supervision is established ( SRM Regulation, art 53(4)). 322 SRM Regulation, art 55(1) and (2) read in conjunction with art 18(1), 3rd para.

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Danny Busch consensus. The Chair has a casting vote in the event of a tie.323 However, since there are five members voting in these cases, the case of a tie will not likely occur, although it seems conceivable that a member with a voting right may not be present or may abstain from voting. 9.106 iii. Condition 3: Resolution Action Necessary in the Public Interest Thirdly,

a resolution action is necessary in the public interest.324 A resolution action is treated as in the public interest if: (1) it is necessary for the achievement of, and is proportionate to one or more of the resolution objectives;325 and (2) winding up of the entity under normal insolvency proceedings would not meet those resolution objectives to the same extent.326 9.107 Although this is not expressly stipulated in the SRM Regulation, it seems that

the determination of the condition that a resolution action is necessary in the 323 SRM Regulation, art 55(3). 324 SRM Regulation, art 18(1)(c). 325 Referred to in SRM Regulation, art 14. See, on the resolution objectives, Section IV(2). 326 SRM Regulation, art 18(5). With regard to Veneto Banca and Banca Popolare di Vicenza, the SRB decided that the resolution of the two banks was ‘not necessary in the public interest, in accordance with art 18(1)(c) in conjunction with Article 18(5) of the SRM’. See SRB ‘notices summarizing the effects of the decision taken in respect of VB and BPVI’, (available online at ). See for an in-depth analysis on these cases Chapter 12, Section V. Also, following the decision by the ECB to declare ABLV Bank, AS and its subsidiary ABLV Bank Luxembourg SA as ‘failing or likely to fail’, the SRB decided that resolution action was not necessary as it was not in the public interest for these banks and that the winding up of these banks should take place under the law of Latvia and Luxembourg, respectively. See press release of the SRB dated 24 February 2018 (available online at , with further links to the summaries of the underlying decisions of the SRB and the ECB). With respect to the ECB’s determination that ABLV Bank and ABLV Bank Luxembourg were failing or likely to fail (FOLTF), the following is notable. The ECB considered that there were objective elements to support a determination that the banks would, in the near future, be unable to pay their debts or other liabilities as they would fall due. However, the Luxembourg court rejected a request from the competent authority (the Commission de Surveillance du Secteur Financier) to liquidate ABLV Bank Luxembourg. The court assessed that ABLV Bank Luxembourg has a strong financial standing and can look for new investors. This outcome directly contradicts the determination by the ECB. It is therefore not surprising that ABLV Bank has brought an action before the CI to annual the decision of the ECB that ABLV Bank and ABLV Bank Luxembourg are FOLTF (CI, T-281/18, Action brought on 3 May 2018 (ABLV Bank v ECB)). The power of the SRB to decide that a bank should be put in liquidation if the resolution conditions are not met is contested by ABLV Bank in its action brought before the CI on 3 May 2018 (CI, T-280/18, Action brought on 3 May 2018 (ABLV Bank v SRB)). At the time of writing this chapter, the CI had not yet assessed the case. Ms König, Chair of the SRB, has emphasized that the FOLTF assessment does not automatically link to the criteria for insolvency/liquidation. Ms Nouy, Chair of the SSM, has suggested amending art 32 of BRRD in such a manner that FOLTF declaration necessarily triggers liquidation under national law. This should make clear that absent ‘public interest’, banks would need to be liquidated under national insolvency law and not resolved. See art 32b of Directive (EU) 2019/879, amending Directive 2014/59/EU as regards the loss- absorbing and recapitalization capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296.

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Governance of the Single Resolution Mechanism public interest is made by the SRB, by consensus, or (if that is not possible within a deadline set by the Chair) by simple majority in its executive session or, where applicable, by the national resolution authorities. If the members327 of the executive session of the SRB are not able to reach a joint agreement by consensus within a deadline set by the Chair, a decision must be taken by simple majority of the Chair and the four further full-time members.328 Again, this means that the members appointed by relevant participating Member States do not have voting rights in the absence of consensus. The Chair has a casting vote in the event of a tie.329 However, since there are five members voting in these cases, the case of a tie will not likely occur, although it seems conceivable that a member with a voting right may not be present or may abstain from voting. E. Involvement Commission and Council In the case of adoption of a resolution scheme by the SRB,330 immediately 9.108 after the adoption of the resolution scheme, the SRB must transmit it to the Commission.331 Within 24 hours after the transmission of the resolution scheme by the SRB, the Commission acting by simple majority332 must either endorse the scheme, or object to it on the ground that: (1) the condition that the relevant entity is failing or likely to fail is not fulfilled;  and/or (2) the condition that there is no reasonable prospect for the relevant entity is not fulfilled.333

327 Those members are the Chair and the four further full-time members (SRM Regulation, art 53(1), 1st para read in conjunction with art 43(1)(b)), and (a): the member appointed by the participating Member State in which the relevant entity or group of entities is established (SRM Regulation, art 53(3)); or (b) the member appointed by the participating Member State in which the group-level resolution authority is situated, as well as the members appointed by the participating Member State in which a subsidiary or entity covered by consolidated supervision is established (SRM Regulation, art 53(4)). 328 SRM Regulation, art 55(1) and (2) read in conjunction with art 18(1), 3rd para. 329 SRM Regulation, art 55(3). 330 In SRM Regulation, art 7(3), 4th para it is not stipulated that references to the SRB in art 18(7) must be read as references to national resolution authorities in the cases referred to in art 7(3), 4th para of the SRM Regulation, which means that art 18(7) does not apply in the case that a national resolution authority (instead of the SRB) is the competent resolution authority. This means that in such cases the Commission and the Council are not involved in the procedure relating to the adoption of the resolution scheme. This may be explained by the fact that in such cases the Meroni-doctrine does not apply, as in such cases there is no delegation of discretionary powers to EU agencies, but merely to national resolution authorities (see 9.112 on Meroni). Of course, the non-involvement of the Commission and the Council in such cases also makes sense from a political point of view. 331 SRM Regulation, art 18(7). 332 According to the general rule of TFEU, art 250. 333 At least, that seems the correct interpretation of the words ‘with regard to the discretionary aspects of the resolution scheme in the cases not covered in the third subparagraph of this paragraph’

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Danny Busch 9.109 Within 12 hours from the transmission of the resolution scheme, the Commission

acting by simple majority334 may propose to the Council:

(1) to object to the resolution scheme because the criterion that the resolution action is necessary in the public interest is not fulfilled; or (2) to approve or object a material335 modification of the amount of the Fund provided for in the resolution scheme of the SRB.336 The Council acts by simple majority of the Member States, apparently including non-participating Member States.337 So, if the Commission believes that the Fund should make a greater or lesser contribution to the cost of winding-up a failing bank, the Council will be able to issue an objection and ask the SRB to change the resolution scheme.338 9.110 The Council or the Commission, as the case may be, must provide reasons for the

exercise of their power of objection.339

9.111 The timing for the Commission and Council to exercise their power of endorsement/

approval and objection is rather sharp, but particularly the Commission will in practice participate as an observer in meetings of the SRB in an early stage, thus enabling an efficient decision-making process. See also Recital 26 of the SRM Regulation: As an observer to the meetings of the [SRB], the Commission should, on an ongoing basis, check that the resolution scheme adopted by the [SRB] complies fully with this Regulation, balances appropriately the different objectives and interests at stake, respects the public interest and that the integrity of the internal market is preserved. Considering that the resolution action requires a very speedy decision- making process, the Council and the Commission should co-operate closely and the Council should not duplicate the preparatory work already undertaken by the Commission.

9.112 The power of endorsement/approval and objection by the Commission and the

Council is explained by the Meroni-doctrine,340 which limits the delegation of

(SRM Regulation, art 18(7), 2nd para). The other discretionary aspects are subject to objection/ approval by the Council (SRM Regulation, art 18(7), 3rd para). 334 According to the general rule of art 250 of the TFEU. 335 A change of 5% or more to the amount of the Fund compared with the original proposal of the SRB should be considered to be material. See SRM Regulation, Recital 26, 2nd para. 336 SRM Regulation, art 18(7), 3rd para. 337 SRM Regulation, art 18(7), 4th para. It is probably not possible to apply TFEU, art 136(2) (on decision-making concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights. 338 Cf Bulletin Quotidien Europe (n 1), 4–5. 339 SRM Regulation, art 18(7), 6th para. 340 Meroni v High Authority [1957/1958] ECR 133 (Cases C-9/56 and C-10/56); and UK v Parliament and Council, 22 January 2014 (Case C-270/12) however, make it clear that the test is a nuanced one: provided there are conditions and criteria to limit the discretion, and the power is precisely delineated so as to be amenable to judicial review, the requirements laid down in Meroni are satisfied.

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Governance of the Single Resolution Mechanism discretionary powers to EU agencies, including the SRB. Of course, particularly the involvement of the Council is also explained by the considerable impact of the resolution decisions on the financial stability of Member States and on the Union as such, as well as on the fiscal sovereignty of Member States. Recital 24 of the SRM Regulation formulates it as follows: Since only institutions of the Union may establish the resolution policy of the Union and since a margin of discretion remains in the adoption of each specific resolution scheme, it is necessary to provide for the adequate involvement of the Council and the Commission, as institutions which may exercise implementing powers in accordance with Article 291 TFEU. The assessment of the discretionary aspects of the resolution decisions taken by the SRB should be exercised by the Commission. Given the considerable impact of the resolution decisions on the financial stability of Member States and on the Union as such, as well as on the fiscal sovereignty of Member States, it is important that implementing power to take certain decisions relating to resolution be conferred on the Council. It should therefore be for the Council, on a proposal from the Commission, to exercise effective control on the assessment by the [SRB] of the existence of a public interest and to assess any material modification of the amount of the Fund to be used in a specific resolution action.341

In any event, where the Council objects by simple majority of the Member States, 9.113 apparently including non-participating Member States,342 to the placing of an institution under resolution on the ground that the public interest criterion is not fulfilled, the relevant entity must be wound up in accordance with the applicable national law.343 Within 24 hours from the transmission of the scheme, the SRB must (in its exec- 9.114 utive session and within eight hours) modify the resolution scheme in accordance with the reasons expressed where:344 (1) the Council has approved by simple majority of the Member States, apparently including non-participating Member States,345 the proposal of the Commission for a material modification of the amount of the Fund provided for in the resolution scheme; or (2) the Commission acting by simple majority346 has objected to the scheme on the ground that the condition that the relevant entity is failing or likely to fail 341 See also SRM Regulation, Recital 26, 1st para: ‘[t]‌he procedure relating to the adoption of the resolution scheme, which involves the Commission and the Council, strengthens the necessary operation independence of the [SRB] while respecting the principle of delegation of powers to agencies as interpreted by the Court of Justice of the European Union’. 342 SRM Regulation, art 18(7), 4th para. It is probably not possible to apply TFEU, art 136(2) (on decision-making concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights. 343 SRM Regulation, art 18(8). 344 SRM Regulation, art 18(7), 7th para. 345 SRM Regulation, art 18(7), 4th para. It is probably not possible to apply TFEU, art 136(2) (on decision-making concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights. 346 According to the general rule of TFEU, art 250.

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Danny Busch is not fulfilled and/or the condition that there is no reasonable prospect for the relevant entity is not fulfilled. Eight hours is not much, of course, and it is hoped that it will be sufficient in practice. Hopefully, such amendment can in practice be prevented through the participation of the Council and the Commission as observers in meetings of the SRB in an early stage (see 9.111). 9.115 Where the resolution scheme adopted by the SRB provides for the exclusion of

certain liabilities from bail-in, and such exclusion requires a contribution by the Fund or an alternative financing source, in order to protect the integrity of the internal market, the Commission acting by simple majority347 may prohibit or require amendments to the proposed exclusion setting out adequate reasons based on infringement of the requirements laid down in Article 27 SRM Regulation (bail-in tool) and in the delegated act adopted by the Commission on the basis of Article 44(11) of the BRRD.348

9.116 The resolution scheme may enter into force only if no objection has been

expressed by the Council (acting by simple majority of the Member States, apparently including non-participating Member States349) or the Commission (acting by simple majority350) within a period of 24 hours after its transmission by the SRB.351

9.117 All in all, the procedure should take place within 24 hours or, at most, 32

hours (eight hours being the period for the SRB to modify the scheme in response to Commission or Council objections). This timing makes it possible to adopt a resolution scheme over the weekend, between the closure of the markets in the United States on Friday night and the opening of the markets in Asia the following Monday morning.352 Hopefully this timeframe will be workable in practice.

F. Role Commission in Case of State Aid or Aid from the Fund 9.118 Finally, where resolution action involves the granting of state aid353 or aid from the Fund,354 the adoption of the resolution scheme does not take place until such time as the Commission acting by simple majority355 has adopted a positive or According to the general rule of TFEU, art 250. 348 SRM Regulation, art 18(7), 8th para. 349 SRM Regulation, art 16(7), 4th para. It is probably not possible to apply TFEU, art 136(2) (on decision-making concerning the euro) per analogiam, which would have the result that only the participating Member States would have voting rights. 350 According to the general rule of TFEU, art 250. 351 SRM Regulation, art 18(7), 5th para. 352 Cf Bulletin Quotidien Europe (n 1), 5. 353 Pursuant to TFEU, art 107(1). 354 In accordance with SRM Regulation, art 19(3). 355 According to the general rule of TFEU, art 250. 347

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Governance of the Single Resolution Mechanism conditional decision concerning the compatibility of the use of such aid with the internal market.356 The SRM Regulation does not provide a time limit for the Commission’s decision. In any event, on application by a Member State the Council may, acting unanimously, decide that the use of the Fund is considered to be compatible with the internal market if such decision is justified by exceptional circumstances. If, however, the Council has not made its attitude known within seven days of the application being made the Commission must give its decision on the case.357 G. Amending and Updating Resolution Scheme In the course of the resolution process the SRB or, as the case may be, a na- 9.119 tional resolution authority, may amend and update the resolution scheme as appropriate in light of the circumstances in the case. For amendments and updates the same procedure as for the adoption of an initial resolution scheme applies.358 5. Execution Resolution Scheme The SRB must ensure that the necessary resolution action is taken to carry out 9.120 the resolution scheme by the relevant national resolution authorities. The resolution scheme must be addressed to the relevant national resolution authorities and must instruct those authorities. The national resolution authorities must take all necessary measures to implement the scheme359 by exercising resolution powers. Where state aid or fund aid is present the SRB must act in conformity with a decision on that aid taken by the Commission.360 The SRB must closely monitor the execution of the resolution scheme by the national resolution authorities. The national resolution authorities have the duty to co-operate with the SRB.361 The national resolution authorities must submit to the SRB a final report on the execution of the resolution scheme.362 If the national resolution authorities refuse to execute a resolution scheme the SRB may take direct action against the relevant institution under resolution.363

SRM Regulation, art 19(1). 357 SRM Regulation, art 19(10). 358 SRM Regulation, art 23, 4th para read in conjunction with art 18 (SRB); SRM Regulation, art 23, 4th para read in conjunction with art 18 and SRM Regulation art 7(3), 4th para (national resolution authority). See Sections IV(4)(A)–(E) for the adoption procedure for initial resolution schemes. 359 In accordance with SRM Regulation, art 29. 360 SRM Regulation, art 18(9). See further SRM Regulation, art 19 (state aid and fund aid). 361 SRM Regulation, art 28(1), opening words and 28(1)(a). 362 SRM Regulation, art 28(1), in fine. 363 SRM Regulation, art 29(2)–(4). 356

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V. Conclusion 9.121 This chapter analysed the governance or decision-making structure of the SRM,

particularly with respect to financing of the Fund and adoption of resolution schemes. As set out in the introduction, in this chapter governance or decision- making is understood in a broad sense. It not only refers to individual decision- making, but also includes decision-making of a more general nature, such as the adoption of delegated or implementing acts.

9.122 The governance structure of the SRM is undoubtedly complex. This may well

have a negative impact on the effectiveness of decision-making within the SRM framework—efficient, impartial, decisive, and quick decision-making is obviously crucial in the case of bank resolution. This is first of all due to the fact that it turned out very difficult to reach agreement on the SRM’s governance structure. The end result is clearly a compromise, desperately trying to strike a balance between the interests of individual Member States within the Eurozone, the interests of the Eurozone or the European Union as a whole, and, sometimes, the interests of Member States outside the Eurozone. However, certain aspects of the complexity are due to technical reasons of European law. In any event, the SRM’s governance structure features several layers of complexity.

9.123 The first layer of complexity is the division of tasks between the SRB and national

resolution authorities in the participating Member States. This division of tasks is probably fairly clear, but the fact that certain tasks are within the competence of national resolution authorities does not mean that the SRB has no responsibility. After all, the SRB has overall responsibility for the effective and consistent functioning of the SRM. The division of tasks is further blurred because co-operation between the SRB and the national resolution authorities obviously remains absolutely crucial. In view of this, the SRB must perform its tasks in close co-operation with national resolution authorities and must, in co-operation with national resolution authorities, approve and make public a framework to organize the practical arrangements for the implementation of this co-operation. So, on the one hand there is a fairly clear division of tasks but, on the other hand, a high degree of co- operation is required. This may in practice prove a complex governance model.

9.124 The second layer of complexity of the SRM’s governance structure is the division

of tasks between the SRB in its plenary session (consisting of the five independent members, nineteen members representing the national resolution authorities of the participating Member States, and observers) and its executive session (consisting of the five independent members, members representing the relevant national resolution authorities, and observers) and the many parties involved even in executive sessions. Again, the division of tasks is probably fairly clear but as decision-making is split between plenary and executive sessions (the latter even in 398

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Governance of the Single Resolution Mechanism different formations) it is crucial the SRB in its executive session keeps the SRB in its plenary session informed of the decisions it takes on resolution. Also, the five independent members of the SRB must ensure that resolution actions, particularly with regard to the use of the Fund, across the different formations of the executive sessions of the SRB are coherent, appropriate, and proportionate. So again, on the one hand there is a fairly clear division of tasks between the SRB’s executive and plenary sessions but on the other hand a high degree of co-operation is required. This may in practice prove a complex governance model. In addition to the members of the SRB (in its plenary session five independent members and nineteen members representing the national resolution authorities of the participating Member States) the ECB and the Commission are permanent observers and may always participate in the meetings of the SRB. Also other observers may be invited, such as representatives of EBA, the ESM, and the Council. To the extent relevant, there is an obligation to invite representatives of resolution authorities in non-participating Member States. On the one hand, this is necessary for efficient decision-making. After all, the ECB, the Commission, and the Council have their own role to play in the resolution process and it is therefore important that they participate in decision-making within the SRB in an early stage. On the other hand, even in executive sessions, there are many parties involved with potentially conflicting interests which adds to the complexity of the SRM’s governance structure. With respect to decision-making concerning the financing of the Fund, there are 9.125 further layers of complexity. First, the calculation of ex ante contributions, is made by the SRB’s executive ses- 9.126 sion (probably without the involvement of the members representing national resolution authorities). However, delegated acts adopted by the Commission under the BRRD apply and the Council, acting on a proposal from the Commission, must adopt implementing acts particularly relating to: (a) the application of the methodology for the calculation of individual contributions; and (b) the practical modalities of allocating institutions to the risk factors specified in the delegated act. Through this procedure the Council ultimately decides on the methodology of the banking sector’s contribution to the Fund. So, even though the SRB in its executive session calculates the individual ex ante contributions the methodology remains, through adoption by the Council, in the hands of the Member States alone. Secondly, and in contrast with ex ante contributions, the SRB in its plenary session 9.127 decides on the necessity of raising extraordinary ex post contributions. Normally, the SRB in its plenary session takes decisions by a simple majority of its members, but in this case a decision is taken by a majority of two-thirds of the SRB members, representing at least 50% of the contributions during the eight-year transitional period until the Fund is fully mutualized and by a majority of two-thirds of the 399

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Danny Busch SRB members representing at least 30% of the contributions from then on. Each voting member has one vote. In case of a tie, the Chair has a casting vote. The foregoing means that the participating Member States representing the national resolution authorities which have the largest banking sector have the most influence although this influence will diminish somewhat after the eight-year transitional period. 9.128 Thirdly, the participating Member States raise the ex ante and extraordinary ex post

contributions on the institutions covered by the SRM which are located in their respective territories. The participating Member States alone remain competent to transfer them to the Fund. There was no consensus among the participating Member States that the obligation to transfer the contributions raised at national level to the Fund could be based on Union law. In view of this, the obligation to transfer the contributions raised at national level to the Fund, as well as the gradual mutualization of the Fund, is established by the IGA, which means that there was no role to play for the European institutions (European Parliament, Council, and Commission). In the future, primary EU law may well be amended to make it possible to address these topics in the SRM Regulation.

9.129 If the SRB adopts the resolution scheme, it will normally do so in its executive

session, including representatives of the relevant national resolution authorities. However, there are further layers of complexity.

9.130 First, if in a specific resolution action the use of the Fund is required above the

threshold of €5bn (or €10bn in case of liquidity) the resolution scheme prepared by the executive session of the SRB is deemed adopted unless, within three hours from the submission of the draft by the executive session of the SRB to the plenary session of the SRB, at least one member of the plenary session has called a meeting of plenary session. In the latter case, a decision on the resolution scheme must be taken by the plenary session. In such a case, a decision is taken by the SRB in its plenary session by simple majority, representing at least 30% of the contributions to the Fund. Through this procedure all nineteen representatives of the national resolution authorities of the participating Member States have a say.

9.131 Secondly, decision-making with respect to the determination of the conditions for

adoption of a resolution scheme is fairly complex involving the ECB, the SRB, or national resolution authorities. Furthermore, in the case that the SRB (rather than a national resolution authority) adopts a resolution scheme, the Commission and the Council have the power of endorsement/approval and objection with respect to the discretionary aspects of the conditions for adoption of a resolution scheme. The involvement of the Commission and the Council is explained by the Meroni- doctrine which limits the delegation of discretionary powers to EU agencies including the SRB. Of course, as set out in Recital 24 of the SRM Regulation, the involvement of particularly the Council is also explained by the considerable 400

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Governance of the Single Resolution Mechanism impact of the resolution decisions on the financial stability of Member States and on the Union as such, as well as on the fiscal sovereignty of Member States. In view of the foregoing, it does not come as a surprise that the review report of 9.132 the European Commission on the application of the SRM Regulation must, inter alia, assess whether: (a) there is a need that the functions allocated by the SRM Regulation to the SRB, to the Council, and to the Commission be exercised exclusively by an independent Union institution and, if so, whether any changes of the relevant provisions are necessary including at the level of primary EU law; and (b) the appropriateness of governance arrangements including the division of tasks within the SRB and the composition of the voting arrangements both in the executive and the plenary sessions of the SRB and its relations to the Commission and the Council.364 It is therefore hoped that the SRM’s governance structure will in the future take a less complex shape. The complex end result clearly shows that the negotiations on the SRM and its 9.133 governance were very difficult. The SRM’s complex governance structure may well have a negative impact on the effectiveness of decision-making within the SRM framework—efficient, impartial, decisive, and quick decision-making is obviously crucial in the case of bank resolution. Whether the complex governance structure of the SRM will indeed have a negative impact on decision-making within the SRM framework remains to be seen. So far, there has been only one SRB-led bank resolution, that of the Spanish bank Banco Popular.365 It would be premature to draw any conclusions from it. But whatever way you look at it, the creation of the SRM (combined with the SSM) is a milestone for the Eurozone and any other Member States deciding to join.

364 SRM Regulation, art 94(1)(a)(i) and (v). The report should have been published by 31 December 2018, but apparently the Commission did not manage to comply with this deadline. 365 See for a detailed treatment of the Banco Popular case Ch. 12 of this volume, §VI.

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10 RECOVERY AND RESOLUTION PLANS OF BANKS IN THE CONTEXT OF THE BRRD AND THE SRM Fundamental Issues Victor de Serière*

I. Introduction II. The Making of Recovery and Resolution Plans: A Theoretical Exercise?

1. Introduction 2. Benefits of Resolution Planning 3. In Some Respects, the Usefulness of Resolution Plans Is Limited 4. Standardization 5. Will Plans Actually Be Used?

VII. A Difficult Debate on the Need for Ex Ante Measures 10.39

10.01

10.03 10.03 10.07 10.09 10.12 10.13

III. Experience with Some Bank Failures 10.17 1. Fortis Bank Nederland 2. SNS Bank 3. Banco Popular Espanyol

10.18 10.23 10.26

IV. Some Intermediate Conclusions V. The Authority to Impose Ex Ante Measures VI. Remedies Against Imposed Ex Ante Measures

10.27 10.29 10.35

1. Which Measures Are Appropriate? 2. The Timing of Measures 3. The Level Playing Field Issue

10.40 10.46 10.47

VIII. The Wider Context in which Ex Ante Measures Are Imposed 10.49 1. The US: Implementation of the Volcker Rule into the Dodd-Frank Act 10.51 2. Europe: The European Banking Union Approach 10.55 3. The Impact of EU State Aid Policies 10.61

IX. Bottlenecks

1. Unknown Unknowns 2. Recognition and Accommodation by Foreign Jurisdictions and Courts 3. Third Parties’ Private Law Rights 4. NCWO 5. Critical Functions

10.65 10.66 10.67 10.73 10.74 10.76

Victor de Serière is Professor of securities law at Nijmegen University in the Netherlands, and * solicitor with Allen & Overy in Amsterdam. The writer has been involved as a solicitor advising on Dutch regulatory law on the bank interventions that took place in the Netherlands in 2008 and subsequent years. He has also advised on bank recovery and resolution plans of Dutch financial institutions. This chapter is, however, solely based on publicly available facts and information. The views expressed in this chapter are personal to the writer and do not in any way reflect the views or opinions of any of the parties involved in these interventions or in the making of living wills. It is noted that substantial new developments have taken place since the first edition of this chapter was published in 2014; as a consequence, this chapter has now been largely rewritten.

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6. SPE/MPE 7. Confidentiality Considerations 8. Confidentiality and Market Abuse

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9. Regulatory Hurdles 10. Burden Sharing Considerations

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Some Concluding Comments

I. Introduction 10.01 This chapter discusses the function of recovery and resolution plans in the context

of a bank restructuring under the BRRD and the SRMR.1 This chapter will focus on various legal and practical issues relating to the use of these plans, in particular resolution plans. The ‘resolvability’ of banks is a central theme of this chapter. The extent of powers of resolution authorities to achieve resolvability on the basis of EU legislation will be examined. An important central question in this exercise is the extent to which recovery and resolution plans would actually in practice prove to be workable. An effort will be made to answer this question with reference to recent experience in saving or resolving troubled banks in the Eurozone. This chapter will conclude with a brief summary of what are believed to be the main ‘stumbling blocks’ for arriving at possibly workable resolution plans.

10.02 For the purpose of simplicity and brevity, certain limitations in scope have been

made in this chapter:

(i) It looks at banks, and does not look at investment firms or insurance companies. Many of the points this chapter raises on bank resolution apply to other categories of financial institutions as well. But it has to be borne in mind that the commercial and legal relationships between these other categories of institutions, their clients and their investors are in many respects fundamentally different, which may accordingly lead to some substantially different analyses and conclusions.2

1 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/ 25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) 1093/2010 and (EU) 648/2012 [2014] OJ L173/190 (BRRD); Regulation (EU) 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) 1093/2010 [2014] OJ L225/1 (SRM Regulation). 2 The Netherlands, on 27 November 2018, passed into law an act on the recovery and resolution of insurance companies, in anticipation of and paving the way for an EU-wide initiative to develop a directive dealing with this subject (Wet herstel en afwikkeling van verzekeraars, Stb. 2018, 489). Interesting also is the perceived need to adopt an EU Regulation on the recovery and resolution of CCPs (see n 3). See further, ; and Zebregs and de Serière, ‘The Clearing and Settlement Framework’ in Capital Markets Union in Europe (OUP 2018) 535ff. 3 See, respectively, arts 32(1)(c) and (5) of the BRRD; and 18(1)(c) and (5) of the SRMR. 4 To be found on the website of the Financial Stability Board, at .

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Victor de Serière Recital (21) of the BRRD states: It is essential that institutions prepare and regularly update recovery plans that set out measures to be taken by those institutions for the restoration of their financial position following a significant deterioration. Such plans should be detailed and based on realistic assumptions applicable in a range of robust and severe scenarios.

Recital (25) of the BRRD and Recital (24) of the SRMR state: Resolution planning is an essential component of effective resolution. Authorities should have all the information necessary in order to identify and ensure the continuance of critical functions. 10.05 Some economists express profound scepticism about the effectiveness of resolu-

tion regimes. Admati and Hellwig, for instance, observe:

Because of the complications associated with the resolution of the largest and most complex institutions, there are serious doubts that authorities would actually trigger these mechanisms even if a major institution were insolvent. Requirements in the Dodd-Frank Act and elsewhere that financial institutions submit living wills to facilitate resolution do not provide enough assurance that resolving such institutions can be sufficiently effective to avoid harming the system and the economy. Even if resolution is trusted enough to be triggered, the process is likely to be lengthy and disruptive.5 10.06 To be critical of resolution planning is useful as it instils a healthy measure of

common sense and relativity, but this should not detract from the actual benefits. 2. Benefits of Resolution Planning

10.07 Benefits of resolution planning may be summarized as follows:

(iv) Resolution planning provides prudential and resolution authorities with the required knowledge and data on the basis of which they are able to take appropriate (preventive, anticipatory and actual) resolution measures when an institution threatens to go under.6 EBA states: Collecting relevant and accurate information on institutions is crucial in order for resolution authorities to draw up resolution plans, substantiate their resolvability assessment and their resolution strategy.7

Admati and Hellwig, The Bankers’ New Clothes (Princeton University Press 2013) 77. 6 The EBA has prepared draft ITS on the provision of data by financial institutions to the resolution authorities for the purpose of preparing resolution plans. See the draft final report of EBA referenced as EBA/ITS/2018/02 of 17 April 2018, available online at . The EU Commission has issued an Implementing Regulation on this subject, the most recent version thereof being referenced as (EU) 2018/1624 dated 23 October 2018. 7 See n 7 above. 5

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Recovery and Resolution Plans of Banks (v) Resolution planning requires focus on the continuance, in one form or another, of critical functions.8 The SRB has declared: the identification of critical functions is relevant for the selection of the preferred resolution strategy, which should be designed to maintain critical functions through resolution. Key elements of that strategy, such as the separability analysis and the determination of loss-absorbing capacity, should preserve the institution’s critical functions and take into account the internal and external services, systems and infrastructure necessary for the provision of such functions.9 (vi) Financial institutions are forced to analyse their own legal and operational structures and activities in terms of (critical) functionality, risk profiles, resolvability and continuity.10 They are forced to identify, and where necessary remedy, operational and structural weaknesses. (vii) Resolution planning makes banks re-assess intragroup interdependencies. In order to allow resolution tools to be effective, intragroup interdependencies may have to be removed or reduced. (viii) Resolution planning enables regulators to better understand how a bank works, how realistic insolvency scenarios are and how realistic it is for regulators to effectively take preventive, preliminary or actual resolution measures when the need arises. (ix) Resolution planning (and recovery planning) provides regulators with an authority to force banks to take ex ante measures to facilitate recovery and resolution (in other words, to ensure their “resolvability”).

An additional advantage of resolution planning is that it forces resolution au- 10.08 thorities and financial institutions to think through all actual practical aspects of the use of resolution tools in accordance with the provisions of the BRRD and SRMR. The analysis of how a resolution would work in practice yields a number of unexpected complications for which the BRRD and SRMR do not provide definitive answers. The use of the bail-in tool is a case in point. How the write down of shares and conversion of other capital instruments is to take place in practical terms, poses a number of questions. For this reason, the Dutch central bank for instance has asked Dutch institutions to prepare and submit to them so-called ‘playbooks’ in which the process of write down and conversion of an institution’s capital and bail-in-able debts is set out in detail step-by-step.11 One of the issues that arises is the question how conversion of capital instruments and debt can be accomplished while it is as yet uncertain what the conversion rate would be for

8 See, inter alia, an SRB 2017 report on critical functions continuity, available online at . 9 See ibid. 10 See, inter alia, Avgouleas et al, ‘Bank Resolution Plans as a Catalyst for Global Financial Reform’ (2012) J. Financial Stability doi:10.1016/j.jfs.2011.12.002. 11 It would be helpful if there is international co-ordination between the SRB and national resolution authorities on these exercises, so that a measure of consistency and level playing field is preserved.

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Victor de Serière debt, particularly also in case of categories of debt that are situated on different steps of the insolvency ladder.12 3. In Some Respects, the Usefulness of Resolution Plans Is Limited 10.09 Resolution plans however cannot realistically be expected to provide a blueprint

for a resolution scheme that resolution authorities must adopt in the proverbial ‘resolution weekend’. Resolution plans are not necessarily based on correct premises as regards the causes of impending failure. In addition, resolution plans do not actually assist in arriving at independent valuations which are key to any takeover or intervention. In the case of nationalization, the valuation of the failing institution concerned is key to answering the question whether expropriated creditors are entitled to compensation. In the context of resolution under the Union resolution regime, two types of valuations must be distinguished. First, the ex ante valuations that are the basis of the decision to take resolution action and the determination of which resolution actions to embark on. These are the valuations referred to in Article 36(1) of the BRRD and Article 20(1) of the SRMR. Second, the ex post valuation that is used to determine what the recovery would have been for holders of shares and debt if ordinary insolvency procedures had been applied to the failing institution concerned (in practice, this is referred to as the ‘Valuation 3’). See Articles 36(1) and 74(1) of the BRRD and Article 20(1) and (16) of the SRMR.

10.10 The ‘aftermath’ of the nationalization of SNS Bank in the Netherlands and of the

resolution of (for instance) Banco Popular Espanyol in Spain amply demonstrates the importance of valuations. The valuation that is to serve as a basis for compensation of holders of subordinated debt issued by SNS Bank is now, six years after the nationalization was effected, still the subject of on-going litigation (of which the end is not yet insight . . .). The valuation of Banco Popular Espanyol is another case in point.13 Multiple court cases in Spain and the United States, mostly to do with valuation issues, have been commenced against the SRB and other parties involved in that resolution process. As an aside, the Banco Popular Espanyol case illustrates how difficult it is to arrive at proper valuations in the stressful

12 There are EBA Guidelines that provide some general guidance in this regard, eg EBA Final Guidelines concerning the interrelationship between the BRRD sequence of writedown and conversion and CRR/CRD, EBA/GL/2017/02; and EBA Final Guidelines on the treatment of shareholders in bail-in or the write-down and conversion of capital instruments, EBA/GL/2017/04. However, these guidelines do not address in any detail the various issues that would, in practice, arise. 13 See Decision of the SRB Appeal Panel of 28 November 2017 (Case 38/2017). This decision illustrates the struggle of the SRB in deciding which information regarding the resolution scheme and the valuation reports can be made public and which information could be withheld on the grounds that this could possibly pose a threat to third parties protected interests, may have an impact on other market participants and/or resolution actions in the future, and, in the words of the Appeal Panel, ‘could objectively raise actual concerns either of financial stability or of protection of commercial interests’.

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Recovery and Resolution Plans of Banks circumstances of bank resolution: Deloitte initially valued the negative worth of this bank to be somewhere within a staggeringly wide range of between €3.3bn to €8.5bn, ultimately arriving at a baseline valuation of minus €2bn. Deloitte had commented that the valuation should be regarded as ‘highly uncertain’.14 A resolution plan is moreover likely to be of limited help in cases where the failure 10.11 of a bank occurs in a sudden, unexpected sequence of events. In that situation, careful execution of controlled resolution planning may simply not be on the cards. Nationalization may then arguably be the best approach to stem the tide of the threatening wider national consequences of a bank failure. ELA, precautionary recapitalization and other measures available to stem the tide might not be sufficient.15 It is likely for reasons such as these that the Dutch legislator decided to retain the expropriation regime of arts 6:1ff of the Financial Supervision Act when implementing the BRRD. It is uncertain whether this Dutch ultimum remedium is compliant with the BRRD/SRMR regime.16 4. Standardization Is it at all possible, and if so is it productive, to establish recovery and resolu- 10.12 tion planning standards? That would necessarily have to be on a ‘one size fits all’ basis. Financial institutions all have their particular widely divergent functions, specializations, idiosyncrasies and risk profiles. The BRRD and the SRMR only contain generalised rules as to the plans that will be prescribed by the resolution authority. The EBA has developed draft Regulatory Technical Standards for recovery and resolution plans, containing (admittedly rather broad) standards and generically phrased substantive requirements that such plans must meet.17 5. Will Plans Actually Be Used? If EU and national resolution authorities are at liberty to apply or not apply 10.13 a resolution plan once formulated, this raises a fundamental question: if banks are asked to prepare plans and perhaps prepare and take ex ante implementation measures, do they have any consequential right to expect their supervisory authorities to implement the plan in which this bank has invested heavily in terms of man hours, money, and possibly also in more or less radical ex ante measures?

14 To provide further (not legally binding) guidance on how valuations should be conducted, EBA has on February 22 2019 published a ‘Handbook on valuation’, see . 15 See De Serière and Milione, ‘Depoliticising European Bank Resolution Processes’ (2019) 34 J.I.B.L.R., Issue 2. 16 See Busch, Van Rijn, and Louisse, ‘How Single is the Single Resolution Mechanism’, EBI Working Paper Series 2019 No 30, available online at . 17 EBA/RTS/2014/11 of 18 July 2014; and EBA/RTS/2014/15 of 19 December 2014.

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Victor de Serière 10.14 Such consequential right does not exist. Resolution authorities are not subject

to any obligation or best efforts undertaking to follow the route of any resolution plan. The BRRD and the SRMR do not contemplate that the resolution authorities take into account existing resolution plans when deciding on which intervention measures should be taken. The SRB brochure published in 2016, entitled ‘The Single Resolution Mechanism, Introduction to Resolution Planning’, discusses both resolution plans and resolution schemes (ie, the actual formal SRB decision in which the resolution tools actually to be used are determined), but does not connect the one to the other in any way. There is logic to this: why would resolution authorities be tied to resolution plans if there is no certainty that these appropriately address the form and challenges of the crisis at hand? But in determining the resolution scheme, the SRB will in practice refer to the resolution plan that has been developed for the failing institution concerned. For instance, in its decision to resolve Banco Popular Espanyol and to apply the sale of business tool in combination with the bail-in tool, the SRB stated: The 2016 Resolution Plan was based on the assumption that the Institution’s failure would be related to a deterioration of its capital position. However [. . .] the events leading to the failure of the Institution are mainly related to the circumstances that the Institution will, in the near future, be unable to pay its debts or other liabilities as they fall due (ie its liquidity position) [. . .] it cannot be ensured that the application of the bail in tool of Article 27(1)(a) SRMR, as provided for in the 2016 Resolution Plan, would immediately and effectively address the liquidity situation of the Institution [. . .]18

10.15 Where (by chance!) a resolution plan focuses on a failure situation that is similar

to the actual failure the resolution authority concerned faces and provides useful guidance for actual resolution, it will of course provide a useful basis for the resolution scheme to be adopted by the resolution authority. Also of course, the input of management of the failing bank will be of paramount importance and cannot be dispensed with (even if they have guided the institution into or to the edge of the abyss19). The dependence in practical terms of the resolution authorities on the co-operation of management may be a worrying aspect of resolving a bank. But the crises of banks such as SNS Bank in the Netherlands and Banco Popular Espanyol in Spain (admittedly these are not large multinational banking conglomerates) appear to indicate that this may be a largely theoretical issue.

18 See SRB Decision of 7 June 2017 (SRB/EES/2017/08), available at . See also Chapter 12 for a description of this case. 19 See arts 27(1)(d), 28, 29, and 30 of the BRRD for the authority of national resolution authorities to dismiss or replace existing management and to appoint a temporary administrator by way of early intervention measures. Article 34(1)(c) of the BRRD provides that in the actual resoution phase management will be replaced, except where their retention is necessary to achieve the resolution objectives. The comparable provisions of the SRMR are to be found in Recitals (60) and (75), art 15(1)(c) of the SRMR.

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Recovery and Resolution Plans of Banks Generally, second echelon management levels at failing banks may well be robust and competent enough to help steer the resolution process. A similar question to the one above in relation to resolution plans, applies to re- 10.16 covery plans that banks are required to have in place pursuant to Article 5 of the BRRD.20 In determining which measures to take in the early intervention phase on the basis of Article 27ff of the BRRD, a resolution authority may require management of the bank concerned ‘to implement one or more of the arrangements or measures set out in the recovery plan’ (Article 27(1)(a) of the BRRD), and/or to draw up a plan for ‘negotiation on restructuring of debt with some or all of its creditors according to the recovery plan, where applicable’ (Article 27(1)(e) of the BRRD).21 Here also, and for the very same reasons, there is no provision in the BRRD (or elsewhere) that competent authorities will in principle in their interventions be expected to abide by the road to recovery as set out in the relevant bank’s recovery plan.

III. Experience with Some Bank Failures It may be useful to see whether the manner in which some bank failures that 10.17 occurred in the recent past, might have been influenced if they had had the benefit of the current European resolution regime. The Dutch banking sector has seen some bank failures and bank interventions over the past decade or so,22 and could well provide a useful testing ground. The example of Banco Popular Espanyol is the most recent, and to date only, resolution of a Eurozone bank according to the SRMR. 1. Fortis Bank Nederland Would the Fortis Bank Nederland failure in 2008 have been resolved more easily 10.18 if recovery and resolution plans would have been in place? The answer, this writer

20 See, inter alia, Kastelein, De Bankenunie en het vertrouwen in een goede afwikkeling (Kluwer 2014) 110ff (in Dutch) 21 See also EBA Guidelines on the minimum list of qualitative and quantitative recovery plan indicators, dated 6 May 2015, reference EBA-GL-2015-02, available online at . In 2016, the EU Commission published its Delegated Regulation (EU) 2016/1075 giving technical standards on the content of recovery and resolution plans, available online at . 22 Van der Hoop Bankiers, DSB, Fortis Bank Nederland, SNS Bank. We will not in this chapter deal with temporary support measures such as the capital injections that the Dutch financial institutions ING, Aegon and SNS received in 2008–2009, nor with the innovative form of support the Dutch government subsequently supplied to ING in relation to its US investments in so-called ‘Alt-A’ securities.

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Victor de Serière believes, is no. If these plans had existed in 2008, they would after the take- over of ABN Amro Bank by the consortium of purchasers (of which Fortis Bank Nederland was a party) have had to be substantially rewritten to reflect the new merged banking group. Such exercise would in a realistic assumption have taken at least the better part of a year to be finalized and approved by the supervisory authorities. Prior to that time span, the failure had already materialized. The devolution of Fortis Bank Nederland into an ailing institution barely surviving on oxygen support from the central bank, took just a few months to materialize. The actual Government intervention whereby the bank was taken over by the State in a private sale transaction23 was accomplished in a time span of just one week after the date upon which it was estimated that the bank could not survive on its own. The period during which this was becoming clear to the Dutch central bank, the Ministry of Finance and management of the bank encompassed a time span of less than two months. During that time, deposits withdrawals began to accelerate and the stock price suffered severely. Liquidity was in short supply and the bank was on life support using ELA facilities.24 One important aspect to take into account in this context is that the process of realization that the bank could not survive on its own can be slow and uncertain. Hope and despondency alternate and fundamentally different analyses and solutions will have been put on the table. But once the determination is made that intervention is inevitable, swift action is paramount. That swift action, which in this case was accomplished in a time span of only a week, involved sketchy due diligence, necessarily superficial valuations, obtaining regulatory approvals where practically feasible, endeavouring co-ordination with the Belgian supervisory authorities (which were the main supervisory authorities for the parent in Brussels, Fortis SA/NV) and Belgian Governmental representatives etc. 10.19 Would a resolution plan, assuming it could have been timely updated in the

circumstances of the ABN Amro merger, have made this process easier? From one perspective, the answer to this question must be positive. If a detailed resolution plan had existed, this would have given the Ministry of Finance a much more comprehensive data base for its decision to take over this bank. The importance of this aspect cannot be underestimated. A bank rescue by necessity will have to be conducted in the utmost of secrecy so as not to precipitate a panic-stricken bank run, and under considerable time duress. In the Fortis Bank Nederland case, decisions had to be based on incomplete and sketchy data,

23 A voluntary sales transaction was entered into. Expropriation was, in the absence of a law authorising nationalization, not on the cards. The Dutch so-called ‘Intervention Act’ was not promulgated until June 2012. 24 ELA stands for Emergency Liquidity Arrangements. These are facilities that a central bank may temporarily provide to institutions that experience a liquidity squeeze. See the Agreement on emergency liquidity assistance, dated 17 May 2017, to be found on the ECB website (available at ). See also De Serière and Milione (n 16).

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Recovery and Resolution Plans of Banks provided by a few management insiders, by the Dutch central bank and from public databanks. This might conceivably have led to a less than ideal intervention structure. The existence of a resolution plan might well have been of help from this perspective. Certain ex ante measures, had they been taken, might have mitigated the di- 10.20 sastrous events as they unrolled. Certainly, the intervention in Fortis Bank Nederland was impeded by the relationship and interdependency between the Dutch bank and the Dutch/Belgian holding company, where central management functions (including the all-important treasury and liquidity management and the legal function) were located. Upon the Fortis Bank Nederland takeover having closed, the Dutch Government needed to inject very substantial sums of liquidity to keep the bank afloat. There were other interdependencies as well. Looked at from the perspective of ‘resolvability’, and these interdependencies are indeed an unwelcome phenomenon. The SNS Bank nationalization five years later amply demonstrated this. I will revert to this point later in this chapter. An important point emerges from the Fortis Bank Nederland scenario: should 10.21 regulatory approvals for bank take-overs and mergers be made conditional upon the development and approval of updated recovery and resolution plans? Prudence suggests that the answer to this question should be affirmative. Although CRD IV, the BRRD and other European banking legislation do not require this expressis verbis, existing European and national regulation would actually permit such conditionality to be imposed. The grounds on which merger approvals (DNOs) may be refused according to the so-called Antonveneta Directive25 are wide enough. According to this Directive, the grounds on which a declaration of no objections may be withheld include concerns relating to: [. . .] (c) the financial soundness of the proposed acquirer, in particular in relation to the type of business pursued and envisaged in the credit institution in which the acquisition is proposed; (d) whether the credit institution will be able to comply and continue to comply with the prudential requirements based on this Directive and, where applicable, other Directives, notably, Directives 2000/46/EC, 2002/87/EC and 2006/49/EC, in particular, whether the group of which it will become a part has a structure that makes it possible to exercise effective supervision, effectively exchange information among the competent authorities and determine the allocation of responsibilities among the competent authorities [. . .]26

25 Directive 2007/44/EC of the European Parliament and of the Council of 5 September 2007, amending Council Directive 92/49/EEC and Directives 2002/83/EC, 2004/39/EC, 2005/68/EC and 2006/48/EC as regards procedural rules and evaluation criteria for the prudential assessment of acquisitions and increase of holdings in the financial sector [2007] OJ L247. DNO stands for Declaration of No Objection. Such declaration constitutes the approval of the regulatory authority, with or without conditions attached, in respect of a bank take-over or merger. 26 Article 5 of Directive 2007/44/EC

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Victor de Serière 10.22 The Joint Guidelines published by the EBA, ESMA and EIOPA dated 20

December 2016 provide further guidance as to the application of these criteria.27 Neither the Directive nor the Guidelines contain specific provisions as to recovery and resolution planning. The vetting of mergers and acquisitions is now the prerogative of the ECB (see Articles 4(1)(c) and 15 of the SSM Regulation).28 At the time of the ABN AMRO merger in 2008, the national supervisory authorities were still entrusted with the granting of DNOs; the notion of bank recovery and resolution planning was at that time still in a more or less embryonic state; regulatory authorities were generally not yet sufficiently focused on these issues.29 It now goes without saying that any bank take-over or merger will be extensively scrutinized from the point of view of the resulting financial institution (or group) not becoming ‘too big to fail’ or largely unresolvable. Whilst the DNO process should probably not (if only for reasons of timing) be burdened with the requirement of ex ante recovery and resolution planning being in place, it is clear that existing plans will need to be revised and new plans will have to be developed after the merger or acquisition is completed. 2. SNS Bank

10.23 Would recovery and resolution planning have facilitated saving SNS Bank? Again

this writer believes the answer is: basically no. The window of time in this instance was rather wider: several months rather than days.30 But the fundamental problem that needed fixing, in short a balance sheet that was severely weakened by unrecoverable real estate loans held by subsidiary SNS Property Finance, proved for a variety of factors to be exceptionally tenacious.31 Other than in the case of Fortis Bank Nederland, the problem of sketchy data did not actually severely hamper intervention (but the problem of valuation, which a recovery and resolution plan could not have resolved, actually did very much complicate matters . . .). So the advantage that recovery and resolution plans could have brought in terms of providing useful data to resolution authorities, did not really apply here. What eventually brought SNS Bank to its knees was a series of events that a recovery/resolution plan could not have helped resolving: a structural weakness of the balance

27 See online at . 28 Council Regulation (EU) 1024/ 2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions [2013] OJ L287. 29 For a criticism of the granting of the DNOs for the ABN AMRO merger and subsequent related transactions, see, inter alia, De Serière, ‘De Nederlandsche Bank en haar President in de Schijnwerpers’ (2009) Ondernemingsrecht 130 (in Dutch). 30 See the expropriation decision of the Minister of Finance dated 1 February 2013 (in Dutch), available on the website of the Ministry. The decision gives a brief overview of the developments at SNS Bank that eventually led to the expropriation of this bank. 31 See Kastelein (n 20), 163ff.

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Recovery and Resolution Plans of Banks sheet, inter alia, caused by a substantial portfolio of acquired real estate loans, resulting in insufficient solvency capital, a weakening share price, a steady outflow of deposits and no hope for an effective solution, proved to be a deadly combination. The balance sheet problem which lay at the heart of this bank’s failure was to a certain extent exacerbated by double leverage32 and interdependencies. The solutions that recovery and resolution plans could have offered were actually tried but failed in the two-year period run up to expropriation. There was no way that SNS Bank could have shored up its balance sheet with a rights issue or issue of hybrid capital. A way out was actually envisaged with the help of private equity houses as white knight outside investors. This plan however among others depended to a certain extent on support by the three large Dutch main street banks, two of which had themselves meanwhile obtained government support. The plan also envisaged assumption of a certain tail risk by the Dutch government. Support by the three Dutch large banks was vetoed by Mr Almunia on the basis of EU State aid rules.33 All in all, a number of factors contributed to the conclusion that this plan was not a viable proposition. However, ex ante measures might well have eased the situation. In the case of SNS 10.24 Bank, interdependencies again proved to be a difficult stumbling block, exacerbated by the double leverage phenomenon. All personnel and IT systems were held in the name of the bancassurance holding company, SNS Reaal N.V., which had also issued guarantees (by way of so-called ‘403 declarations’) for the benefit of the creditors of SNS Bank. A resolution without involving the bancassurance holding company (and as a consequence by necessity also including the insurance subsidiary of this holding company) was made impossible by these interdependencies and double leverage. The State was compelled to expropriate the entire group rather than just the ailing bank. Ex ante measures might have removed at least some of these interdependencies, and might have somewhat alleviated the double leverage.34 But any such measures taken by themselves would in any event not have prevented the downfall of this bank. 32 Double leverage refers to the situation where a bank holding company issues debt instruments on the capital markets and uses the proceeds of these issues to inject equity capital into the bank subsidiary below. If the bank subsidiary is not, because of its deteriorating solvency position, able to pay dividends or distributions to the bank holding company, the bank holding company is at risk of being unable to service its debt. An insolvency at the bank holding company level could have disastrous consequences for the bank subsidiary but also for the other subsidiaries of the bank holding company. In the case of SNS Bank, the bancassurance holding company SNS Reaal NV was also the parent of the insurance company Reaal. 33 The EU Commission, when approving the earlier State support given to ING Bank and ABN AMRO Bank, had imposed the condition that these banks should not enter into take over transactions, and for this reason the EU Commission approval for their participation was required (although this is questionable, since strictly speaking their participation in the SNS Bank plan would take the form of loans rather than equity investments). 34 Removing double leverage is of course a time consuming and complex exercise. It involves at the minimum a restructuring of the equity and debt at both the holding company and the bank subsidiary level. The question then arises whether the market would be willing to accommodate such

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Victor de Serière 10.25 The decision to nationalize SNS Bank took a relatively long period of time to ar-

rive at. This was perhaps in part due to regulatory processes and legal issues (the Dutch Intervention Act35 enabling nationalization had not been applied before, so there were no precedents to rely on or to draw lessons from), perhaps in part also to intermediate developments, such as the presentation of alternative plans by private equity parties as mentioned above. The interdependency and double leverage factors will undoubtedly also have complicated the process. The description of the procedures followed as contained in the Report on the Evaluation of SNS Reaal (the ‘SNS Report’) dated 23 January 201436 bear out that even in a relatively small and transparent domestic banking operation such as that of SNS Bank the decision making process on intervention is rather complex and time consuming. Such process would be exponentially more complex in case of a SIFI. The notion of a so-called ‘resolution weekend’ that is at the heart of resolution plans, suggesting that quick resolutory action is possible under the BRRD and the SRMR, is a misleading illusion. The resolution of Banco Popular Espanyol, briefly discussed below, could be accomplished in a very short time frame, but unusual circumstances (including the timely availability of Banco Santander as a white knight) made this possible.37 3. Banco Popular Espanyol

10.26 The experience with Banco Popular Espanyol was the first instance where reso-

lution was effected using a resolution scheme adopted by the SRB in accordance with SRMR rules.38 The resolution of this bank was stated by the SRB to be ‘proof ’ that the system of the SRMR works: The SRB, by its decision, managed to avoid adverse effects on financial stability and the real economy, without using any public funds. This showed the new regime works—but of course, there is always room for fine-tuning, and the Banking Union is still not complete.39

Indeed the Banco Popular Espanyol resolution in many respects provides a showcase for the resolution of banks under the SRMR regime.40 But, as stated above, restructuring: essentially, debt holders would be asked to refinance their debt with equity, thereby accepting a more subordinated ranking than they previously enjoyed. 35 Largely contained in ss 3:159aff and 6:1ff of the Dutch Financial Supervision Act. The Intervention Act of 2011 has meanwhile been replaced by the SRMR and the BRRD (as implemented in the Dutch Financial Supervision Act); See, inter alia, Kastelein (n 20). 36 Dutch Ministry of Finance, ‘Het rapport van de Evaluatiecommissie Nationalisatie SNS Reaal’, 23 January 2014 (the SNS Report), available online at . 37 See n 27. 38 See De Serière and Milione (n 16), and Chapter 14 for a summary discussion of this case. 39 Elke König, ‘An Assessment Ten Years After the Financial Crisis’, SRB press release of 14 September 2018. 40 See for details the SRB decision of 7 June 2017 adopting the resolution scheme for this bank, available online at . See also the FROB Decision implementing the resolution scheme, available online at . The FROB is the Spanish resolution authority. See Chapter 14 for a discussion of this case. 41 See, inter alia, Thomas Hale, ‘Investors Launch Legal Action over Banco Popular Firesale’ Financial Times (London, 17 August 2017). An overview of 86(!) claims instituted against the SRB (and, in some cases, also against the EU Commission) is to be found online at . Robert Smith, ‘Banco Popular Bondholders Take Legal Fight to US’ Financial Times (London, 4 April 2018); Louise Bowman, ‘Aggrieved Banco Popular Bondholders Train Their Sights on Banco Santander’ Euromoney (17 April 2018). Initial results of these proceedings have been reported at online at . The recent SRB Report on contingent liabilities, OJ 2019/C48/01 of 6 February 2019 lists the number of cases instituted in relation to the Banco Popular Espanyol resolution against the SRB (103), the EU Commission (30), and the EU Council (1). See, in particular, para 18 of this Report, where it is noted that because the statute of limitations in regard to tort claims is five years, more court cases may in future be instituted. 42 The bank did have subsidiaries and branches in third countries, mainly the US and Mexico, but these overseas operations were not relevant in the resolution process.

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Victor de Serière (2) The irony in the above examples is that these bank failures were as much supervisory failures as they were management failures. Fortis should never have been given the green light for the proposed take-over of ABN Amro Bank. DSB, a small regional Dutch bank, should never have been allowed to maintain the dubious governance structure that permitted its owner and principal director to abuse the managerial freedom he enjoyed. SNS should never have been given approval for the acquisition of a toxic real estate portfolio that ultimately brought it to its knees. In the case of Banco Popular Espanyol, there would appear to be no discernable supervisory failure, but the description of events leading to the SRB adoption of the resolution scheme for that bank does not give the impression of decisive regulatory intervention.43 Hindsight wisdom? Perhaps, at least to a certain degree. But I note that the ex post facto report relating to the SNS failure for instance does not exonerate the Dutch Central Bank by giving it the benefit of hindsight correction on its perceived failures.44 (3) Timing is of the essence. A recovery/resolution plan will be a hindrance rather than a help if the data that such plans provide to the resolution authorities are overtaken by developments or otherwise outdated. It is accordingly essential, if such plans are to provide a meaningful contribution to resolution, that they be regularly effectively updated. Also, they should ideally take into account realistic failure scenario’s. For instance, a resolution plan based only on capitalization weakness whereas the liquidity risk is the main cause of failure, is useless. At the same time, one has to realize that this imposes a very substantial and costly administrative burden on banks. (4) Valuations are crucial to any intervention exercise, and recovery/resolution plans do not by themselves provide assistance in arriving at realistic valuations. (5) Interdependencies can be a serious obstacle to resolution. It is safe to assume that in larger banking concerns, these interdependencies are intricate and manifold. Ex ante measures may possibly be helpful here, but the difficulties in imposing and enforcing effective ex ante measures must not be under-estimated. (6) Double leverage can likewise prove to be a difficult issue in the context of bank resolution. 10.28 In his book Governance of International Banking: the financial trilemma45 Dirk

Schoenmaker summarizes causes and impacts of six international failures, ie

43 See n 41. In item 3.3 of the SRB decision it is noted that: ‘There is no reasonable prospect that any supervisory action, including early intervention measures, could prevent the failure of the Institution’. But that comment relates to the situation as per the date of the resolution scheme rather than to the preceding period. 44 See n 37. >. 45 Schoenmaker, Governance of International Banking: the Financial Trilemma (Oxford University Press 2013)

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Recovery and Resolution Plans of Banks Lehman Brothers, AIG, Fortis, Dexia, the Icelandic banks and the Central and Eastern European Banking system. Schoenmaker concludes on p 87: these six cases illustrate a wide range of causes, consequences, and outcomes. In each case, resolution was, out of necessity, improvised. In some cases, the improvisation succeeded in limiting spillovers, but at substantial cost to taxpayers. In other cases, the resolution process protected domestic interests without regard to spillover effects in the rest of the world.

V. The Authority to Impose Ex Ante Measures The basis for the authority of supervisors to impose ex ante measures is to be 10.29 found in Articles 6 and 17 of the BRRD, and in Articles 8 and 9 of the SRMR. Institutions must provide recovery plans that include appropriate conditions and procedures to ensure the timely implementation of recovery actions as well as a wide range of recovery options. Member States shall require that recovery plans contemplate a range of scenarios of severe macroeconomic and financial stress relevant to the institution's specific conditions, including system wide events, legal entity specific stress and group- wide stress.46

If institutions fail to develop adequate recovery plans, the competent authority 10.30 have the authority to issue wide ranging instructions to institutions, to: ‘ (a) reduce the risk profile of the institution, including liquidity risk; (b) enable timely recapitalisation measures; (c) review the institution's strategy and structure; (d) make changes to the funding strategy so as to improve the resilience of the core business lines and critical functions; (e) make changes to the governance structure of the institution.’47

These are wide ranging powers. Moreover, the Directive permits Member States 10.31 to authorize their authorities to ‘take additional measures under national law’. The authorities are required to adopt ‘reasoned and proportionate’ decisions, on which the institutions concerned will have a right of appeal. The EBA is to provide regulatory technical standards (RTS), to be adopted by the EU Commission. In respect of resolution plans, the BRRD envisages that the local resolution au- 10.32 thorities will assess the ‘resolvability’ of institutions.48 This assessment must be done on the basis of RTS developed by the EBA, and as adopted by the EU

46 Article 5(6) of the BRRD. 47 Ibid. 48 See, inter alia, Bierens, ‘Het Vereiste van Afwikkelbaarheid: een Breuklijn in het Denken over de Governance van Systeemrelevante Banken?’, Ondernemingsrecht 2017/41.

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Victor de Serière Commission (see below). Article 16(1) of the BRRD and Article 8(3) of the SRMR define the meaning of the term ‘resolvability’: An institution shall be deemed resolvable if it is feasible and credible for the resolution authority to either liquidate it under normal insolvency proceedings or to resolve it by applying the different resolution tools and powers to the institution while avoiding to the maximum extent possible any significant adverse consequences for financial systems, including in circumstances of broader financial instability or system wide events, of the Member State in which the institution is situated, or other Member States, or the Union and with a view to ensuring the continuity of critical functions carried out by the institution. 10.33 If ‘substantive impediments’ for resolution exist, Article 17 of the BRRD and

Article 8(9) of the SRMR provide for a procedure for the removal thereof. In this connection, the resolution authorities have been given wide ranging powers, ie to: ‘(a) require the institution to revise any intragroup financing agreements or review the absence thereof, or draw up service agreements (whether intra-group or with third parties) to cover the provision of critical functions; (b) require the institution to limit its maximum individual and aggregate exposures; (c) impose specific or regular additional information requirements relevant for resolution purposes; (d) require the institution to divest specific assets; (e) require the institution to limit or cease specific existing or proposed activities; (f ) restrict or prevent the development of new or existing business lines or sale of new or existing products; (g) require changes to legal or operational structures of the institution or any group entity, either directly or indirectly under its control, so as to reduce complexity in order to ensure that critical functions may be legally and operationally separated from other functions through the application of the resolution tools; (h) require an institution or a parent undertaking to set up a parent financial holding company in a Member State or a Union parent financial holding company; (i) require an institution or an entity referred to in points (b), (c) or (d) of Article 1 to issue eligible liabilities to meet the requirements of Article 45 [minimum own funds requirements]; (j) require an institution, or an entity referred to in points (b), (c) or (d) of Article 1, to take other steps to meet the minimum requirement for own funds and eligible liabilities under Article 45, including in particular to attempt to renegotiate any eligible liability, additional Tier 1 instrument or Tier 2 instrument it has issued, with a view to ensuring that any decision of the resolution authority to write down or convert that liability or instrument would be effected under the law of the jurisdiction governing that liability or instrument; and (k) where an institution is the subsidiary of a mixed-activity holding company, requiring that the mixed-activity holding company set up a separate financial holding company to control the institution, if this is necessary in order to

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Recovery and Resolution Plans of Banks facilitate the resolution of the institution and to avoid the application of the resolution tools and powers specified in Title IV having an adverse effect on the non-financial part of the group.’

There is actually very little that the resolution authorities cannot do. The BRRD 10.34 and the SRMR do provide a certain measure of protection to institutions against wrongful use of these powers. Resolution authorities must, inter alia, take into account ‘the effect of the measures on the business of the institution, its stability and its ability to contribute to the economy’. See also Article 17(7) of the BRRD and Article 7 of the SRMS: consultation is to be held with the local national authorities, and the ‘potential effects of those measures on the particular institution, on the internal market for financial services, on the financial stability in other Member States and the Union as a whole’ must be taken into account. Although the relevant Union rules do not contemplate formal consultation of institutions in the determination of ex ante measures on resolvability, institutions will in practice be intimately involved in the process. The EBA has developed further guidelines,49 and Articles 23ff of EU Commission Delegated Regulation (EU) 2016/ 107550 contain detailed provisions on resolvability assessments. Banks are understandably concerned as regards the ex ante powers of competent authorities, albeit in recognition of the potential advantages of resolvability exercises.

VI. Remedies Against Imposed Ex Ante Measures This topic enjoys wide interest in literature. See Chapter 3 with references to fur- 10.35 ther sources. A brief summary may suffice here. The BRRD gives banks a right of appeal against the imposition of resolvability 10.36 measures (Article 17(6)(c) of the BRRD). This would be an appeal under national administrative law before national administrative courts (Article 85(2) of the BRRD). It is not clear whether Article 85(3) and (4) BRRD apply; this is dependent on whether a resolvability measure falls within the category of a ‘crisis management measure’, which is unclear but appears unlikely to be the case. If Article 85(3) of the BRRD does not apply, the requirement of immediate enforceability imposed by Article 85(4) of the BRRD would not apply. This is unlikely Guidelines of 19 December 2014, EBA/GL/2014/11. 50 Commission Delegated Regulation (EU) 2016/ 1075 of 23 March 2016 supplementing Directive 2014/59/EU of the European Parltime and of the Council with regard to regulatory technical standards specifying the content of recovery plans, resolution plans and group resolution plans, the minimum criteria that the competent authority is to assess as regards recovery plans and group recovery plans, the conditions for group financial support, the requirements for independent valuers, the contractual recognition of write-down and conversion powers, the procedures and contents of notification requirements and of notice of suspension and the operational functioning of the resolution colleges, C/2016/1691, [2016] OJ L184. 49

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Victor de Serière to make a difference, if a no-stay requirement would anyhow apply under the national administrative law concerned. Suspension of a resolvability measure may be deemed by the administrative courts to be ‘against the public interest’ as referred to in Article 85(4) of the BRRD. It is however certainly imaginable that in case of an appeal against an ex ante resolvability measure that has a substantive and irreversible impact on a banking group, an administrative court (or a court in summary proceedings) could be convinced to order a stay. 10.37 A right of appeal is also given against the imposition of ex ante measures decided

upon by the Single Resolution Board to improve the resolvability of a bank (Article 85(3) of the SRMR in conjunction with Article 10(10) of the SRMR). Since resolvability measures will be taken by the national resolution authority on the basis of decisions of the SRB containing instructions to that effect, this would however be an appeal against the decision of the national resolution authority under national administrative law. Appeal directly against SRB decisions would in principle be excluded; such appeal would only be admissible if it can be argued that the SRB decision concerned directly affects the institution concerned.51 This would in principle only be the case if the national resolution authority would have no choice but to implement an SRB instruction without being able to exercise any discretion in respect thereof.52 This is unlikely to be the case where ex ante resolvability measures are concerned. If appeal against SRB decisions is possible, that appeal may be lodged with the Appeal Panel of the SRB if it concerns the matters referred to in Article 85(3) of the SRMR; those matters include resolvability decisions (but not any SRB decision to impose a resolution scheme).53 Decisions of the Appeal Panel may be contested before the EU Court of Justice in Luxemburg. Decisions of the Single Resolution Board which pursuant to Article 85(3) of the SRMR are not subject to appeal with the Appeal Panel may also be contested before the EU Court of Justice in Luxemburg. See Article 86 of the SRMR.54, 55

10.38 That a bank would not agree on ex ante measures imposed by resolution au-

thorities and would resort to administrative proceedings is not inconceivable but 51 Article 263 of the TFEU requires that there must be ‘an act addressed to that person or which is of direct and individual concern to them, and does not entail implementing measures’. 52 Article 6(7) of the SRMR provides a certain measure of discretion to the national resolution authorities. 53 In literature, some doubt has been expressed as to whether the list of Article 85(3) of the SRMR is exhaustive. See, inter alia, Dominik Skauradzun, ‘Legal Protection against Decisions of the Single Resolution Board pursuant to Article 85 Single Resolution mechanism Regulation’, available online at . 54 See, inter alia, Drijber, ‘De Europese Bankenunie op weg naar voltooiing: het gemeenschappelijk afwikkelingsmechanisme’, SEW 2015/5 (in Dutch), with references to further literature on the subject. 55 It is noted that the European Banking Institute maintains a useful compilation of cases concerning actions of Union agencies in the context of bank resolution; see see online at .

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Recovery and Resolution Plans of Banks generally seems rather theoretical: in the ultimate analysis, the wide powers of the regulators when prudently exercised should probably make this a fruitless exercise. Generally, recovery and resolution plans are put together in close co-operation between the competent authorities and the institutions concerned. Decisions on ex ante measures will generally be the result of intimate consultations between parties concerned. The fact that legal remedies are available may in itself however have some sobering effect on the process.

VII. A Difficult Debate on the Need for Ex Ante Measures Recovery and solution planning exercises have meanwhile on occasion led to un- 10.39 comfortable discussions between banks and supervisory authorities as to whether ex ante measures are appropriate to be pursued in certain circumstances. To name three: 1. Which Measures Are Appropriate? A simple example. Imagine for instance bank XYZ with its headquarters in 10.40 Paris, but (for historical reasons or otherwise) with the bulk of its IT systems situated in London and ‘owned’ by a Belgian global banking subsidiary of bank XYZ. Is it appropriate to require a separation of the IT systems out of the Belgian subsidiary and a transfer thereof to a ring-fenced risk-averse single purpose group entity? The idea behind separation would be that the risk of denied access to IT systems as a result of a sudden insolvency of the subsidiary is removed. Another consideration would be that if the subsidiary is sold as part of an XYZ group recovery/resolution exercise or if XYZ bank is split up into a ‘good bank’ and a ‘bad bank’, the continuity of IT services ought to be ensured without having to go through a cumbersome carve out process during resolution. Taken at face value, this separation of IT systems would appear to be a sensible 10.41 idea. But such separation may have a serious operational impact. There will be legal issues (licensing issues, contract amendments, drawing up a network of new Service Level Agreements, etc. etc.). Personnel problems will need to be addressed (IT personnel may be shared with other bank operations, personnel will have to be transferred, will wish to have continuity undertakings, there may be pension entitlement breakage issues, etc). Tax problems will arise (not the least of which will be transfer pricing problems and the possible loss of tax incentives). The notion that cost issues, reductions in profitability consequences or opera- 10.42 tional problems should be taken into consideration may be countered by the argument that these aspects are dwarfed by the immeasurable cost of a bank failure. 423

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Victor de Serière Reductions in profitability should not worry shareholders, since the result of the costly exercise will be a (hopefully commensurate) reduction in risk.56 10.43 Now the above example is perhaps a relatively straightforward case, where the cost/

benefit analysis may not be too difficult. But the consequences of other ex ante measures may be much more complex; imagine a substantial downsizing requirement to diminish the insolvency risks to which a ‘too big to fail’ institution is exposed.

10.44 There may, for good reasons, be widely divergent views between regulators on

the one hand and banks on the other hand as to the appropriateness of proposed measures. Should banks be given the benefit of the doubt where no compromise seems reachable? The answer to this question may be very different depending on the circumstances in which the question is raised. A profitable institution with a significant surplus of regulatory capital and thus comfortable loss absorption capacity will have a more convincing story to tell than an institution struggling along at the lower levels of required ratios. Would the level playing field argument hold sway here?

10.45 In conclusion on this point, it may be argued that the BRRD and SRMR provisions

described above do not sufficiently reflect the complexity of the issue: although they do provide certain safeguards,57 they arguably do not properly cater for the situation where justifiable divergent views may arise and the interests of the bank concerned are at risk. 2. The Timing of Measures

10.46 This is another thorny issue. Imagine, for example, a bank that is caught in a

crossfire of regulatory and difficult market conditions, besieged by eg fines for alleged manipulation of benchmarks, mishandling of mortgage loans, OFAC and sanctions violations, a cold shoulder from the money market funds, shrinking interbank lending volumes. Stress tests show a need to bolster its core capital ratio’s by issuing new stock or hybrid debt. Should a bank faced with these challenges be required, on top of all of its woes, to fundamentally restructure by taking ex ante measures? Taking into account that such measures would or could affect this bank’s profitability, which would not be good news to disseminate in the offering circular when this bank taps the capital markets. One way to look at this is

For this argument, see, inter alia, Admati and Hellwig (n 6), 180. 57 See art 17(4), 2nd para of the BRRD; and art 6(10), 2nd para of the SRMR. Admittedly, when competent national authorities take measures, they wil be bound by principles of good administration according to their national administrative law, and likewise the SRB and other Union agencies are bound by such principles as developed under Union law, as well as by general principles of Union law. On the topic of principles of good administration, see, inter alia, Mihaescu Evans, The Right to Good Administration at the Crossroads of the Various Sources of Fundamental Rights in the EU Integrated Administrative System (Nomos 2015); Jans, Prechal, and Widdershoven (eds), Europeanisation of Public Law (Europa Law Publishing 2015). 56

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Recovery and Resolution Plans of Banks to argue that especially in such circumstances risk reduction measures are appropriate. Another is to argue that a prudent measured approach would be appropriate to enhance unthreatened continuity. 3. The Level Playing Field Issue The approach of the BRRD leaves a wide scope of different measures that might 10.47 be imposed by the national resolution authorities. Although there is obviously no full discretion as to which measures are to be imposed in which circumstances, it will be clear that the leeway granted to the resolution authorities may, at least in theory, lead to diverging requirements affecting competitiveness. The BRRD and SRMR aim to achieve convergence. In the BRRD this is envis- 10.48 aged through guidelines developed by the EBA. Policies of the Single Resolution Board and the common rules to be applied by that Board will obviously achieve some convergence, but only in the Eurozone. A level playing field threat possibly exists in the competitive relationship between Eurozone banks and banks outside the Eurozone, and in the competitive position of EU banks and non-EU banks that do not fall under the regime of the BRRD/SRMR. And it remains in any event to be seen whether level playing field distortions can effectively be avoided when EU converging provisions are implemented in practice. It must also be borne in mind that each bank has its own structure, specializations, idiosyncrasies, and risk profiles, which means that appropriate ex ante measures for one bank may be fundamentally different from the ex ante measures for another bank, and it is quite possible that this inadvertently leads to a divergent treatment that is perceived by these banks to be discriminatory and distortionary.

VIII. The Wider Context in which Ex Ante Measures Are Imposed The measures that resolution authorities may impose in the context of recovery 10.49 and resolution planning of course have a very different goal and purpose than measures that may be imposed on banks generally to safeguard their solvency and continuity. The former set of measures aim to enhance ‘resolvability’ of banks: they aim, in other words, to ensure that, if things go wrong, the resulting mess can be effectively cleaned up while minimising harm to the stability of the financial sector generally. The latter set of measures looks at the problems of the financial sector from a different, more general viewpoint. They look primarily at the removal of those structural failures in the regulatory regime applicable to banks that led or contributed to the financial turmoil of 2008 and later years. However, the latter set of measures (many of them discussed but not or not comprehensively implemented) substantially influences the former set of measures. They affect resolvability and as they require solid capital and liquidity ratio’s, they 425

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Victor de Serière reduce the insolvency risk. Conversely, ex ante measures can conceivably be used on an ad hoc basis to achieve what the latter set of measures cannot achieve on a generally applicable level. 10.50 Below, some of these more general measures are summarized.

1. The US: Implementation of the Volcker Rule into the Dodd-Frank Act 10.51 The Volcker rule was a significant driver of structural bank reform. Whilst the

original concept is rather simple, the manner in which this concept was designed to be translated into the Dodd-Frank Act is far from simple and appears to have caused a fair amount of dilution of the original concept. The Volcker rule in its pure form stated that banks should no longer be permitted to engage in proprietary trading activities. As efforts were undertaken for implementation, the rule almost drowned in a swamp of definitional and other technical problems. The US banking industry lobbied with some considerable success against a broad application of the rule; institutions largely feared losing out on profitable business that boosted their return on equity and that was thought to be intricately linked to their ‘traditional’ banking business, and sought to preserve as much as possible the synergies between proprietary trading and investment banking on the one hand and traditional retail banking on the other hand.58 What did the Volcker rule as translated into Dodd-Frank Act provide? A summary: (i) Statutory prohibitions on proprietary trading by US banks and their affiliates. US banks and their affiliates will no longer be able to engage in short-term proprietary trading of securities, derivatives, and other financial instruments for their own account. (ii) A measured, tailored approach to market making and underwriting activities as statutory exceptions to the prohibition on proprietary trading. Permitted market making activities include trading in a wide variety of financial and derivative instruments, including those for which there is relatively limited liquidity, provided the firms concerned are ready, willing, and able on request to provide quotes and respond to trading interest on both sides of the market. There are clear requirements regarding the maintenance and enforcement of risk and inventory limits—at the trading desk level—that are reasonably and closely tied to the nature of the instruments traded and to customer and counterparty demand. (iii) Limitations on the ability to sponsor or invest in hedge funds or private equity funds—called ‘covered funds’. These do not include entities that do not present the same risks as the covered funds targeted by the statute, such as entities used for general corporate—rather than investment—purposes, mutual funds and certain foreign funds that are publicly offered abroad; and See Admati and Hellwig (n 6), 3 and 230–1. 58

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Recovery and Resolution Plans of Banks vehicles used by banks to conduct loan securitizations as permitted by the statute. (iv) Firms that sponsor or advise a covered fund will be barred from, for example, purchasing assets from the fund or extending credit to it. But for instance asset management on behalf of customers will be permitted. (v) Limitations on otherwise permitted activities if they involve a material conflict of interest; a material exposure to high-risk assets or high-risk trading strategies; or a threat to the safety and soundness of the banking entity or to the financial stability of the US. (vi) Permitted underwriting activities include the full range of securities offerings in which underwriters participate, and encompass the various activities that they commonly undertake to facilitate distributions. But the trading desks must maintain and enforce robust risk limits that are tied to the demand from clients, customers, and counterparties. (vii) As to foreign banks and their affiliates, the statutory prohibition on proprietary trading does not apply to all transactions entered into by these entities. These may engage in certain limited proprietary trading activity with US firms, but only if the risks of such trading activity are held and managed outside the United States. Foreign banks will, for example, be able to conduct cleared transactions through US exchanges and with unaffiliated, regulated US market intermediaries. This admittedly oversimplified summary amply illustrates the complexity of the 10.52 issues at hand and the ensuing complexity of the rule as implemented in the Dodd-Frank Act, with all its detail and all its exceptions as well as exceptions to exceptions.59 However one may criticize the manner in which the Volcker rule originally was 10.53 implemented, it in any event definitively promoted the relevant issues to the top of regulators’ agendas in the early years of this decade, stimulating the all- important discussion on the acceptability of risk profiles of SI banks, both in the US and in Europe. Over the past few years, however, efforts to dilute the effects of the Volcker rule 10.54 have intensified. Proposals published in mid-2018 by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency sought to change the Volcker rule, placing more emphasis on banks with large trading operations and providing relief to banks with smaller such operations. The proposals also provide more

59 See for a comprehensive summary and the text of the ‘final rule’: Federal Register/Vol 79, No 21/Friday, January 31, 2014/Rules and Regulations, 5536ff. The Davis Polk website (https://www. davispolk/insights/) contains a useful and user friendly section with comprehensive Volcker Rule materials..

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Victor de Serière flexibility as to permitting short term proprietary trading, as well as more flexibility for foreign banking entities.60 The current Republican drive for deregulation makes it difficult to predict where Dodd-Frank will ultimately end up in terms of structural requirements for the financial industry in the US. 2. Europe: The European Banking Union Approach 10.55 The European approach to increased bank resilience was largely inspired by the

now all but forgotten Liikanen Report, published on 2 October 2012. The debate was in those years likewise fuelled by various contributions to the debate on structural reform, such as the Turner Review of 18 March 200961 and the Vickers Report of September 201162 as well as the contributions of Volcker. While Turner stopped short of recommending separation of risk-prone activities from ‘ traditional’ banking activities but recommended slapping discouraging additional solvency capital requirements on the former activities, Vickers went much further and required a radical ring-fencing (albeit not a complete legal hive off) of retail operations from investment banking operations.

10.56 The Expert Group responsible for the Liikanen Report formulated a number of

proposals that may be summarized as follows:63

(1) Proprietary trading and other significant trading activities must be assigned to a separate legal entity if the activities to be separated amount to a significant share of a bank's business. This would ensure that trading activities beyond the threshold are carried out on a stand-alone basis and separate from the deposit bank. As a consequence, deposits, and the explicit and implicit guarantee they carry, would no longer directly support risky trading activities. The long-standing universal banking model in Europe would remain, however, untouched, since the separated activities would be carried out in the same banking group. Hence, banks' ability to provide a wide range of financial services to their customers would be maintained. (2) Banks were to draw up and maintain effective and realistic recovery and resolution plans, as proposed in the BRRD. The resolution authority should request

60 See . See also Madison, Shirley, and Lewis, ‘Volcker Rule 2.0: A Significant but Unfinished Proposal’, containing a uaewful summary of the proposed changes, available online at . 61 See . 62 See or . A useful summary of the Vickers report and of the follow up in terms of UK banking regulations can be found online at . 63 See also Alexander, ‘Regulating the Universal Model Banking in Europe’, in the first (2015) edition of this book, at 487ff.

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Recovery and Resolution Plans of Banks wider separation than considered mandatory above if this is deemed necessary to ensure resolvability and operational continuity of critical functions. (3) The use of designated bail-in instruments was encouraged. Banks were to build up a sufficiently large layer of bail-inable debt that should be clearly defined, so that its position within the hierarchy of debt commitments in a bank's balance sheet is clear and investors understand the eventual treatment in case of resolution. Such debt should be held outside the banking system. This was thought to increase overall loss absorptive capacity, decrease risk- taking incentives, and improve transparency and pricing of risk. (4) More robust risk weights in the determination of minimum capital standards and more consistent treatment of risk in internal models. Following the conclusion of the Basel Committee's review of the trading book, the Commission should review whether the results would be sufficient to cover the risks of all types of European banks. Also, the treatment of real estate lending within the capital requirements framework should be reconsidered, and maximum loan- to-value (and/or loan-to-income) ratios included in the instruments available for micro-and macroprudential supervision. (5) Existing corporate governance reforms by specific measures to (1) strengthen boards and management; (2) promote the risk management function; (3) rein in compensation for bank management and staff; (4) improve risk disclosure; and (5) strengthen sanctioning powers. The first and second of these proposals are of particular interest in the context of 10.57 this chapter. The basic premise that the Liikanen Report proposed is for regulators to push through separation of an entity referred to as the Deposit Bank and an entity into which trading activities are conducted, referred to as the Trading Entity. These entities would be permitted to live together under one roof beneath a bank holding company, but there must be legal separation. This separation requirement would only apply once a threshold is reached. According to the Liikanen Report, this would be the case if: (a) assets held for trading and available for sale exceed 15–25% of the bank’s total assets or €100bn; or (b) the share of trading activities relative to the banks’ activities as a whole is ‘significant’ by reference to various parameters such as revenue. The lead given by Liikanen (and to a certain extent Volcker, Turner, and Vickers) 10.58 was taken up by the EU Commission by introducing a proposed Regulation for the improvement of the resilience of European credit institutions,64 published in April 2014. The rules contained in this proposal would apply to all European banks, but the rules on separation of proprietary trading activities would only apply to entities that were identified as being globally significant, meeting the criteria of: (i) assets exceeding €30bn; and (ii) total trading assets and liabilities exceeding 64 Proposal for a Regulation of the European Parliament and of the Counsel on structural measures improving the resilience of EU credit institutions COM/2014/043 final—2014/0020 (COD).

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Victor de Serière €70bn or 10% of total assets (a somewhat lower threshold than Liikanen, see above). The proposed Regulation included: (1) A ban on proprietary trading, focusing especially on activities dedicated to taking positions for making a profit for own account, without any connection to customer activity or hedging the entity’s risks. (2) Local supervisory authorities could prescribe separation of certain activities, including market making, lending to venture capital and private equity funds, investment and sponsorship of risky securitizations, sales, and trading of derivatives, etc.; the basic principle being that deposit taking entities within banking groups would only be permitted to engage in such activities as long as the supervisors would not have determined that they need to be performed within a distinct trading entity. (3) Local supervisory authorities would be required to impose separation if the trading activities of banks (market making, investing in and sponsoring risky securitization and trading in certain derivatives) and the related risks are found to exceed certain thresholds. If the bank would demonstrate to the satisfaction of the authority that these activities do not endanger EU financial stability, taking into account the objectives of the proposed Regulation, the competent authority could decide not to require separation. (4) Derivatives such as interest rate, foreign exchange, credit, emission allowance, and commodity derivatives eligible for central counterparty clearing could be sold by credit institutions to its non-financial clients, insurance undertakings and institutions for occupational retirement provision, but only to hedge interest rate, foreign exchange and credit risk, commodity risk, and emission allowance risk, and subject to caps on the resulting position risk. (5) Actual separation of trading activities (see (2) and (3) above) would have to be preceded by an obligation for relevant banks to submit a ‘separation plan’ to competent authorities. Article 18 of the draft Regulation contemplated that this plan should be approved by the competent authority, with the latter having the possibility to require changes to the plan as appropriate, or setting out its own plan for separation in case of inaction by the relevant bank. 10.59 The approach of this draft Regulation proved to be rather too ambitious for the

European Union, and after lengthy deliberations in the Council and Parliament, the proposal was eventually scrapped by the EU Commission, stating that: the main objectives of the proposed regulation have already been addressed by other regulatory measures in the banking sector, most notably with the entry into force of the Banking Union’s supervisory and resolution arms.

10.60 It is fair to summarize that the debate on the necessity of insulating risky non-

core banking activities from mainstream traditional banking activities, high on the agenda of regulators and politicians in the early years of this decade, have somewhat faded into the background. In the US the watering-down of the original Volcker rule as part of deregulation efforts now appears to be well underway. In Europe, the debate was overshadowed by the gradual build-up of the European Banking Union and the Capital Markets Union. Strong expressions of industry disenchantment with the various proposals will have helped these developments. It was considered that the European Banking Union rules contained in the 430

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Recovery and Resolution Plans of Banks Single Rulebook, the Single Supervisory Mechanism and the Single Resolution Mechanism largely addressed the underlying issues. To a large extent that is indeed the case, particularly through the possibility for resolution authorities to impose ‘resolvability’ measures and to impose additional capital charges in case of unwarranted risk exposures. This chapter will not further elaborate. 3. The Impact of EU State Aid Policies The EU state aid policies have had a very substantial impact on banks that have re- 10.61 ceived state aid during the crisis of 2008 and later years. Unprecedented amounts of State aid were given in these years: more than 10% of EU GDP.65 Tough measures such as divestments and deleveraging were imposed on beneficiaries of state aid; beneficiaries were forced to undergo fundamental restructuring with the aim to ensure their long term viability. A form of burden sharing was imposed to curtail as much as possible future moral hazard issues; this entailed that a heavy price was to be paid for receiving state aid (in certain instances the terms imposed included debt service levels exceeding commercial levels), and that restrictions were imposed on dividend and coupon payments. Market conduct restrictions were also imposed to prevent distortion of competition. The EU State aid policies have been laid down in various so- called Crisis 10.62 Communications. Successively, the ‘2008 Banking Communication’, the ‘Recapitalization Communication’, the ‘Impaired Assets Communication’, the ‘Restructuring Communication’, the ‘2010 Prolongation Communication’ the ‘2011 Prolongation Communication’ and the ‘Banking Communication’ were issued by the EU Commission, showing an evolution in the EU Commission’s policies in the context of the changeable circumstances of the financial markets in 2008 and following years.66 The Restructuring Communication67 is especially relevant to the topic of this chapter. It stipulates that: [B]‌anks in need of restructuring have to demonstrate strategies to achieve long-term viability without State support under adverse economic conditions. The Communication specifies in detail the type of information that is required to determine whether the

65 State aid is defined as measures where: (1) there has been an intervention by the State or through State resources; (2) the intervention confers an advantage on a selective basis; (3) competition has been or may be distorted; and (4) the intervention is likely to affect trade between Member States. State aid rules are based on art 107(3)(b) of the TFEU. Under these rules, approvals were given for support of more than sixty institutions in the EU. The State aid in this crisis period amounted to no less than 10% of gross EU GDP. In 2008, money at risk pledged by EU member States amounted to some €1,400bn. 66 The latest of the communications, the Banking Communication, is to be found online at . The references to the other communications can be found in footnote 1 of the Banking Communication. For a general overview of State aid rules published by the EU Commission, see online at . 67 [2009] OJ C195/9.

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Victor de Serière proposed restructuring measures are apt to restore a beneficiary’s long-term viability. The restructuring plan must include a thorough diagnosis of the bank’s problems, including a stress test to demonstrate that a restructured bank will be able to withstand adverse macroeconomic conditions, and details on impaired assets if applicable. That information is necessary to devise sustainable strategies for a return to viability. In some cases, divestments are not needed but in many cases they are essential, either to ensure viability of core businesses or to compensate the negative competitive impact of aid on key market segments. Additionally, banks under restructuring obligations, and their capital holders, should contribute to the cost of restructuring as much as possible with their own resources. Such burden-sharing is of paramount importance as it contributes to addressing moral hazard and to creating appropriate incentives for future behaviour. It is achieved primarily by temporary restrictions on payment of dividends and coupons on hybrid capital by loss-making banks. Where such burden-sharing is not immediately possible due to the market circumstances at the time of the rescue, it needs to be addressed at a later stage of implementation of the restructuring plan, for example through exceptional claw-back clauses. The restructuring should also include measures to limit undue distortion of competition caused by the aid. Tailor-made to the market circumstances of each case and to the scale of State intervention indicative of market distortion, measures to limit competition distortion may include divestments, temporary restrictions on acquisitions by beneficiaries and other behavioural safeguards. Where the immediate implementation of structural measures is not possible due to market circumstances (for example where finding buyers for divested assets is objectively difficult), the Commission can extend the time period for the implementation of those measures. They are designed not only to limit distortions between aided banks and those surviving and restructuring without State aid, and between banks in different Member States, but also to create conditions which foster the development of competitive markets. Therefore they focus on the overall national market structures and market opening, to avoid that the large number of simultaneous restructuring cases closes down national markets, and to preserve cross-border activities of banks. 10.63 This policy statement neatly coincides with then rapidly developing notions at the

level of the EU Commission as regards the need for bank recovery and resolution planning.

The restructuring of ING Groep NV imposed by the EU Commission as a condition to approving the state aid packages consisting of a €10bn capital injection that ING Groep NV received in 2008 and a State back-up facility assuming the risk of a portfolio of so-called Alt-A mortgages, provides a graphic example of the fundamental radical impact that application of the EU State aid policies can have.68 To a large extent, the aims of these policies run parallel with and coincide with the underlying aims of requiring banks to be ‘resolvable’. Thus, from various different angles, the EU has provided a firm legislative basis on which to require banks to be resolvable.

68 The imposition of the strict measures imposed in respect of State aid given in 2008 was actually challenged by ING Group NV before the European Court of Justice, and this challenge was in part successful. For a summary of the state aid received by ING, see online at .

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Recovery and Resolution Plans of Banks It is noted that State aid rules and policies are of particular importance in the 10.64 context of so-called ‘precautionary recapitalization exercises’. Precautionary recapitalization is perhaps the most practically useful ‘tool’ that governments can apply in case of impending bank failure. Use thereof is permitted under Article 32(4)(d)(iii) of the BRRD subject to certain conditions. This chapter will not discuss these conditions; see the ECB publication, ‘What is a precautionary recapitalisation and how does it work’ dated 27 December 2016.69 Precautionary recapitalizations can only be effected if and as long as the institution concerned is still ‘solvent’, which is deemed to be the case if the institution still meets the Pillar 1 capital requirements and has not shown a shortfall under the baseline scenario of a relevant recent EBA stress test. Use of this tool is subject to approval of the EU Commission under the State aid rules, and of course such approval can be made conditional. An example of such conditionality can be found in the EU Commission’s approval of State aid granted to Banco Espirito Santo in August 2014; in a pre-BRRD resolution, healthy assets and liabilities of this bank were transferred into a new ‘good bank’ which received Portuguese state funding. In approving this funding, the EU Commission understandably imposed the condition that claims of shareholders and holders of subordinated and other hybrid debt that stayed behind in Banco Espirito Santo, the old ‘bad bank’, were not permitted to be transferred to the ‘good bank’. The EU Commission’s approval of State aid in this instance is currently the subject of prolonged litigation.70

IX. Bottlenecks Effective resolution planning needs to cope with a number of complex regulatory 10.65 and other issues. Probably the most important of these are the following. 1. Unknown Unknowns Resolution planning is by necessity based on past experience, in particular the 10.66 lessons learnt in relation to the crisis of 2008 and following years. The legislators and regulators by necessity drive forward looking in the rear view mirror. Though efforts are undertaken to tackle ‘known unknowns’, it is impossible to tackle Mr Rumsfeld’s so-called ‘unknown unknowns’. Do risks exist which have not yet been identified as being able to bring down a SIFI? Unlikely, since the past few years have seen a variety of failures or near failures, occurring in differing circumstances;

69 See online at . See also De Serière and Milione (n 16) 79ff. 70 See EU Court of Justice 7 November 2018, C-544/17 P. The introductory paragraphs of this judgement provide a clear summary of the resolution scheme adopted for Banco Espirito Santo: see online at .

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Victor de Serière the regulators’ expertise in this regard is (unfortunately) expanding. But there is no certainty. In particular combinations of adverse factors may prove to be the downfall of an institution. A multitude of mishaps are conceivable: large losses in the trading book, regulatory difficulties (particularly if fines are imposed and regulatory restrictions are put into place, undermining customer and stock market confidence), cases of severe fraud, large collective customer misspelling claims causing a dramatic fall of the stock price and rating agency downgrades, large loan portfolios becoming non-performing eroding the capital buffers, a forced write off of government debt paper held by an institution etc. Many of such events can be foreseen and anticipated upon well in advance, but not always. Large banking conglomerates generally appear able to absorb the consequences of heavy unexpected losses and/or hefty regulatory fines.71 But smaller institutions would seem rather more at risk. 2. Recognition and Accommodation by Foreign Jurisdictions and Courts 10.67 Resolution planning stretches across borders, also beyond the boundaries of the

Eurozone and the EU. How can it be ensured that European resolution measures are given effect to in other countries to which the BRRD/SRMR regimes do not apply? This is a vexing problem that seems impossible to definitively resolve (save perhaps on the basis of a treaty).72 The uncertainties complicate both resolution planning as well as any implementation of cross border resolutions. Transfers of assets and liabilities, terminations of contracts, restrictions on the exercise of contract rights, write off or conversion of creditor claims may all be part of any resolution plan, and could be subject to the laws of jurisdictions other than Member States. The absence of an internationally recognized rule of conflicts law that ensures that Union law will prevail is a serious stumbling block for any resolution plan with cross-border effect. And perhaps such a rule of conflicts law cannot realistically be achievable: this may be so simply because interests of other

71 To name a few examples: JPMorgan apparently comfortably dealt with the consequences of the ‘London whale’ episode. The loss of US$6.2bn was dwarfed by the bank’s 2012 profit of 21.3bn, according to Bloomberg: see online at . In the summer of 2015, BNPP pleaded guilty to sanctions violations and agreed to payment of a US$8.9bn fine; apart from the pain of the fine, BNPP suffered temporary restrictions on clearing dollar transactions and it restructured part of its trade finance business. Upon BNPP’s announcement how it would absorb the fine in July 2015, the BNPP share price rose 3%: see online at . In May 2015 Credit Suisse avoided withdrawal of its US license by admitting to regulatory violations and paying a hefty fine of US$2.6bn. Upon announcement to the market of how it would deal with this fine, Credit Suisse stock rose 2.2% according to Reuters: see online at . 72 See, comprehensively, Berends, ‘Why overriding mandatory provisions that protect financial stability deserve special treatment’, NTIR 2014. See also Lehmann, ‘Bail-in and Private International Law: How to Make Bank Resolution Measures Effective Across Borders’, (2017) 66(1) International and Comparative Law Quarterly.

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Recovery and Resolution Plans of Banks countries than those of the European Union under whose laws a resolution must be accomplished, have legitimate diverging interests of their own to be observed. Two brief simplified examples may illustrate the difficulties one faces: (1) An 10.68 EU bank has entered into a series of derivatives with a US counterparty. The derivatives are governed by NY law and the courts in NY have jurisdiction.73 Under the law applicable to the EU institution, a temporary stay on early termination rights is imposed in the context of resolution,74 and the right of the US counterparty to receive the termination payment (assuming the derivative positions are ‘in the money’ for them) is bailed in. Why would a NY court endorse such temporary stay and subsequent bail-in? One might be inclined to assume that NY courts would agree that the resolution measures are taken pursuant to ‘overriding mandatory provisions of law’ and would exercise ‘comity’, but is it certain that this would indeed be the final outcome of litigation on the matter? This may be particularly pertinent where the consequences of the EU resolution measures severely affect the US counterparty’s financial situation. It will not always be a given that the interests of resolution should take precedence over the interests of the affected counterparty. There may also be a contagion risk to be taken into account here. (2) In the context of resolution, assets of the EU institution are transferred into a ‘bad bank’ or a ‘good bank’. This may include assets situated in a non-EU country. If such transfer would under the law of that non- EU country be invalid unless advance regulatory approvals in that country are granted, can it be expected that the interests of the resolution will take precedence over the interests of that non-EU country? Particularly if the allocation of those assets is important to the non-EU country concerned (eg, if such transfer affects the financial position of local branch offices or subsidiaries of the failing institution), it is not a foregone conclusion that the consequences of a resolution under Union law will be accommodated. There is some limited practical experience with these issues. The pre-BRRD take- 10.69 over by the Dutch State of Fortis Bank Nederland was accomplished without any regard to non-Dutch regulatory approval requirements in relation to overseas activities of this bank. These approvals were ex post facto applied for. In most countries ‘comity’ was given without much ado. In this instance, ‘local’ regulators showed understanding and accommodated the applications (a process that took the better part of a year to complete). But the foreign operations concerned did not have systemic impact in the jurisdictions concerned, so one cannot really draw conclusions from this experience. A similar outcome was enjoyed in the case of the resolution of Banco Popular Espanyol, where certain overseas assets of that

73 In this connection it is noted that in the context of insolvency proceedings one increasingly sees that courts in eg the US and the UK are happy to assume jurisdictional competency also in cases where the connectivity to the jurisdiction in question is meagre. 74 See art 68ff of the BRRD.

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Victor de Serière bank came under the control of Banco Santander as a result of the shares in the bank being transferred to Banco Santander.75 10.70 There is no guarantee that such accommodations will always be forthcoming, and

there is certainly no guarantee that non-EU local courts would be agreeable to recognize foreign intervention measures. This is in particular relevant when the sale of business tool, the asset separation tool, the bridge institution tool, and/or the bail-in tool in combination with a business reorganization are being applied as contemplated by Articles 37ff of the BRRD.

10.71 To a certain extent, the issues raised in this paragraph are addressed by art. 55

BRRD.76 As of 1 January 2016 banks are required to include contractual clauses in any agreements governed by the laws of non-EU Member States designed to ensure recognition of the bail-in tool under the BRRD. This purports to ensure the effectiveness of bail-in in any cross-border resolution situation. By virtue of such clause the non-EU counterparty of the institution to the agreement creating the liability recognizes that the institution’s liability under the agreement concerned may be subject to write-down and conversion under Union resolution rules. The non-EU counterparty ‘agrees to be bound by any reduction of the principal or outstanding amount due, conversion or cancellation that is effected by the exercise of those powers by a resolution authority’. The broad scope of Article 55 of the BRRD (and the potentially broad scope of the bail-in tool) means that any contract with a non-EU counterparty by virtue of which a bail-in-able debt may be created must contain such a clause; this creates an unnecessary burden on EU banks when contracting with counterparties, especially if it concerns contracts with suppliers to cover routine operational needs. A de minimis exception is in practice being applied by regulators in member States, and efforts are underway in Brussels to formalize such exception.

10.72 Brexit will mean that the UK will become a non-EU Member State for the purposes

of Article 55.77 This Chapter will not discuss this issue. Recently adopted UK legislation, i.e. the Bank Recovery and Resolution and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018,78 aims to ensure that the BRRD regime will largely continue to operate as before between the Union and the UK. In any event, going forward so-called ‘Article 55 bail-in clauses’ will have to be included in contracts with English counterparties where claims are subject to write off or conversion risk as a result of bail-in under the Union resolution regime (or, conversely, as a result of bail-in under the separate comparable UK resolution regime); financial markets practice is already taking this into account. See Chapter 12 for a discussion of the Banco Popular Espanyol case. 76 See also art 44 Commission Delegated Regulation (EU) 2016/1075 (n 50). 77 See, inter alia, Kilapakkam and Kleftouri, ‘The “Bail-in Clause”: Purpose, Effects and Potential treatment in the UK after Brexit’ (2019) 34(2) J.I.B.L.R.. 78 Available online at . 75

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Recovery and Resolution Plans of Banks 3. Third Parties’ Private Law Rights Implementing resolution plans affect third party private law rights. There may thus 10.73 be a clash between the ‘public law’ under which resolution plans are implemented and the ‘private law’ interests of the counterparties of the bank concerned. It will not always be clear that the ‘private law’ interests should be the victim of that clash. In many instances, Union law and national laws governing resolution will have taken these ‘private law’ interests adequately into account, in particular where compensation rights are concerned, but there will undoubtedly also be instances where ad hoc solutions will need to be found. 4. NCWO Application of the ‘no creditor worse off’ (NCWO) principle79, as contained in 10.74 Artile 34(1)(g) of the BRRD: No creditor shall incur greater losses than would have been incurred if the institution or entity [. . .] had been wound up under normal insolvency proceedings in accordance with the safeguards in Articles 73 to 75.80

The same language is used in Article 13(1)(f ) of the SRMR. The principle is of course for reasons of fairness fundamental to any resolution 10.75 outside of normal insolvency proceedings, and for that reason it is expressis verbis included in the EU legislation as well as in most national laws that regulate bank resolution.81 But the principle is difficult to apply in practice. At the time resolution is decided upon, there is no way in which a reasonably dependable determination can be made of what creditors would have received in insolvency. In case of a relatively small institution it is already a complicated exercise to make approximations, but with large international banks this is practically impossible. Difficulties one would encounter here include the following (in random sequence): (1) How to determine what secured creditors would have received if their security coverage was insufficient? This obviously depends on the proceeds of foreclosure on the security concerned, and the amount of such proceeds will very much depend on the circumstances and market conditions during the

79 See, inter alia, World Bank Group Report dated April 2017, entitled ‘Understanding Bank Recovery and Resolution in the EU: A Guidebook to the BRRD’, 139ff, available online at . See also De Serière and Van der Houwen, ‘ “No Creditor Worse Off” in resolution: food for litigation? (2016) 7 J.I.B.L.R. 376ff 80 Articles 73–75 of the BRRD referred to here prescribe a separate valuation for the purposes of assessing whether shareholders and creditors would have received a better treatment if the institution under resolution had entered into normal insolvency proceedings. 81 See also paras 5.1 and 5.2 of the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions (n 5).

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Victor de Serière period foreclosure is being realized. Foreclosures might take years after the hypothetical bankruptcy date. (2) How to determine what claims arise under derivatives contracts? This very much depends on the time of the termination, and the value of collateral posted at that time. But it can be very unclear at the outset of the resolution process what the exact termination date and the exposure amount is for the purposes of the calculation of claims under the contracts concerned. (3) What creditors would receive very much depends on the proceeds of divestment of assets by the bankruptcy trustee (assuming that he would wish to undertake such divestment in lieu of a run-off; see point (4) below). The divestment process, particularly in the case of the unwind of a bank, is likely to take years to complete. There may meanwhile be significant swings in asset values, possibly significantly affecting the outcome of divestment. (4) A bankruptcy procedure for a bank may take a significant number of years to complete. Particularly if a bank has a sizable portfolio of retail or commercial mortgage loans with long maturities (in case of mortgage loans sometimes extending to twenty to thirty years) and perhaps also other loan portfolio’s which generate profits over time, it may well be in the interest of the bankrupt estate of such bank to await the maturity of such assets rather than to sell these at large discounts; the end result could be that the bankruptcy process takes many years to complete but that creditors and holders of debt issued by the failed institution ultimately may not suffer a significant loss on their investment, and may even recoup their claims. An important factor here is that (at least under Dutch bankruptcy law82) interest on unsecured debt is not recognized to the extent accruing as from the date bankruptcy was pronounced. Post-bankruptcy interest would only become payable if there is a surplus at the end of the road. Effectively this may mean that an insolvent bank ironically gets a significant boost in terms of distributable income: no interest is payable on the funding of that bank as of the bankruptcy date, but the bank continues to earn the full contractually agreed interest on its loan portfolios. Longwinded bankruptcies could thus conceivably end up positively for creditors and debt holders of banks. This could mean that the claims of both subordinated and concurrent creditors are paid in full in so far as their nominal value is concerned, whilst both categories of creditors have to suffer losses on their interest claims.83 Even if, other than under Dutch law, interest

82 Article 128 of the Dutch Bankruptcy Act. Other Member States’ bankruptcy laws may differ, allowing for post-bankruptcy accrued interest to be counted as part of the debt recoverable from the bankruptcy estate. 83 The Dutch bankruptcy of DSB Bank NV is a case in point. The bankruptcy trustees expect that creditors can expect to be paid 100% of the nominal value of their claim, therefore suffering losses only on their post-bankruptcy accrued interest claims. See the 2018 report of the bankruptcy trustees, available online at (in Dutch).

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Recovery and Resolution Plans of Banks accruing post-bankruptcy is recognized as a claim that may be submitted in the bankruptcy proceedings, the end result could be that investors recoup the principal amount of their claims; this could conceivably be the case if the margin between funding costs and interest income received is significant. Such end result could run contrary to the insolvency ladder prescribed by Article 34(1) of the BRRD. It could also possibly mean that bail-in inevitably results in a sizable NCWO claim of creditors.84 In this regard, it must be taken into account that payment of NCWO claims will be funded by the Resolution Fund.85 Ultimately, the bill would be payable by contributing Eurozone banks.86 The BRRD/SRMR resolution regime does not take this possibility into account. An added complication is that it is doubtful whether a resolution scheme can be decided upon by a resolution authority if there is no certainty that creditors would actually suffer losses on their claims. (5) A further complicating requirement for an NCWO evaluation is also that (previously granted) State aid must be disregarded. See Article 74(3)(c) of the BRRD and Article 17(18)(c) of the SRMR. This requirement forces the adoption of various complex assumptions as to what would be the hypothetical situation of the bank concerned if no State aid had been forthcoming. Obviously, this is not simply a question of deducting the amount of State aid from the own funds of the failed institution and extrapolating the result over the operating results of the institution concerned during the period ending on the resolution date. How to take all these complicating factors into account when applying the NCWO principle? It is, as stated, impossible to make NCWO calculations in advance of structuring a resolution. At best, one has to work with guesstimates, which will need, ex post facto, to be verified. This means that there is, during the process and probably for a long period of time after the resolution has been

84 A comparable situation arises in respect of the nationalized claims of holders of subordinated debt of SNS Bank NV. Whilst it was at the outset assumed that these claims would have to be fully written off in a bankruptcy scenario, and that therefore holders of these claims would not receive any expropriation compensation, a scenario involving a long run-off of this bank could arguably lead to a different valuation. See the Experts Valuation Report dated April 2018, available online at (in Dutch). Interestingly enough, in the NCWO valuation that Deloitte made in the case of Banco Popular Espanyol, Deloitte adopted the premise that a run-off longer than seven years would not be acceptable to bailed-in creditors (see n 88). See Chapter 12 for a discussion of this case. 85 Article 76(1)(e) of the SRMR. This only applies to NCWO claims that arise in the context of resolution of Eurozone banks. Otherwise, the financing arrangements under arts 99ff of the BRRD apply. The limited size of the Resolution Fund is definitiely an issue here, even given the fact that ECOFIN ministers have proved to be willing to arrange that back-up Loan Facilities are extended by Eurozone Member States to the Fund to cover at least initial shortfalls. See online at . 86 Article 67(4) of the SRMR.

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Victor de Serière carried through, a significant amount of uncertainty as to the magnitude of claims that remain to be settled.87 More guidance from the EU legislators (or the EBA) would be welcome! 5. Critical Functions 10.76 Resolution requires an ex ante determination of what are critical functions. The

critical functions determine how a resolution is to be structured, and may also be determinant in the ex ante context of resolvability. The basic premise is that the continuity of critical functions exercised by the failing institution in the relevant jurisdiction is to be safeguarded. But what a bank or its resolution authorities regard as a critical function for a certain bank in Member State A may be quite different from the characterization in respect of another bank in Member State B. So there can, at least in theory, be a conflict of determinations. Such conflict may lead to distortions of the level playing field. The FSB and EBA have given descriptions as to what functions may be seen to be critical, and these will of course help harmonize the concept.88

10.77 The determination of whether or not a certain activity of a bank qualifies as crit-

ical must not be confused with the issue of risk allocation to certain banking operations. A critical activity consisting of hedging operations to mitigate funding disparities or other risks associated with ‘traditional banking’ may well be considered a critical function but would possibly carry significant risk. Accordingly, the notion that a separation of critical functions’s from non-critical functions’s in a bank would mitigate the risk profile of a bank is probably only partially true. A not so easy to resolve ‘technical’ issue which a resolution plan must address is whether it will be necessary to carve out non-CEA activities or whether these can be ‘run off’ without being separated from the surviving bank or bank group.

87 In the case of Banco Popular Espanyol (see Chapter 14) the NCWO valuation report prepared by Deloitte, often referred to as the Valuation 3 Report, was made available to the SRB in June 2018 (one year after the resolution date). Subsequently a non-confidential version of that report was made available to interested parties, and the SRB commenced a public hearing on the report, to be held in November 2018. The public hearing procedure was deemed necessary their right to be heard pursuant to Article 41(2)(a) of the Charter of Fundamental Rights of the European Union. A final decision on the NCWO determination was to the knowledge of this writer not yet made by the SRB at the time of writing this chapter. See online at . 88 The FSB has published a chapter, Guidance on Identification of Critical Functions and Critical Shared Services, dated July 16 2013, available online at . On 6 March 2015, the EBA published a report entitled ‘Comparative report on the approach to determining critical functions and core business lines in recovery plans’, available online at . The role of critical functions in resolution planning is set out in some considerable detail in Commission Delegated Regulation (EU) 2016/1075 of 23 March 2016.

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Recovery and Resolution Plans of Banks 6. SPE/MPE Resolution planning may take a Single Point of Entry (SPE) or a Multiple Point 10.78 of Entry (MPE) approach.89 The SPE approach means that if a bank threatens to fail, the resolution mechanism to be applied is determined by the supervisory authority of the ‘home country’, ie the country where the bank (or the bank holding company) has its headquarters, and that determination is in principle to govern the resolution process also in other jurisdictions. This approach also assumes that the ‘bulk’ of resolution measures is de facto to take place in the home country. The MPE approach on the other hand uses the basic premise that the resolution measures will need to be taken primarily in the jurisdiction where the problems that threaten the continuity of the bank in question arises. This does not necessarily mean that the resolution authority in that jurisdiction is to take the lead; the home country authority could also determine the resolution measures to be taken. Obviously, where more jurisdictions are involved the various competent resolution authorities must act, necessarily in co-ordination with each other. Over the past few years, there has been a prolonged debate on the pros and cons 10.79 of both approaches. In the US the debate was finally decided in favour of the SPE approach, evidently due to, inter alia: (1) the more centralized federal supervisory system in place; (2) the fact that US SIFI’s and their principal activities are to a very large extent US based; and (3) US banks having, mainly for historical reasons, a top bank holding company structure allowing ‘thick’ layers of loss absorbing equity and unsecured debt to be in place at that bank holding company level.90 In Europe the debate has not really yet been concluded.91 The debate is ‘tainted’ by various factors, including: (A) Uncertainty at the level of national resolution authorities as to the way they might be expected to deal with ‘local’ interests as opposed to ‘overriding general interests’ in case a conflict between the two should exist or be perceived to exist (the ‘national bias’ problem). The SRMR has resolved this issue to a certain extent, but of course only as regards the Eurozone resolution authorities. (B) A similar uncertainty at the level of banks as to the manner in which the resolution authorities in the various jurisdictions may be expected to co-operate and respect each other’s local interests.92 89 See, inter alia, FSB chapter entitled ‘Recovery and Resolution Planning for Systematically Important Financial Institutions: Guidance on Developing Effective Resolution Strategies’, dated 16 July 2013, 12ff; Valentina Caria, ‘Treatment of Cross Border Groups’ in Wessels and Haentjens (eds), Bank Recovery and Resolution, A Conference Book (Eleven Publishing 2014). 90 Reference is made to Chapter 16. 91 See Chapter 16, p. 617. The supervisory authorities referenced there make a strong case for SPE strategies, as do Gordon and Ringe themselves. See also Schoenmaker (n 45), 90ff. 92 Graphic examples of co-operation difficulties are illustrated in Schoenmaker (n 45), 69ff.

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Victor de Serière (C) The uncertainties mentioned above are to a certain extent ‘fuelled’ by the complex consultation processes that the BRRD and particularly the SRMR prescribe to be necessary in arriving at resolution decisions. See for instance the elaborate provisions on the process of deciding on a resolution scheme in Artices 16 and 16a of the SRMR. That nevertheless an SRB decision on a resolution scheme may be effected timely and efficiently (at least in relatively benevolent factual circumstances) is illustrated by the Banco Popular Espanyol case.93 (D) The absence of burden sharing arrangements. This issue is discussed below. (E) If it is to be assumed in resolution planning that local restrictions will prevent the ‘sharing’ of liquidity and funding between separate banking entities within the same group, this may seriously affect the ability of separate entities to survive on a ‘stand-alone’ basis.94 Excess capital and excess liquidity may well not be transferable from one part of a banking group to another. (F) The risk of contagion. A failing subsidiary that could in theory be resolved using an MPE strategy could through contagion (reputation risk, exacerbated by perhaps other weaknesses elsewhere) spill over into the bank group as a whole. (G) Significant variations in the way banks are organized. A number of institutions use a structure whereby operations in various jurisdictions or regions are organized on a ‘stand alone’ basis, often with independent capitalization and other funding of their own. Others appear more to be in favour of a centralized approach, which would mean that foreign operations take the form of branch offices rather than independent legal entities. 10.80 The choice between an SPE and an MPE approach must basically be made by

the resolution authority concerned, but that choice is to a significant extent determined by the way in which the bank concerned is organized and capitalized. There may well be a divergence between the choice made in the resolution plans themselves and the choice that eventually needs to be made when resolution must be implemented. Given that resolution plans are in practice arrived at in close co-operation between the bank in question and its resolution authority, the bank concerned may be able to exert some influence over that choice. In case a bank has sufficient loss absorption capacity at the holding level and that capacity can be made effectively available to refinance loss making banking subsidiaries, the SPE approach may be preferred. Indeed, as Gordon and Ringe convincingly argue in Chapter 16 of this book, the SPE approach has the great practical advantage that multi-jurisdictional issues could largely be avoided. Where stand-alone entities in particular jurisdictions or regions sail into stormy weather and have their own See nn 39 and 41. 94 See, for instance, art 8 of the CRR for limited possibilities of applying liquidity requirements on a consolidated rather than on a solo basis. 93

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Recovery and Resolution Plans of Banks loss absorption capacity, an MPE strategy may however conceivably be better workable. An MPE strategy may have the advantage of ‘localising’ the problem, assuming that the contagion risk can be contained (probably a big ‘if ’). As the FSB rightly points out: There is no binary choice between the two approaches. In practice, a combination might be necessary to accommodate the structure of a firm and the local regimes in the key jurisdiction where it operates. For example, some MPE strategies may involve applying multiple SPE resolutions to different parts of the firm, for example regional blocs that are separable from one another.95

When the Dutch supervisory authorities commenced discussing resolution plans 10.81 with the high street banks in the Netherlands in 2013, they initially required resolution planning preparations to be based on both an SPE and an MPE approach—thereby placing these institutions in a difficult predicament. It is difficult to exaggerate the complexities of that choice in resolution strategies for large global SIFIs such as Citibank or HSBC. Over the past few years, there has been an interesting development in the banking 10.82 sector in this connection. On the one hand one has seen, in the wake of the 2008 banking crisis, a retreat of larger European banks to their own shores or their own regions. (This trend appears now to be less marked, and institutions are again looking at wider horizons.) At the same time we have seen stricter regulation in the ‘host jurisdictions’ of cross-border activities of banks. This coincides with the policy of some international banks to let their overseas operations fly their own flag in terms of independence and funding. On the regulatory front, European supervisory authorities have expressed and tried to impose a preference for subsidiaries rather than branches. (It is of course not possible to impose this preference on EU banks using EU passports.) In case of branches of non-EU banks, some countries (eg Germany) are currently imposing regulatory requirements on branches fully as if they were stand-alone subsidiaries. At the same time, one sees increasing regulatory restrictions on the ability of banks to extract liquidity from their overseas branches, whether within or outside the EU. The trend towards greater independence and self-supporting capacity of cross- 10.83 border operations can be regarded, from a use of capital and funding opportunities viewpoint, as inefficient.96 The question arises whether these inefficiencies may be regarded as an acceptable price to pay for the benefit of spreading risk and perhaps easier ‘resolvability’? From a local supervisory standpoint, the subsidiary

See n 92, the FSB chapter at 13. 96 See Schoenmaker (n 45), 65ff. See also Cerutti, Dell’Áriccia, and Martinez Peria, ‘How Banks Go Abroad: Branches or Subsidiaries’ [2007] 31 (6) Journal of Banking and Finance 31, 1669–92; and Cerutti, Makarova, and Schmieder, ‘Bankers Without Borders? Implications of Ring-fenCing for European Cross-Border Banks’, IMF Working Paper No WP/10/247. 95

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Victor de Serière approach would anyhow be preferable as it strengthens their supervisory remit and control. 10.84 Further discussion of this dilemma is beyond the remit of this chapter.

7. Confidentiality Considerations 10.85 Maintaining confidentiality is key to any resolution. Prior to resolution taking

effect, confidentiality is a sine qua non for effective resolution.97 If the market has realized that recovery is no longer on the cards but resolution is the remaining option prior to parties concerned being ready to carry out the required resolution scenario, market forces more likely than not will ‘take over’ and this might well result in a rather more chaotic and rather less effective resolution of the SI institution in question. The risk of such market reaction is perhaps exacerbated by the increased likelihood that any precautionary measures and preventive resolution measures, if public, are seen to be the precursors to inevitable resolution schemes being put in place.

10.86 The BRRD embraces the notion that as a precursor to resolution a private re-

covery solution should and will be attempted if and when the relevant recovery triggers have occurred. A private sector solution, be it a rights issue or issue of hybrid instruments together with implementing a divestment program and/or isolation of toxic assets, is of course impossible without the market realising what is going on, and this means that the market is already ‘on full alert’ as to what may happen if the private sector solution for one reason or another does not materialize or does not provide an adequate remedy. This also applies if a government would resort to a so-called ‘precautionary recapitalization’ on the basis of Article 32(4)(d)(iii) of the BRRD.98

10.87 The impression of this writer is that legislators, regulators and market parties are

as yet not fully geared up to dealing with this issue.99 Confidentiality requires detailed advance planning and organization, both at the level of the supervisors and at the level of the bank concerned. Any recovery/resolution plan should ideally address this issue in full detail (including in relation to adherence to relevant Union market abuse rules; see 10.89 ff below). Advance planning may seem a bit

97 For instance, the alleged leakage of SRB concerns regarding the woes of Banco Popular Espanyol may have contributed to the then occurring large scale withdrawal of deposits. See F Guarascio, ‘Exclusive: EU Warned of Wind-Down Risk for Spain’s Banco Popular’ Reuters (London, 31 May 2017), available online at . 98 See, inter alia, Olivares-Caminal and Russo, ‘Precautionary Recapitalisations: Time for a Review’ (July 2017), to be found on the website of the European Parliament; Véron, ‘Precautionary Recapitalisation: Time for a Review?’, Bruegel Policy Contribution, No 2017/ 21; Mesnard, Margerit, and Magnus, ‘Precautionary Recapitalisations under the Bank Recovery and Resolution Directive: Conditionality and Case Practice’, briefing for the European Parliament 5 July 2017. 99 See art 74ff of the BRRD, in particular art 76. See also art 79ff of the SRMR.

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Recovery and Resolution Plans of Banks like the periodic office fire drill: you recognize that it may perhaps be useful, and though you are sceptical and annoyed at the work-disruption, the waste of time and the piercing fire alarm, you participate because everybody expects you to. But when a fire actually does break out . . . Once the bank ‘closes its doors’ temporarily during the proverbial resolution 10.88 weekend to permit a resolution scheme to be decided upon and carried out, confidentiality is no longer an issue: the market then knows that the institution is to be resolved. The need for confidentiality is then largely replaced by the need for speed. To avoid unnecessary market confusion, it will be of fundamental importance to inform the market as soon as practically feasible what measures are going to be taken. 8. Confidentiality and Market Abuse Public companies’ disclosure requirements pose a dilemma from two different 10.89 angles. Firstly, European legislation and national rules on stock market conduct require publication forthwith of inside information which directly concerns the institution (Article 17 of the MAR.100 Article 17(4) will permit institutions, on their own responsibility, to delay disclosure if immediate disclosure ‘is likely to prejudice the legitimate interests’ of the institution, provided that the delay is not likely to mislead the public and the confidentiality of the information concerned can be assured. Clearly, the condition ‘not likely to mislead the public’ is a difficult hurdle to overcome. In particular when an institution is in dire straights, withholding information relevant to either or both of creditors and shareholders of that institution seems more likely than not to be misleading. Where there is a genuine risk that disclosure will have unpredictable unfavourable (possibly systemic) consequences, one could imagine that the supervisory authorities will be more easily inclined to deem this condition fulfilled (perhaps on the basis of a reasonable expectation that recovery or restructuring efforts will eventually be successful). Article 17(5) of the MAR provides a specific exemption for situations where dis- 10.90 closure ‘entails a risk of undermining the financial stability of the institution concerned and of the financial system’ (italics added) and where it is ‘in the public interest to delay the disclosure’. The exemption is only available if: (a) confidentiality of the information can be assured; and (b) the competent supervisory authority has given its prior consent to the delay, having been satisfied that all conditions are fulfilled. There is a twist to this consent requirement: if consent is not given, the information concerned must be disclosed ‘immediately’. Not

100 Regulation (EU) 596/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72 [2014] OJ L173.

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Victor de Serière only does this requirement put some considerable pressure on the supervisory authority concerned (within a short time span it will need to make a difficult assessment of the practical consequences of immediate disclosure101), it also poses a serious dilemma for the institution concerned. That dilemma might conceivably cause an institution not to opt for this exemption but to resort to the delay option offered by Article 17(4) of the MAR discussed above. 10.91 It is noted, in conclusion, that because of the ‘ public interest’ condition, the ex-

emption of Article 17(5) of the MAR would not be available in case of threatening failures of smaller banks (perhaps unless there is a threat of contagion). Smaller quoted banks are thus faced with a real difficulty if the delay option offered by Article 17(4) of the MAR would not be available to them.

10.92 The second angle relates to the prohibition of market manipulation. Once an

institution is known to be sailing in stormy weather, it will often be paramount that public confidence in its continuity be maintained. Obviously a severe tension may arise between market abuse requirements that the public should not be misled on the one hand (Article 12(1)(c) of the MAR), and the practical need to assure clients and shareholders that there is no cause for undue concern on the other. This need in particular arises during the period when recovery efforts are underway. Public disclosures by embattled institutions have a tendency to paint a more rosy picture than is objectively warranted. In the months preceding the takeover by the Dutch State of Fortis Bank Nederland NV, press announcements by management and by the Minister of Finance were acted upon by investors claiming that soothing public statements made had led them to believe that the bank’s position did not warrant divestment or discourage investment. In connection with this case, the question arose whether the Minister of Finance could invoke justification102 on grounds of Dutch tort law against damages claims of investors, and whether Union law, in particular the principle of effectiveness, would permit this line of defence. Legal doctrine is divided on this issue.103 This paper will not discuss this issue in any detail.104 The point being made here, as, 101 The gravity of that assessment is underscored by the requirement of art 17(6) of the MAR that the prudential supervisor must be consulted. 102 In Dutch legal terminology: rechtvaardigingsgronden. See art 6:162(2), in fine, of the Dutch Civil Code. 103 See, inter alia, Busch, ‘Civielrechtelijke gevolgen van een schending van de Verordening Marktmisbruik’ in Busch et al (ed), Handboek Marktmisbruik (Wolters Kluwer 2018) 480ff; see also the advice (in Dutch) of the Advocate General Timmerman preceding HR 30 September 2016, NJ 2017/47; Busch, ‘Private Law Enforcement of the Market Abuse Regulation in European Law’ in Ventoruzzi and Mock (eds), Market Abuse Regulation: Commentary and Annotated Guide (OUP 2017) 99ff. 104 It is noted that Busch (n 104, 488) recommends that the MAR is made to contain an exception to the market manipulation rules to the effect that disclosures made in the context of recovery and resolution would not be considered market manipulation. Drafting a statutory exception in such manner that no unjustifiable discretion is granted to the failing institution, its shareholders or supervisors would however be a daunting task indeed.

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Recovery and Resolution Plans of Banks inter alia, borne out by extensive litigation following the Fortis Bank collapse in the Netherlands in 2008, is that confidentiality and disclosure issues are a minefield in the context of recovery and resolution. Although it is evidently difficult to anticipate on a disclosure strategy in a recovery or resolution plan, it does seem advisable at the very least to set out the basic confidentiality rules as well as disclosure do’s and don’ts in such plan. These things are best not left to be handled at the time the ship is tilting and about to sink, with commensurate surging stress levels. 9. Regulatory Hurdles If a resolution arrangement consists in part of a separation of toxic assets and 10.93 liabilities and/or of assets and liabilities that do not comprise ‘critical economic activities’, it may well be that the ‘bad bank’ where these assets will be parked will be an entity requiring a license as a credit institution. The effectiveness of a resolution arrangement should not be delayed because of having to deal with a license application and compliance with other regulatory rules (scrutiny of Board members as to suitability and trustworthiness, etc). It would appear that Article 66 of the BRRD would generally require member States to issue exemptions, but the exact scope of Article 66 is not quite clear in this respect. Article 40(9) and (10) of the BRRD provides some relief, and Article 41(1) in fine of the BRRD provides for waivers of bank license requirements (but appears to leave it to the national regulators to decide whether or not such waiver is appropriate). Regulatory hurdles may also exist in other aspects of a resolution arrangement. 10.94 Normally, transfers of significant chunks of assets and liabilities by a bank will require regulatory consent, as will the divestment of a subsidiary, a merger or other type of reorganization. Within the EU, it may safely be assumed that regulatory consent requirements will not be a major stumbling block, but outside of the EU it is another story; it is not a given that non-EU (or non-Eurozone) authorities would easily accommodate resolutions, particularly not if local interests are at stake. See also paragraph (ii) above. 10. Burden Sharing Considerations The term burden sharing has different meanings depending on the context. It can 10.95 relate to the notion that shareholders and creditors should share in the burden of recovery and resolution by way of bail-in. It can also relate to the sharing of the burden of bail-out costs among states where the failing institution concerned conducted its activities. Burden sharing considerations in the context of bail-in arise not only in resolution, but also in the recovery phase: precautionary recapitalizations require EU Commission consents under State aid rules, and the EU Commission requires that the aid beneficiary (meaning the institution concerned and holders of its capital instruments) provide ‘an appropriate contribution 447

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Victor de Serière to restructuring costs’.105 As the various Commission Communications on this subject do not quantify the term ‘appropriate contribution’, it is difficult to assess how this requirement would translate in a given situation of a near failing bank.106 In the case of Banca Monte Paschi di Siena, subordinated bondholders were made the ‘victim’ of the burden sharing principle; the conversion of their claims of course also struck a dilutory blow at shareholders. 10.96 The notion that a resolution can be carried out without financial support of

Government is in the view of this writer generally unthinkable (except possibly in the case of smaller regional banks); at least a measure of bail-out seems unavoidable. But if financial support is to be given, the question arises who (ie, tax-payers from which country?) are to suffer. In past State aid and resolution arrangements, burden sharing between States was not achieved, and as a result States have taken on burdens that, at least arguably, should in whole or in part have been assumed elsewhere or at least shared. The bail-out of the Dutch Government in 2009 in relation to the investments by US insurance subsidiaries of ING Groep NV in so-called Alt-A securities is an example. It is not necessarily ‘logical’ or ‘just’ that the risk of the support granted (by way of a complicated back-up arrangement) should have been borne by the Dutch Government. The bail-out by the US Government of AIG is another example. Why should the US Government bear the costs of bailing out AIG thereby enabling AIG to comply with its commitments under credit default swaps entered into with European banks? It is not necessarily ‘logical’ or ‘just’ that US tax payer money should be used for the benefit of European banks. Conversely, one may question the bail-out of Dexia at the expense of Belgian and French taxpayers, inter alia, enabling this bank to honour its commitments under credit default swaps it had entered into with US counterparties. The default position for want of better arrangements between governments appears to be that the country in which the main prudential supervisory function is being carried out in respect of the bank or bank group concerned should carry the bail-out burden, probably loosely based on the premise that it is principally the responsibility of the main supervisory authority concerned to prevent a bank failure from occurring. Though this view holds the advantage of simplicity in approach, the logic and the fairness of this approach is unconvincing. This is a problem for which no solutions are readily available. Broad principles for burden sharing could perhaps be set out in protocols between governments and

105 Commission Communication on the return to viability and the assessment of restructuring measures in the financial sector in the current crisis under the State aid rules [2009] OJ C195/9. See also Commission Communication on the application of State aid rules to support measures in favour of banks in the context of the financial crisis (‘Banking Communication’) [2013] OJ C216/ 1. See also nn 66 and 67. 106 However, The Commission has further narrowed down the measure of burden sharing by shareholders and debt holders, in a fact sheet of 25 June 2017: see online at .

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Recovery and Resolution Plans of Banks their respective resolution authorities. It will be a daunting task to even formulate these broad principles. Such protocols should be set up in such a loose way that the authorities concerned are granted enough discretion to deal on a taylor-made basis with particular failing banks, but without thereby sacrificing the compulsion to arrive at ‘fair’ compromises. The question as to what is ‘fair’ is extremely difficult to answer, as the above mentioned AIG and ING examples already amply illustrate. This writer is not aware of any more or less successful attempts to arrive at such protocols. It is noted that the resolution of Dexia in France, Belgium and Luxembourg did accomplish a voluntary ad hoc burden sharing arrangement between these three countries; common economic drivers more than anything else seem to have enabled this arrangement. This Chapter will not discuss the burden sharing arrangements if the Single 10.97 Resolution Fund (with its backstop) or the ESM is to be used to cover resolution shortfalls.107 It is noted in conclusion that recovery plans may not take into account any access to or receipt of extraordinary public financial support (EPFS); likewise, resolution plans are not permitted to take into account EPFS except as specifically provided for in the BRRD/SRMR.108 One may well question whether these restrictions negatively affect the practical feasibility of recovery and resolution planning; on the other hand, making bail-out an intricate part of a recovery or resolution plan would be presumptuous and likely to be politically unacceptable.

X. Some Concluding Comments The complications that need to be addressed and resolved in devising effective 10.98 resolution planning are many. Below, I draw some conclusions in staccato format. (1) One cannot assume that resolution plans devised for SI institutions will be a workable blueprint for a resolution scheme. (2) However, this does not mean that making such plans is a theoretical exercise. Living wills have other and important rationales, the most important of which are: • They serve to provide information to the prudential and resolution authorities essential for deciding on preventive, preliminary and actual resolution measures under the SSM and the BRRD/SRMR.

107 For a summary of the limited possibilities of using ESM and SRF funds in this context, see Concetta Brescia Morra, ‘The New European Framework for Banking Crisis Management: Rules Versus Discretion’, a paper presented at the European Banking Institute conference of 21 and 22 February, to be published on the EBI website (available at ). 108 See arts 5(3), 10(3) and 100 of the BRRD; and art 8(6) of the SRMR.

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Victor de Serière • They provide a basis for resolution authorities to decide on whether ex ante measures ought to be taken in order to make an SI institution ‘resolvable’. Such ex ante measures might, at least in theory, involve substantial changes in the structure of SI institutions. These changes should be the result of intense consultation with the SI institution concerned, and the consequences of these changes should be thoroughly understood and assessed as to their workability prior to their imposition. • They force or encourage institutions to examine their operational structure from not only a risk perspective but also from a recoverability and resolvability viewpoint. • They require the focus to always be on the need to ensure continuity of critical economic functions of a bank. (3) The notion of a so-called ‘resolution weekend’, suggesting that very quick resolutory action is practically feasible, is misleading. Whilst the majority of bank failures can be seen coming and anticipated on in advance (vide Banco Popular Espanyol), a failure out of the blue cannot realistically be expected to be resolved quickly under the BRRD/SRMR, and resolution plans are unlikely to provide much practically useful guidance in such instances. (4) That recovery and resolution plans must assume that no EPFS will be provided, is a politically motivated and understandable requirement. Nevertheless, it makes planning unrealistic. At the very least liquidity support, but also perhaps more fundamental fiscal backstop support is likely to be required. (5) The uncertainties surrounding the recognition of resolution measures in cross border situations, especially where measures have impact in non-Member States, regretfully undermine the effectiveness of resolution planning. (6) Unless the ‘burden sharing’ issue among Governments is resolved for in case bail-out costs are to be shared, it will be difficult to ensure effective international co-operation between resolution authorities across borders, regardless whether an SPE or an MPE approach is taken. The burden sharing issue may not be of direct concern in the context of resolution planning itself, but as long as this issue is not resolved, effective international co-operation in achieving cross border resolutions seems elusive, and therefore significantly increases the complexities of planning.

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11 BAIL-I N Preparedness and Execution Anna Gardella*

I. Introduction II. Bail-in: Main Features III. Building-up Bail-in Preparedness: TLAC/MREL

11.01 11.06

11.12 1. Overview of the TLAC/MREL Regime 11.15 2. TLAC/MREL in Cross-border Groups: Prepositioning and Ring-fencing 11.34

3. Eligible Liabilities, Market Discipline, and Investor Protection 11.43

IV. Bail-in Execution

1. Data Requirements 2. Valuation 3. Securities Laws

11.49 11.50 11.52 11.56

I. Introduction Bail-in is the most emblematic tool of the resolution authority’s toolkit, it epitomizes 11.01 the resolution policy goals embodied in the Financial Stability Board (‘FSB’) Key Attributes of Effective Resolution Regimes for Financial Institutions1 (‘KA’) that have been implemented into the European system by Directive 2014/59/EU on the recovery and resolution of credit institutions and investment firms (‘BRRD’). For governments and policymakers, reacting to State bail-outs and preventing the socialization of costs of banks’ failures ranked high in the political agenda. The envisaged solution is the internalization of financial institutions’ losses and

Senior Legal Expert, European Banking Authority. The views expressed do not necessarily re* flect those of the EBA. I would like to thank my colleagues at the EBA for exchange of views on bail-in and TLAC/MREL topics. Mistakes are the author’s only. 1 Available online at , November 2011 (updated October 2014).

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Anna Gardella of recapitalization needs through the forced write down and conversion of capital instruments and eligible liabilities (‘WDCCI’). The WDCCI applies whenever a bank or an investment firm reaches the point of non-viability (‘PONV’) or meets the conditions for resolution. Bail-in, one of the four instruments—together with the sale of business, the bridge bank, and the asset management vehicle—of the resolution authority’s toolkit, goes beyond the WDCCI. Bail-in rests on the assumption that the internally resourced loss absorption and recapitalization capacity enables a financial institution to withstand financial distress and continue to operate as a going concern. Continuity of critical functions, maintenance of financial stability, loss absorption by shareholders and creditors first, and minimization of recourse to taxpayers’ money are the backbone of the resolution regime and of the political and regulatory plan to overcome too big-to-fail (‘TBTF’). 11.02 Despite embodying such generally supported objectives, bail-in is the resolution

regime’s most controversial tool and is subject to various criticisms. Academics, banking industry, and some policy makers point out that the tool suffers from intrinsic shortcomings such as its unsuitability in case of systemic crisis,2 the trigger of domino effects via cross-holdings of liabilities by financial institutions,3 need to be coupled by adequate liquidity framework,4 increase in banks’ funding costs, adverse impact on investors, in particular retail bondholders (often the same taxpayers that the regime intends to safeguard), and operationalization complexity. Recent practice where the tool has not been used and/or where general underpinning principles have not been followed through, have fueled a heated debate and challenged bail-in’s credibility. Among other things, the safeguard of senior creditors from write-down and the practice of public reimbursements of retail junior bondholders in those recent cases have made arguing that bail-in is a theoretical solution only.5

11.03 This chapter acknowledges that early (partial) execution practice where senior

bondholders have not been affected and retail shareholders and creditors have been

2 Charles Goodheart and Avegouleas, ‘A Critical Evaluation of Bail-ins as Bank Recapitalisation Mechnisms’ (2014) Centre fir Economic Policy Research Discussion Paper n. 10065, available online at https://ssrn.com/abstract=2478647 3 Wolf-Georg Ringe and J Patel, ‘The Dark Side of Resolution: Counterparty Risk through Bail’ (2019) European Banking Institute Working Paper n 31, available online at . The opposite conclusion, ie that bail-in is not such as to trigger contagion and domino failure of other creditors with holdings in the bank under resolution, is discussed by Anne-Caroline Hüser, Grzegorz Hałaj, Christoffer Kok, Cristian Perales, and Anton van der Kraaij, ‘The Systemic Implications of Bail-in: A Multi-layered Network Approach’ (February 2017) ECB Working Paper Series n 2010, available online at , based on a model using European System of Central Banks (‘ESCB’) proprietary data on the securities holdings of the twenty-six largest euro area banking groups. 4 Wolf-Georg Ringe, ‘Bail-in between Liquidity and Solvency’ (2016) Oxford Legal Research Papers n 33, available online at . 5 Tobias H Tröger, ‘Too Complex to Work: A Critical Assessment of the Bail-in Tool under the European Bank Recovery and Resolution Regime’ (2018) Journal of Financial Regulation 35.

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Bail-in: Preparedness and Execution reimbursed may have affected the credibility of the bail-in tool. At the same time, it notes that recent and past cases,6 including resolution of Banco Popular, of Banco Espirito Santo (Novo Banco case), and of the Italian four banks (Banca delle Marche, Banca Popolare dell'Etruria e del Lazio, Cassa di Risparmio di Ferrara and Cassa di Risparmio della Provincia di Chieti) to name a few, have established the effectiveness of the resolution authorities’ write down power. Investors are therefore perfectly aware of the concrete possibility to incur losses by operation of authority in case the financial institution is no longer viable. This awareness cannot be underestimated. It is also worth noting that bail-in became applicable on 1 January 2016, one year 11.04 after the transposition of the BRRD into national law, a compromise solution between prompt political reaction to unsustainable bail-outs and the need for preparedness by both investors and authorities. Ex post and despite the delayed entry into force, the envisaged timeline for its application looks very ambitious, considering the necessary and significant preparatory work by resolution authorities, financial institutions, and investors. Some critiques against the tool may be ascribed to its early/premature entry into force. This chapter will therefore illustrate legislative and regulatory progress made after the entry into force of the resolution regime to make bail-in operational, and emphasizes that to counter bail-in being labeled as a theoretical tool, authorities have to keep focusing on the operationalization of bail-in as the indispensable premise to ensure bail-in execution. Authorities’ and institutions’ preparedness efforts have to maintain pace during the resolution planning phase in order to build-up loss absorbing and recapitalization capacity and to lay down precise processes on data provision, valuation, and co-ordination with other authorities and stakeholders such as custodians, for their implementation in the execution phase. This chapter therefore argues against confining bail-in to a theoretical tool, 11.05 and maintains that in order to bridge the bail-in’s credibility gap, resolution regulators and resolution authorities have to continue enhancing preparedness and operationalization. Parallel to this, the credibility of the resolution regime needs to be step up by creating a new liquidity resolution framework to address post bail-in financing needs, including as part of the completion of the Banking Union. Along these lines, the first part of this chapter focuses on loss absorption and recapitalization capacity, providing an overview of the relevant legal and

6 Unlike the bail-in tool, WDCCI has become immediately applicable as of the entry into force of the BRRD and even before—under the State aid framework—as burden-sharing precondition to access public financial support. See also Kotnik (Case C-526/14) of 19 July 2016, holding that ‘the protection of legitimate expectations and the right to property must be interpreted as not precluding points 40 to 46 of the Banking Communication in so far as those points lay down a condition of burden-sharing by shareholders and holders of subordinated rights as a prerequisite to the authorisation of State aid’. See also Commission Communication on the application, from 1 August 2013, of State aid rules to support measures in favour of banks in the context of the financial crisis (‘Banking Communication’), [2013] OJ C16/1, 30 July 2013.

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Anna Gardella regulatory framework, including that of the shortcomings of the cross-border intra-EU current setting. The second part will then turn on the data needs, processes, and co-ordination necessary to ensure the feasibility of bail-in execution.

II. Bail-in: Main Features 11.06 Bail-in is the forced write down and conversion of capital instruments and other

eligible liabilities implemented by the resolution authority with a view to absorbing the institution’s losses and restoring viability and market confidence. The tool’s ultimate objective is to maintain the financial institution under resolution as going concern in an orderly manner, preserving continuity of critical functions and financial stability, and minimizing the use of taxpayers’ money.7

11.07 The forced write down and conversion of own funds and eligible liabilities by

operation of administrative authority implements the burden sharing, a precondition to access State aid: shareholders and creditors are required to bear losses first, before any resort to extraordinary public financing. Only when the internal resources are bailed-in for at least 8% of own funds and eligible liabilities, other financial resources may be tapped to finance resolution costs. First, the resolution fund—which is alimented by banks’ levies but operates under the public direction and is therefore tantamount to State aid—may be accessed. Requiring shareholders and creditors to bear losses first reflects the normal insolvency ranking; tapping the resolution fund before shareholders and creditors would give rise to immediate spillover effects, and affect the confidence in and the stability of the banking system. The size of the fund, furthermore, would not be sufficient for the purpose.

11.08 Unlike State aid practice, which preserved the European Commission’s discretion

as to the appropriate measure of burden sharing, the BRRD sets out a clear- cut rule on resolution authorities, providing that access to State aid may only be granted subject to the application of bail-in to at least 8% of the total liabilities including own funds of the institution under resolution. Consistent with the harmonization goal pursued by the BRRD, the indication of the exact measure of the burden sharing intends to increase transparency and to establish a level playing field across the EU with a view to curtailing divergent practices. It is regrettable, however, that the BRRD fails to explain the rationale of that minimum burden-sharing amount, thus lending support to the criticism of the system’s 7 Anna Gardella, ‘Bail-in and the Financing of Resolution within the SRM framework’ in Danny Busch and Guido Ferrarini (eds), European Banking Union (Oxford University Press 2015) 373 and additional references therein; Karl-Philipp Wojcick, ‘Bail-in in the Banking Union’ (2015) 53 Common Market Law Review 91; Marco Ventoruzzo and Giulio Sandrelli, ‘O Tell Me the Truth about Bail-In: Theory and Practice’ (2019) European Corporate Governance Institute, Working Paper Series in Law n 442, available online at .

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Bail-in: Preparedness and Execution excessive rigidity. Whilst it clearly draws on the experience and case analysis of the financial crisis, clarifications would have been expected. The calculation methodology of the 8% is also left unspecified in the BRRD—in particular whether reference should be made to the moment when the institution is in resolution (as the literal wording of Article 44(5) of the BRRD suggests) or before meeting those conditions—potentially giving rise to divergent practices. For sake of clarity, the forced WDCCI is not distinctive of the bail-in tool, its 11.09 execution by the resolution authority is required whenever the financial institution reaches PONV or meets the conditions for resolution. To put it in other words, WDCCI is a precondition for the application of any resolution tool. Its operational modalities do not significantly differ from the bail-in tool; the operationalization of the latter, however, is more complex since it has to ensure, among other things, that the same entity under resolution continues as going concern, raising a host of additional complexities compared to a closed bank bail-in. WDCCI is commonly perceived as tantamount to bail-in since, as recent practice 11.10 demonstrates, it has the same ultimate effect of imposing losses on shareholders and investors. For this reason, public opinion tends to point the finger against the power itself vested in the resolution authority to enforce the write down and conversion of capital instruments and eligible liabilities and to directly attribute losses to shareholders and creditors.8 The administrative infliction of losses is somehow counter-intuitive if one considers that financial authorities are perceived as public guardians, entrusted with protecting the public, usually associated with depositors and investors. The idea that when imposing losses on shareholders and creditors, resolution authorities act as taxpayers’ and financial stability’s public guardians is an abstract and indirect concept hard to focus on. Clearly, the trade-off between interference with private property rights and safeguard of taxpayers and financial stability holds authorities to due diligence and responsibility obligations. When deprived of property rights, investors do hold authorities to account and challenge their decisions. It should not come as a surprise that resolution cases give rise to considerable litigation, as confirmed by recent resolution cases such as Banco Popular, the four Italian banks etc. The judicial definition of due diligence, standards of judicial review, as well as potential restoration of damages against the resolution authority’s conduct may significantly impact the overall balance of the resolution regime. Close attention should therefore be paid to the litigation currently pending before the Court of Justice against the SRB, the ECB, and the European Commission in relation to the Banco Popular resolution.9

8 In Italy it has also been claimed that it is in contrast with art 47 of the Italian Constitution, encouraging and protecting private savings. 9 More than ninety cases are currently pending before the Court of Justice in respect of the Banco Popular resolution, relating to various critical issues of the crisis-management resolution regime, including: the conditions to declare a bank failing or likely to fail by the supervisor, the ECB in

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Anna Gardella 11.11 In addition, despite WDCCI application in various actual cases (eg Banco

Popular, four Italian banks, Veneto banks to name a few), the credibility of the bail-in tool is still undermined (‘theoretical’) by the fact that, save for less than a handful of cases,10 write down has not been executed on senior liabilities. It is the arbitrage opportunity between EU harmonized resolution and insolvency law, coupled with the related divergent treatment of shareholders and creditors, which is at the heart of the criticism about the bail-in credibility. Unlike for resolution, 8% burden sharing and senior creditors involvement is not a precondition for the granting of stabilization State aid under normal insolvency proceedings. Admittedly, the conflicting views of the SRB and of the European Commission on the public interest test in the Veneto banks cases and the absence of EU harmonized normal insolvency law are a major gap of the EU regime that lends itself to such arbitrage opportunities.

III. Building-up Bail-in Preparedness: TLAC/MREL 11.12 Essential to the implementation of the bail-in tool is the availability of sufficient

internal loss absorption and recapitalization capacity to ensure burden-sharing and restoration of market confidence without—or minimizing—resort to extraordinary public financial support. The Total Loss Absorbing Capacity (‘TLAC’) term sheet for G-SIBs, developed by the FSB11 is a key element of the resolution regime. This requirement is crucial to the implementation of the resolution principle that shareholders and creditors (rather than taxpayers) bear losses first and taxpayers are protected. The idea of the availability of a liability buffer to ensure

the case at hand; the adequacy of the scrutiny exercised by the European Commission in the Single Resolution Mechanism decision-making process; the possibility and extent to which the valuation, as part of the resolution decision, may be challenged in court; the obligation to perform a definitive valuation when the sale of business tool is adopted etc. 10 Notably: resolution of Andelskassen in Denmark on which see Jens Verner Andersen, Pamela Lintner, and Susan Schroeder, ‘Andelskassen: Resolution Via Bridge Bank and Bail-in Including of Uninsured Depositors’ in World Bank, Bank Resolution and ‘Bail-in’ in the EU: Selected Case Studies Pre and Post BRRD (2016), available online at ; the resolution of Jadranska banka in Croatia (see notification at https://eba.europa.eu/documents/10180/1227439/ Letter+to+the+EBA.pdf ); resolution of Banco Espirito Santo in Portugal, in particular the decision of the resolution authority to transfer back from the bridge bank to the bank in resolution some senior liabilities which de facto amounts to bail-in of senior liabilities (see notification of the decision at https://eba.europa.eu/regulation-and-policy/recovery-and-resolution/notifications-on-resolution- cases-and-use-of-dgs-funds). Decisions about all European resolutions and of insolvency cases entailing DGS payouts can be retrieved on the EBA website at . 11 FSB, ‘Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution, including Total Loss-absorbing Capacity (TLAC) Term Sheet’ (9 November 2015), available online at .

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Bail-in: Preparedness and Execution loss internalization has been reflected in Article 45 of the BRRD, setting out the minimum requirement for eligible liabilities and own funds (‘MREL’), to be maintained at all times by the financial institution, and mandating the EBA to develop a regulatory technical standard (‘RTS’) to specify the criteria for MREL calibration. The TLAC/MREL requirements and the criteria for their determination are not 11.13 only technically complex but also politically sensitive, given the trade-off between the credibility and feasibility of resolution strategy and the financial institutions’ increase in funding costs. It should not come as a surprise that the finalization of the EU TLAC/MREL regime has taken time and has been completed only recently. The FSB finalized the TLAC principles and the related term sheet setting the relevant standard in November 2015 and the EBA submitted its RTS on criteria to set MREL to the European Commission for endorsement in July 2015.12 Thereafter, the EBA has conducted further in-depth examination of MREL design and implementation,13 providing significant analysis to the European Commission in view of the development of the proposal for the implementation of the TLAC term sheet in the EU legal system. Such proposal has been submitted to the European Parliament and the Council in November 2016, in the context of the Banking Package of risk reduction measures revising various legal instruments, notably Regulation (EU) 575/2013 on capital requirements (‘CRR’), Directive 2013/36/EU on access to the market and the prudential supervision of credit institutions and investment firms (‘CRDIV’), the BRRD, and Regulation (EU) 806/2014 on the single resolution mechanism (‘SRMR’).14 The negotiation process of the Banking Package has been technically and politically complex, requiring almost two-and-a-half years to be finalized, and has been eventually approved in May 2019. The regulatory regime to set TLAC/MREL 12 See EBA, ‘Final Regulatory Technical Standards on criteria for determining the minimum requirement for own funds and eligible liabilities under Directive 2014/59/EU’. To testify of the matter’s political sensitivity, such RTS has been one of the very few cases where the Commission has partially rejected the EBA’s RTS. A procedure has followed in accordance with art 10 and following of Regulation (EU) 1093/2010. The EBA Final RTS and the EBA Opinion to the European Commission are available online at . 13 EBA, ‘Final Report on the Implementation and Design of the MREL Framework’, EBA- Op-2016-21 (14 December 2016), available online at ; and EBA, ‘Quantitative Update of the EBA MREL Report (December 2016 data)’ (20 December 2017), available at https:// eba.europa.eu/documents/10180/1720738/Quantitative+update+of+the+EBA+MREL+Report. pdf; see also EBA, ‘Interim Report on Implementation and Design of the MREL Framework’, EBA- OP-12 (19 July 2016), available online at . 14 European Commission Proposal of amendment of Regulation (EU) 575/2013, COM(2016) 850 final; European Commission Proposal of amendment of Directive 2013/36/EU COM(2016) 851 final; European Commission Proposal of amendment of Directive 2014/59/EU (COM(2016)852 final) of 23 November 2016.

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Anna Gardella has therefore been a moving target since the entry into force of the BRRD, has progressed in several stages, and has only recently come to a stable framework. 11.14 The approval of the Banking Package and the immediate entry into force of the

TLAC Pillar 1 regime are a major step forward for the completion of the resolution regulatory framework providing support for the credibility and feasibility of orderly resolution. The granularity and complexity of the provisions underscore the political sensitivity of the negotiations and the difficulty to reach an agreement. In light of these considerations and of the circumstance that the adoption of the Banking Package is too recent to allow an in-depth analysis of its policy and technical details, a high level, non-comprehensive overview of its main features is presented below. 1. Overview of the TLAC/MREL Regime

11.15 Broadly speaking, TLAC and MREL enshrine the same objective and building

blocks—they are made of a loss absorption and of a recapitalization amount, have to be maintained by the financial institution at all times and other common requirements; TLAC and MREL differ, however, in many respects. To start with as regards the types of institutions they are addressed to, the statutory and authoritative determination of their respective amounts, the relevant parameters, calibration, composition, and subordination requirements etc.

11.16 TLAC has been developed at the international level by the FSB to be applicable

to G-SIIs only, whereas MREL is the EU regime applicable to credit institutions and investment firms as well as the other entities covered by the BRRD. TLAC envisages a common minimum amount for all G-SIIs (‘Pillar 1’), determined based on fixed parameters. In particular, TLAC features laid down in the FSB TLAC term sheet include: (a) harmonized minimum level (Pillar 1) for all G-SIIs; (b) institution specific add-on; (c) Pillar 1 subordination requirement; (d) eligible liabilities quality and eligibility criteria; (e) scaling of 75% to 90% internal TLAC to material sub-group of a resolution entity, composed of subsidiaries outside the resolution entity’s jurisdiction and which are not themselves resolution entities; and (f ) deduction of eligible liabilities holdings and cross-holdings.

11.17 As indicated in Recital (16) of CRR2, TLAC and MREL regimes should be ‘com-

plementary elements of a common framework’, and the relevant provisions in the CRR2 and the BRRD2 -Directive (EU) 2019/878 amending the CRDIV (‘CRDV’) -should be read together.15 To note that by virtue of including the

15 Recital (16) of Regulation (EU) 2019/876 of the European and of the Council, of 20 May 2019, amending Regulation (EU) 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) 648/2012, in [2019] OJ L150/1 of 7 June 2019Regulation (EU) 2019/876 amending Regulation (EU) No 573/2013 (‘CRR2’).

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Bail-in: Preparedness and Execution TLAC regime and the eligible liabilities criteria in the CRR2, resolution authorities are given powers under that legislation and it is also provided that resolution and competent authorities have to co-operate to ensure compliance with own funds and eligible liabilities (Article 2 of the CRR2). Preliminary to the high level description of the TLAC/MREL regime resulting 11.18 from the approved Banking Package, is the illustration of their application within the group and the interaction with the resolution strategy. Consistent with the TLAC term sheet, the BRRD2 introduces the notions of ‘resolution group’, ‘resolution entity’ and ‘non-resolution entity’. To put it in plain words, a ‘resolution entity’ is the financial institution that is the ‘point of entry’ of a specific resolution group, ie to which resolution tools are applied by the resolution authority. In case of a single point of entry strategy, the resolution entity will be the only point of entry for the whole group and it will include various direct and indirect subsidiaries which are non-resolution entities, ie which are not destined to be put in resolution, but rather are meant to remain viable and maintain continuity of critical functions. In case of multiple point of entry strategy, there will be more than one resolution entity within the whole group, which may or may not have an underlying resolution group. The regulatory regime of the TLAC/MREL requirement is mostly concerned with the ‘resolution entity’, which is issued to external investors and is also called ‘external TLAC’ or ‘external MREL’. A significant part of the regulatory regime also deals with the internal pre-positioning of TLAC/ MREL to non-resolution entities. Broadly speaking, regulatory provisions about TLAC/MREL mostly refer to the resolution entity. Similarly the following overview focuses on TLAC/MREL requirements at the level of the resolution entity. A. TLAC Requirement In as much as a statutory requirement, the TLAC harmonized Pillar 1 minimum 11.19 level requirement, including provisions on liabilities’ eligibility and quality criteria, internal TLAC prepositioning calibration, deduction of eligible liabilities, and disclosure requirements are set out in the CRR2. The TLAC Pillar 2 add-on for G-SIIs and the MREL requirement are set out in the BRRD2. This entails that, in terms of implementation deadline, the Pillar 1 TLAC requirement has become applicable as 28 June 2019, whereas the MREL regime will enter into force after the BRRD2 transposition into national law to be carried out by 28 December 2020, ie 18 months after the BRRD2 entry into force. By the same date, the MREL amended regime set out in the SRMR2 will also enter into force. The TLAC Pillar 1 calibration is set out in the CRR2, it is a statutory regime with 11.20 parameters embodied in a EU Regulation. This makes the requirement directly applicable to banks without any resolution authority implementing decision. In details, the target Pillar 1 minimum harmonized requirement until 31 December 2021 for G-SIIs and entities that are part of G-SIIs is equal to an external TLAC requirement of a risk-based ratio of 16% of Total Risk Exposure Amount (‘TREA’)/a non-risk based 459

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Anna Gardella ratio of 6% of Leverage Ratio Exposure Measure (‘LREM’). As of 1 January 2022, the requirement will be 18% of TREA/6.75% of LREM (Article 92a of the CRR2). 11.21 Such requirement has to be met by external TLAC eligible liabilities complying

with the requirements laid down in Articles 72a and 72b of the CRR2. In particular, TLAC eligible liabilities have to be fully subordinated to excluded liabilities. Eligibility criteria of specific liability instruments are laid down in Article 72b of the CRR2, which deals with issuing entity; ownership requirements; subordination to excluded liabilities; absence of set-off and netting; redemption, call, repurchase or acceleration by holders etc. A grandfathering regime for some eligibility conditions introduced by the new framework is set out in Article 494b of the CRR2, for those instruments issued prior the entry into force of the CRR2. Furthermore, the TLAC requirement has to be met after discounting deductions set out in Article 72e of the CRR2.

11.22 In line with the TLAC term sheet, the CRR2 lays down express disclosure

requirements upon G-SIIs to support adequate external risk analysis and foster market discipline. In particular, pursuant to Articles 434a, 437a, and 447(h) of the CRR2, G-SIIs are required to disclose (i) on a quarterly basis: own funds and eligible liabilities ratios, as calculated in accordance with Article 92a of the CRR2; and (ii) on a semi-annual basis: the composition of own funds and eligible liabilities, their maturity and main features; the ranking of eligible liabilities in the creditor hierarchy; the total amount of each issuance of eligible liabilities as per Article 72a of the CRR2; and eligible liabilities items within the limits specified in Article 72b(3) and (4) of the CRR2.

11.23 Such discipline will be further clarified in implementing technical standards de-

veloped by the EBA in accordance with the mandate set out in Article 434a of the CRR2, relating to the specification of uniform disclosure formats and associated instructions. In line with the TLAC terms sheet, such disclosure requirements have been further elaborated by the Basel Committee on Banking Supervision (‘BCBS’) in the context of the Pillar 3 review and the EBA is expected to develop such ITS in line with the international standards.16

11.24 Last but not least, Article 92b of the CRR2 is concerned with the allocation of

internal TLAC by non-EU G-SIIs to material subsidiaries located in the EU. Within the scaling envisaged by the TLAC term sheet ranging between 75% and

16 See Recital (56) of the CRR2 indicating that: ‘As the provision of meaningful and comparable information to the market on institutions’ common key risk metrics is a fundamental tenet of a sound banking system, it is essential to reduce information asymmetry as much as possible and facilitate comparability of credit institutions’ risk profiles within and across jurisdictions. The BCBS published the revised Pillar 3 disclosure standards in January 2015 to enhance the comparability, quality and consistency of institutions’ regulatory disclosures to the market. It is, therefore, appropriate to amend the existing disclosure requirements to implement those new international standards’.

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Bail-in: Preparedness and Execution 90% of the external TLAC, the EU legislator has taken a rigid stance, requiring EU material subsidiaries, which are not resolution entities, to be prepositioned 90% of the externally issued TLAC. Whilst this reinforces certainty in cross- border relationships, it leaves little room to the institution to create a buffer to allocate resources within the group where needed in case of crisis. B. MREL Requirement The BRRD original key provision for MREL is Article 45, laying down the 11.25 features of the requirement and the criteria for its determination. This regime, as specified by the European Commission Delegated Regulation (EU) 2016/1450 (based on the EBA RTS), as well as the subsequent resolution authorities’ policy documents explaining how the methodology is further operationalized for the adoption of MREL decisions,17 will remain in force until the transposition and applicability of the BRRD2 and SRM2, ie 28 December 2020. After the entry into force of the BRRD2/SRM2 MREL regime, new MREL targets determined based on the BRRD2 criteria, are envisaged to be generally met by January 2024. It can therefore be expected that 2021 resolution authorities’ decisions setting MREL levels will fully internalize the Banking Package MREL discipline. As recalled above, under the regime currently in force, MREL is exclusively an 11.26 institution-specific requirement, to be set by the resolution authority having regard to the characteristics of the institution and the resolution strategy. It is composed of a loss absorbing and a recapitalization amount and may include a market confidence buffer. No mandatory subordination requirement is currently envisaged, or the notion of ‘internal’ MREL. Such regime has been significantly amended by the BRRD2, which is very detailed and technically complex requiring thorough examination. In the light of the novelty of the legislative act, this chapter does not provide a comprehensive and critical analysis, but rather a reasoned guidance through the most distinctive changes of the new MREL discipline set out in the BRRD2. The main issues of the political and technical debate accompanying the risk re- 11.27 duction measures package have revolved around, inter alia: (i) ensuring the level playing field across the EU and a proportionate approach between G-SIIs, which are subject to TLAC, and the other banks that may give rise to systemic concerns in case of failure; (ii) the need (and the limits) of a subordination requirement as a

17 SRB, ‘2018 MREL Policy’, available online at ; ‘Bank of England’s approach to setting a minimum requirement for own funds and eligible liabilities (MREL)’ (updated November 2016), available at ; Swedish National Debt Office, ‘Application of the Minimum Requirement for Own Funds and Eligible Liabilities’ (23 February 2017), available online at .

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Anna Gardella means to ensure the orderly execution of the resolution strategy without incurring in NCWO concerns; (iii) application of the MREL requirement to resolution and non-resolution entities; (iv) alignment between ex ante determination of MREL and credibility and feasibility of the resolution strategy, having regard to the investor base of eligible liabilities and in particular to retail investors; (v) resolution authorities’ power to sanction breaches of MREL requirements; and (vi) resolution authorities’ powers to authorize eligible liabilities redemption. 11.28 Along these lines, as a result of the BRRD2 approval, the MREL regime has

undergone a significant transformation. Article 45 of the BRRD which laid down the notion, principles, and main criteria for the MREL determination has been replaced and supplemented by several other provisions set out in Articles 45a to 45i of the BRRD2. Among the most significant changes of the MREL regime are (a) the departure, for certain banks, from an exclusively Pillar 2, institution-specific regime, and the move towards a Pillar 1 MREL requirement; and (b) the introduction of a minimum subordination Pillar 1 requirement for non-G-SIIs, that has been articulated on the basis of a new categorization of banks.

11.29 Other amendments include (i) the alignment of TLAC/MREL denominators,

turned into the percentage of the total risk exposure amount and the leverage ratio exposure of the relevant bank, for consistency purposes (Article 45(2) of the BRRD2);18 (ii) the specification that resolution entities have to meet MREL requirements at consolidated resolution group level only (Article 45e of the BRRD2), whereas non-resolution entities have to meet the requirement at the individual level, except in case of application of the waiver envisaged by Article 45f of the BRRD2; (iii) the inclusion of breaches to TLAC or MREL requirements within the impediments to resolvability and the amendment of the relevant procedure; and (iv) the provision of express rules on the sale of eligible liabilities to retail investors, going beyond and reinforcing the regime set out in Directive 2014/65/EU on Market on Financial Instruments (‘MIFID2’).

11.30 With regard to the calibration of the MREL requirement, Article 45c of the

BRRD2 sets out the bank-specific criteria to be applied by the resolution authority when taking the MREL decision. They include the need to meet resolution objectives; the adequacy of loss absorption and recapitalization capacity within the resolution group (for both resolution and non-resolution entities); the need to make up any potential exclusion of liabilities from bail-in (as envisaged 18 Recital (6) of the BRRD2 reads: ‘In order to align denominators that measure the loss- absorbing and recapitalisation capacity of institutions and entities with those provided for in the TLAC standard, the MREL should be expressed as a percentage of the total risk exposure amount and of the total exposure measure of the relevant institution or entity, and institutions or entities should meet simultaneously the levels resulting from the two measurements’.

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Bail-in: Preparedness and Execution in the resolution plan); the size, business model, funding model, and risk profile of the entity; and the potential contagion effects of the failure of the institution. The relevant general determination criteria of loss absorption and of recapitalization amount composing the MREL requirement are set out in Article 45c(3). Paragraph (5) of that provision deals with the adoption of a minimum Pillar 1 MREL requirement for ‘top-tier’ banks, and paragraph (6) with an optional minimum Pillar 1 MREL requirement for ‘fished’ banks. In order to impose minimum Pillar 1 subordination requirements, the BRRD2 11.31 creates three new categories of banks, in addition to the internationally acknowledged and regulated G-SIIs: (a) ‘top-tier’ banks, a sub-set of O-SIIs, with a consolidated size or resolution group above €100 bn (Article 45c(5) of the BRRD2); (b) selected banks (‘fished’), which are neither G-SIIs nor top-tier banks (ie resolution group total assets are lower than €100 bn) and are selected by the resolution authorities in as much likely to pose systemic risk in case of failure (Article 45c(6) of the BRRD2); (c) other banks, ie other than G-SIIs, top-tier, and ‘fished’ banks, which may be subject to subordination requirement on a case-by-case having regard to the NCWO principle. A minimum Pillar 1 subordination requirement for external MREL is set out 11.32 for ‘top tier’ and ‘fished’ banks if the relevant conditions are met. To note that in both cases, the determination of such minimum subordination amount is based on 8% total liabilities and own funds (‘TLOF’) (Article 45b(4)). Reference to such last parameter, which can be lowered by the resolution authority by application of a specific reduction factor, is significant for its direct relation with the minimum burden-sharing requirement to be met prior to access to the resolution fund. Note that, based on the BRRD2, the 8% TLOF parameter may be relevant also for G-SIIs. Along the reference to the 8% parameter in the determination of the subordination amount of the total MREL level , a requirement for the resolution authorities to take it into account is set out also with regard to the MREL calibration. The wording of the relevant provision, Article 43c(3) and(7) of the BRRD2, might however be apt to interpretationsince it requires authorities to ‘take account’ the 8% requirement—therefore not necessarily to base the calibration on this parameter.19 The BRRD2 also empowers the resolution authority to impose a Pillar 2 sub- 11.33 ordination requirement in certain circumstances, to predetermined group of banks only (30% of G-SIIs, top-tier of ‘fished’ banks of one jurisdiction), where impediments to resolvability are not addressed, or where the resolution strategy is

19 The relevance of the 8% requirement to calibrate the MREL level has been disputed also before the SRB Appeal Panel, Appellant v SRB, Case 8/18 of 16 October 2018, available online at www.srb.europa.eu, where the SRB Appeal Panel has upheld the absence of direct link between the MREL level and the 8% minimum burden sharing.

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Anna Gardella not sufficiently credible and feasible, or where the bank belongs to the 20% riskiest banks with regard to Pillar 2 supervisory requirement in the Banking Union. Other banks, which are neither G-SIIs, nor top-tier nor ‘fished’ banks may be imposed a minimum subordination requirement on a case by case basis to avoid incurring in NCWO. 2. TLAC/MREL in Cross-border Groups: Prepositioning and Ring-fencing 11.34 The Banking Package solution in respect of cross-border group TLAC/MREL

regulation shows the persistent political sensitivity of home–host relationships within the EU and the difficulty of the negotiations. Although the outcome of the negotiations is consistent with the cross-border group prudential regulation approach, in particular the (absence of ) cross-border waivers to capital requirements, it is questionable whether the EU’s territorial approach is satisfactory in terms of fully reaping the benefits of the internal market, or of providing suitable remedies to the ring-fencing practices adopted by national authorities in the course of the financial crisis which have ultimately ended up deepening the crisis.

A. Cross-border Resolution Strategies: SPE and MPE 11.35 When it comes to planning the resolution of a cross-border group, there is no ‘one size fits all’. Depending on the group structure, funding model, interconnectedness, and centralization of functions, a Single Point of Entry (SPE) or a Multiple Point of Entry (MPE) strategy may be appropriate. The SPE is particularly suitable for those banking groups that are highly interconnected and operationally and financially centralized. Under this strategy, the resolution action is in principle concentrated only at the top level of the group, without affecting the operating subsidiaries. The underlying rationale is precisely to ensure that such operating subsidiaries are able to continue running their business without being put under resolution. The view from the top is meant to ensure the smooth implementation of the strategy and the preservation of the group’s functions and value. The MPE strategy envisages more than one point of entry for resolution actions and is better suited for the less financially and operationally interconnected groups, where internal functions are carried out in a more autonomous rather than in a centralized manner. The rationale underlying the MPE strategy is the low level of interconnectedness with the rest of the group, making it in principle more ‘territorial’ in scope. Admittedly, given that the MPE entails the decentralization of the resolution strategy, a high level of co-ordination and co- operation is needed among the authorities responsible for the various resolution sub-groups, both those affected by the resolution and those that are not. Viewed from the ring-fencing perspective, the SPE and MPE strategies are in principle neutral, given that they are meant to reflect the operational and funding organization of the group and their degree of centralization of functions—to the extent 464

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Bail-in: Preparedness and Execution the subsidiaries subject to MPE strategy are independent from the rest of the group, it hardly results in ring-fencing.20 To be successful, both an SPE and MPE (the latter provided that it gives rise to 11.36 a sub-consolidated resolution group) must rely on an intragroup funding model enabling the up-streaming of losses from the operating subsidiaries (non-point of entry/non-resolution entities) to the resolution entity, and the down-streaming of capital by the latter to the former.21 As recalled above, the BRRD2 provides important clarifications, specifying that 11.37 those resolution entities within the group that are a point of entry of the resolution strategy (resolution entities), regardless of whether it is SPE or MPE, should maintain MREL at the consolidated level only. Such MREL shall be issued externally to third parties (external MREL). The relevant criteria, calibration and subordination requirements have been illustrated in the paragraphs above. The calibration and eligibility criteria of internal MREL are outlined below. B. Non-resolution Entities: Calibration, Quality Criteria, and Waivers to Internal MREL Under the BRRD2 non-resolution entities within the resolution group are re- 11.38 quired to meet MREL requirements at the individual level. This entails the prepositioning of MREL internally within the resolution group (internal MREL). Upon reach of PONV such instruments or liabilities are written down or converted into equity of the non-resolution entity. This mechanism ensures the up- streaming of losses from the subsidiary to the parent and the down-streaming of capital from the parent to the subsidiary, which is key to the effective implementation of both the SPE and the MPE strategies. The calibration paramenters for internal MREL are the same applicable to the calibration of external MREL (Article 45f cross-refers to Article 45c of the BRRD2). Unlike the TLAC term sheet, the BRRD2 does not provide for any scaling range, thus leaving in principle no buffer to the institution to move resources to the group entity in distress in case of crisis. The BRRD2 does not specify that the amount of external MREL must be equal 11.39 to the sum of the amounts of the MREL requirement to be met at the individual levels, with the consequence of a potential mismatch between external and internal MREL. 20 The degree of decentralization of an institution’s shared services is under elaboration within the regulatory environment, as testified by the EBA decision adopted in the context of a mediation case relating to an MPE resolution plan between the SRB and the National Bank of Romania (17 April 2018), available online at . 21 Anna Gardella, ‘Bail-in and the Two Dimensions of Burden Sharing’ in ECB Proceedings of the ECB Legal Conference 2015, From the Monetary Union to the Banking Union on the way to Capital Markets Union.

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Anna Gardella The determination of the MREL requirements should be achived via the adoption of a joint decision by the relevant resolution authorities on both external and internal MREL levels at the same time (in case of cross-border groups fully or partially established outside the Banking Union). In case of disagreements among the authorities, the host decision should precede the home decision. Both should duly take into account the assessment of the home or of the host respectively. The EBA may be requested by the host or the home authorities respectively to settle the disagreement via mediation (Article 45h of the BRRD2). 11.40 Special waivers to the prepositioning of internal MREL are provided for intra-

State situations. Notably, a full waiver may be granted by the resolution authority when a) the resolution entity and the non-resolution entity are located in the same Member State and are part of the same resolution group; b) the resolution entity complies with the MREL requirement on a consolidated basis; c) there is no impediment to the transferability of funds or to the repayment of liabilities to the waived subsidiary; d) the resolution authority is satisfied with the prudent management of the subsidiary and with other relevant conditions set out in Article 45f(3) of the BRRD2. A partial waiver, allowing the substitution of liabilities with collateralized guarantees may be granted by the resolution authority when the subsidiary that is not a resolution entity and its parent undertaking are located in the same Member State and the parent undertaking complies with the external MREL at consolidated level (see Article 45f(5)). Such guarantees have to satisfy the conditions set out in that provision, including that they can triggered when the subsidiary is unable to pay its debts or upon PONV.

11.41 Based on a preliminary assessment, the overall system on internal MREL laid

down in the BRRD2 appears to priviledge certainty over flexibility, regardless of the crisis-management regulatory and institutional progress made at the EU level after the financial crisis. The current regulatory layout, and in particular the absence of scaling, of the requirement that the sum of the internal MREL equals the external MREL, and of the cross-border internal MREL waivers (only intra-State waivers are provided either for intra-Banking Union or for intra-EU in general) signals that progress still needs to be done to overcome national concerns in case of actual crisis. The outcome of the negotiations arguably lags behind the internal TLAC term sheet and the Commission Proposal of review of the BRRD2, which envisaged a more ambitious project towards the establishment of the EU as a single jurisdiction. The Commission Proposal of review of the BRRD actually provided for the possibility of cross-border intra-EU prepositioning waivers, similarly to the proposal to introduce cross-border intra-EU capital waivers in the Commission Proposal of review of the CRR. Both proposals for cross-border intra-EU waivers have been excluded from the approved texts of the CRR2 and BRRD2 respectively. 466

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Bail-in: Preparedness and Execution This is regrettable if one considers that such lack of waivers also applies to banking 11.42 groups established within the Banking Union that are subject to the single supervision of the European Central Bank and to the resolution jurisdiction of the Single Resolution Board. Arguably, the balancing exercise between host authorities’ comfort against potential adverse fiscal impacts of bank failures and a smooth and co- operative set-up allowing for the transfer of capital and liquidity within the group where the circumstances so require, is still in favour of ex ante controlled ring-fencing. The earmarking of capital and liquidity along jurisdictional borders instead of its free movement within the group to absorb asymmetric shocks intends to provide reassurances to host Member States but may adversely impact market integration. 3. Eligible Liabilities, Market Discipline, and Investor Protection WDCCI and bail-in are no ‘silver bullet’: clearly they do not make losses disap- 11.43 pear, rather embody the policy choice of protecting taxpayers from supporting the costs of market failures, by placing them on shareholders and creditors. The removal of the implied State guarantee by the internalization of resolution costs is expected to work ex ante as a market discipline incentive to avoid financial institutions’ excessive risk-taking and underpricing practices. Transparency and market discipline are expected to be reinforced by investors’ monitoring of their investment’s risk profile, based on Pillar 3 disclosure requirements introduced by the CRR2 as regards TLAC, and by the BRRD2 as regards MREL (Article 45i(3)).22 The latter in particular concerns the levels of eligible and bail-inable liabilities and the composition of those liabilities, including their maturity profile and ranking in normal insolvency proceedings. Such disclosure obligations, however, will become applicable on 1 January 2024 at the latest, ie after the envisaged meeting of the MREL target requirements by the institutions in an orderly fashion (Article 3(1) of the BRRD2). It is disputable the opportunity to set disclosure requirements as of the end of the build-up period. Such choice relies on the assumption that there is a trade-off between the institutions’ funding costs and the market’s transparency needs. In the policy discussion preceding the submission of the Banking Package, the EBA took a view in favor of the disclosure of some MREL information also in the transition to the build-up of the requirement target, on the assumption—among other things—that withholding information from the market may be conducive to speculation about a bank’s condition. In particular, the EBA expressed the view that ‘during the transition period investors should be aware of information on the creditor hierarchy applicable to the instrument and the overall MREL quantum and composition for each institution’.23

22 The different level of disclosure requirements between categories of banks reflects the Basel approach imposing Pillar 3 obligation on internationally active banks only. The disclosure requirements will be specified in an implementing technical standards by the EBA. 23 EBA, Final Report on MREL, 9.

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Anna Gardella 11.44 The resolution regime therefore relies on market principles to identify potential

investors in eligible liabilities (at least as of the application of Pillar 3 requirements) and intervenes with regulatory requirements about deductions and cross-holding deductions, in particular for TLAC, to mitigate potential systemic effects.

11.45 Additionally, significant regulatory provisions, supplementing those set out in

MiFID2, are now laid down in Article 44a of the BRRD2 relating to the sale of eligible liabilities to retail investors and in Recital (15) clarifying that holdings of MREL liabilities by retail investors or by other institutions or entities may constitute an impediment to resolvability. Such provisions aim at a workable compromise between freedom of investment choices, investor protection, financial institutions funding needs, and credibility and feasibility of the resolution regime.

11.46 The selling restrictions set out in Article 44a only apply to subordinated liabilities

and not to own funds instruments, but Member States are given the option to extend such regime to the sale of other instruments that qualify as own funds or bail- inable liabilities. The rationale of the new BRRD2 rules is to reinforce MiFID2 provisions that do not expressly target this specific case. The remedies envisaged by the legislature aim to increase retail investors’ awareness and informed consent to the purchase of subordinated liabilities, by enhancing requirements relating to the fair representation of the risk profile of the instruments. The clear cut solution advocated by some to outright exclude retail held subordinated debt from MREL eligibility would have been a disproportionate measure going beyond the pursued objective. Rather, it is confirmed that such liabilities, to the extent they are purchased with informed consent, are eligible for bail-in. In line with this rationale, the first requirement laid down in Article 44a(1) and (2) is the performance of specific suitability test by the seller coupled with a minimum investment of €10 000. As an alternative measure, however, Member States are given the option to impose ‘a minimum denomination amount of at least EUR 50.000 for liabilities referred to in paragraph 1, taking into account the market conditions and practices of that Member State as well as existing consumer protection measures within the jurisdiction of that Member State’. For smaller Member States with total assets of resolution group amounting up to €50 bn, is given the option to only apply the requirement of the minimum investment aggregate amount of €10 000.

11.47 As a preliminary comment to this discipline, it should be noted that although the

articulation of measures may be in line with proportionality criteria, the existence of various national regimes may give rise to difficulties when monitoring of the transposition regimes.

11.48 The clarification that holdings of MREL instruments by retail investors or by

other institutions or entities may constitute an impediment to resolvability is the crystallization of the policy development elaborated by the EBA and ESMA following early resolution cases where the write down of retail bondholders had given rise to public debate and to the practice of public reimbursements affecting 468

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Bail-in: Preparedness and Execution the confidence in the banking system and the credibility of the resolution regime.24 Recital (15) of the BRRD2, by making cross-reference to Commission Delegated Regulation 2016/1075 bundling together several EBA RTS on resolution matters, including on assessment of resolvability, specifies that an impediment to resolvability could be identified by the resolution authority when ‘a significant part of an institution’s or entity’s MREL instruments is held by retail investors that might not have received an appropriate indication of relevant risks’. This is therefore a discretionary assessment, based on the materiality of the MREL amount held by retail investors, and on the absence of fully informed consent to the purchase by the retail investors themselves. Unlike the rules set out in Article 44a of the BRRD2, they apply to all MREL instruments rather than just to subordinated liabilities. Furthermore, and in line with the EBA-ESMA statement, the application of such provision may entail the exemption of the instruments from the MREL requirement in the specific case.

IV. Bail-in Execution As indicated in the FSB Principles on bail-in execution,25 the tool’s implementa- 11.49 tion relies on the interplay of several actions to be taken simultaneously or in a

24 See EBA and ESMA, ‘Joint Statement on Statement on the Treatment of Retail Holdings of Debt Financial Instruments Subject to the Bank Recovery and Resolution Directive’ of 30 May 2018, available online at . It is worth recalling that the EBA/ESMA statement, confined within the limits of the legal text in force at that time, ie the BRRD, aimed at drawing the resolution authorities’ attention on the interplay between retail held eligible liabilities and the credibility and feasibility of the resolution strategy. It moved from early BRRD application cases, in particular of four mid-size banks in Italy, which showed investors’ unawareness about their investment risk profile and the implications of the resolution regime. See Bank of Italy factsheet information and decisions relating to the resolution of CariChieti, Cassa di Risparmio di Ferrara, Banca Popolare dell’Etruria, and Banca Marche, implemented on 22 November 2015, available online at . In an effort to reverse negative impact on the confidence in the banking and political system, the Italian government approved the allocation of funds to reimburse those retail investors meeting pre-determined statutory requirements, including compliance with the State aid framework. See the analysis and proposals set out by S Alvaro, M Lamandini, D Ramos Muñoz, E Ghibellini, and F Pellegrini, ‘The Marketing of MREL Securities After BRRD. Interactions Between Prudential and Transparency Requirements and the Challenges Which Lie Ahead’ (2017) CONSOB, Legal Research Papers, available online at . Maintenance of confidence in the banking and political system have underpinned subsequent similar governmental initiatives in the context of the precautionary recapitalization of Monte dei Paschi di Siena following a voluntary liability management exercise (see R Olivares Caminal and C Russo, ‘Precautionary Recapitalisations: Time for Review’ (July 2017), including references the relevant cases, available online at . 25 FSB, ‘Principles on Bail-in Execution’ (21 June 2018), available online at .

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Anna Gardella co-ordinated way by the resolution authority in co-operation with the financial institution, other stakeholders (such as the independent valuer, the custodians) and authorities (such as the supervisor and the capital markets authority). The Principles focus in particular on the (i) exact determination of the bail-in scope, notably the identification of bail-inable liabilities, hierarchy and transparency requirements; (ii) valuation; (iii) exchange mechanism; (iv) securities law and securities exchange requirements; (v) governance; and (vi) resolution communication. Whilst the main features of the elements relating to the scope have been illustrated in the previous paragraphs relating to TLAC/MREL, this section focuses on some of the aspects set out in the other sections of the bail-in Principles. 1. Data Requirements 11.50 The feasibility of bail-in largely relies on a significant amount of granular data

that banks have to be able to swiftly supply to the resolution authority in order to support the implementation of the write down and conversion powers on the eligible liabilities. Data fields are necessary to identify the specific liabilities subject to such powers, the determination of the required amounts, the assessment of the potential breach of the NCWO and the external aspects of the execution of the tool in close co-operation with the financial market infrastructures, in particular the securities custodians. For this reason, resolution authorities have started to integrate the EBA template on the Liability data structure, required for resolution planning purposes, and the SRB Liability Data Report26 with additional data points necessary for bail-in execution.27 The exercise of data identification is therefore a complex one for authorities and burdensome for banks, considered also the requirement of being able to provide them within a very short timeline (some within 24 hours).

11.51 Bank’s data provision is also necessary in order to perform the valuation which

informs the resolution decision and the determination of the write down and recapitalization amount as well as the conversion rate. For purposes of valuation, data, and information should cover the liability and the asset side of the balance sheet, as well as off-balance sheet positions. To note that whilst most liability data points are useful also for valuation purposes, asset data positions may be more burdensome to provide by banks, if any for the much larger areas covered by the asset side. In the context of the EBA Handbook on valuation for purposes of resolution illustrated below, a section—under finalization—relates to the banks’ organization of management information systems for resolution valuation purposes. It focuses on mapping, organizing and collecting valuation

26 Available online at . 27 BaFin, ‘Minimum Requirements for Implementation of Bail-in’, available online at .

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Bail-in: Preparedness and Execution suitable data and information to be submitted to the resolution authority and/ or the valuer in case of crisis. It is acknowledged that such requirement may be a significant burden on the bank and that proportionality considerations should be taken into account and be reflected in the policy approach. 2. Valuation Further to the publication and entry into force of the EBA RTSs on valuation 11.52 before resolution and on valuation after resolution,28 the EBA has undertaken substantive work to operationalize the valuation process. The EBA Valuation Handbook for purposes of resolution29 (‘Handbook’) is a non-exhaustive guidance addressed to resolution authorities to support them in the implementation of this crucial phase of resolution execution. The Handbook builds upon the legislative and regulatory requirements for valuation laid down in the BRRD and the in Level 2 regulations just mentioned, and illustrates with practical examples and processes the concepts set out therein, with a view to bridging regulatory aspects of resolution with valuation methodologies in a consistent manner. Whilst not impinging on the valuers’ independence, it also aims to reach out to valuers and to establish, in business as usual, a dialogue with them and a common understanding of the valuation resolution specific features in order to enhance preparedness for cases of crisis. The Handbook covers all types of resolution valuations—before resolution and 11.53 after resolution, as well as provisional and definitive—with special focus on ‘valuation 2’, the economic valuation informing the resolution decision. It also deals with the appointment of the independent valuer—recommending resolution authorities to make sure in business as usual to have a shortlist of potential valuers ready to be appointed in a short time in case needed after running conflict of interest controls on a case by case basis—and with the valuation report to be prepared by the independent valuer for the resolution authority. Given the relationship between the valuation and the resolution decision, the valuation report lays down a non-exhaustive list of information the report should contain to ensure that the resolution authority can take an informed decision. As mentioned above, the Handbook will be completed by a chapter on valuation management information systems relating to data and information. With regard to valuation methodologies, the Handbook operationalizes some 11.54 aspects of the application of the ‘hold value’, which is the measurement basis set 28 Respectively Commission Delegated Regulation 2018/ 345 and Commission Delegated Regulation (EU) 2018/344 further to their endorsement. 29 EBA, ‘Handbook on Valuation for Purposes of Resolution’ (22 February 2019), available online at . See also the SRB ‘Valuation Framework’, setting out expectations for valuers, available online at . The two documents take consistent approaches and are broadly complementary.

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Anna Gardella out in the Regulation on valuation before resolution to be applied when bail- in is adopted. It is defined as ‘the present value, discounted at an appropriate rate, of cash flows that the entity can reasonably expect under fair, prudent and realistic assumptions from retaining particular assets and liabilities, considering factors affecting customer or counterparty behaviour or other valuation parameters in the context of resolution’ (Article 1(e) of that Regulation). The last sentence of Article 11(4) of the same Regulation provides that: ‘The hold value may, if considered fair, prudent and realistic, anticipate a normalisation of market conditions’. To note that in light of bail-in forward-looking nature— the bank is assumed to remain going concern—the valuer should be able to take into account to the extent known and possible, potential disposals to be implemented in the context of the restructuring phase of the institution. In that case, certain assets would be retained in order to be disposed of, in accordance with, for instance, the balance sheet destination of specific assets or with business plans and forecasts . . . The valuation of such assets that are ‘held to exit’ may therefore have regard to their expected treatment following entry into resolution. This would entail the application of the disposal value having regard to ‘the expected disposal horizon’ (Articles 11(5) and (6) or 12(4) of the Regulation on valuation before resolution). 11.55 Furthermore, bail-in execution also requires an equity valuation in order to esti-

mate the post conversion equity value.

This should be an estimate of the market price for those shares that would result from generally accepted valuation methodologies, and should inform the determination of the conversion rate or rates pursuant to Article 50 of the BRRD (Article 10(5) of the Regulation on valuation before resolution). Once the equity value is determined, it has to be allocated to the new shareholders in accordance with valuation criteria that respect the requirements set out in the BRRD, in the Regulation on valuation before resolution, and in the EBA Guidelines on the rate of conversion of debt to equity in bail-in.30

3. Securities Laws 11.56 Interaction with securities laws is a further delicate aspect of bail-in execution,

dealing with, on the one hand, the powers relating to trading suspensions, delisting, and listing, and on the other hand, the trade-off between market transparency, which is a pillar of capital markets regulation, and resolution confidentiality to prevent bank runs and domino effects.

11.57 With regard to the first aspect, the BRRD requires Member States to ensure that

resolution authorities are conferred specific powers to complete the administrative processes and requirements to make bail-in effective, including in particular

Handbook, 66. 30

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Bail-in: Preparedness and Execution ‘(a) the amendment of all relevant registers; (b) the delisting or removal from trading of shares or other instruments of ownership or debt instruments; (c) the listing or admission to trading of new shares or other instruments of ownership; (d) the relisting or readmission of any debt instruments which have been written down, without the requirement for the issuing of a prospectus pursuant to Directive 2003/71/EC of the European Parliament and of the Council’ (Article 53(2)). Although the BRRD confers such sweeping powers to the resolution authority, 11.58 their implementation requires ex ante co-ordination, to be achieved already in the resolution planning phase with the other subjects involved in the process, notably capital markets authorities, regulated markets, and custodians. Processes need to be laid down, agreed upon, and completed with the conclusion of co-operation arrangements. Similarly, the issue relating to market disclosures is not only technically com- 11.59 plex but also politically sensitive since it confronts two opposite needs: on the one hand the resolution authority’s concern with financial stability and with confidentiality of the resolution process, in particular of the phases before actual resolution action is taken (for instance starting from the valuation), and the capital markets authorities’ mandate to ensure transparency and completeness of information. Such trade-off is implied in FSB Principles 11 and 12 on bail-in execution where reference is made to the resolution authority’s requirement to understand the existence of conditions for exemptions or postponements of such requirements,31 and to the need to co-ordinate with the capital markets authority and with the firm where disclosure requirements could affect the successful implementation of bail-in. Although the securities framework seems not to leave much room for manoeuvre, the reference to the resolution authority’s co-ordination with the firm may be conducive to a more flexible approach having regard to the special regime for credit institutions and investment firms set out in Article 17(5) of the EU Regulation on market abuse. This provision envisages the possibility for the firm to ‘delay the public disclosure of inside information’. The application of such provision, however, is not only subject to the meeting of all conditions set out in that provision (adverse impact of the issuer’s and the financial system’s stability, assurance of the information’s confidentiality, public interest, agreement of the competent authority), but also to the responsibility of the firm and the competent authority’s agreement. This entails a willingness of both the firm’s and the authority’s board to face potential responsibilities in order to derogate to the ordinary provisions. The determination of the circumstances where all such conditions may be considered met and the reconciliation of such exemption

Principle 11, 17. 31

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Anna Gardella (where applied) with the potential liabilities the firm or the competent author may incur is undisputedly a hurdle in the actual application of the provision. More work needs to be done, in co-operation with all the parties involved (resolution and competent authorities and firms) to identify ex ante circumstances that can be deemed to meet all the conditions and where the provisions can therefore be safely applied.

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12 BANK RESOLUTION IN PRACTICE Analysis of Early European Cases Guido Ferrarini and Alberto Musso Piantelli*

I. Introduction

12.01 1. Bank Resolution in the EU and the Eurozone 12.01 2. Resolution Tools 12.04 3. Normal Insolvency Proceedings 12.10

II. Crisis Management Pre-BRRD 1. UK and Germany 2. Ireland

III. Crisis Management in the Transition to the New EU Regime 1. Greece 2. Cyprus 3. Portugal

IV. The New Regime: Crisis Management in Italy

1. Background 2. Italian Bank Insolvency 3. Monte dei Paschi di Siena

12.13 12.13 12.16

V. The New Regime: The Resolution-like Liquidation of Venetian Banks

1. Veneto Banca and Banca Popolare di Vicenza 2. Insolvency Proceedings 3. The EU Commission Decision 4. Rationale and Path-dependence

12.40 12.40 12.47 12.51 12.54

VI. The New Regime: Crisis Management in Spain 12.20 12.21 12.24 12.28 12.30 12.31 12.33 12.36

12.64 1. Bank Restructuring after the Financial Crisis 12.64 2. The Crisis of Banco Popular 12.68 3. The Resolution of Banco Popular 12.71 4. Successful Outcomes and Specificities 12.78

VII. Conclusions

12.81

A first draft of this chapter was presented at the meeting of the ‘International Working Group * on European Banking Union’ organized in Milan by Università Cattolica del Sacro Cuore and the European Banking Institute on 20 October 2017. We are grateful to Stefano Cappiello and Sergio Lugaresi for helpful discussion and to other participants for their comments.

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I. Introduction 1. Bank Resolution in the EU and the Eurozone 12.01 The Bank Resolution and Recovery Directive (BRRD)1 and the Single Resolution

Mechanism Regulation (SRMR)2 represent the cornerstones of the bank crisis management regime in the EU and the Eurozone respectively. They are based on the international principles3 and govern crisis management, including recovery and resolution planning, early intervention in a crisis, and resolution of the same. Insolvency proceedings remain a matter for national legislation.

12.02 The resolution regime lies at the heart of both the BRRD and the SRMR. Its

goals are defined as follows: (a) ensuring the continuity of critical functions; (b) avoiding significant adverse effects on the financial system; (c) protecting public funds by minimizing reliance on extraordinary public financial support; and (d) protecting depositors, client funds and assets. When pursuing these goals, the resolution authority shall minimize the cost of resolution and avoid destruction of value if possible.4

12.03 Resolution is governed by a number of principles5 such as the following: (a)

shareholders bear losses first; (b) creditors bear losses after shareholders following the order of priority under normal insolvency proceedings, save as provided otherwise; (c) the management body and senior management are replaced, if their staying is not necessary for achieving resolution objectives; (d) except where otherwise provided, creditors of the same class are treated in an equitable manner; (e) no creditor shall incur greater losses than would have been incurred under normal insolvency proceedings. In addition, when applying resolution tools Member States shall comply with the EU State Aid framework, where applicable.6

1 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/ 25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) 1093/2010 and (EU) 648/2012, of the European Parliament and of the Council [2014] OJ L173. 2 Regulation (EU) 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) 1093/2010 [2014] OJ L225. 3 See FSB, ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’, October 2011. 4 See SRMR, art 14(2) and BRRD, art 31(2). For an overview of resolution objectives, see Jens-Hinrich Binder, ‘Resolution: Concepts, Requirements and Tools’ in Jens-Hinrich Binder and Dalvinder Singh (eds), Bank Resolution: The European Regime (Oxford University Press, 2016), 40ff. 5 See SRMR, art 15 and BRRD, art 34. 6 See SRMR, art 19 and BRRD, art 34.

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Bank Resolution in Practice: Analysis of Early European Cases 2. Resolution Tools Resolution authorities fulfil their mandate through four resolution tools, which 12.04 can be resorted to individually or in combination:7 sale of business, bridge institution, asset separation and bail-in. The first three were already known in a number of jurisdictions prior to the 2008 crisis and remain the preferred solution for banking crises when practicable.8 The fourth tool—the bail-in—is new and was introduced with the aim to contain bailouts and moral hazard in banking.9 No doubt, the preservation of taxpayers’ money is one of the main political and ideological objectives of the whole resolution framework.10 In the case of a bail-in, losses are imposed on shareholders and a large part of the 12.05 creditors through a mandatory debt restructuring process in which debt owed to the bank is either written down or converted into equity.11 To the extent that it allows an orderly resolution and the protection of public funds, the bail-in tool is well grounded.12 However, scholars also point out to serious shortcomings of this tool, especially if it is made mandatory to the exclusion of any type of bailout.13 Indeed, fully private resolution of a bank through the bail-in of creditors can bring two major negative outcomes. Firstly, it may represent a channel for direct or indirect contagion,14 and act 12.06 pro-cyclically as a result.15 The major direct contagion effect derives from the spreading of losses to the holders of other bail-inable debt. The risk of direct contagion is particularly high when bail-inable liabilities are held by other financial institutions in significant amounts.16 In similar cases, losses of one or more banks 7 See SRMR, art 22 and BRRD, art 37. 8 See Simon Gleeson, ‘Legal Aspects of Bank Bail-Ins’, LSE Financial Markets Group Paper Series—Special paper 205 (2012), 10. 9 See SRMR, Recital 73 and BRRD, Recital 67. 10 See, for example, Christos Hadjiemmanuil, ‘Limits on State-Funded Bailouts in the EU Bank Resolution Regime’ (2017) EBI Working Paper Series 2, 7. 11 Extensively on the bail-in tool see Anna Gardella, Chapter 13 of this volume. 12 See, Thomas F. Huertas, ‘The Case for Bail-in’ (2012) available online at  1. 13 See, for example, Mathias Dewatripont, ‘European Banking: Bailout, Bail-in and State Aid Control’ (2014) International Journal of Industrial Organization 34; Giovanni Dell’Ariccia, Maria Soledad Martinez Peria, Deniz Igan, Elsie Addo Awadzi, Marc Dobler, and Damiano Sandri, ‘Trade- offs in Bank Resolution’ (2018) IMF Staff Discussion Note SDN/18/02. 14 For a comprehensive approach to contagion effects during banking crisis and their impacts on systemic risk, see Olivier De Brandt and Philipp Hartmann, ‘Systemic Risk: a Survey’ (2000) ECB Working Paper No 35. 15 On cyclical effects of Bail-in, see Amitai Aviram, ‘Bail-Ins: Cyclical Effects of a Common Response to Financial Crises’ (2011) University of Illinois Law Review 1633ff. 16 See Dirk Schoenmaker, ‘A Macro Approach to International Bank Resolution’ (2017) Bruegel Policy Contribution Issue n˚20, 3. The topic is currently under debate in Europe. See, for example, ‘Position of the European Parliament adopted at first reading on 16 April 2019 with a view to the adoption of Regulation (EU) 2019/ . . . of the European Parliament and of the Council amending Regulation (EU) No 806/2014 as regards the loss-absorbing and recapitalisation capacity of credit institutions and investment firms’ (‘BRRD II reform’), recital 15; Andrea Enria, ‘Interview with

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Guido Ferrarini and Alberto Musso Piantelli automatically pass on to other banks with a possible impact on their solvency and ability to provide credit. As a result, the overall stability of the banking system is put in danger, regardless of whether bail-in concerns a large bank failure or multiple failures of small banks.17 Indirect contagion occurs when bail-in sparks panic amongst depositors because of asymmetric information and becomes particularly dangerous when it spreads out to other comparable, but still viable institutions.18 12.07 Secondly, bail-in may be perceived as unfair when it involves small savers, as the

negative impact produced on them raises concerns both from a financial stability and a consumer protection perspective.19 As has been argued, shifting from

La Stampa’, 1 May 2019 available online at ); Wolf-Georg Ringe and Jatine Patel, ‘The Dark Side of Bank Resolution: Counterparty Risk through Bail-in’ (2019) EBI Working Paper Series No 31. 17 See Schoenmaker (n 16), 4 18 See Emilios Avgouleas and Charles Goodhart, ‘Critical Reflections on Bank Bail-ins’ (2015) Journal of Financial Regulation 1, 21; Tobias H. Tröger, ‘Too Complex to Work: A Critical Assessment of the Bail-in Tool under the European Bank Recovery and Resolution Regime’ (2017) SAFE Working Paper Series No 179, 10. 19 See Claudia Pigrum, Thomas Reininger, and Caroline Stern, ‘Bail-in: Who Invests in Non- covered Debt Securities Issued by Euro Area Banks?’ (2016) Oesterreichische Nationalbank Financial Stability Report 32, 112. Relations between consumer protection and resolution regimes are troublesome. Significantly, the SRB makes it explicit that there is not ‘any legal basis for resolution authorities to exclude ex ante and uniformly eligible liabilities held by natural persons or small and medium sized enterprises from MREL or from bail-in’. In fact, ‘the EU legislation includes many safeguards to ensure financial products are sold to suitable investors only’ and that ‘any possible failure to comply with investor protection rules is not an argument to exclude these liabilities from the computation of MREL targets or finally bail-in’. However, the SRB also recognizes that ‘holdings of subordinated or senior instruments by retail customers could prove to be an impediment to resolution’ since ‘large holdings of liabilities sold to retail investors make banks difficult to resolve for various reasons, including (i) the potential loss of a bank’s customer base and the risk of deposit withdrawals and (ii) potential litigation brought by retail investors upon or after resolution, which might endanger the bank’s future viability’. See SRB ‘Minimum Requirement for Own Funds and Eligible Liabilities (MREL) SRB Policy for 2017 and Next Steps’, 20 December 2017, available online at , 16. Consistently, according to Götz and Tröger: ‘The power of bail-in to serve as a regulatory tool to recapitalize banks during times of distress depends crucially on the characteristics of debt holders. We argue that debt holders of bail-in able debt should be sophisticated investors outside the banking industry with no asset-liability mismatch.’ See Martin R. Götz and Tobias H. Tröger, ‘Should the marketing of subordinated debt be restricted/different in one way or the other? What to do in the case of misselling?’ (2016) In-depth analysis provided in advance of the public hearing of the Chair of the Single Supervisory Mechanism in ECON on 22 March 2016. See also Dell’Ariccia, Peria, Igan, Addo Awadzi, Dobler, and Sandri (n 13). From a slightly different point of view, Resti suggests ‘rather than prohibiting the sale of subordinated debt to small investors, supervisors should tackle risk originating from self-placement (including mispricing) through a thorough implementation of MiFID and MiFID II rules on conflicts of interest. National authorities may use such rules to require banks: (i) to set maximum concentration limits in their customers’ portfolios; (ii) to develop adequate pricing procedures; (iii) to ensure that remuneration schemes do not lead to improper selling practices’. See Andrea Resti: ‘Should the marketing of subordinated debt be restricted/different in one way or the other? What to do in the case of misselling?’ (2016) In-depth analysis provided in advance of the public hearing of the Chair of the Single Supervisory Mechanism in ECON on 22 March 2016, 5. Considering the ongoing

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Bank Resolution in Practice: Analysis of Early European Cases bail-out to bail-in simply transfers the burden of losses from one group of citizens, the taxpayers, to another, the pensioners and savers, which is not necessarily the right choice.20 Moreover, hitting small savers might be politically costly since parliaments are traditionally inclined to protect ‘poor’ savers who are also voters. Therefore, a bail-in of non-professional debtholders is unlikely without some form of compensation.21 As a result, commentators agree that bail-in based resolution should not be resorted 12.08 to in conditions of financial distress and system-wide banking weaknesses, which could be aggravated as a result. Optimal fields of application of bail-in are idiosyncratic crises where confidence in the system is not an issue and the risk of contagion is limited.22 In the presence of widespread distress, the bail-in of one bank is likely to lead to other banks’ claimholders reappraising their position. This would increase the cost of obtaining money from the market, precisely when the banking sector is in the greatest need to raise additional funds.23 It has also been argued that bail-in mechanisms only work ‘for good banks with 12.09 bad balance sheets’. In fact, bail-in provides no new money, so that a bailed-in institution has a chance to survive only if its stakeholders reasonably believe that they can look to its future with optimism.24 3. Normal Insolvency Proceedings The SRMR and the BRRD do not cover ‘normal’ insolvency proceedings that 12.10 remain regulated under national law.25 This raises the issue of the relationship between EU resolution and national insolvency proceedings.26 Both the BRRD and the SRMR provide that a failing institution should in principle be liquidated

BRRD II reform, the problem is likely to lose most of its relevance in future perspective. See BRRD II Reform, Recitals 15, 16 and para 16. 20 See Avgouleas and Goodhart (n 18), 17 21 See Schoenmaker (n 16), 4 22 See, for example, Avinash D. Persaud, ‘Why Bail-In Securities Are Fool’s Gold’ (2014) Peterson Institute for International Economics, Number PB 14-23; Binder (n 4), 58; Gleeson (n 8), 4; Hadjiemmanuil (n 10), 13. The argument has also received empirical support by the research conducted by Boccuzzi and De Lisa with respect to the resolution of four Italian less significant banks. See Giuseppe Boccuzzi and Riccardo De Lisa, ‘Does Bail-in Definetly Rule out Bailout?’ (2017) Journal of Financial Management, Markets and Institutions 1, 93. 23 Hadjiemmanuil (n 10), 14. 24 Gleeson (n 8), 24 25 They are defined as the ‘collective insolvency proceedings which entail the partial or total divestment of a debtor and the appointment of a liquidator or an administrator normally applicable to institutions under national law and either specific to those institutions or generally applicable to any natural or legal person’. See BRRD, art 2(47). 26 On this topic, see Giuseppe Boccuzzi, The European Banking Union Supervision and Resolution (Palgrave Macmillan, 2016), 169–171; and Matthias Haentjens, ‘National Insolvency Law in International Bank Insolvencies’ in Bernard Santen and Dick Van Offeren (eds), Perspectives on International Insolvency Law: A Tribute to Bob Wessels (Uitgeverij Kluwer, 2014).

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Guido Ferrarini and Alberto Musso Piantelli under normal insolvency proceedings.27 However, liquidation ‘could jeopardise financial stability, interrupt the provision of essential services, and affect the protection of depositors’.28 In similar cases, there is a public interest in applying the resolution tools. ‘The objectives of resolution should therefore be to ensure the continuity of essential financial services, to maintain the stability of the financial system, to reduce moral hazard by minimising reliance on public financial support to failing entities, and to protect depositors.’29 12.11 Therefore, resolution is the rule whenever necessary to protect financial stability and/

or critical functions and/or public funds and/or depositors and/or client funds and assets, whereas insolvency proceeding are left to a residual role. Consistently, Article 18(5) of the SRMR provides: For the purposes of point (c) of paragraph 1 of this Article, 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 14 and winding up of the entity under normal insolvency proceedings would not meet those resolution objectives to the same extent.

12.12 This establishes a clear hierarchy between normal insolvency proceedings and res-

olution tools.30 When the latter respond to one or more of the resolution goals identified in Article 14(2) of the SRMR, national insolvency proceedings can be resorted to only if they meet the same resolution objectives as a resolution by the SRB. Therefore, the choice between resolution and winding-up of a bank inevitably depends on the national liquidation procedures, with clear consequences on the possibility of a European level playing field. As the case of the Venetian banks will show (see Section V below), the border between resolution and liquidation gets blurred where national insolvency proceedings provide for typical ‘resolution tools’ such as the authoritative power to transfer assets or liabilities either to other banks or to ‘bad banks’. A similar overlap between EU resolution and national liquidation may result in the generalized disapplication of resolution in favour of liquidation under national law, still in compliance with the letter of Article 18(5) of the SRMR.31 27 See SRMR, Recital 59 and BRRD, Recital 45. 28 See BRRD, Recital 45. 29 See SRMR, Recital 58. 30 In this respect, the speech delivered at the Belgian Financial forum of 27 January 2017 by the SRB Chair, Elke König (available online at ) raises some concerns, as she argues: ‘The extra safety net of resolution is only for the few, not the many’. In our opinion, resolution under SRM rules should be viewed as the preferred option for the management of European significant banks, especially under the realistic assumption that a failure of any of those institutions is likely to produce negative effects on financial stability and the real economy. 31 Emblematically, the IMF notes: ‘Diverging national bank insolvency regimes, subject to less stringent loss sharing requirements under state aid rules than in the SRM, deliver substantially different outcomes for bank creditors, and therefore create an uneven playing field across the banking union in terms of banks’ funding costs. Moreover, these divergences provide strong incentives for Member States to resolve systemic banks under national bank insolvency regimes’

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II. Crisis Management Pre-BRRD 1. UK and Germany Before being adopted by EU legislation, bank resolution regimes were enacted 12.13 at national level as a result of the great financial crisis.32 The UK and Germany offer good examples of it.33 In the UK, the 2009 Banking Act introduced a special resolution regime34 envisaging ‘stabilization options’ such as the sale of business, the transfer to a bridge bank and temporary public ownership.35 Moreover, the 2011 Finance Act introduced a levy on banks’ balance sheets, so as to assure their full and fair contribution to the potential risks posed to the whole economy.36 In addition, the 2013 Financial Services Act added bail-in to the list of ‘stabilization options’.37 In Germany, a resolution regime was adopted in 2010 with the German Bank 12.14 Restructuring Act, which came into force on the 1st January 2011.38 Section 2 of this Act strengthened the prudential supervisory toolkit that was already in place and introduced the transfer order as a crisis management tool. In addition, section 3 provided for a Restructuring Fund to finance bank restructuring

and suggests ‘to further harmonize the framework, the SRMR should include an administrative bank liquidation tool’. See International Monetary Fund, ‘Euro Area Policies Financial System Stability Assessment’ (July 2018), IMF Country Report No 18/226, 26–7. On the need of further harmonization of insolvency proceedings see also, for example, Elke König, ‘Why We Need an EU Liquidation Regime for Banks’ Eurofi Articles, 5 September, 2018 (available online at ). 32 For an overview of national reforms see Sebastian Schich and Byoung- Hwan Kim, ‘Developments in the Value of Implicit Guarantees for Bank Debt: The Role of Resolution Regimes and Practices’ (2012) OECD Journal: Financial Market Trends: Vol 2, Appendix I. 33 In both countries, the need for legislative changes was triggered by difficulties encountered in the management of first major crisis episodes (Northern Rock in UK and Hypo Real Estate in Germany). See Barbara Jeanne Attinger, ‘Crisis management and bank resolution—Quo vadis, Europe?’ (2011) ECB legal working paper series No 13, 20. 34 The 2009 Banking Act followed the initially adopted emergency legislation (Banking (Special Provisions) Act of 2008) introduced to facilitate the saving of Northern Rock and then used in two other main cases: the crisis of Bradford and Bingley and the rescue of U.K. assets of Icelandic banks Landsbanki and Kaupthing. See Peter Brierley, ‘The UK Approach to Resolution of Failed Banks in the Crisis’, Presentation to EBRD conference on Operational Aspects of Bank Resolution and Restructuring of 19 March 2012, available online at . 35 See Banking Act 2009, ss 11–13. 36 See Finance Act 2011, s 73 and Sch 19. See also Jeffrey Gordon and Wolf-Georg Ringe, Chapter 15 of this volume. 37 See Financial Services (Banking Reform) Act 2013, s 17 and Sch II. 38 Also this structural reform followed a first set of emergency laws adopted in 2008–2009 (ie The Financial Market Stabilisation Act adopted in October 2008, The Financial Market Stabilisation Amendment Act of April 2009, and the Financial Market Stabilisation Development Act (‘Bad Bank Act’) of July 2009). See Deutsche Bundesbank, ‘Annual Report 2009’, 91.

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Guido Ferrarini and Alberto Musso Piantelli and resolution.39 Bail-in was adopted in 2015 with the Act on the Recovery and Resolution of Credit Institutions transposing the BRRD in Germany.40 12.15 Both in the UK and Germany, legislative innovation concerned the resolution

procedures and tools rather than the funding of resolution. Indeed, the new resolution regimes did not prevent the UK and German governments from spending substantial amounts of money to bail-out their national banking systems.41 Interestingly, both countries regulated the bail-in mechanism at a later stage, once the main rescues had been accomplished.42 Therefore, the modern philosophy of privately funded bank resolution through bail-in in a systemic crisis remained substantially untested before the BRRD and the SRMR implementation.43 2. Ireland

12.16 Also the Irish reform of bank crisis management was put in place and largely ap-

plied to the crisis of national banks before 2014. However, this crisis was dealt with largely at supranational level, given that Ireland required external help in 2010,44 similarly to what done by other Euro area countries like Greece, Cyprus, Portugal and Spain (see Sections III and VI below).

12.17 In the years preceding the great financial crisis, the Irish economy increasingly

relied upon the construction and property sector. Starting in the late 2007, investors exited the real estate sector and the country experienced revenue falls,

See Deutsche Bundesbank, ‘Monthly Report June 2011’, 62. 40 See Bafin, ‘Recovery and resolution: Implementing act for European directive now in force’ (available online at ). 41 Between 2008 and 2014, the UK spent a total amount of €785.3bn of state aids of which €100.1bn for recapitalizations, €40.4bn in form of impaired asset measures, €502.6bn in terms of guarantees, and €142.2bn for other liquidity measures. In the same period, Germany spent €488bn of which €64.2bn for recapitalizations, €80bn in form of impaired asset measures, €335.5bn in terms of guarantees, and €8.3bn for other liquidity measures. See EU Commission, ‘State Aid Scoreboard 2018’ (available online at ). 42 The UK provided €30.6bn of State guarantees and €24bn of other liquidity measures between 2014 and 2016, while Germany did not provide any state aid in 2015 and 2016. See EU Commission (n 41). 43 In those years, the first cases of bail-in of senior creditors concerned the Danish small retail Amagerbanken (total assets of €4.5bn) and Fjordbank Mors (total assets of €1.8bn). See Tracy Alloway ‘Concerns Grow Over Denmark’s Bail-in Rules’ Financial Times (London, 23 May 2011); Alexander Schäfer, Isabel Schnabel, and Beatrice Weder di Mauro, ‘Bail-in Expectations for European Banks: Actions Speak Louder Than Words’ (2016) ESRB Working Paper Series No 7, 7; Patrick Honohan, ‘Management and Resolution of Banking Crises: Lessons from Recent European Experience’ (2017) Peterson Institute for International Economics, Policy Brief 1, 9. 44 For that reason (ie the supranational relevance of the crisis) we treat the Irish case as an additional example in this section. 39

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Bank Resolution in Practice: Analysis of Early European Cases while domestic banks suffered large losses on their real estate loans’ portfolios. The global crisis exacerbated these problems and despite some policy responses three years later the whole economy lost investors’ confidence. In November 2010, severe difficulties pushed the Irish government to require external help.45 Between 2011 and the end of 2013, the assistance program agreed with the EU and international authorities provided Ireland with a total of €67.5bn co-financed by the European Financial Stability Facility (EFSF) (€17.7bn), the European Financial Stabilisation Mechanism (EFSM) (€22.5bn) and the International Monetary Fund (IMF) (€22.5bn), plus €4.8bn in bilateral loans from the UK, Denmark and Sweden.46 On the regulatory side, Ireland firstly passed The Credit Institutions 12.18 (Stabilization) Act in December 2010, which granted the Minister of Finance temporary powers to perform the restructuring actions and/or recapitalizations envisaged in the Programme.47 Secondly, the Central Bank and Credit Institutions (Resolution) Act entered into force in October 2011 attributing competent authorities a robust set of powers and tools—such as the bridge institution and the transfer of assets tools,48 however not the bail-in49—to ensure the prompt and effective resolution of distressed banks. The 2011 legislation also established the Credit Institutions Resolution Fund ‘to provide a source of funding for the resolution of financial instability in, or an imminent serious threat to the financial stability’.50 Ireland successfully exited its assistance Program in 2013. As for the UK and 12.19 Germany, the establishment in Ireland of a special regime for bank resolution was part of the national bail-out strategy with no reference to the bail-in philosophy later adopted at EU level.51

45 On the origins of Irish crisis see: EU Commission, ‘The Economic Adjustment Programme for Ireland’ (2011) Occasional Papers 76, 6–18. 46 See ESFS press release, 08 December 2013 (available online at ). 47 See EU Commission (n 45), 25. 48 See Central Bank and Credit Institutions (Resolution) Act 2011, ss 17ff and 20ff. 49 Bail-in was introduced by the European Union (Bank Recovery and Resolution) Regulations 2015 (SI 2015/289) and came into operation on 1 January 2016. See art 1(3). 50 See Central Bank and Credit Institutions (Resolution) Act 2011, arts 10 ff. 51 More precisely, subordinated bondholders suffered losses for €15.5bn, while senior bondholders were bailed out. The bail-in of senior bondholders was supported by the IMF, but was finally excluded mainly because of the contrary opinion of EU authorities. See Dirk Schoenmaker, ‘Stabilising and Healing the Irish Banking System: Policy Lessons’ (2015) Paper prepared for the CBI-CEPR-IMF Conference Ireland—Lessons from its Recovery from the Bank-Sovereign Loop; Suzanne Lynch, ‘IMF Wanted Senior Bondholder ‘Bail-in’ for Ireland’ The Irish Times (3 February 2014).

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III. Crisis Management in the Transition to the New EU Regime 12.20 While the BRRD/ SRMR framework was enacted and implemented (2014–

2016),52 a number of other EU countries were facing severe economic distress as a consequence of the 2008 financial turmoil and of the subsequent sovereign debt crisis.53 1. Greece

12.21 Greek sovereign debt became a matter of common concern soon after the finan-

cial crisis and, when borrowing costs rose to unsustainable levels in 2010, the IMF and the EU decided to engage in co-operation to preserve the Eurozone stability.54 The EU-IMF intervention relied on strict structural and fiscal measures,55 which further contributed to undermining the already weak balance-sheets of Greek banks, forcing them to a system-wide process of restructuring and consolidation.56 In order to provide for a proper legal framework, the Parliament passed new laws,57 which enabled the Bank of Greece to adopt resolution measures based on the transfer of assets and bridge institution tools, with the financing of the Hellenic Deposit and Investment Guarantee Fund (HDIGF) and especially of the Hellenic Financial Stability Fund (HFSF).58 Bail in-like mechanisms were not included in the reform. 52 Specifically: (i) on 15 May 2014 the European Parliament and the Council adopted BRRD; (ii) on 15 July 2014 the European Parliament and the Council adopted SRMR; (iii) Member States should have transposed the BRRD before 31 December 2014 and applied the same starting with 1 January 2015 except for provisions related to bail-in (see BRRD, at 130); (iv) starting on 1 January 2016 SRMR was fully applicable and bail-in became mandatory. 53 In this section, our analysis is limited to the cases of Greece, Cyprus, and Portugal (with reference to the case of Banco Espírito Santo) which, since 2010, benefitted of international support. Ireland and Spain are the two other countries which took part in international programs in those years but, for narrative reasons their vicissitudes are treaded respectively in Sections II and VI. 54 The first financial support programme for Greece (€73bn in total), consisted of rescue loans from euro area countries (€52.9bn), and from the IMF (€20.1bn). See ESM official calculation (available online at ). 55 See EU Commission, ‘The Economic Adjustment Programme for Greece’ (2010) Occasional Papers 61. 56 See Maria Mavridou, Aikaterini Theodossiou, and Triantafyllia Gklezakou, ‘Greece—Several Greek Banks and Foreign Branches: Resolution via Public Recapitalization and Bail-in and State Aid Issues (2009–2015)’ in World Bank, Bank Resolution and ‘Bail-in’ in the EU: Selected Case Studies Pre- and Post-BRRD (2016), 29–37. 57 The new resolution framework consisted of Law 4051/2012, arts 9–11, amending Law 3864/ 2010, Law 3601/2007, and Law 3746/2009, in conjunction with provisions of Law 4021/2011 on the enhanced measures for the supervision and resolution of credit institutions. See Bank of Greece, ‘Annual Report 2011’, 149. 58 HFSF was established by Law 3864/2010 with the objective to safeguard the stability of the Greek banking system. Its entire capital was subscribed solely by the Greek State. See Hellenic Financial Stability Fund, ‘Annual Report for the financial year from 21/07/2010 to 31/12/2011’, 2. Note that between February 2012 and December 2014, the Hellenic Deposit and Investment

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Bank Resolution in Practice: Analysis of Early European Cases Over the years 2012–2015, 14 ‘less significant’ banks59 were officially resolved 12.22 either under the 2012 law or under the new law implementing the EU resolution regime60 (in the case of the Peloponnese Cooperative Bank61). After deduction of private contributions, the total cost of resolutions amounted to €15,191bn and was afforded by the HFSF (for €13.489bn) and the HDIGF (for €1.702bn).62 Full bail-in was never applied as it became mandatory only from January 2016. Alongside the resolution of smaller banks, two ‘significant’ banks—Piraeus Bank 12.23 and National Bank of Greece—were admitted in 2015 to the precautionary recapitalization foreseen by the new EU legislation.63 In particular, after Greece asked the European Stability Mechanism (ESM) for additional financial support,64 the latter requested the possible capital needs of four significant banks (ie Alpha Bank, Eurobank, National Bank of Greece and Piraeus Bank)65 to be addressed by the end of 2015.66 Based on the SSM comprehensive assessment (CA), the four banks were required to increase their capital, which they did by raising substantial amounts of private money, without resorting to resolution and bail-in. However, the National Bank of Greece and Piraeus Bank only managed to raise the capital needed with respect to the (CA) ‘baseline scenarios’.67 Therefore, the Hellenic Financial Stability fund injected about €2.7bn in each one.68 The EU Guarantee Fund was suspended, and the sole Hellenic Financial Stability Fund supported the cost of resolution measures (see Information available online at ). 59 None of those banks was in the number of ‘significant banks’ that felt under ECB direct supervision in 2014. 60 The BRRD was implemented in Greece by Law 4335/2015. 61 See Bank of Greece—Resolution Measures Committee, ‘Application of the sale of business tool under Article 38, within Article 2, of Law 4335/2015 to the credit institution under resolution “Cooperative Bank of Peloponnese Coop Ltd” ’, Meeting 28/18.12.2015. 62 Mavridou, Theodossiou, and Gklezakou (n 57), 33 63 See BRRD, art 32. 64 After the first financial support programme (see n 54), between 2012 and 2015, Greece beneficiated of a second economic adjustment program financed by the EFSF (€141.8bn in loans) and the IMF (€12bn in loans). See European Commission, ‘The Second Economic Adjustment Programme for Greece’ (2012) Occasional Papers 94. When that programme expired in June 2015, Greece failed to repay IMF loan. See IMF Press Release 30 June 2015 No 15/310 (available online at ). Then, the Greek government made a request for support from the ESM on 8 July 2015. See ‘Memorandum of Understanding Greece’, August 2015 (available online at ). Therefore, the ESM disbursed an additional total amount of €61.9bn. See ESM official calculation (n 54). 65 The four banks had already benefited of state capital injections, guarantees and bond loans granted under the support measures put in place by Greece in November 2008 (see EU Commission Press Release IP/08/1742), and of a bridge recapitalization provided by the HFSF for a total amount of €18bn in July 2012 (see EU Commission press release IP/12/860). 66 See ‘Memorandum of Understandings Greece’ (n 64), 18. 67 Contrary, Alpha Bank and Eurobank fully raised necessary from private investors (see EU Commission press release IP/15/6184). 68 The intervention was based on the amended HFSF law and the Cabinet Act No 36 of 2 November 2015. Those legislative interventions allowed the four significant banks to receive HFSF

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Guido Ferrarini and Alberto Musso Piantelli Commission approved this public subsidy under State Aid rules, welcoming that the two banks had covered a significant part of their capital needs with money from private investors and expressing confidence in the two banks’ return to long- term viability.69 2. Cyprus 12.24 Following a growth period after entry in the EU, the Cypriot banking sector

revealed serious weaknesses in 2010 and within a couple of years was near to collapse with the whole country.70 After losing its investment grade status with all three largest rating agencies in June 2012, Cyprus requested assistance from the EU and the IMF.71 Negotiation did not really take off until mid-March 2013,72 when a first draft of rescue package included a one-time tax on banks deposits equal to 6.75% for deposits up to €100 000 and of 9.9% for larger ones.73 The Cypriot Parliament did not follow-up with this proposal.74 Banking business temporarily stopped and banks remained closed to prevent massive withdrawals while the terms of the deal were revised.75

12.25 On 22 March, the Cypriot Parliament urgently approved a law empowering the

Central Bank of Cyprus with new generation resolution tools, including the recapitalization tool, the transfer of assets, the bridge institution and the bail-in.76 On 25 March, a new plan for financial support was presented. The new proposal did not require parliamentary approval since the resolution framework already

support in the form of ordinary shares and/or CoCos in a precautionary recapitalization and/or in resolution. 69 See EU Commission, press releases IP/15/6193 and IP/15/6255. For an extended and sharp reconstruction of the precautionary recapitalization of National Bank of Greece and Piraneus Bank see respectively: State Aid SA.43365 (2015/N)—Greece and State Aid SA.43364 (2015/ N) —Greece. 70 The remarkable exposure of Cypriot to Greece was probably decisive for Cyprus’ collapse since the decision of the EU Council to restructure the Greek debt with a considerable private sector involvement resulted in a €4.5–5bn loss. See Daniel Stavárek, ‘Lessons Learned from the 2013 Banking Crisis in Cyprus’ (2013), European Financial Systems. Proceedings of the 10th International Scientific Conference, Brno: Masaryk University, 2013, 314. 71 See James Wilson, ‘Cyprus Requests Eurozone Bailout’ Financial Times (London, 25 June 2012). 72 That delate was probably mainly due to political reasons. See Athanasios Orphanides, ‘ “What Happened in Cyprus?” The Economic Consequences of the Last Communist Government in Europe’ (2014) LSE Financial Markets Group Paper Series—Special paper 232. 73 See Alexander Michaelides, ‘Cyprus—Bank of Cyprus (BoC) and Laiki: Resolution via Public Support and Bail-in, Including of Uninsured Depositors (2013)’ in World Bank (n 56), 20. 74 See Panicos O. Demetriades, ‘Political Economy of a Euro Area Banking Crisis’ (2016) LSE Financial Markets Group Paper Series—Special paper 245, 10. 75 See Central Bank of Cyprus’s announcements of 8, 18, 20, 21, and 25 of March 3013 (available online at ). 76 See the Resolution of Credit and Other Institutions Law of 2013 (Basic Law)—L. 17(Ι)/ 2013,—Part III. For a brief overview see Central Bank of Cyprus’s announcement of 15 April 2013 (available online at ).

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Bank Resolution in Practice: Analysis of Early European Cases adopted was sufficient to put the rescue plan into practice. Under this ‘adjustment programme’: (i) the ESM and the IMF were to provide up to €10bn;77 (ii) Cypriot banks’ branches in Greece were to be sold in order to safeguard financial stability both in Cyprus and Greece;78 (iii) the two largest commercial banks79—Marfin Laiki Popular Bank80 and Bank of Cyprus—were resolved with contribution of shareholders, bondholders and uninsured depositors.81 Moreover, the Memorandum of Understanding signed by Cyprus and the 12.26 European Commission on 26 April 2013 provided for a State-supported recapitalization and restructuring of the sector of co-operative banks. The strategy for the restructuring of the Cooperative sector foresaw the merger of over ninety co-operatives into eighteen regional entities under the Central Cooperative Bank (CCB).82 The State injected €1.5bn into the CCB becoming the 99% shareholder of the bank while Cooperatives (the old owners) maintained 1% through the CCB Holding Company.83 In November 2015, the ECB required CCB to submit a capital plan after it identified a €470.7m shortfall in the provisions for loan losses. As a result, the new established Recapitalization Fund injected €175m into the CCB in return for ordinary shares. Even if Cyprus had not yet transposed the BRRD into national law, the Commission considered the possible violation of BRRD provisions concluding that ‘such support is not of precautionary nature as it aims at covering a capital shortfall which stems from additional loan loss provisioning’ and that ‘the provisions of the measure are in line with Article 34(1)(a) of Directive 2014/59.’84 However, contrary to expectations, CCB was unable to return to viability. Therefore, it was put into liquidation and, in September 2018, Hellenic Bank acquired substantially all its performing business.85 The deal was possible thanks to around €3.5bn (plus guarantees) of liquidation aids granted by

77 Only €6.3bn was actually disbursed by ESM and around €1bn by IMF. See ‘Conclusion of ESM Programme for Cyprus: an overview—31 March 2016’ (available online at ) 78 See Central Bank of Cyprus’s announcements of 2 April 2013 and of 7 June 2013 (available online at ). 79 The two banks together comprised about 88% of commercial banks’ assets. See Daniel Stavárek, ‘Lessons Learned from the 2013 Banking Crisis in Cyprus’ (2013), 313 80 Cyprus Popular Bank had already benefited of a public recapitalization in 2012 when the State injected about €1.8bn becoming the majority shareholder of the bank (see EU Commission press release IP/12/958). 81 For resolutions details, see Central Bank of Cyprus’s announcement of 30 March 2013 (available online at ). 82 See EU Commission, ‘The Economic Adjustment Programme for Cyprus—First Review— Summer 2013’ (2013) Occasional Papers 161, 73–74; and EU Commission, ‘The Economic Adjustment Programme for Cyprus Second Review—Autumn 2013’ (2013) Occasional Papers 169, 26–7 and 68. 83 For details on State intervention, see State Aid SA.35334 (2014/N)—Cyprus. 84 See State Aid SA.43367 (2015/N)—Cyprus. 85 See Hellenic Bank press release 03 September 2018.

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Guido Ferrarini and Alberto Musso Piantelli Cyprus. As the restructuring of CCB started before the BRRD and SRMR entered into force, the whole process remained governed by Cypriot national law.86 12.27 The Cypriot experience represents the only case to date of a fully-fledged bail-in in

the solution of a systemic crisis. However, the bail-in of depositors in Cyprus was highly criticized87 and remains isolated in Europe. 3. Portugal

12.28 In early 2011, Portugal lost access to the financial markets as a result of a long

standing crisis and the Government was forced to ask for external financial assistance.88 As a result, the EU, the European Financial Stability Facility and the IMF made €78bn (€26bn each) available over a period of three years upon the condition that certain predefined policy objectives were achieved,89 including the safeguard of stability in the financial sector.90 In order to meet its international commitments,91 Portugal adopted, inter alia, Decree-Law 31-A/2012 amending the Legal Framework of Credit Institutions and Financial Companies adopted with Decree-Law No 298/ 92 of 31 December 1992. The 2012 Decree introduced a national resolution regime including resolution tools (transfer of assets and bridge institution92 but not the bail- in) and a resolution fund to provide for financial assistance in the case of resolution.93

12.29 Before being amended by Law 23-A/2015 of 26 March 2015 transposing the

BRRD, the Portuguese resolution regime was tested in the crisis of Banco Espírito Santo (BES) in 2014.94 The Bank went into troubles in May 2014, as a result of difficulties emerged in Bank of Portugal of Espírito Santo International—the controlling shareholder of Espírito Santo Financial Group—and its liquidity

86 See EU Commission press release IP/18/4212. 87 Paul De Grauwe, ‘The New Bail-in Doctrine: A Recipe for Banking Crises and Depression in the Eurozone’ (2013), (available online at ). For a more cautious analysis, see Thomas Philippon and Aude Salord, ‘Bail-ins and Bank Resolution in Europe: A Progress Report’ (2017) Geneva Reports on the World Economy Special Report 4, 438. 88 See ESM official summary (available online at ). 89 See Eurogroup and ECOFIN Ministers Statement of 16 May 2011 (available online at ). 90 €12bn (out of €78bn) of the financial assistance programme was allocated for bank recapitalization. See ‘The Economic Adjustment Programme for Portugal, June 2011–2014’ (2014) Occasional Papers 202, 51 91 See EU Commission, ‘The Economic Adjustment Programme for Portugal’ (2013) Occasional Papers 79. 92 See Decree-Law No 298/92, as emended by Decree-Law 31-A/2012, art 145.º-E. 93 See Decree-Law No 298/92, as emended by Decree-Law 31-A/2012, arts 153-Bff. 94 In March 2014, Banco Espírito Santo (BES) had €76.6bn of total assets and €37.3bn of costumers’ deposit. It was present in twenty-five countries and employed almost 10,000 people. It was the third largest Portuguese banking group. See State Aid n°SA.39250 (2014/N)—Portugal, §11

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Bank Resolution in Practice: Analysis of Early European Cases profile deteriorated in a couple of months.95 By the end of July, BES announced €3.577bn of losses related to the first-half of 2014, triggering the immediate reaction of Portuguese competent authorities. The transfer of assets to an another bank was not practicable due to the absence of buyers and the creation of a bridge bank was the only solution available for safeguarding national financial stability. On 3 August 2014, the Portuguese authorities declared the resolution of BES.96 Its retail deposits and performing loans were transferred to a bridge bank named ‘Novo Banco’,97 while the rest—especially shares and subordinated bonds—remained into BES, which became a bad bank98 to be orderly wound up. Novo banco was financed by the Resolution Fund, which injected €4.899bn by subscribing the common shares of the new entity.99 Then, in December 2015, Banco de Portugal ordered the re-transfer from Novo Banco to BES of some selected non-subordinated bonds (five series of notes for a total amount of €2.2bn) originally transferred from BES to Novo Banco in order to face further impairments and negative adjustments emerged after the declaration of 3 August 2014.100 Finally, on 18 October 2017, Novo Banco ceased to be a bridge bank when Nani Holdings (held by Lone Star investment funds) invested €750m in a capital increase becoming the major shareholder of Novo Banco with 75% of the share capital, while the Resolution Fund maintained the remaining 25%.101

IV. The New Regime: Crisis Management in Italy Around the time when the EU resolution regime entered into force in the Member 12.30 States, major crises affected in Italy Monte dei Paschi di Siena (MPS), Banca Popolare di Vicenza and Veneto Banca, while in Spain Banco Popular was the first

95 For a comprehensive analysis of the case, see José Engrácia Antunes, ‘Anatomy of a Banking Scandal in Portugal’ in Danny Busch, Guido Ferrarini, and Gerard van Solinge (eds), Governance of Financial Institutions (Oxford University Press, 2019), 553ff. 96 See press release of Banco de Portugal on the application of a resolution measure to Banco Espírito Santo, SA 03/08/2014, (available online at ). 97 Overall, €64bn assets were transferred to Novo Banco. See State Aid n°SA.39250 (2014/ N)—Portugal,  §28 98 Ibid, §29 and §89. 99 The €4.9bn equity capital for Novo Banco was provided by the Resolution Fund. To carry out the operation, the Resolution Fund had to require loans from the Government (€3.9bn) and from a group of credit institutions members of the Resolution Fund itself (€700 million). See Ana Rita Garcia ‘Portugal Banco Espírito Santo, SA: resolution via a bridge bank including a re-transfer’ in World Bank (n 56), 54. 100 For more details, see Banco de Portugal, ‘decision of the meeting of the Board of Directors’, 29 December 2015. The decision was highly criticized and led to legal actions against Banco de Portugal. See, for example, Thomas Hale, ‘The Novo Banco Debacle and the Rule of Law in Europe’ Financial Times (London, 19 January 2018). 101 See Novo Banco, ‘Annual Report 2017’, 14.

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Guido Ferrarini and Alberto Musso Piantelli bank to be resolved under the SRMR.102 In this and the following sections, we analyse the cases of the Italian banks, while in Section VI we analyse the case of Banco Popular. 1. Background 12.31 The Italian financial sector performed relatively well throughout the 2008 crisis103

so that, in a first phase, Italian banks made limited recourse to government support.104 However, when the financial turmoil extended to sovereign debt in Europe, Italian banks were substantially affected. Their average non-performing loan (NPL) ratio raised from 5.5% in 2007 to about 14% in 2012, while their return on assets dropped from 0.7% to –0.9% between 2007 and 2011.105 As a consequence, Italian banks had to improve their solvency ratios under very difficult conditions reflecting requests by the European Banking Authority and the Bank of Italy.106 This led banks to solicit the massive participation of retail savers, along a practice already followed in previous years.107 Between 2006 and 2009 Italian banks placed over 12,200 bonds for about €350bn euros to retail customers and more than 600 bonds for about €130bn to professional investors.108 After the

102 We limit our analysis to the main cases. Minor cases of resolution (where the bail-in was sometimes applied) occurred in Austria (Heta Asset Resolution AG in 2016), Croatia (Jadranska banka d.d. Šibenik in 2015), Denmark (Andelskassen J.A.K. Slagelse in 2016 and Københavns Andelskasse in 2018), Greece (Panellinia and the already mentioned Cooperative Bank of Peloponnese, both in 2015), Hungary (MKB Bank Zrt in 2016), Italy (Banca delle Marche, Banca Popolare dell’Etruria e del Lazio, Cassa di risparmio di Ferrara, and Cassa di risparmio della provincia di Chieti all in 2015), Portugal (Banco Internacional do Funchal in 2015). An updated list of resolution decisions is available on the EBA website: . Moreover we do not consider as directly relevant for this chapter the case of the ‘significant’ Latvian ABLV Bank, which was resolved for violations of money laundering laws. See, for example, Financial Crimes Enforcement Network, press release, 13 February 2018. 103 That was probably for two main reasons. Firstly, thanks to low exposures to complex financial products; secondly, because there was no major real estate bubble. See IMF, ‘Italy: 2010 Art IV Consultation’ (2010) Country Report No 10/157102, 102. 104 Between 2008 and 2010, Italy used €4.1bn for the recapitalization of four banks through the issuance of special bonds called Tremonti Bonds. In the same period, in Europe the total amount of State aids to banks was equal to €299.4bn for recapitalization measures, €143.3bn for impaired asset measures, €2036.1bn for guarantees, and €155bn for other liquidity measures. See EU Commission (n 41). 105 See IMF, ‘Italy: Financial System Stability Assessment’ (2013) Country Report No 13/300, 9 106 See ibid, 13. See also EBA, ‘Recommendation on the Creation and Supervisory Oversight of Temporary Capital Buffers to Restore Market Confidence’ (EBA/REC/2011/1), 8 December 2011; and Bank of Italy press release, ‘EBA Recommendation About Banks’ Capital’, 8 December 2011. 107 Traditionally, bonds have been a considerable sources of funding and a relevant financial asset held by Italian households also because of structural features of the Italian Financial System. See Massimo Coletta e Raffaele Santioni, ‘Le Obbligazioni Bancarie nel Portafoglio delle Famiglie Italiane’, (2016) Bank of Italy Occasional Paper—October, 6. 108 More precisely, after Lehman default, institutional investors’ subscriptions declined, while bond funding from retail customers rose from about 50% in the pre-crisis period (July 2006–June 2007) to reach approximately 80% in two years. See R. Grasso, N. Linciano, L. Pierantoni, and

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Bank Resolution in Practice: Analysis of Early European Cases 2011 sovereign debt crisis, the issuance of bonds by Italian banks further increased. In 2012, their total amount reached €960bn representing more than 50% of the investment portfolio of families and almost 11% of their total financial assets.109 In 2014, the Single Supervisory Mechanism came into operation and the fourteen 12.32 major Italian banking groups were declared to be under the direct supervision of the ECB. Capital and organizational requirements became heavier under the impetus of post-crisis regulatory reform, while technology brought serious challenges to the traditional business models followed by most Italian banks. In 2015, persisting difficulties confirmed the fragility of the banking sector and the weakness of the real economy.110 In the years 2016–2017 Italy was on the verge of a truly systemic crisis hitting the whole financial sector and a considerable number of banks of different size.111 The crises of MPS and the Venetian banks must be located in a similar context. 2. Italian Bank Insolvency The Italian bank insolvency procedure is dubbed as compulsory administrative liq- 12.33 uidation (CAL) and differs from that applicable to other firms.112 CAL is regulated under Legislative Decree 385/1993 (Testo Unico Bancario, TUB) as amended and complemented by the decrees implementing the BRRD (Legislative Decrees 180– 181/2015). CAL is mainly governed by administrative law given that banks are regulated institutions. Consistently, the Bank of Italy (rather than a Court) is in charge of this procedure,113 the main purpose of which is bank reorganization, while atomistic liquidation is a last resort measure. When a financial institution is declared as ‘failing or likely to fail’ and resolution 12.34 is not in public interest, the Ministry of Economy and Finance (MEF) provides for CAL upon a proposal by the Bank of Italy or upon request of the institution concerned.114 Once CAL is started, the banking license is withdrawn and the institution’s governing bodies cease to function.115 Moreover, the Bank of

G. Siciliano ‘Bonds Issued by Italian banks—Risk and Return Characteristics’ (2010) Consob Working Papers 67, 6. 109 Coletta and Santioni (n 107), 9. 110 See EBA, ‘Risk Dashboard—data as of Q4 2015’; and IMF, ‘Italy: Staff Report for the 2015 Art IV Consultation’ (2015) IMF Country Report No 15/166. 111 According to BRRD, art 2(30), a crisis is ‘systemic’ if a disruption in the financial system may produce serious negative consequences for real economy and the internal market. 112 In its essence, the whole Italian banking crisis model dates back to the Banking Law of 1936. In 1993, the relevant rules were transferred more or less unchanged into the Consolidated Banking Act (CBA). 113 However, also courts and the Ministry of Economy and Finance (MEF) play some roles. 114 See CBA, art 80(1) and (2). 115 See CBA, art, 80(5).

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Guido Ferrarini and Alberto Musso Piantelli Italy appoints one or more liquidators to replace the management bodies116 and a supervisory committee to perform monitoring functions.117 The Bank of Italy maintains a general power of oversight. 12.35 Throughout the liquidation procedure, creditors’ rights are assessed and the bank’s as-

sets are sold either by way of atomistic liquidation or—as is often the case—through a sale in bulk of assets and liabilities to other banks. The latter type of sale could also relate to either a transfer of assets and/or contractual relationships identified in bulk, or a transfer of the entire business or part of it, or a transfer of portfolios of liabilities.118 The relevant provisions make of CAL a resolution-like procedure, which does not fall however under the BRRD framework. Since 1974, the transfer of assets and liabilities within CAL or even before it has been the main way of managing banking crisis. Moreover, the solution of major banking crises was facilitated by public aid granted by the Bank of Italy under the ‘Sindona Decree’ (dubbed after the name of Michele Sindona, the banker who ran Banca Privata Italiana to disaster),119until when EU central banks were forbidden to grant similar subsidies.120 3. Monte dei Paschi di Siena

12.36 The first significant banking casualty in Italy after the financial crisis affected

Monte dei Paschi di Siena (MPS), the fourth largest Italian bank and one of those subject to SSM supervision. Despite occurring after the EU resolution framework was in place, this banking crisis was managed through precautionary recapitalization by the Italian Government.

12.37 MPS had been in troubles since some time after the great financial crisis and

benefitted from public aid since 2009.121 Nonetheless, the results of the 2016

116 See CBA, art 81. As a rule, liquidators have all necessary powers to carry out CAL (see CBA, art 84); certain activities mentioned by law or indicated by the Bank of Italy are subject to the binding opinion of the Supervisory Committee and/or to the Bank of Italy’s prior authorization (see, for example CBA, arts 84(3) and 90(2)). 117 See CBA, art 84(2). 118 Whichever option is chosen, the transfer can take place after the positive opinion of the Supervisory Committee and under the authorization of Bank of Italy and without prejudice to the equal treatment principle and to the hierarchy of claims. See CBA, art 90(2). 119 Under the Ministerial Decree of 27 September 1974, the Bank of Italy granted a special loan to banks taking over the assets and liabilities of banks under CAL. The rate of interest (1%) on this loan was fixed below the market rate (which was much higher over the period in question) and the acquiring banks invested the loan proceeds in government bonds, profiting from the spread. See Giuseppe Boccuzzi, ‘Towards A New Framework for Banking Crisis Management: The International Debate and the Italian Model’ (2011) Bank of Italy—Quaderni di Ricerca Giuridica della Consulenza Legale 71, 229–231 120 See TFUE, art 123(1): ‘Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as “national central banks”) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.’ 121 See State Aid n°SA. 36175 (2013/N)—Italy, §§23ff.

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Bank Resolution in Practice: Analysis of Early European Cases EU-wide stress tests revealed serious shortcomings in an adverse scenario122 and MPS ran into further difficulties. In July 2016, its board approved a combination of actions aimed at deconsolidating bad loans (for a gross value of €27.7bn) and strengthening the bank’s capital.123 However, by December 2016 the capital increase had not succeeded and other actions had to be initiated. Firstly, MPS applied for and obtained a State guarantee124 on its liabilities, which 12.38 were issued for a total of €110bn between January and March 2017.125 Secondly, in June 2017 the bank received additional public support in the form of a precautionary recapitalization under Article 18(4)(d)(iii) of SRMR. The EU Commission approved this recapitalization upon the condition that burden sharing was applied to shareholders and subordinated debt holders. Consequently, the Italian Ministry of Economy and Finance was authorized to subscribe €3.9bn of newly issued shares and to spend €1.5bn to compensate for the mis-selling of junior bonds issued by the bank to retail clients who were hit by the burden sharing.126 These actions were regarded by some commentators as a possible circumvention of 12.39 the single resolution and bail-in regimes.127 While answering this question would not be manageable in the confines of this chapter, the fact that MPS was not declared ‘failing or likely to fail’ avoided both a resolution of the bank and a bail-in of its creditors, so that once more a banking crisis was financed through taxpayers’ money, this time in the form of a precautionary recapitalization as allowed under EU law.

V. The New Regime: The Resolution-like Liquidation of Venetian Banks 1. Veneto Banca and Banca Popolare di Vicenza Veneto Banca and Banca Popolare di Vicenza, two former co-operative banks 12.40 based in the Veneto Region in Northern Italy, were subjected to CAL in 2017.128

See MPS press release 29 July 2016, ‘2016 EBA Stress Test Results’. 123 See MPS press release 29 July 2016, ‘Structural and Definitive Solution to the Bad Loan Legacy Portfolio’. 124 State guarantees were provided pursuant to Law Decree No 237/2016, art 7, which was approved by the Council of Ministers on 23 December 2016. 125 See MPS press releases 25 January 2017 and 15 March 2017. 126 See State Aid SA.47677 (2017/N)—Italy, in particular §30. 127 See, for example, Philipp Lassahn, ‘Struggling Banks and Struggling Politicians: Precautionary Recapitalisation as a Threat for Goals of European Financial Regulation?’ (2017) (available online at ). 128 On the case of Venetian Banks, see Paolo Giudici, ‘The Venetian Banks’ Collapse’ in Busch, Ferrarini, and van Solinge (n 96), 515ff. 122

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Guido Ferrarini and Alberto Musso Piantelli Veneto Banca (VB) had been founded in 1877 under the name of Banca Popolare of Montebelluna. In 1997, VB undertook a route that would have led it to become an important player on the Italian banking scene. Since 2000, its growth program became more intense with the opening of numerous branches and the acquisition or creation of new banks both in Italy and in Eastern Europe.129 At the end of 2012, VB had total assets of €33.5bn, 586 branches and 6,241 employees;130 it was at the helm of one of the ten largest banking groups in Italy. 12.41 Banca Popolare di Vicenza (BPVi) was founded in 1866 and was the oldest co-

operative bank in the Venetian area. The recent history of BPVi does not differ too much from that of VB. In the 1990s BPVi entered into a period of expansion that became particularly vibrant in the first decade of the new millennium. In those years, BPVi opened prestigious representative offices in San Paolo, Shanghai, Hong Kong, New Delhi and Moscow.131 In 2014, BPVi had total assets of €46.5bn, 654 branches and 5.295 employees.132 Also BPVi was in control of one of the ten largest banking groups in Italy.

12.42 In 2013, an onsite inspection of the Bank of Italy at Veneto Banca discovered the first

signs of a deteriorated financial condition. Among other things, VB had not deducted from its own funds the capital raised through the issuance of new shares, which had been financed by granting larger or even ad hoc loans (so called ‘kissed loans’) to the client/investors. The Inspection Report of the Bank of Italy required adjustments to the value of the loan portfolio with a substantial negative impact on the balance sheet of VB. In addition, it required strengthening the asset base.133 It was the beginning of a turbulent period for the bank, which was subjected to further inspections by the Bank of Italy, CONSOB (the Italian Securities Commission), and the ECB on behalf of the SSM. The relevant reports showed a number of violations and misconducts concerning corporate governance and the relationships with clients.134 Only in 2015, the market for shares reflected the ongoing problems at VB: after the annual general meeting, the share price collapsed from €39.5 to €30.5.135

12.43 In December 2015, the shareholders approved the ‘Serenissa project’ which in-

cluded the transformation of VB from a public co-operative company (società c-operativa per azioni) into a joint stock company (società per azioni); a share capital increase up to €1bn; and the listing of the Bank’s ordinary shares on the Italian

129 See VB Prospectus (protocol no 0052874/16) of 7 June 2016, 328ff. 130 See VB, 2012 Consolidated Financial Statement. 131 See BPVi Prospectus (protocol no 0035634/16) of 21 April 2016. 132 See BPVi, 2012 Consolidated Financial Statement. 133 See Bank of Italy, ‘Technical Note Transmitted by the Bank of Italy to the Committee of Enquiry of the Regional Council of Veneto’ (2016) (available online at ). See also VB press releases of 14 November 2013 and 4 December 2013. 134 See VB Prospectus (n 129). 135 See VB press releases of 26 April 2014 and 18 April 2015.

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Bank Resolution in Practice: Analysis of Early European Cases Stock Exchange main market. The ECB considered the ‘Serenissima project’ as essential to avoid the worst consequences.136 Before the IPO, the share price was established in the range of €0.10 and €0.50.137 However, the 98.86% of the Global Offering remained unsubscribed, so that Borsa Italiana did not admit VB’s shares to trading.138 As a result, the Atlante fund139 subscribed shares for an amount of €988,582,329.50, becoming a shareholder with the 97.64% of VB’s share capital from 30 June 2016.140 By year end, the Atlante fund injected additional €628m in VB.141 In 2017, efforts to rescue VB intensified. In January, VB tried to limit its legal risks 12.44 by launching a settlement initiative with small shareholders who had seen most of their investment in VB’s shares evaporate.142 In February and June, VB issued State guaranteed bonds for a total nominal amount of €4.9bn,143 while in March it applied for ‘precautionary recapitalization’ from the Italian Government.144 In addition, VB worked on a merger plan with Banca Popolare di Vicenza. However, VB was not admitted to precautionary recapitalization.145 BPVi followed a parallel path within a similar time span. In 2014, during BPVi 12.45 comprehensive assessment, the Bank of Italy reported cases of non-authorized trading in own shares. It was not the first time that the supervisors criticized the conduct of BPVi;146 however, this time more light was shed on it. Inspections conducted in 2015 by the Bank of Italy jointly with the ECB and by CONSOB revealed, as in the case of VB, the ‘kissed loans’ phenomenon together with many others irregularities, including Mifid violations and deficiencies in the evaluation process concerning the BPVi shares.147 As of 30 June 2015, the CET1 ratio and

ECB letter of 9 December 2015 in VB Prospectus (n 129), 176. 137 See VB press release of 31 May 2016. 138 See VB press release of 24 June 2016. 139 Atlante was an investment fund for professional investors. Subscribers were Cassa Depositi e Prestiti, banking foundations and financial institutions. Atlante was created to invest in banks with a low capital ratio and/or, in Non-Performing Loans of Italian banks. 140 See VB press release 30 June 2016. 141 See VB press release 21 December 2016. 142 VB proposed an indemnity of 15% of theoretical losses due to purchases of VB in the period 2007–2016, at any of the Group’s banks. The amount would have been issued against renunciation of legal action regarding investments in VB shares. See VB press release of 9 January 2017. 143 The guaranteed bonds were issued in accordance with Law Decree No 237/2016. 144 See VB press release of 24 June 2017. VB applied for the a temporary and extraordinary public financial support measure pursuant to Law Decree 237/2016, art 13. 145 The abandonment of the precautionary recapitalization hypothesis was due to the EU authorities’ evaluation with respect to losses that VB had incurred or was likely to incur in the near future. See Bank of Italy, ‘La Crisi di Veneto Banca S.p.A. e Banca Popolare di Vicenza S.p.A.: Domande e risposte’ (2017) (available online at https://www.bancaditalia.it/media/notizie/2017/crisi-banche- venete/index.html). 146 See Bank of Italy, ‘Clarification Regarding the Banca Popolare di Vicenza’ (2015) (available online at https://www.bancaditalia.it/media/approfondimenti/2015/chiarimenti-popolare-vc/ index.html?com.dotmarketing.htmlpage.language=1). 147 See BPVi Prospectus (n 131). 136

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Guido Ferrarini and Alberto Musso Piantelli the Total Capital Ratio were below the targets set by the ECB.148 Also the share price was hit by events, declining from 62,5 to 48 Euro after the shareholder meeting of 11 April 2015.149 As a result, BPVi prepared a recapitalization plan to restore its CET1 and Total Capital to levels above the minimum targets. The plan involved the transformation of BPVi into a joint-stock company, a share capital increase up to €1.5bn and the listing of BPVi’s shares on the Italian Stock Exchange main market by spring 2016.150 Upon the ECB recommendation,151 the Extraordinary Shareholders’ Meeting of 5 march 2016 approved the plan.152 12.46 From this moment on, the story of BPVi developed in tandem with that of VB.

Before the IPO, the share price was fixed in the range of €0.10 and €3.0 per share;153 in May the global offering was subscribed for only the 7.66% and BPVi shares were not admitted to trading on the Italian Stock Exchange.154 Consequently, the Atlante fund subscribed shares in BPVi for a total of €1.5bn becoming the first shareholder of the bank with 99.33% of its share capital.155 In December, Atlante committed to make an extra payment of €310m to the Bank.156 In January 2017, the Bank launched a settlement initiative with shareholders,157 while in February and June it issued State guaranteed bonds for €5.2bn.158 In March, BPVi applied for the ‘precautionary recapitalization’ from the Italian Government.159 At the same time, BPVi was working with VB on a merger plan of the two banks. However, also BPVi was not admitted to precautionary recapitalization for the same reasons as VB.160 2. Insolvency Proceedings

12.47 After about one and a half year of agony, on 23 June 2017, the ECB stated that VB

and BPVi ‘were failing or likely to fail’; this determination was made pursuant to

148 See BPVi press releases of 28 August 2015 and 27 November 2015. 149 See BPVi press releases of 26 April 2014 and 11 April 2015. 150 See BPVi press releases of 7 July 2015 and 28 August 2015. 151 See ECB letter of 24 February 2016 in the written report of BPVi’s shareholders meeting of 5 March 2016, 34. 152 See BPVi press release of 5 March 2015. 153 See BPVi press release of 19 April 2016. 154 See BPVi press release of 2 May 2016. 155 See BPVi press release of 4 May 2016. 156 See BPVi press release of 21 December 2016. 157 The proposal was articulated as follows: ‘pay the sum of 9 euros for every share purchased through a bank of Gruppo Banca Popolare di Vicenza (the Group) as of 1 January 2007, up until 31 December 2016, net of sold shares. The sum will be paid in exchange for the waiver by the shareholders of the right to take legal action for any claim related to the investment (or failure to disinvest) in Banca Popolare di Vicenza shares, that in any case will remain in possession of the shareholders.’ It was mainly directed to small and/or retail shareholders. See BPVi press release of 9 January 2017. 158 See BPVi press releases of 3 February 2017 and 25 May 2017. 159 See BPVi press release of 17 March 2017. 160 See BPVi press release of 23 June 2017.

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Bank Resolution in Practice: Analysis of Early European Cases Article 18 of the SRMR. According to it, ‘the two banks repeatedly breached supervisory capital requirements’; moreover, ‘the ECB had given the banks time to present capital plans, but the banks had been unable to offer credible solutions going forward’.161 The ECB immediately informed the SRB of its determination. However, the latter 12.48 decided not to take resolution action in relation to VB and BPVi since the conditions listed in Article 18 of the SRMR had not been met. In particular, the resolution of the two banks was ‘not necessary in the public interest, in accordance with Article 18(1)(c) in conjunction with Article 18(5) of the SRMR’. The SRB grounded its determination on the following reasons applicable to each of the two banks:162 “(a) the functions performed by the Bank, e.g. deposit-taking, lending activities and payment services, are not critical since they are provided to a limited number of third parties and can be replaced in an acceptable manner and within a reasonable timeframe; (b) the failure of the Bank is not likely to result in significant adverse effects on financial stability taking into account, in particular, the low financial and operational interconnections with other financial institutions; and (c) normal Italian insolvency proceedings would achieve the resolution objectives163 to the same extent as resolution, since such proceedings would also ensure a comparable degree of protection for depositors, investors, other customers, clients’ funds and assets164”.

161 See ECB press release of 23 June 2017 (available online at ). The ECB motivated as follows: ‘ECB Banking Supervision has closely monitored the two banks since capital shortfalls were identified by the comprehensive assessment in 2014. Since then, the two banks have struggled to overcome high levels of non-performing loans and underlying challenges to their business models, which resulted in further deterioration of their financial position. In 2016, the Atlante fund invested approximately €3.5bn in Veneto Banca and Banca Popolare di Vicenza. However, the financial position of the two banks deteriorated further in 2017. The ECB had therefore asked the banks to provide a capital plan to ensure compliance with capital requirements. Both banks presented business plans which were deemed not to be credible by the ECB.’ 162 See SRB, ‘Notices Summarizing the Effects of the Decision Taken in Respect of VB and BPVi’ (available online at ). 163 Once excluded the presence of critical functions and the risk adverse effects on financial stability, the reference to ‘resolution objectives’ should be intended as limited to the remaining goals listed in art 14(2) of the SRMR (ie to protect public funds by minimising reliance on extraordinary public financial support; to protect depositors covered by Directive 2014/49/EU and investors covered by Directive 97/9/EC; and to protect client funds and client assets.) 164 With reference to the objective ‘to protect public funds’ the SRB only stated: ‘In case of CAL proceedings, any pay-out by the DGS to the covered depositors would not qualify as “extraordinary public financial support” and therefore is not taken into account when comparing insolvency with resolution. The IBA provides for the transposition of Art 11(6) of Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014 on deposit guarantee schemes (the “DGS Directive”) and allows the DGS to finance the transfer of assets and liabilities of a credit institution to a purchaser. If any DGS funds are used to assist in the restructuring of credit institutions, including to finance the transfer of assets and liabilities to a purchaser in case of insolvency, these funds could qualify as State Aid and therefore, as extraordinary public financial support. It should be noted that any such extraordinary public financial support can be provided only if the strict conditions of the State Aid rules are met, which is assessed by the Commission.’ See SRB decisions

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Guido Ferrarini and Alberto Musso Piantelli 12.49 As a result, VB and BPVi were wound-up under the Italian law of compul-

sory administrative liquidation. The CAL of VB and BPVi took place under Law Decree No 99/2017. The businesses of the two banks, their branches and the major part of assets and liabilities were transferred to a large bank, Intesa Sanpaolo (ISP), for €1.165 ISP was chosen at the end of an open, competitive and non-discriminatory procedure.166 ISP acquired €45.9bn of assets167 and €51.3bn of liabilities,168 keeping a claim for the ensuing imbalance against the two banks.169 The Italian Government undertook to guarantee the risks deriving from VB and BPVi’s warranties in the share-purchase agreement and other legal risks up to a maximum of €1.991bn. It also provided €3.5bn to ISP to cover its capital needs and an additional €1.285bn for the corporate restructuring170 as required under the State Aid regime.171 NPLs that were not transferred to ISP were transferred to SGA SpA (a public bad bank)172 and the two banks got credit to their value.173 Non-transferred equity participations for €1.7bn and non-transferred liabilities remained in the two Banks under liquidation. Moreover, small retail investors were restored, under certain conditions, by the Fondo di Solidarietà for 80% of the value of their claims174 and by ISP itself.

concerning the assessment of the conditions for resolution in respect of VB and BPVi (‘VB and BPVi decisions’), respectively at §4.2.2 and §4.2.3 (available online at ). No reference was made regarding the possibility of ‘Liquidation State Aids’. 165 For details, see ISP press release of 26 June 2017. 166 See State Aid SA.45664 (2017/N)—Italy, §19ff. 167 Part of them were low quality credits (even if in bonis). If those credits will become ‘high risk’ before 31 December 2020, ISP may transfer the assets back to the banks under liquidation. The buy-back is guaranteed by the State for €4bn. See ISP press release of 26 June 2017; and Law Decree No 99/2017, art 4(1)(a)(ii). 168 See Bank of Italy, ‘Informazioni sulla Soluzione della Crisi di Veneto Banca S.p.A. e Banca Popolare di Vicenza S.p.A.’, Memoria per la VI Commissione Finanze della Camera dei Deputati’ (2017), (available online at ) 169 As a result, ISP had a claim of €5.4bn (subject to final quantification) against the two banks under liquidation. The State guaranteed the two banks’ debt up to a maximum of €6.351bn. See Law Decree 99/2017, art 4(1)(a)(i). 170 See Law Decree 99/2017, art 4(1)(b)–(d). 171 See EU Commission press release IP/17/1791. 172 Technically, SGA SpA is not a public bad bank. Nevertheless, it is something very similar. Originally, it was used as a vehicle for the management of the Banco di Napoli crisis in 1997. In June 2016, SGA was transferred to the Ministry of Economy and its activity was expanded to the general NPL market. Therefore, SGA became a private-law corporation, owned by MEF whom main scope is the purchase and management of bad loans originated by Italian banks. See SGA mission available online at http://www.sgaspa.it/mission/. 173 See Law Decree 99/2017, art 5(2). 174 The ‘Fondo di solidarietà’ was established by Law Decree 183/2015 to reimburse retail investors of four less significant Italian banks resolved in November 2015. Law Decree 17/2017 extended the application of the fund to retail investors of Veneto Banca and Banca Popolare di Vicenza.

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Bank Resolution in Practice: Analysis of Early European Cases The Bank of Italy described the rationale for the solution adopted by the 12.50 Government in a report to the House of Representatives as follows: Under this scheme the costs of the two banking crises fall firstly on shareholders and secondly on subordinated bondholders of the two banks. (. . .) One of the core principles of EU law is therefore complied with, i.e. that in order to fight moral hazard the burdens [of a crisis] should fall firstly on the owners and then on the investors in capital instruments of the failing institutions. (. . .) Given that a resolution procedure had not been activated, there was no need to apply the bail in tool. Therefore full protection has been assured to liabilities not covered by the Interbank Deposit Protection Fund (like deposits of more than 100,000 Euros and ordinary bonds), which were held mainly by households and SMEs. The Italian Government has decided to grant a liquidation aid along the compulsory administrative liquidation procedure. A similar choice appeared as indispensable in order to identify a purchaser and so preserve the operating continuity of the two firms, which would have ceased in the case of ‘atomistic’ liquidation. After that the precautionary recapitalization failed, the latter would have been the only alternative to the choice made; it would have caused very high costs for all the player involved. Approximately 100,000 SMEs and 200,000 households would have been forced to fully reimburse their debts (about 26 billion); this would have caused widespread insolvencies. The ensuing value destruction would have stricken debt holders. Depositors not covered by the guarantee fund and senior bondholders would have had to wait for the time of liquidation (several years) to obtain reimbursement (approximately 20 billion). The Interbank Deposit Protection Fund (FITD) would have had to face an immediate payout of about €10bn save for a claim against the liquidation in the following years. Considering the limited resources readily available at the FITD, the banking system would have had to bear most of the costs of reimbursement to depositors within a very short time. The State guarantees on the liabilities issued by the two banks for about €8.6 billion would have been called. In conclusion, the procedure adopted has allowed to continue relationships with existing clients, to avoid severe repercussions on the local economy of the two banks, to limit effects on employees, and to minimize the whole cost of the crisis.175

3. The EU Commission Decision On 25 June 2017, the Commission approved the Italian Government measures 12.51 to facilitate the compulsory liquidation of BPVi and VB and the sale of business to ISP.176 As argued by the Commission, the SRB had concluded that resolution action was not warranted in the public interest for either BPVi or Veneto Banca. Therefore, Italian authorities had to wind-down the two banks under Italian national insolvency procedures. In this context, Italy determined that the winding up of these banks had a serious impact on the real economy in the regions where they were most active, while EU rules foresaw a possibility for Italy to seek

175 See Bank of Italy (n 168), 2. The English translation is ours. 176 See EU Commission press release IP/17/1791.

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Guido Ferrarini and Alberto Musso Piantelli Commission approval for the use of national funds to facilitate the liquidation by mitigating such regional economic effects. 12.52 Under EU State Aid rules, in particular under the 2013 Banking Communication,

shareholders and subordinated bondholders must fully contribute to the costs (so- called ‘burden-sharing’), while senior bondholders do not have to contribute and depositors remain fully protected in line with EU rules. The Commission found that the measures adopted by the Italian Government were in line with EU State Aid rules for existing shareholders and subordinated debt holders had fully contributed to the costs, reducing the cost of the intervention for the Italian State. Both aid recipients, BPVi and Veneto Banca, would be wound up in an orderly fashion and exit the market, while the transferred activities would be restructured and significantly downsized by Intesa. The subsequent deep integration by Intesa would return the sold parts to viability. The Commission also confirmed that the measures do not constitute aid to Intesa, because the same had been selected after an open, fair and transparent sales process, fully managed by Italian authorities, ensuring that the activities were sold at the best offer available.

12.53 In addition, the Commission stated:

Banca Popolare di Vicenza is a small Italian commercial bank, located in the Veneto Region, which mainly operates in the north-eastern regions of Italy. As of 31 December 2016, Banca Popolare di Vicenza had around 500 branches and a market share in Italy of around 1% in terms of deposits and around 1.5% in terms of loans. As of December 2016 the bank had total assets of slightly below €35 billion. Veneto Banca is a small Italian commercial bank, located in the Veneto Region, which mainly operates in the North of the country. As of 31 December 2016, Veneto Banca had around 400 branches and a market share in Italy of around 1% in terms of deposits and in terms of loans. As of December 2016 the bank had €28bn of total assets.

4. Rationale and Path-dependence 12.54 The foreseeable impact of the liquidation of VB and BPVi was assessed at least

three times in a couple of days before the liquidation was started.177 Firstly, the SRB concluded that resolution actions with respect to VB and BPVi were not necessary in the public interest. Secondly, the Italian Government declared the compulsory administrative liquidation of the two banks and at the same time granted State Aid to support their liquidation, motivating that the relevant measures were essential to avoid a serious disturbance to the economy in the regions where VB and BPVi were active.178 Thirdly, the Commission approved the state aid to the two banks implicitly acknowledging the necessity of mitigating the

177 From 23–25 June 2017. 178 See Law Decree 99/2017, Recital 15.

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Bank Resolution in Practice: Analysis of Early European Cases serious economic effects of their winding up in the relevant regions. At the same time, the Commission defined VB and BPVi as ‘small’ banks, a definition which appears to be rather surprising given the size of the two banks which had been defined as significant for SSM purposes. No doubt, the three authorities (SRB, Italian Government, and EU Commission) 12.55 were not bound to have the same view of the relevant facts and their decisions were taken under different sets of rules.179 However, the distance between the positions taken with respect to the relevance of the two banks in their economy and the impact of their failure on financial stability raises some concerns. To start with, the SRB stated that the functions performed by the two banks were 12.56 not critical since they were provided to a ‘limited number of third parties’ and were replaceable ‘in an acceptable manner and within a reasonable timeframe’. The SRB decisions were grounded on Article 6 of the Commission Delegated Regulation 2016/778 which defines the criteria relating to the determination of critical functions.180 However, according to the Bank of Italy, the ‘third parties’ of the two banks were ‘approximately 100,000 SMEs and 200,000 households’ and benefited from about €26bn of loans. Moreover, the choice made by the Italian Government appeared as ‘indispensable’ in order to ‘preserve the operating continuity of the two firms’. Their winding up would have caused very high costs for all the players involved. Possibly, the role of third parties was somehow downplayed by the SRB,181 which however also argued that there was enough competition in the relevant regions.182

179 On this topic see Ioannis G. Asimakopoulos ‘The Veneto Banks Resolution: It Shall Be Called “Liquidation” ’, (2018) European Company Law Journal 5; Seraina Grünewald, ‘Legal challenges of bail- in’ (2017) ECB Legal Conference— Shaping a new legal order for Europe: a tale of crises and opportunities, 287 ff. More generally, on the relationship between the Single Resolution Mechanism and the EU State Aid rules, see Stefano Micossi, Ginevra Bruzzone and Miriam Cassella, ‘Bail-in Provisions in State Aid and Resolution Procedures: Are they Consistent with Systemic Stability?’ available online at https://www.ceps.eu/publications/ bail-provisions-state-aid-and-resolution-procedures-are-they-consistent-systemic. 180 The Board stated the following: ‘Based on the below analysis, the Institution does not provide critical functions (. . .) In particular, the Institution does not perform activities, services or operations the discontinuance of which would be likely to lead to: (i) the disruption of services that are essential to the real economy of Italy and/or (ii) the disruption of financial stability in Italy. In particular, the functions identified by the Institution as critical, i.e. deposit-taking, lending activities and payment services, are provided to a limited number of third parties and can be replaced in an acceptable manner and within a reasonable timeframe by such parties.’ See ‘VB and BPVi decisions’ (n 164), §§4.2.1 in each one. 181 The SRB argued, for each bank, that ‘the outstanding loans are relatively old, as the Institution has only limited capacity for granting new loans due to capital constraints. Therefore, under current conditions, potential clients would already need to find new loans from other providers in the market. Due to persisting capital constraints, the Institution also presents a limited potential for lending growth on a forward-looking basis.’ See ‘VB and BPVi decisions’ (n 164), §§4.2.1.2 in each one. 182 However, this argument remains unproven and its empirical grounds are doubtful.

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Guido Ferrarini and Alberto Musso Piantelli 12.57 Moreover, the SRB stated that the failure of the two banks was ‘not likely to

result in significant adverse effects on financial stability taking into account, in particular, the low financial and operational interconnections with other financial institutions’.183 However, according to the Bank of Italy, the two banks were connected with the other through the Interbank Deposit Protection Fund, which ‘would have had to face an immediate payout of about €10bn save for a claim against the liquidation in the following years. Considering the limited resources readily available at the FITD, the banking system would have had to bear most of the costs of reimbursement to depositors within a very short time’. This was a very clear case of dangerous interconnection.

12.58 Furthermore, the SRB stated that the normal Italian insolvency proceedings

would have achieved the resolution objectives to the same extent as resolution, since they would have ensured a comparable degree of protection for depositors, investors, other customers, clients’ funds and assets.184 A comparison had to be made between the hypothetical resolution action and the CAL proceedings. In this respect, the application of the sale of business tool would have met the resolution objectives more effectively, as it could ensure ‘the integration of a confined portfolio (i.e. mainly covered and preferred deposits, balanced by appropriate assets) into another entity and thereby, maintain the viability of the transferred business.’185 Since CAL allows for the transfer to a purchaser of the same portfolio which could be transferred in case of resolution action, the SRB concluded that CAL proceedings could meet the resolution objectives to the same extent.

12.59 However, under Article 18(5) of the SRMR the winding up of a bank under

normal insolvency proceedings is only possible if resolution objectives are met ‘to the same extent’. In the case of the two banks, resolution would have achieved more than the objective of protecting depositors that the SRB only mentions. Indeed, two other objectives (continuity of critical functions and preserving financial stability) were also relevant and would have been reached under resolution proceeding administered by the SRB. Moreover, a fourth objective was also relevant and would have been achieved by resolution, ie ‘to protect public funds by minimizing reliance on extraordinary public financial support’. The only way to achieve this goal would have been for the two banks to undergo a resolution where both the bail-in tool and the Single Resolution Fund contributed to minimize the reliance on public financial support.

183 The SRB further explained: ‘There is a low contagion risk within the financial system due to the low interconnectedness of the Banks with other financial institutions. In particular, there is no other Italian bank with an exposure on any of the two Banks higher than [. . .]% of eligible capital according to Large Exposures reporting.’ See ‘VB and BPVi decisions’ (n 164), §§4.2.2 in each one. 184 See SRB notices summarizing the effects of the decision taken in respect of VB and BPVi. 185 See ‘VB and BPVi decisions’ (n 164), Recital 5 in each one.

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Bank Resolution in Practice: Analysis of Early European Cases The bail-in tool was not applicable to VB and BPVi as they were not resolved, but 12.60 liquidated. The Bank of Italy also argued that the bail-in would have been unfair as ‘the risk of a banking crisis should fall on creditors who assumed the risk consciously while the how and the when the BRRD Directive has been implemented have de facto prevented this from happening’.186 According to the Bank of Italy this would have justified State intervention. However, a similar argument does not take into consideration that in exceptional circumstances the impact of a bail- in can be mitigated under Article 27 of the SRMR providing what follows:

‘(5) In exceptional circumstances, where the bail-in tool is applied, certain liabilities may be excluded or partially excluded from the application of the write-down or conversion powers where: (. . .) (c) 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; (. . .)

(6) Where an eligible liability or class of eligible liabilities is excluded or partially excluded pursuant to paragraph 5, and the losses that would have been borne by those liabilities have not been passed on fully to other creditors, a contribution from the Fund may be made to the institution under resolution to do one or both of the following: (a) cover any losses which have not been absorbed by eligible liabilities and restore the net asset value of the institution under resolution to zero in accordance with point (a) of paragraph 13; (b) purchase instruments of ownership or capital instruments in the institution under resolution, in order to recapitalise the institution in accordance with point (b) of paragraph 13.’

In consideration of the above, the bail-in tool could have been applied in the reso- 12.61 lution of VB and BPVi subject to the exceptions provided for in the provision just quoted concerning the risk of widespread contagion. Moreover, the Resolution Fund could have contributed to the financing of the resolution as specified above. All this would have satisfied the requirement to minimize the recourse to State intervention contrary to what happened with the CAL of the two banks. The resolution-like liquidation of the Venetian banks and the relevant state aid 12.62 to liquidation were no doubt path dependent with respect to how the national legal system had been enforced over the previous fifty years. Moreover, a similar outcome was likely caused by a set of contingent circumstances. Firstly, the crisis of both banks became apparent at a time when the European Banking Union

See Bank of Italy (n 145). 186

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Guido Ferrarini and Alberto Musso Piantelli and the BRRD/SRMR were being implemented. Even if not decisive, the fact that both crises were dealt with under brand new institutions, procedures and tools contributed to complicate and slow down the resolution187 of them lengthening their agony and increasing the relevant costs and losses. Secondly, Italian banks and their clients were totally unprepared to the consequences of a bail-in, as openly recognized by the Bank of Italy arguing that ‘the risk of a banking crisis should fall on creditors who assumed the risk consciously, while the how and the when BRRD Directive has been implemented have de facto prevented this from happening’. Thirdly, also the Single Resolution Fund was being formed at the time of the two banks’ crises and is still in its infancy. 12.63 Therefore, the decisions of all competent authorities were likely influenced by a

set of contingent circumstances, such as the negative impact that a bail-in would have had on the Italian financial system, which was totally unprepared to it, and the eurozone-wide resistance to draining the scarce resources of the newly formed Resolution Fund. In the end, a bail-out was preferred to the strict compliance with the letter and spirit of the new EU resolution framework.

VI. The New Regime: Crisis Management in Spain 1. Bank Restructuring after the Financial Crisis 12.64 When the first signs of a financial turmoil began to emerge in 2007, the Spanish

economy had already slowed down after several years of economic growth. In the second half of 2008, Spain fell into recession.188 The restructuring and recapitalization of the banking system became an urgent priority, especially for the part of it that was strictly connected with the real estate sector, which had been hit by the crisis.189 Between 2009 and 2012 a significant amount of public resources had been mobilized190 mainly through the ad hoc Fund for Orderly Bank Restructuring (FROB),191 which injected about €15.5bn through the

187 On the complexities of the new Single Resolution Mechanism see Danny Busch, Chapter 9 of this volume. However, the EU architecture performed relatively well in the Spanish case of Banco Popular (see Section VI). 188 Bank of Spain, ‘Report on the Financial and Banking Crisis in Spain, 2008–2014’ (2017), 73 189 While the financial crisis was systemic, the core banks were not substantially affected, as the financial distress was largely concentrated in cajas. See Tano Santos, El Diluvio: The Spanish Banking Crisis, 2008–2012’ (2017) Columbia Business School and NBER, 13 Kuly 2017; and Maribel Sàez and Marìa Gutiérrez, ‘The Spanish Banking Crisis as a Corporate Governance Problem’ in Busch, Ferrarini, and van Solinge (n 96), 539ff. 190 See Bank of Spain, ‘Background Note on the Public Financial Assistance in the Recapitalization of the Spanish Banking System (2009–2013)’ (2013) (available online at ). 191 FROB was established by the Royal Decree-Law 9/2009 then repealed by Royal Decree-Law 24/2012.

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Bank Resolution in Practice: Analysis of Early European Cases underwriting of convertible preference and common shares issued by banks.192 Nevertheless, with the sovereign debt crisis, this public intervention appeared to be insufficient. The asset quality of banks continued to deteriorate, while loan provision coverage on bad loans dropped below 60%.193 In June 2012, the Spanish Government applied to the EFSF/ESM for external 12.65 financial assistance.194 The ESM provided €39.47bn in December 2012 and a further €1.86bn in February 2013 with the main objectives of increasing the long-term resilience of the banking sector and restoring the country’s economy.195 In the meantime, Spain enacted a new legal framework for the orderly resolution of financial institutions,196 as already done in Ireland, Greece, Cyprus, and Portugal. Bank of Spain was empowered to resolve the credit institutions through the ‘sale of business’ tool and the ‘transfer of assets to bridge banks or asset managers’ tool.197 Business acquirers, bridge banks and asset managers could benefit from the financial support granted by FROB in the form of guarantees, acquisition of assets and liabilities and acquisition or subscription of recapitalization instruments.198 Moreover, FROB created an asset management company named Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria, SA (SAREB),199 which immediately started operations. Two major restructuring measures were put in place. Firstly, Bank of Spain identi- 12.66 fied ten banks requiring a strengthening of their capital. While two of these banks managed to find a private solution, the eight remaining banks received public aid for about €39 billion.200 Secondly, the latter transferred most illiquid and difficult-to-value assets to SAREB in exchange for state-guaranteed securities: a

192 See ‘2014 FROB Presentation’ (available online at ) 193 See IMF, ‘Technical Note on Impaired Assets and Nonperforming Loans for Spain’, (2017) IMF Country Report No 17/343, 7. 194 EFSF was set up as a temporary solution in June 2010 in reaction to the sovereign debt crisis; then, ESM was established in October 2012 as a successor to the EFSF. For a general overview of the Spanish request, see EU Commission, ‘The Financial Sector Adjustment Programme for Spain’ (2012) Occasional Papers 118. 195 See ESM Overview (available online at ). The used tool was the ‘Loans for indirect bank recapitalization’. See ESM, ‘Guideline on Financial Assistance for the Direct Recapitalisation of Institutions’, 8 December 2014. 196 See Royal Decree-Law 24/2012 replaced by Law 9/2012. Law 9/2012 was itself partially repealed by Law 11/2015 of 18 June 2015 transposing the BRRD in Spain. 197 See Royal Decree-Law 24/2012, arts 25–7. 198 See Royal Decree-Law 24/2012, arts 28–34. 199 See Royal Decree-Law 24/2012, Additional provision 7. De facto, SAREB was intended as a bad bank to give a contribution to clean up the financial sector. The majority of Sareb’s shares is privately owned (55%), while 45% is owned by the FROB. See SAREB, ‘Frequently Asked Questions’ available online at 200 The recapitalized banks were: BFA- Bankia, Catalunya- Caixa, NCG Banco, Banco de Valencia, Banco Mare Nostrum, Banco Ceiss, Caja 3, and Liberbank. See ESM Overview available online at .

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Guido Ferrarini and Alberto Musso Piantelli total of nearly 200,000 assets were sold for a transfer price of about €51 billion.201 In order to constrain the public intervention, banks resorted to considerable burden sharing.202 12.67 This financial sector programme expired in January 2014. Overall, the combina-

tion of previous initiatives and measures taken under the ESM program led to a major and successful consolidation of the Spanish financial sector. In the first-half of 2017, the EU Commission could state: ‘The financial sector is benefitting from the strong economic recovery. At the aggregate level, the banking system comfortably meets the regulatory capital requirements and the quality of banks’ assets has further strengthened, with the non-performing loan ratio continuing its downward trend’.203 This overall scenario helps understanding the success of Banco Popular’s resolution which is analysed below. 2. The Crisis of Banco Popular

12.68 Banco Popular (BP) was founded in 1926 under the name of ‘Banco Popular de

los Previsores del Porvenir’. In 1947, its share capital was raised to 100m pesetas and the Bank became a primary national institution. Since 1975, BP expanded throughout Spain and diversified its activities. At the turn of the century, BP went through an ambitious program of expansion abroad. At the end of 2015, it was the sixth largest bank in Spain with total assets of €158.65bn, 1,936 branches and 15,079 employees.204

12.69 The BP difficulties presumably date back to the 2008 financial turmoil;205 how-

ever, a fully-fledged crisis emerged only in February 2017, when BP announced the need for a new capital injection in the amount of €5.7bn in order to cover losses of €3.5bn in 2016, while at the same time replacing its long-standing chairman Angel Ron.206 Those unexpected announcements caused tensions around the bank. DBRS cut BP rating to BBB,207 while clients started visiting BP branches more frequently and deposit withdrawals intensified.208 On 3 April, 201 Bank of Spain (n 188), 186. 202 Ibid, 185. 203 See ECB press release of 28 April 2017, ‘Statement by the Staff of the European Commission and the European Central Bank following the Seventh Post-programme Surveillance Mission to Spain’ (available online at ). 204 See BP, ‘Annual Report 2016’. 205 See Santos (n 188), 102ff. 206 See SRB, ‘Decision Concerning the Assessment of the Conditions for Resolution in Respect of Banco Popular Español S.A.’ (‘BP Resolution Decision’) (2017) (available online at ) 207 Ibid. 208 See ECB, ‘Failing or Likely to Fail Assessment of Banco Popular Español’ (‘BP FOLTF Assesment’) (2017) (available online at ), §6

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Bank Resolution in Practice: Analysis of Early European Cases BP informed that internal audit had found some irregularities with potentially significant impact on the bank’s financial statements and that the CEO had been replaced.209 In a few days, BP suffered two other rating downgrades by Standard and Poors and Moody’s and was forced to announce that it would not pay a dividend to shareholders and that either a capital increase or a corporate transaction could have been necessary.210 Things went even worse in May when the Bank disclosed negative quarterly 12.70 results.211 Notwithstanding its attempts to reassure the public,212 the bank suffered continuous negative press coverage, which continued to fuel the fire of deposits lost especially after 31 May213 when the media revealed that BP could have faced a winding-up if the projected sale process had not been closed in very short terms. In the meanwhile, BP tried looked for ways to generate liquidity. On 5 and 6 June, BP obtained emergency liquidity assistance (ELA) for €3.6bn from the Bank of Spain to face customers’ demands for repayment of their deposits. The new liquidity lasted for no more than a few hours.214 3. The Resolution of Banco Popular On 6 June 2017, the ECB stated that BP was failing or likely to fail under Article 12.71 18(4)(c) of the SRMR since ‘there were sufficient grounds supporting the determination that the Institution would, in the near future, be unable to pay its debts as they fall due’.215 In fact, the emergency liquidity assistance had been insufficient and BP was unlikely to get new funding from the market or through additional central bank funds.216 In addition, measures foreseen in the recovery plan were judged unappropriated and no early intervention seemed to be able to restore the position of the Bank as quick as it was necessary to overcome the grave state of liquidity deterioration.217 The ECB also considered that BP was trying to implement its sale to a stronger competitor, but excluded that a sale was reasonably foreseeable in a timeframe permitting BP to fulfil its obligation.218 All that considered, the ECB concluded: Given the above, particularly the excessive deposit outflows, the speed at which liquidity is being lost from the bank and the inability of the bank to generate further

See BP press release of 3 April 2017. 210 See ‘BP Resolution Decision’ (n 206), §2.3. 211 See BP press release of 5 May 2017. 212 See, for example, BP press releases of 11 May 2017 and 15 May 2017. 213 See ‘BP FOLTF Assessment’ (n 208), §8. 214 See Tobias Buck and Jim Brunsden, ‘Emergency Funds Failed to Save Banco Popular from Death Spiral’ Financial Times (London, 8 June 2012). 215 See SRB, ‘Notice Summarizing the Effects of the Resolution Action Taken in Respect of Banco Popular Español Pursuant to Art 29(5) SRMR’ (available online at ). 216 See ‘BP FOLTF Assesment’ (n 208), §17. 217 Ibid, §§17 and 19. 218 Ibid, §18. 209

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Guido Ferrarini and Alberto Musso Piantelli liquidity, there are objective elements indicating that the Supervised Entity is likely in the near future to be unable to pay its debts or other liabilities as they fall due.219 12.72 The day after the SRB declared that a resolution action of BP was necessary in the

public interest according to Article 18(1)(c) and (5) of the SRMR and on the basis of the following arguments:220 ‘(i) resolution action is necessary for the achieving of, and is proportionate to the following resolution objectives, referred to in Article 14(2) SRMR: i. to ensure the continuity of critical functions221; and ii. to avoid significant adverse effects on financial stability, in particular by preventing contagion, including to market infrastructure, and by maintaining market discipline.222 (ii) winding up of the institution under normal insolvency proceedings would not achieve the above resolution objectives to the same extent as resolution action.’223

12.73 Therefore, the SRB adopted a resolution scheme providing for the application of

the sale of business tool. The decision was preceded by preliminary verifications, which the SRB carried out in co-operation with FROB. First, the SRB required BP to disclose information about the private sales process mentioned above and to stay ready for a potential sale procedure orchestrated by resolution authorities. Second, the SRB initiated the marketing procedure also involving the FROB in accordance with Article 39 of the BRRD and, on 4 June 2017, two potential purchasers entered in a non-disclosure agreement. In parallel, Deloitte was empowered to perform an independent valuation in accordance with Article 20 of the SRMR with the purpose: (a) to assess the value of BP assets and liabilities; (b) to provide an estimate of the treatment that shareholders and creditors would have received in case of normal insolvency proceeding; and (c) to inform the decision on the shares or other instruments of ownership to be transferred.224

12.74 Under the resolution scheme adopted and following the sale process already

in place, the SRB decided to transfer BP to Banco Santander SA. The whole

Ibid, Conclusion. 220 See ‘BP Resolution Decision’ (n 206), §4.2. 221 Critical functions identified also in accordance with criteria set out in art 6 of Commission Delegated Regulation 2016/778 were: (i) deposit taking; (ii) lending to SMEs; and (iii) payment and cash services. See ibid, §4.4.1. 222 SRB also stated that Resolution would have also met the other resolution objectives (ie the protection of public funds, depositors and client funds and assets) ‘at least to the same extent as insolvency proceedings’. See ibid, §4.4.3. 223 According to the SRB: ‘The winding up of the institution under normal insolvency proceedings, which is a long and complex procedure, would result in the creditors bearing higher losses than in resolution, since the liquidation of the Institution would result in its assets being sold at low exit price’. See ‘BP Resolution Decision’ (n 206), §4.4.3. 224 See SBR, ‘Memo Regarding the Non-confidential Version of the Documents Related to the Resolution of Banco Popular’ (available online at ). 219

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Bank Resolution in Practice: Analysis of Early European Cases transaction was executed under the Spanish Law 11/2015 in five steps. First, the capital of BP (€2.1bn) was reduced to zero by writing down all shares. Second, a capital increase was carried out to convert the Additional Tier 1 capital instruments (AT1) into share capital for a total amount of €1.347bn. Third, the shares resulting from the conversion of AT1 instruments were written down with the share capital reduced again to zero. Fourth, a new capital increase was approved to convert all Tier 2 capital instruments into newly issued BP shares for €684m. Fifth, all shares resulting from the conversion of Tier 2 instruments were sold to Banco Santander, for the symbolic price of €1.225 One month later, Santander launched a capital increase for €7bn to cover the cap- 12.75 ital and the provisions required to reinforce the balance sheet of Banco Popular and to maintain adequate solvency levels.226 The offer was successfully concluded with total subscriptions for more than €58bn.227 After the acquisition, Santander became the market leader in both lending and deposits, serving over 17 million customers with a credit market share of 20% and a 25% market share in SME lending in Spain.228 Moreover, Banco Santander decided to implement a commercial action to offer 12.76 repair to retail clients who owned shares and/or subordinated obligations of Banco Popular and were affected by the bank’s resolution. The offer was directed exclusively to retail clients and provided savers with perpetual obligations issued by Banco Santander.229 The offer was successfully completed, with 78% subscription of the bonds.230 In the BP resolution neither State aids nor aids from the Single Resolution Fund 12.77 were provided. Therefore, the Commission endorsed the resolution scheme rising no objections.231

225 See FROB, ‘7 June 2017 Resolution of the FROB Governing Committee Adopting the Measures Required to Implement the Decision of the Single Resolution Board in its Extended Executive Session of 7 June 2017 Concerning the Adoption of the Resolution Scheme in Respect of Banco Popular Español, S.A., Addressed to FROB, in Accordance with Article 29 of Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010’ (available online at ) 226 See Santander press release of 3 July 2017. 227 Santander CEO, Jose Garcia Cantera, could therefore state: ‘The acquisition of Popular is a unique opportunity to accelerate our strategy in Spain and Portugal and we are delighted with the success of this rights issue and the support we have received from investors. It is a testament to the strength of the strategic and financial rationale supporting the deal, as well as a strong vote of confidence in Banco Santander, in Spain and in Europe.’ See Santander press release of 26 July 2017. 228 See again Santander press release of 26 July 2017. 229 See Santander press release of 13 July 2017. 230 See Santander ‘Annual report 2017’, 21 231 EU Commission press release IP/17/1556

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Guido Ferrarini and Alberto Musso Piantelli 4. Successful Outcomes and Specificities 12.78 BP was the first institution to be resolved under the Single Resolution Mechanism.

Leaving aside litigation, which was brought in the following months,232 the BP resolution has generally been considered as a success and a good example of how a ‘significant’ banking crisis should be managed under the new European resolution regime. In fact, the institutional architecture performed well and all involved institutions contributed to devise and implement a resolution scheme in a few days, almost along the myth of ‘resolution in a week end’. Moreover, the whole operation avoided negative impacts on Spanish and European financial stability, while public resources were preserved since resolution costs were entirely paid by the shareholders and subordinated debtholders, and by the market through the issue of new shares by Santander.

12.79 However, the BP resolution was also facilitated by a favourable environment. First,

the Spanish financial system had just recovered from a national crisis. As indicated above, the whole system had been strengthened by the public interventions of the previous years and investors’ confidence was arguably coming back. Secondly, BP and public authorities could rely on Santander’s support. In fact, the transfer of assets and especially of a business is a better way to solve a crisis, since it is both a simple (less costly) solution and the safest for customers and financial stability. In the case of BP, the transfer of assets to a large group also permitted to avoid the full application of the bail-in tool and its negative consequences, also considering that Santander was able to raise fresh money on the market in a short time frame.233

12.80 Summing up, the resolution of BP can be regarded as a first positive test for the

new EU framework. No doubt, favourable conditions which facilitated the resolution do not permit to overemphasize the success of this case, but a first important point has been set: the single resolution mechanism is now in place, it can work and it is the baseline scenario for the management of the crisis of EU significant banks.234

232 See, eg, Reuters, ‘Investors file 51 Lawsuits Against EU for Shutting Banco Popular’, 30 April 2017 (available online at ). 233 The SRB excluded also the application of bail-in in ‘open bank scenario’, affirming: ‘With regard to the bail-in tool of Art 27(1)(a) SRMR (even If combined with the asset separation tool), it cannot be ensured that it would immediately and effectively address the liquidity situation of the Institution, hence, restoring it to financial soundness and long-term viability. Given the specific circumstances of the case, the sale of business tool would meet the resolution objectives more effectively than the bail-in tool of Art 27(1)(a) SRMR’. See ‘BP Resolution Decision’ (n 206), §5.3(a). 234 For a similar and deeper analysis of BP resolution, see Jens-Hinrich Binder, ‘Wunderkind is Walking? The Resolution of Banco Popular as a First Test for the Single Resolution Mechanism’ (2017) Oxford Business Law Blog, 14 July (available online at ). See also Victor de Serière, Chapter 10 of this volume.

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Bank Resolution in Practice: Analysis of Early European Cases

VII. Conclusions In this chapter we have argued that, notwithstanding prompt regulatory responses 12.81 to the 2008 crisis, the road to effective and credible resolution is slow and bumpy. No doubt, the BRRD and the SRMR have deeply changed the way in which banking crises are managed and financed in the EU and the Eurozone. However, our analysis of the main cases so far has shown that resolution is often different in practice from what one could have expected in theory or upon an abstract reading of the BRRD and the SRMR. Moreover, the need for special regimes on crisis management of banks is widely 12.82 acknowledged and the competent authorities have made recourse to resolution tools like the ‘transfer of assets’ and ‘bridge-bank institution’ long before the BRRD was enacted. However, bank insolvency regimes are not yet harmonized, so that the EU resolution framework is subject to the risk of being displaced by path-dependent national rules, as argued for the case of Venetian banks. In addition, the bail-in doctrine has met heavy opposition in practice, remaining de facto largely unapplied in major crisis episodes, including the resolution of Banco Popular which was the first to be performed under the SRMR, showing that bank stakeholders, politicians, and the public in general are still unprepared to a radical change in approach to crisis management.

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13 THE ARCHITECTURE OF THE BRRD —A UK PERSPECTIVE Simon Gleeson

I. Introduction II. Scope of the Legislation

13.01 13.04 13.05 13.07 13.09 13.11

1. Group Companies 2. Investment Firms 3. Pre-Resolution Intervention 4. Bank Resolution and Insolvency

III. Approach

1. Valuation Mechanisms

13.15 13.20

IV. Tools

13.24

1. Sale of Business/Transfer to Private Sector Purchaser 2. Bridge Bank/Bridge Institution and Asset Separation Tools 13.26 3. Transfer to Public Ownership 4. Bail-in

13.25 13.31 13.23

V. Other Powers

1. Powers and Instruments 2. Capital Instrument Write-down 3. Termination Rights 4. Recovery Plans 5. Intra-group Financial Support 6. Intervention Triggers 7. Administrators in Recovery 8. Financial Collateral 9. Eurozone Resolution 10. Third-country Resolution 11. Resolution Financing 12. Depositor Preference

VI. MREL & TLAC II. Brexit and Bank Resolution V VIII. Conclusion

13.37 13.37 13.39 13.43 13.45 13.49 13.53 13.55 13.56 13.57 13.58 13.60 13.67 13.72 13.77 13.82

I. Introduction The UK was one of the few European Union (‘EU’) countries to have a fully de- 13.01 veloped bank resolution legislative scheme in place prior to the Bank Resolution and Recovery Directive (‘BRRD’), and the architecture of the BRRD owes much to the UK model. However, the process of implementing the BRRD approach in the UK created challenges which highlighted the underlying policy choices within the BRRD, and demonstrate that the underlying model of the structure of resolution within the BRRD is very different from that assumed in the UK (and, in passing, the US). It also demonstrates that the BRRD is to some

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Simon Gleeson extent intended to operate in tandem with the Single Resolution Mechanism (‘SRM’) as well as EU State Aid guidelines—implementing BRRD in a non- Euro area country which is not part of the SRM created a distinctly different set of outcomes as compared with the implementation of the same directive within the SRM area—this is particularly clear when it comes to issues such as the establishment and operation of resolution funds and the conduct of bail-in. The chapter explores these issues, seeks to identify the extent to which the BRRD and the UK statutory approaches are compatible, and uses incompatibilities to identify the underlying intellectual architecture of the BRRD structure. Finally, the onset of Brexit presents a new set of challenges for both UK and EU resolution authorities, and the chapter examines the extent to which these may be significant in the future. 13.02 It is probably fair to say that prior to the crisis, most members-states of

the EU did not accept the necessity for special bank resolution regimes at all, and took the view that banks should be subject to the same resolution regimes as everyone else. It was only when the events of 2008–2009 provided dramatic demonstrations of the significant impact on economies of bank insolvency that the need for specialist bank resolution regimes became widely accepted.

13.03 When individual Member States started to create bank resolution regimes, they

naturally looked to the US Federal Deposit Insurance Corporation as an intellectual template. Whereas bank failure in the EU is relatively uncommon, the structure of the US banking market means that FDIC resolves an average of forty-three banks a year,1 and as a result FDIC is the undisputed leader in the field of bank resolution mechanisms. This means that the bank resolution regimes introduced by many Member States in the late 2000s tended to share a common intellectual DNA, and this DNA is clearly visible in the BRRD.2 Thus the task for Member States on the implementation of the directive was to bring their own regimes into line with a directive which corresponded with those regimes in broad principle, but diverged in a number of ways. In this regard the comparison between the BRRD and the UK Banking Act 2009 (the UK BA) is particularly interesting since the UK BA was the earliest of the EU national regimes, and has been significantly revised and improved as a result of experience during and after the crisis.

1 FDIC website, ‘Historical statistics on banking’. This figure incudes the year 1989, when at the peak of the savings and loan crisis FDIC resolved 531 banks. In a ‘normal’ year there might be around ten resolutions. There have only been two years in the FDIC’s history when there were no bank resolutions at all (2005 and 2006). 2 Directive 2014/59/EC.

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The Architecture of the BRRD—A UK Perspective

II. Scope of the Legislation One of the most important issues with bank resolution legislation regards the 13.04 precise identity of the entities which can be subject to resolution. All bank resolution regimes must, by definition, apply to banks. However there are issues both as to application as to regulated non-banks (can we resolve Lehmans?) and as to non-bank group entities (can we intervene at the holding company, as opposed to the bank, level?). 1. Group Companies The UK BA, as initially drafted, applied only to banks—that is, to the legal en- 13.05 tities which held a UK deposit-taking authorization.3 However, since in general banks conduct their activities through banking groups rather than as single entities, it rapidly became clear that for a group of any size it was necessary for the resolution authority to act in respect of group companies other than the authorized bank. Thus, as from 1 August 2014, the resolution powers and tools set out in the Act can be applied to any UK incorporated member of a bank group.4 Article 1(1) of the BRRD provides that it should apply to ‘financial holding com- 13.06 panies, mixed financial holding companies and mixed-activity holding companies that are established in the EU’. This, in principle, creates a problem for banks owned by non-banks. In very broad terms, EU bank law distinguishes between a financial holding company—a holding company the majority of whose subsidiaries are financial institutions—and a mixed activity holding company (an ‘MAHC’), a majority non-financial entity which holds some financial institutions (a typical MAHC would be a supermarket or manufacturer with a captive bank subsidiary). Article 33(3) provides that Member States are not required to take action against MAHCs ‘where the subsidiary institutions of a mixed-activity holding company are held directly or indirectly by an intermediate financial holding company’. This is reflected in the UK by the Banking Group Companies Order 20145, which provides that a resolution power can only be exercised in respect of a bank group company which is within the bank group. Where the bank is a sub-group under a holding company whose activities are not mainly financial (a mixed-activity holding company, or MAHC), the MAHC does not count as a parent for this purpose. This means that only members of the sub-group containing the bank can be resolved. The UK approach to implementing this will be that the Bank

3 Although even then there were some carve-outs—for example, many UK insurance companies have deposit-taking authorizations, and it was necessary to exclude them from the scope of the act—see now the Banking Act 2009 (Exclusion of Insurers) Order 2010 (SI 2010/35). 4 For this purpose a ‘group company’ has the meaning given in the Companies Act 2006. 5 2014/1831

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Simon Gleeson of England will be given powers to require any MAHC to hold its regulated subsidiaries through an intermediate financial holding company 2. Investment Firms 13.07 The BRRD applies to ‘institutions’, that is, to banks and to those investment

firms which are subject to the Capital Requirements Directive (‘CRD’).6 The UK BA, as initially drafted, applied only to banks, but has been extended by the Financial Services Act 20127 (‘FSMA’) to apply to investment firms.

13.08 Within the UK this creates an interesting tension as regards the interface between

supervision and resolution. In general, UK banks are supervised as to prudential issues by the Prudential Regulation Authority (‘PRA’) and as to conduct by the Financial Conduct Authority (‘FCA’), whereas investment firms are supervised exclusively by the FCA. However, it is possible for the PRA to be a supervisor of an investment firm,8 and, conversely, for a deposit taker to be prudentially supervised by the FCA rather than the PRA.9 Thus in practice the resolution authority will have to work with multiple supervisors. It is interesting to note in this context that the Bank of England’s resolution powers are in this regard wider than those of the European Central Bank acting as the Single Resolution Authority for the Eurozone. For reasons of consistency with the Single Supervisory Mechanism, the resolution powers of the ECB are confined to those institutions which it supervises.10 Thus, within the Eurozone banks subject to ECB supervision (either directly or indirectly) will be subject to ECB resolution, but investment firms outside the scope of that supervision will be subject to resolution by national resolution authorities working with national securities authorities. The UK, by contrast, has a single resolution authority charged with resolving all banks and investment firms, which faces multiple national supervisors. It should also be noted that the bank’s resolution directorate is structurally separate from the PRA function which is also discharged by the Bank. 3. Pre-resolution Intervention

13.09 Early intervention is, both in the UK and in the EU regime, a matter for the su-

pervisor (the competent authority) rather than the resolution authority. Thus the UK BA does not contain early intervention powers, since it establishes only the 6 Directive 2013/36/EC. This means all investment firms other than those identified in art 29 of the CRD—that is, investment firms which deal for their own account and hold client money or assets. 7 Section 101(1), inserting a new s 89A into the BA. 8 The PRA may designate investment firms for prudential supervision by it—art 3(4) of the Financial Services and Markets Act 2000 (PRA Regulated Activities) Order 2013 (SI 2013/556). 9 See s 83A of the Banking Act 2009. 10 See art 2 of the Single Resolution Mechanism Regulation 806/2014, which cross-refers to art 4(1) the Single Supervisory Mechanism Regulation 1024/2013.

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The Architecture of the BRRD—A UK Perspective resolution authority. The PRA and FCA have powers to instruct authorized firms to take specific action under sections 55L and 55M of the FSMA. In practice, the existing approved person regime is sufficient to give the competent authorities power over individual staff—however, it will be necessary to give them a further power to require an institution to remove members of its board and/or senior managers who are directly accountable to the board. The UK BA sets out a mechanism that can only be applied in resolution—there 13.10 were initially (and currently are) no powers in the UK BA which can be applied outside resolution. The trigger for resolution is the determination by the bank supervisor (originally the Financial Services Authorty (‘FSA’), now the PRA) that the bank needs to be placed in resolution. In order to determine that resolution needs to be commenced, the PRA must determine both that the bank has met, or is likely to meet, one of a series of triggers. These triggers are the threshold conditions for authorisation, set out in Schedule 6 to the FSMA. Interestingly, the key condition here (relating to adequacy of capital) does not apply any of the quantitative requirements of the Capital Requirements Regulation (‘CRR’),11 but merely specifies that the institution concerned must have ‘appropriate financial and non-financial resources’. Financial resources are required to be ‘appropriate’ given the liabilities of the business, and non-financial resources is explained to mean the capacity to value, risk-assess and manage the asset portfolio of the institution. The PRA is therefore able to place an entity in resolution even if the entity is (and is likely to remain) compliant with the minimum capital requirements of the CRR if it feels that there are significant deficiencies in its ability to manage its own business.12 The PRA is required to consult the treasury, the Bank of England and the securities supervisor (the FCA), but the decision is vested in the PRA alone. This is distinctly different from the BRRD approach, which provides that a decision to place an institution into resolution can be made by a resolution authority after consulting the supervisor (although it also provides that the determination may be made by the supervisor after consulting the resolution authority).13 4. Bank Resolution and Insolvency Bank resolution is optional—no major bank resolution regime provides that all 13.11 banks must be placed in formal resolution. Resolution is an alternative to insolvency, and in general the approach is that resolution tools may be applied only if some form of public interest test in their use is met. If that test is not met, resolution tools are not used, and the bank is placed in ordinary insolvency.

Regulation 575/2013. 12 FSMA Sch 6, Pt 1E, para 5D. 13 BRRD art 32. 11

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Simon Gleeson 13.12 The design philosophy of the UK regime was—and is—intended to make the

barrier to the commencement of resolution a high one. The aim is to make insolvency the norm and resolution the exception. The Code of Practice which accompanies the Banking Act notes that ‘the Bank of England may only exercise [resolution] powers if satisfied that the exercise of the power is necessary having regard to the public interest in the stability of the financial system of the UK, the maintenance of public confidence in the stability of that system, or the protection of depositors . . . The test of “necessity” is a high one’.14

13.13 However, when considering whether or not to place an institution in resolution,

the determination which falls to be made—that is, whether public welfare will be improved by resolution action—is in fact a comparison of the outcome of resolution with the outcome of the application of insolvency law. One of the consequences of this is that the worse the outcome of the application of insolvency law, the stronger the incentive to apply resolution measures, and the lower the bar to their application. Thus, one of the key features of the UK BA is that it both creates the resolution regime and amends the applicable UK insolvency regime to create a special ‘Bank Insolvency Regime’. The BRRD, by contrast, establishes a resolution regime but does not address the underlying insolvency issues.15 Thus in applying the tests for the commencement of resolution set out in the BRRD, individual Member States will be applying a common EU test in respect of common EU remedies against distinctly different national insolvency outcomes.

13.14 Conversely, however, the BRRD addresses a wide variety of issues which in the

UK are regarded as supervision rather than resolution. The mechanisms set out in the BRRD as regards recovery planning, early intervention, the imposition of special measures on firms in recovery, and the assessment of resolvability are all matters which in the UK are addressed by giving powers to supervisors under the the FSMA rather than in resolution legislation.

III. Approach 13.15 In the broadest terms, both the UK BA and the BRRD approach resolution on

the basis that resolution should only be effected if the result of the intervention is to produce a better outcome than would have been achieved had the firm concerned been placed into insolvency. However, the mechanisms which are used to Banking Act 2009 Special Resolution Regime: Code of Practice, November 2010, paras 5.12–5.15. 15 The EU has traditionally struggled to justify interference in the domestic insolvency regimes of individual Member States under the doctrines of subsidiarity and proportionality, although it can and does intervene in cross-border insolvency issues. 14

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The Architecture of the BRRD—A UK Perspective produce this result are very different, and the task of reconciling the two for the purposes of UK implementation is likely to be difficult. The basis of the safeguards set out within the UK BA is the idea of compensation. 13.16 The basis of calculation of the entitlement to compensation is that no creditor should be being left, as a result of the resolution action, in a position where he is financially worse off than he would have been had the resolution action not been taken and the institution placed in the appropriate insolvency proceeding (the ‘no creditor worse off’, or ‘NCWO’ safeguard). There are two ways in which a NCWO safeguard can operate. The existing UK 13.17 BA mechanism is quite clear that the requirement is an after the event compensation calculation, and does not limit the freedom of the resolution authority to take resolution actions. The BRRD, by contrast, sets out the NCWO safeguard as an explicit limitation on the resolution authority's freedom of action. The question is therefore as to the scope of this limitation. It is quite clear that some parts of the BRRD text are intended to place express 13.18 limitations on the powers of resolution authorities (see eg Recital 95). Article 34(1) also makes clear that Member States are required to ensure that their resolution authorities act in accordance with the principles set out in that article, including the principle that no creditor shall be worse off than on insolvency (Article 34(1)(g)). This is, however, qualified by the reference to Articles 73 to 75. The effect of this is that Member States must prohibit resolution authorities from acting in a way which is contrary to Articles 73 to 75. The question is therefore as to what these articles require. Article 73 contains two safeguards, one as regards partial property transfers 13.19 (‘PPTs’) and another as regards bail-in. The revised language on the partial property transfer safeguard Article 73(a) makes clear that the obligation imposed is to compensate—that is, to ensure that those affected by a PPT ‘receive at least as much’ as they would have done under insolvency. Article 73(b), however, makes no reference to property being ‘received’, but states that: where resolution authorities apply the bail-in tool, the shareholders and creditors whose claims have been written down or converted to equity do not incur greater losses than they would have incurred if the institution under resolution had been wound up under normal insolvency proceedings immediately at the time when the decision referred to in Article 82 was taken.

It seems clear that ‘do not incur greater losses’ means ‘do not incur greater losses as a result of the bail-in’. It is very hard to see how this requirement could be said to be satisfied by inflicting a loss on an investor through a bail-in and compensating him afterwards. In this regard it is critical that the two safeguards are expressed in different ways. If it had been intended that the Article 73(b) requirement could be satisfied by compensating over-bailed-in creditors after the event 519

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Simon Gleeson there would have been no reason to divide Article 73(a) and (b) into different safeguards. Consequently, the effect of Article 34 is to require Member States to prohibit their domestic resolution authorities from ‘over-bailing-in’ senior creditors beyond the NCWOL level and compensating them afterwards. It will be interesting to see how the UK amends its legislation to take account of this limitation on the freedom of action of the resolution authority. 1. Valuation Mechanisms 13.20 There are a number of facets to the NCWOL calculation. Having established

what the value of the claim in insolvency would be, you either compare it with the value of what the creditor received assessed at the initial valuation, or you compare it with the actual value. This is particularly important where a creditor receives shares, since the value of shares may be more or less than their book value.

13.21 The BRRD provides for two valuations to be undertaken. The Article 36 valua-

tion determines the extent to which bail-in can be effected at all (Article 36(4)(d)). The Article 74 valuation determines what the position would have been had the institution concerned been placed in insolvency rather than resolution. Article 74 then provides that the insolvency valuation must be compared with ‘the actual treatment that shareholders and creditors have received’. The question is as to how this latter figure is to be obtained. It would be somewhat odd to use the figure derived from the Article 36 valuation, since this is by definition a pre-estimate of the effect of action rather than a measure of the outcome of that action. Thus in order to apply Article 74, the independent valuer will need to make two determinations—one under Article 74(2)(a) of the position that would have obtained on insolvency and one under Article 74(2)(b) of the actual economic outcome of the measure.

13.22 This follows logically from the function performed by Article 74 as regards bail-

in. If a proposed bail-in were to result in a NCWO situation, it would be prohibited by Article 34 (as set out above). Thus the only way a bailed-in creditor is entitled to compensation under Article 73 is if the bail-in was, at the time it was undertaken, permissible under Article 34, but the outcome of the bail-in has been to leave the creditor worse off than he would have been under insolvency. In this case it would be a nonsense to use the Article 34 valuation as the basis for compensation, since it is the inaccuracy of the Article 34 valuation which has given rise to the necessity for the valuation in the first place, and using the Article 34 number would always give a compensation value of zero.

13.23 The biggest flaw in the BRRD bail-in proposals is the failure to address insolvency

set-off rights. If a senior creditor can only be bailed-in to the extent of his position on insolvency, that means that in practice he can only be bailed-in to the extent 520

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The Architecture of the BRRD—A UK Perspective of his net position after insolvency set-off. Thus, if a bondholder has a £100m position in bonds, in order to know the extent to which he can be bailed-in you would need to know the extent of his insolvency set-off against the bond issuer. Given that insolvency set-off (in the UK at least) is extremely broad, that means you would need to know every claim of every description that the bondholder concerned had against the issuer. It would be impossible either to maintain this information or to accumulate it in any reasonable period of time. Thus it will be impossible in practice to know what the NCWOL position of bondholders would be, and it seems to us that there is a real risk that this fact alone would make bail- in impossible under the BRRD architecture.

IV. Tools Once a bank has been placed in resolution, the next question is what the resolu- 13.24 tion authority is permitted to do. The powers set out in the BRRD and the UK BA may be compared as follows: UK BA

BRRD

Transfer to private sector purchaser Transfer to a bridge bank

Sale of business tool Bridge institution tool Asset separation tool Bail-in Government financial stabilization tools

Bail-in Transfer to temporary public ownership

Note: The bail-in provisions of the BA are inserted by the Financial Services (Banking Reform) Act 2013.

1. Sale of Business/Transfer to Private Sector Purchaser These are broadly equivalent tools, which allow resolution authorities to change 13.25 the legal ownership of an entity itself (ie a share sale) by a transfer of equity to a third party or private sector purchaser. As an alternative to a share sale, the tool can also be used to effect a business sale, by mandatory transfer of the assets and/or liabilities of an institution. Whether the share sale or business sale route is taken, there is no requirement to obtain the consent of the institution's shareholders or any third party other than the transferee. Transfers are required to be made on commercial terms and in accordance with EU State aid rules. 2. Bridge Bank/Bridge Institution and Asset Separation Tools The reason that the single UK tool is reflected in two separate tools in the BRRD 13.26 is that the UK regime imposes no significant restrictions on the entity to which the assets are transferred—a ‘bridge bank’, in the UK, is simply a transferee of the assets of a bank in resolution. The BRRD, however, subdivided this tool into two 521

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Simon Gleeson separate tools, which are distinguished primarily by the restrictions placed on the recipient in each case. 13.27 The essence of a UK bridge bank structure is that the resolution authority may

transfer property to a bridge institution owned by the Bank of England. Bridge banks must be (in effect) time-limited entities, subject to particular requirements as to management, reporting and eventual disposal, and the relevant provisions are contained in the code of practice created under section 5 of UK BA. It is notable that there is no restriction on the way in which a bridge bank may be used—the resolution authority may transfer good assets to a bridge bank with the intention of selling it as a going concern, but may also transfer bad assets to the bridge bank with the aim of returning the transferee bank to financial health. In the latter case the bridge bank is not sold, but wound up.

13.28 The BRRD, by contrast, draws a clear distinction between asset management

vehicles and bridge banks. Under the BRRD scheme a bridge bank is intended to transform into a solvent authorized institution or to be wound down within a period of two years,16 whereas an asset management vehicle is subject to no such time limit, and can therefore be used as a repository for the working-out over a long-term of bad assets.

13.29 A BRRD bridge institution is subject to normal prudential requirements under

the CRR (although it can be established and authorized subject to a short exemption from usual prudential requirements at the beginning of its operation, where necessary to meet resolution objectives). The Directive makes provision requiring Member States to ensure that the bridge institution enjoys continued access to financial market infrastructure and to deposit guarantee schemes in which the institution under resolution participated.

13.30 The BRRD asset separation tool must be used in conjunction with other tools.

It allows resolution authorities to remove assets (and potentially accompanying liabilities) off the balance sheet of a failing bank and into a run-off vehicle. The run-off vehicle is not authorized as a bank, but is not time-limited, and may take as long as it wishes to realize the portfolio of assets transferred to it. 3. Transfer to Public Ownership

13.31 The Transfer to Public Ownership tool is not classed in the BRRD as a resolu-

tion tool at all, but is provided for by Articles 56 to 58, which deal with government financial support. This is probably a correct classification, since for good

16 Another possibility is that the vehicle is sold to a private purchaser. At that point it ceases to be an asset management vehicle (since such a vehicle is defined in the BRRD as ‘wholly or partially owned by one or more public authorities’) and becomes a normal company.

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The Architecture of the BRRD—A UK Perspective and obvious reasons this is not a power which can be exercised by the resolution authority, but only by the government concerned. Since neither the UK BA nor the BRRD prohibit direct government aid, it is 13.32 necessary to address the position which arises if it is sought to combine government support with resolution. This can appear to be an either/or situation—if the treasury concerned appears to be backing the bank, it is difficult to argue that the bank satisfies the normal conditions for resolution. Under the UK BA, a carve-out is provided whose effect is that where the Treasury both provide financial support to the institution concerned and recommend that the relevant stabilization power be used, the resolution authority may exercise that power in that way if it feels that such exercise is appropriate. The test for the application of the bail-in power is the same, save that there is no ability to exercise this power after a treasury bail-out unless the conditions are then satisfied. In practice this means that if treasury does decide to make public funding available to a bank, the resolution authority can only exercise the power to bail-in if it is satisfied that the bank would otherwise fail or threaten public confidence in the banking system, and this in turn could only happen if the amount of funding provided by the Treasury had proved to be insufficient to stop the bank from collapsing. 4. Bail-in There are in practice two elements to recapitalising a failed institution. One is to 13.33 absorb losses so that the balance sheet has a positive value. The second is to recapitalize the institution by creating new equity. In general, the no creditor worse off sanction does not restrict the first of these. The issue therefore arises once losses have been absorbed, and creditors' claims are to be converted into equity. At this point the question of whether credit claims can be converted into equity within the ‘no creditor worse off sanction’ depends largely on the degree of damage which it is argued would be inflicted on creditor's claims if the institution were to be liquidated. Put simply, assume that it is possible to show that a creditor with a claim of one hundred would only receive eighty on a liquidation. This means that that creditor’s claim could be written down to eighty without violating the no creditor worse off principle. However, if it is subsequently intended that of the remaining eighty a further ten should be written off in exchange for new equity, this will only be possible under the no creditor worse off rule if it is certain that then new equity will be worth at least 100% of its written-down value. Since it is likely that at least some creditors will not be written down in this way (preferred creditors are an example), this is unlikely to be easily demonstrable. This issue is made more complex by the conclusion of the UK insolvency of Lehman 13.34 Brothers International (Europe) (‘LBIE’). Historically the Bank of England’s approach to hypothetical resolutions was to assume that the gap between liquidation 523

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Simon Gleeson value and resolution value would be very great; thus enabling them to create large amounts of new equity by writing down creditors without contravening the NCWOL criterion. However the experience of LBIE has been that creditors were paid out in full, even though the process was dealt with through an ordinary insolvency administration. 13.35 Bail-in under the BRRD is difficult. While the other three tools occupy a mere six

Articles of the text between them, the Section of the Directive dealing with bail-in comprises well over a dozen separate Articles spread across four separate subsections in Chapter IV of the Directive. Additionally, the bail-in provisions need to be read alongside the provisions of Chapter V, which regulate the write-down and conversion of capital instruments. Together the provisions are designed to ensure, first that an institution's most loss absorbent capital is written off in a bid to restore its solvency and secondly, to bail-in creditors to cover any remaining losses and to recapitalize the institution and ensure it is not merely solvent but also complies with regulatory capital requirements and has a strong enough balance sheet to continue as a viable operation.

13.36 Bail-in under the provisions of the UK BA is easier. It may be effected either by a

direct variation of the terms of the securities or by the making of an order transferring the securities to a ‘bail-in administrator’. The purpose of such a transfer would be that once the securities were in the hands of the bail-in administrator, their terms could be varied by agreement between the bail-in administrator and the issuer. It is likely that it is envisaged that any new or varied securities in the hands of the bail-in administrator would then be redelivered to their original owners. The bail-in administrator is a peculiarly UK creature, who does not appear in the BRRD, but does not appear to be incompatible with it and is expected to survive its introduction.

V. Other Powers 1. Powers and Instruments 13.37 The BRRD proceeds by giving resolution authorities an explicit group of powers

to do specific acts. The UK resolution authority has these powers, but rather than being made explicit on the facer of the UK BA, they are left implicit in the scope of the ‘share transfer instrument’ which is expected to me made in respect of any resolution.

13.38 To the uninitiated, a share transfer instrument might be assumed to be an in-

strument whose purpose is the transfer of ownership of shares. This would be a serious misunderstanding of the Act. First, the terms ‘share’ and ‘share transfer instrument’ have unnaturally extended meanings. The term ‘share’ includes not only shares but also any instrument comprising own funds, debt securities or 524

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The Architecture of the BRRD—A UK Perspective warrants entitling the holder to acquire any of the above).17 Equally a ‘transfer’ it not merely a change of ownership, but includes extinction of trust or similar claims, extinguishment of new subscriptions or acquisition rights,18 and permits securities to be ‘converted from one form or class to another’.19 Thus a share transfer instrument may be used to transform debt in to equity. Share transfer instruments are also the instruments used to make bail-in provisions. Finally, a share transfer instrument may enable the resolution authority to appoint and remove directors of a bank. In reality, therefore a share transfer means a set of measures taken where the securities issued by a bank in resolution are varied or transferred, and associated measures. Provision is also made for further transfers—thus, for example, securities can be transferred to a third party, the third party may consent to the variation of those securities, and the resulting, varied securities may be transferred back to the original owners or onward to new owners. 2. Capital Instrument Write-down This is a wholly new type of power for the UK—existing UK BA powers can 13.39 only be used once the entity concerned has been placed in resolution, whereas the BRRD write-down power is to be used before the entity is placed in resolution. In a breach of the general UK convention that pre-resolution powers are exercised by the supervisory rather than the resolution authority, it will be implemented by the grant of a new statutory power to the resolution authority. It is notable that although the BRRD envisages this power being exercised in advance of a formal determination of the commencement of resolution, the UK proposals suggest that in practice the same triggers will have to be met for the exercise of this power as for the commencement of resolution. This does, however, raise another fascinating cross-border issue. Where a group has capital instruments issued by both a parent and a subsidiary, it is entirely possible that one or other of these entities may theoretically be viable even without the write- down. Article 59(3) of the BRRD therefore provides a mechanism whereby the relevant authorities as regards the parent and the subsidiary may collectively make a determination that without a write-down the group as a whole will not be viable. This permits both authorities to write down the relevant instruments, subject to the constraint in Article 59(7) that: ‘A relevant capital instrument issued by a subsidiary shall not be written down to a greater extent or converted on worse terms . . . than equally ranked capital instruments at the level of the parent undertaking which have been written down or converted.’ However, it should be noted that the UK view is that this only applies where the subsidiary

UK BA s 14. 18 UK BA s 17. 19 UK BA s 19. 17

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Simon Gleeson is not otherwise failing—if the subsidiary itself is failing then the requirement for equivalence of treatment between holders of subsidiary capital and parent capital no longer applies. 13.40 There is a significant issue with the interaction of this power and the bail-in

tool. Both provide for the write-down of the face value of obligations of the institution in resolution, but there are significant differences between the way in which the two powers are operated. In particular, whereas the bail-in power is subject to the no creditor worse off safeguard, the write-down tool is not. Also importantly, in a bail-in the hierarchy of write-downs must follow the regulatory capital hierarchy—thus AT1 may not be bailed-in until CET1 has been written down to zero, and Tier 2 may not be bailed-in until AT1 has been written down to zero.20 Thus, where a resolution authority is contemplating writing down the claims of Tier 2 holders in order to increase the common equity Tier 1 of the institution in resolution, it has, in effect, a choice of which of the two tools to use.

13.41 There is nothing in the BRRD which indicates how this choice is to be made—

the point is in effect left to the discretion of the resolution authority. However, this approach creates considerable uncertainty for investors in capital and subordinated instruments, since the whole purpose of the no creditor worse off safeguard was to provide reassurance to those creditors that the existence of resolution powers should not affect their investment analysis, since they could never be left worse off in resolution than they would be in an insolvency. This unpredictability was felt to have a detrimental effect on bank capital instruments.

13.42 The UK has in practice addressed this in statute. Section 6A(2)(c) of the UK BA

effectively provides that the write-down power may only be used where the bail- in power is not to be used. Thus the only circumstances in which the write-down power can be used is in a situation where that power will not be used in conjunction with a bail-in power—that is, in a situation where write-down of capital instruments alone will be sufficient to recapitalize the bank. There is only one factual situation in which this is possible—where the institution has a surplus of total capital after losses, but that capital is made up of surplus Tier 2 and a deficit of CET1. This is an unlikely scenario. As the Bank of England said in their original ‘Approach to Resolution’ document,21 it is very unlikely that an institution could get to a condition where it could be resolved by a write-down of capital instruments without being classified as failing or likely to fail, and therefore requiring to be placed in resolution proper.

20 BRRD art 45; UK BA s 12AA. 21 ‘The Bank of England’s Approach to Resolution’, October 2017.

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The Architecture of the BRRD—A UK Perspective 3. Termination Rights The UK BA suppresses termination rights in a number of ways. A typology is estab- 13.43 lished between Type 1 events (that is, events which occur when a specific event occurs or situation arises) and Type 2 events (provisions which are suspended provided that a particular event does not occur), and provision is made for the property transfer instrument to be disregarded in determining whether a particular right has occurred or not. The BRRD makes more general provision in Article 68, and does not explicitly address Type 2 events. A familiar problem for UK banks is that many of their assets and obligations will be 13.44 choses in action governed by laws other than laws of the UK. As a result, section 39 provides that both the transferor and the transferee are required to take any necessary steps to ensure that the transfer is effective as a matter of the relevant foreign law. Where this cannot be done, the transferor is required to hold the asset on trust for the transferee, or discharge the liability on behalf of the transferee. 4. Recovery Plans The UK BA as originally drafted provided that it was the responsibility of UK banks 13.45 and building societies to draw up recovery plans. The BRRD requires any group which is subject to consolidated supervision in the EU to draw up a recovery plan. This means that the UK must be given powers to compel unregulated group entities to compile such plans. It is also technically possible for a group to have a UK parent but to be subject to consolidated supervision elsewhere in the EU—in such a case the UK had to be given powers to require the UK parent to create a recovery plan and deliver it to the relevant EU consolidating supervisor. It is also interesting to note that the existing UK BA ‘resolution plan’ provision (sec- 13.46 tion 137K) will be repealed. These provisions of the UK BA relating to resolution plans in fact imposed a requirement to compile and provide the information that resolution authorities would require to implement a resolution strategy (known as a ‘resolution pack’). The requirement to prepare a resolution pack will continue outside the scope of the resolution plan requirements. Separately, it will be necessary to introduce provisions requiring the Bank of England 13.47 (‘BoE’)—as resolution authority—to assess the ‘resolvability’ of institutions and group entities, and communicate the results of this finding to the EBA. Article 17 of the BRRD provides that a resolution authority may order a firm to 13.48 restructure itself in order to make itself more resolvable. These powers may be grouped into three broad classes; powers to change the structure of the group concerned,22 powers to restrict financial exposures of members of the group,23 22 BRRD art 17(5)(a), (g), (h), and (k). 23 BRRD art 17(5)(b), (d)–(f ), (i), and (j).

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Simon Gleeson and powers to impose information requirements.24 One of the interesting issues that arose in the UK implementation of this is that resolution authorities are generally not structured as regulators, and as such do not have enforcement powers. Thus the question arises of what happens if a resolution authority imposes a requirement on a firm but is not happy with the firm's implementation of that requirement. The default setting would be that enforcement would be the responsibility of the competent supervisory authority, leading to the situation where one authority imposes a requirement and a different authority enforces it—a potentially undesirable position. One way to address this would be to give the resolution authority enforcement powers in respect of these matters. However, this in turn leads to the resolution authority coming to look increasingly like a supervisor, and faces the relevant firm with the prospect of multiple—potentially conflicting—supervisory requirements being imposed as to its structure. This issue is of less importance where—as in the Eurozone— the resolution authority is also the supervisor, but remains a difficult issue for the UK. 5. Intra-group Financial Support 13.49 These provisions of the BRRD are not easy to understand in isolation.

Intra-group support is common within financial groups,25 and the difficulty is to identify which particular arrangements fall within the scope of these requirements. To complicate the picture, national legal systems within Europe vary widely in their approach to group support arrangements. At one extreme, the French and German systems permit companies within a group to act for the good of the group as a whole, on the basis of the indirect interest that each entity affiliated to a group has in the prosperity of the group as a whole.26 However, many other systems give primacy to the rights of creditors of individual legal entities, and provide that those entities must be run by their directors and managers in their own bests interests. This gives rise to a series of issues: • Under banking law, intra-group transfers may trigger supervisory action to defend the financial soundness of banks subject to that supervisor’s jurisdiction. This may result in ring fencing of a local bank’s assets. An intra-group transfer of assets is also normally considered to be a transaction with a connected party which may be subject to additional regulatory conditions (such as a requirement for arm’s length pricing). BRRD art 17(5)(c). 25 For a useful overview, see ‘The Joint Forum Report on Intra-Group Support Measures, February 2012, available online at . 26 For example, see for France, Cour de Cassation Criminelle 4 fèv 1985, Rozenblum, Rev Soc 1985, p 665; and for Germany, the German Companies Act (Aktiengesetz) of 6 September 1965 24

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The Architecture of the BRRD—A UK Perspective • Under company law, the influence and liability of a parent company over its subsidiary is usually limited, and the board of directors’ fiduciary duties and duty of loyalty are usually to the individual company, rather than the group as a whole. • Adverse tax implications can be expected in many cases—intra-group transfers of funds may not be tax-deductible. • Under insolvency law, transfers of assets executed in a suspect period before the opening of the insolvency proceedings of the transferor might be latter found retroactively void or ineffective vis-à-vis other creditors. The initial idea behind the BRRD proposal was therefore to create a permissive regime, under which a bank group could obtain advance consent for a particular arrangement which would be upheld within resolution. The idea of this regime as a pure privilege was thoughtful and effective, and is still 13.50 in the directive—Article 19(4) provides that ‘Member States shall remove any legal impediment in national law to intra-group financial support transactions that are undertaken in accordance with this Chapter’. However, almost as soon as this was proposed it was hedged about with requirements that the various supervisors of the group should be granted the right to review and ultimately veto the provision of such support. The reason that this creates difficulty is that most financial groups already have rel- 13.51 atively significant arrangements for intra-group support. These are generally specific to the tax, corporate and financial requirements to which different members of the group are subject. The issue which arises is as to how to distinguish between the ‘directive’ intra-group support arrangements—which require regulatory consent and are subject to regulatory control—and ‘non-directive’ intra-group support arrangements, which do not. This distinction is acknowledged—but not clarified—by Recital 38 of the Preamble to the BRRD, which provides that: ‘The provisions regarding intra-group financial support in this Directive do not affect contractual or statutory liability arrangements between institutions which protect the participating institutions through cross-guarantees and equivalent arrangements.’ It seems likely that the UK, at least, will take the view that ‘intra-group finan- 13.52 cial support arrangements’ are narrowly confined to the partial definition set out in Article 19, which refers to ‘an agreement to provide financial support to any other party to the agreement that meets the conditions for early intervention pursuant to Article 27’. This approach would mean that the regulatory power of control would be applied only to arrangements which are specifically triggered by the occurrence of one or more of the triggers set out in Article 27. If this approach is adopted, ordinary intra-group arrangements will be unaffected. 529

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Simon Gleeson 6. Intervention Triggers 13.53 One of the more important philosophical points of the UK BA is that the juris-

diction to decide whether to commence resolution should rest with the competent authority. The logic of this was that the sequence of events should normally be first recovery, then resolution, and since the competent authority is in charge of recovery it is best placed to decide when recovery has become hopeless. The BRRD provides optionality in this regard, since it prescribes in Article 32 that the person who determines when resolution should commence may be either the resolution authority or the supervisory authority, at the election of the Member State concerned. The UK will elect to retain the function for the supervisory authorities.

13.54 The process does, however, disclose an interesting problem where a bank in one

EU jurisdiction has a holding company in a different jurisdiction. Although the bank may be failing, the holding company may not be, and it is necessary in such a situation for the authorities in the jurisdiction where the holding company is located to be able to intervene. In such a case responsibility for commencement cannot be left with the competent authority, since in general holding companies are not regulated by competent authorities. Thus the determination as to whether to commence resolution at the holding company level must be made by the resolution authority (in the UK the resolution authority is given this power by sections 81A and 81B of the UK BA, which enable it to be exercised directly where an institution in the group is likely to fail. Where the institution is in a different jurisdiction, however, that determination is properly made by the competent authority in the jurisdiction concerned. Thus the BoE, as resolution authority, will need to be given a power to intervene to resolve a holding company where the competent authority in the jurisdiction where the subsidiary institution is located determines that that institution is failing. 7. Administrators in Recovery

13.55 Another innovation in the BRRD is the provision under Article 29 for the com-

petent authority to appoint a ‘temporary administrator’ during the early intervention phase whose function will be ‘either to replace the management body of the institution temporarily or to work temporarily with the management body of the institution’, and the provision under Article 35 to appoint a ‘special manager’ to replace the management of the institution under resolution. The first of these does not exist under English law, and will be created by statute. However, the current view of HMT is that the existing UK regime already complies with the second requirement, since if the resolution is conducted using a bail-in a ‘bail-in administrator’ will be appointed, and if the resolution is accomplished using a transfer to a bridge bank or private sector purchaser, the residual bank will be placed into 530

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The Architecture of the BRRD—A UK Perspective the ‘bank administration procedure’, which involves the appointment of an administrator who is subject to resolution authority control. 8. Financial Collateral When the UK implemented the Banking Act, it was required to respect EU law as 13.56 it then stood, and in particular the Financial Collateral Directive (2002/47/EC) which provided that certain collateral arrangements should be absolutely protected. The BRRD reverses this priority, as Article 118 of the BRRD amends the FCD so as to provide that the resolution powers contained in the BRRD prevail over the protections set out in the FCD. As a result, the major change to the UK safeguards regime will be the removal of the carve-out for FCD qualifying arrangements. 9. Eurozone Resolution Within the Eurozone, resolution will be undertaken by the European single reso- 13.57 lution authority, the Single Resolution Board (SRB). The distribution of powers between the SRB and national resolution authorities is outside the scope of this chapter, but in practice decisions will be taken by the SRB in respect of banks designated as Globally Systemically Important Banks (G-SIBs), subsidiaries of G-SIBs.and other European subsidiaries of non-EU banks which are above a size threshold. Decisions in rrespect of other entities will be taken by national resolution authorities. Thus in the event of a resolution of a UK bank with subsidaries in the Eurozone, there will be an interaction between the UK resolution authority and either the SRB or the relevant national authority. 10. Third-country Resolution The UK BA carefully confined itself to issues arising in respect of UK incorpo- 13.58 rated entities. This sensible approach—confining national authorities to powers which they actually have—is disturbed by the third-country regime set out in Articles 93 to 98 of the BRRD. The provisions relating to co-operation with other countries are relatively easily managed, and will be reflected in legislation. The challenge, however, is posed by Article 96, which provides that if the bank elects not to recognize third-country resolution mechanism then it must be given sufficient powers to act in relation to a branch of a third-country institution. The difficulty with this is that the assets of the branch belong to the relevant 13.59 third-country legal entity, and creditors of that branch are creditors of that legal entity. It is perfectly possible for a government to appropriate assets in its territory regardless of their ownership, but such appropriation generally leads to difficulty, compensation and litigation. The insolvency approach, whereby UK proceedings are commenced for the purpose of getting in local assets and distributing them amongst local creditors is fraught with difficulty, and would be unlikely to be 531

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Simon Gleeson practicable in any useful time period. One option which is being considered is the creation of a power which would have the effect of transferring the assets and liabilities of the branch into a separate legal entity incorporated in the UK and therefore capable of being resolved under ordinary UK jurisdiction. This, however, begs the question of how particular assets or liabilities would be attributed to the branch as opposed to the parent—a question which is made more complex for a UK operation by the fact that there is unlikely to be a necessary correlation between English governing law and the situs of the asset. This line of reasoning also leads to the conclusion that if we are to subsidiarize the branch upon resolution, we could make the problem go away altogether by simply requiring foreign branches to be constituted as subsidiaries ab initio. 11. Resolution Financing 13.60 Whilst acknowledging the crucial role of central bank emergency liquidity in any

resolution, the notion that taxpayers should not be on the hook for solvency support to banks underpins the BRRD, although the Directive does not completely exclude the possibility of public financial support and even contemplates temporary public ownership as a resolution option in sufficiently extreme scenarios. The Directive requires each Member State to establish a national resolution financing arrangement, which may use the same administrative structure as national bank deposit guarantee schemes—ie an organized and dedicated fund. Within the Eurozone these arrangements are to be pooled into a common Eurozone resolution fund, but outside the Eurozone each Member State is required to create its own domestic fund financed by its national banking industry. Such resolution financing arrangements are to be empowered to levy ex ante industry contributions from institutions authorized in the Member State and from local branches of third-country  firms.

13.61 The BRRD permits a derogation from the requirement to establish a national

resolution financing arrangements in the form of a dedicated fund controlled by the resolution authority. Article 100(6) instead permits Member States to satisfy the requirement to establish financing arrangements through general industry contributions (subject to certain requirements including that the amount raised be equal to the amount that a dedicated fund would raise and that the resolution authority be entitled to access the contributions for resolution purposes). In effect, this derogation should enable jurisdictions (such as the UK) that already collect a bank levy whose proceeds are paid into the general exchequer to side-step the Directive’s requirements for a separate, pre-funded arrangement.

13.62 The Directive sets a number of purposes for which resolution financing may be

used, including (but not limited to):

(a) funding NCWO compensation payments to shareholders and creditors; (b) to make loans to or purchase assets from, an institution in resolution; 532

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The Architecture of the BRRD—A UK Perspective (c) to guarantee the assets or liabilities of an institution in resolution, its subsidiaries, a bridge institution or an asset management vehicle; (d) to contribute in lieu of write down or conversion where the carve out from bail- in has been extended to exclude the bail-in of certain creditors otherwise susceptible to bail-in. Critically, the BRRD expressly prohibits the use of the resolution financing arrangement directly to absorb losses or recapitalize a failing institution. This express prohibition may be problematic when weighed against the idea that 'no creditor worse off' acts as an ex ante limitation in the Directive. The BRRD sets a resolution fund ‘target level’ of at least 1% of the value of in- 13.63 sured deposits of all authorized institutions in a Member State. The Directive aims to reach this minimum level, through industry contributions, by 31 December 2024 (with scope to extend that deadline where payouts have been made in the meantime and with a mechanism to maintain that target level beyond the deadline date on an ongoing basis). The Directive also requires the European Banking Authority (‘EBA’) to report to the Commission by 31 October 2016 with an analysis as to whether total liabilities would be a more appropriate reference point for setting resolution financing arrangements than insured deposits. In addition to annual ex ante industry contributions, the Directive also establishes 13.64 a framework for extraordinary ex post industry contributions to be levied in cases where existing resources are inadequate. Such ex post contributions are capped at three times the normal annual contributions. The UK takes the view that it is not required to establish a separate bank resolu- 13.65 tion fund provided that it imposes mandatory contributions from the banking sector. The UK Bank levy27 is a mandatory levy paid by banks. Consequently, it is argued, there is no requirement to establish a separate bank resolution fund, since such a fund already has a notional existence in the form of the government's accumulated bank levy revenues. There are a number of problems with this approach. First, the bank levy 13.66 itself excludes banks with equity and liabilities below £20bn. It is therefore imposed on a subset (albeit a large subset by value) of the banks which might require to have recourse to resolution funding. Second, Article 104 provides that a mechanism must be in place for raising resolution funding after the even if necessary, and it is out of line with general principles of taxation to vary a tax rate in order to recompense government for specific expenditures.

See Sch 19 to the Finance Act 2011. 27

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Simon Gleeson 12. Depositor Preference 13.67 The BRRD establishes a preference in the ordinary insolvency hierarchy for both

insured depositors (or a Deposit Guarantee Scheme (‘DGS’) subrogating to the depositors’ rights having made a payout to depositors or otherwise contributed to the costs of resolution) and for all other deposits of individuals and micro-, small- and medium-sized enterprises held in both European Economic Area (‘EEA’) and non-EEA branches of an EEA bank.

13.68 This requirement needs to be considered alongside the recast EU Directive on

deposit guarantees (the ‘DGD’), which will increase the volume of deposits that are insured (and thus preferred) to include all deposits, including all corporate deposits (unless the depositor is a public sector body or financial institution) plus some temporary high value deposits. These changes to the insolvency hierarchy may have important practical and commercial implications, potentially impacting the cost of senior unsecured debt. Firms and banks will need to consider whether to address the issue as a disclosure matter in prospectuses for senior bond documentation, as the preference amounts to a partial subordination of the claims of senior bond holders. Institutions will also need to assess whether there are pari passu or other provisions in existing or standard form documentation which might be contravened by the change in law

13.69 Under the Directive, a deposit guarantee scheme can be used to contribute to reso-

lution to the extent that it would have suffered loss on paying out bank depositors if the bank had gone into ordinary insolvency proceedings (Article 109). The preference for insured depositors in winding up means that it is very unlikely that there will be an absolute loss to depositors, except in exceptional cases. However, the pre-funding of the deposit guarantee scheme may act as a source of liquidity to help meet the target of seven days for paying out insured deposits under the DGD in the event that a bank is not placed into resolution but instead enters ordinary insolvency proceedings.

13.70 Depositor preference is an entirely new concept for UK banking law—although

the UK has classes of creditors who are preferred on insolvency, in general the recent trend has been to reduce or eliminate such preferences. Prior to the BRRD the Financial Services (Banking Reform) Act 2013 had introduced a preference for insured depositors on a UK bank insolvency. However, insured depositor preference is really deposit protection scheme preference, in that the insured depositor is in effect guaranteed by the deposit protection scheme, so that it is the deposit protection scheme which is the creditor of the institution, and who would suffer the loss on any shortfall, and whose claim is consequently protected. It should be noted in this context that the effect of this priority is that A DGS is exceptionally unlikely to suffer any loss at all in the insolvency of an insured deposit-taker. This in turn means that Article 109 of the BRRD—which provides that a DGS should not be liable to contribute to a bank resolution to a greater extent than ‘the 534

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The Architecture of the BRRD—A UK Perspective amount of losses that it would have had to bear had the institution been wound up under normal insolvency proceedings’ has the effect in practice of barring any recourse to DGSs to fund resolution. The specifically UK issue which arises here is as to the relative position of pre- 13.71 ferred depositors as against creditors secured by a floating charge. It is quite clear that secured creditors secured by a fixed charge rank in priority to all preferred creditors, but the position of floating charge holders is less intuitively obvious.28 There was some discussion of whether floating charge holders should be treated as secured creditors as against uninsured preferred depositors, but the eventual policy choice seems likely to be that floating charge holders will be effectively subordinated to both insured and uninsured creditors—thereby achieving the legally anomalous status of being subordinated secured creditors.

VI. MREL & TLAC In order to resolve a bank by bailing-in senior creditors, it is necessary that 13.72 there should be some senior creditors to bail-in. There are a series of proposals which require banks to have a minimum number and size of creditors in a form which can be bailed-in—ie not insured deposits or secured financing. The Financial Stability Board’s (‘FSB’) proposal for a requirement for TLAC (total loss-absorbing capital) was produced on 10 November 201429 and the FSB then issued its final standards30 in November 2015. The TLAC standard defines a minimum requirement for the instruments and liabilities that should be readily available for bail-in within resolution at global systematically important banks (‘G-SIBs’), but does not limit authorities’ powers under the applicable resolution law to expose other liabilities to loss through bail-in or the application of other resolution tools. Strictly speaking the FSB’s remit in this regard extends only to the thirty largest 13.73 G-SIBs,31 and applies only at the consolidated level. It is proposed to come into effect in 2019. Consequently, the position as regards other banks is left to national authorities. The EU, predictably, regarded this as a possible source of competitive tension within 13.74 the EU, and responded by seeking to harmonize the position as regards all EU institutions. The BRRD therefore introduced the concept of MREL—Minimum

28 It should be noted in this context that it is extremely rare for UK banks to grant floating charges. 29 See online at . 30 See online at . 31 .

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Simon Gleeson Requirement for own Funds and Eligible Liabilities32—which in theory is applied to every institution in the EU on both an individual and a consolidated basis.33 13.75 This has resulted in the EU adopting two separate approaches. The TLAC ap-

proach is applied in CRR2 to globably systematically important insitutions (‘G- SIIs’) (and EU institutions members of G-SII groups)34 as a capital requirement, set by the bank supervisory authority and assessed as part of the own funds supervisory process. The MREL approach applies to all institutions other than G-SIIs, is a resolution requirement, set by the resolution authority and is assessed as part of that institution’s resolvability assessment.

13.76 The UK has, in effect, combined these two approaches. In particular, it proposes

to set internal MREL requirements for all UK banks, whether G-SIIs or not, and whether the group parent is UK, EU or third-country. The UK is also committed to calibrating the relevant requirement using the same methodologies regardless of whether the entity concerned is subject to an MREL or a TLAC requirement (the fact that the BoE is now both the UK bank supervisor and the UK bank resolution authority is helpful in this regard).

VII. Brexit and Bank Resolution 13.77 The impact of Brexit on the UK bank resolution regime is, understandably, very

limited. The core principles that the UK will apply as regards financial services in respect of Brexit are as follows:35 (a) EEA firms and Financial Market Infrastructures (‘FMIs’) that were able to provide services into the UK through passporting arrangements will need to obtain UK authorization to continue to be able to do so after exit day. UK legislation provides that EEA firms, FMIs and funds may continue their activities in the UK for a period of three years after exit day before such firms and FMIs require full authorization or recognition.36 (b) Roles and responsibilities that are currently being carried out by EU authorities are being reallocated to the most appropriate UK authority, to the extent that they remain relevant when the UK has left the EU. For example, the responsibility for central counterparty (CCP) recognition will be transferred from ESMA to the BoE.

BRRD, art 45 and following. 33 BRRD, art 45(8). 34 CRR, art 92a. 35 See ‘HM Treasury’s approach to financial services legislation under the European Union (Withdrawal) Act’. 36 The draft (at time of writing) EEA Passport Rights (Amendment, etc and Transitional Provisions) (EU Exit) Regulations 2018. 32

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The Architecture of the BRRD—A UK Perspective (c) Detailed obligations that arise as part of EU membership for UK regulators to share information and co-operate with EU authorities will be deleted. This includes obligations to participate in EU supervisory colleges and to take joint decisions with other EU regulators. However, while these detailed obligations are being removed, the UK has actively worked since the financial crisis to build strong bilateral and multilateral co-operation mechanisms. The UK regulators will continue to be able to rely on existing FSMA provisions that support supervisory co-operation with third countries and will, for example, continue to host and participate in global supervisory colleges and crisis management groups. (d) In general, preferential treatment of the EU and its Member States will cease and they will be treated in the same way that third countries are currently. For example, the ranking in the insolvency hierarchy of deposits made through EU branches of UK banks will be aligned with the ranking of deposits held by third- country branches of such banks. (e) Where capital or liquidity consolidation was only required at the EU level previously, this will be required at the UK level after exit day. (f) References to directly applicable EU legislation will in general be updated to refer to the onshored version of that legislation. References to EU Directives will in general be updated to refer to the UK implementation of the Directive. The European Union (Withdrawal) Act 2018 (the ‘Withdrawal Act’) converts 13.78 directly applicable EU law (eg EU Regulations) into UK law, and preserves domestic law that relates to EU membership (including domestic law that was introduced to implement EU Directives). This body of law is referred to as ‘retained EU law’. The Withdrawal Act also provides Government ministers powers to make changes to the law so that it continues to operate effectively after the UK’s withdrawal from the EU. These processes are often referred to as ‘onshoring’ or ‘Nationalising the Acquis’ (NtA). This onshoring process will adopt EU Binding Technical Standards (‘BTS’) into 13.79 English law. However, a power to vary such legislation in order to address ‘deficiencies’ is given to UK financial regulators.37 Responsibility for the BTS adopted by the European Commission pursuant to the BRRD is given to the Bank of England. The most important aspect of this as regards resolution is that the UK will no 13.80 longer be part of EU resolution colleges, and will no longer be required to provide information to EEA bodies. However this is of less significance than it at first appears. Given the UK’s long history as a host for third-country banks, the resolution processes and architectures in the UK were developed with the aim of accommodating resolution of multi-jurisdictional institutions. More importantly,

37 By the (draft at time of writing) Bank Recovery and Resolution and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018.

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Simon Gleeson both the UK BA38 and the BRRD39 contain provisions which facilitate the implementation of cross-border resolution of third-country institutions. Thus the only significant change is that UK authorities are no longer required to have regard to the impact on EEA markets or economies of the commencement of resolution in the UK (and, of course, vice versa). However, given the degree of interconnectedness of these economies, the fact that authorities are not required to have regard to this impact will not affect the extent to which they will in fact do so. 13.81 In some respects, the most important aspect of Brexit for institutions in practice

is that created by the operation of Articles 45(5) and 55 of the BRRD. These provide that where an EEA institution has liabilities (or MREL) in issue governed by a law other than the law of an EEA country, it must include certain provisions in the documentation relating to those liabilities recognising EEA resolution measures. When the UK ceases to be an EEA member, EEA firms issuing MREL in the international capital markets will be faced with a choice as to whether to include these clauses in the terms of their instruments or to try and persuade investors to accept bonds governed by their domestic law.

VIII. Conclusion 13.82 The position of the UK as regards the implementation of the BRRD demonstrates

that harmonization has costs. Even though the architecture of the BRRD was extremely similar to the architecture of the UK BA regime, considerable redrafting was required to bring the UK legislation into line with the BRRD, and the resulting legislation, although complex, is by no means always clear. Areas of significant differences of policy (such as the utility of a pre-funded resolution fund and the degree of co-operation which should be afforded to subsidiaries of third- country banks) are largely elided rather than addressed, However, somewhat surprisingly, the forthcoming withdrawal of the UK from the EEA and the EU is unlikely to have any very significant impact on the actual level of co-operation between UK and EU resolution authorities in the event of a failure of a significant institution.

38 Sections 89H–89J. 39 Articles 94 and 95.

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14 EUROPEAN DEPOSIT INSURANCE SYSTEM (EDIS) Cornerstone of the Banking Union or Dead End? Veerle Colaert and Gilian Bens*

I. Introduction II. Why Is There a Need for a Fully-fledged Third Pillar in the Banking Union?

1. Goals of Deposit Insurance in General 2. Additional Goal of Deposit Insurance in the EU 3. Goals of the Banking Union 4. Goals of a European Deposit Insurance System as Third Pillar of the Banking Union

III. Legislative Proposals for EDIS 1. First Ideas

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14.04 14.04 14.05 14.09 14.11 14.20 14.20

2. Commission Proposal 2015 3. European Parliament Draft Report 2016 4. Further Developments 2016–2019

IV. Main Features of the EDIS Proposals

1. Introduction 2. Scope of EDIS 3. Funding of EDIS 4. Payout 5. Single Resolution and Deposit Insurance Board 6. Sanctions

V. Conclusion

14.22 14.27 14.30 14.33 14.33 14.35 14.37 14.47 14.61 14.66 14.69

I. Introduction Banking Union. The Banking Union has been defended as ‘imperative to break 14.01 the vicious circle between banks and sovereigns’1 and a key factor in a strong

Veerle Colaert holds the chair for Financial Law at KU Leuven University, is the chair of * ESMA’s Securities and Markets Stakeholder Group and a member of the Belgian Resolution Authority. Gilian Bens is a student at KU Leuven University. 1 European Council, ‘Conclusions of the European Council of 27–28 June 2013’(EUCO 104/2/13) at 2 and 10.

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Veerle Colaert and Gilian Bens Economic and Monetary Union.2 European legislators have indeed managed to agree in an extremely short timeframe of less than three years, to realize the first two pillars of the Banking Union, a Single Supervisory Mechanism for prudential banking supervision in the Eurozone (SSM)3 and a European Resolution Mechanism for the Eurozone (SRM).4 For there to be a genuine Banking Union, so it has been argued, a shared deposit guarantee system should, however, be installed as a third ‘pillar’ of the Banking Union.5 14.02 Proposal for a third pillar. The realization of this third pillar has proven to be a

bigger challenge. In November 2015 the European Commission issued a proposal for a ‘European Deposit Insurance System’ (‘EDIS’).6 One year later, the European Parliament rapporteur for this proposal heavily critiqued the Commission proposal in her draft report to the European Parliament.7 Even though this report had been discussed in the EU Parliament’s Committee for economic and monetary affairs (ECON) in January 2017, and the plenary vote had been scheduled for February 2017, such plenary vote has been postponed sine die and the dossier is on hold ever since. Since then, the legislative train has effectively stopped, with the Council making the EDIS discussion dependent on additional risk reduction measures for the banking sector. With an agreement in December 2018 on a number of such risk reduction measures between Parliament and Council, progress on EDIS may finally gain momentum.8

2 B Cœuré, Speech at the conference ‘Bank funding—markets, instruments and implications for corporate lending and the real economy’ (8 October 2012), available online at ; European Commission, ‘Communication on completing the Banking Union’ (COM(2017)592 final, 11 October 2017) at  3–4. 3 Council Regulation (EU) 1024/2013 of 15 October 2013 conferring specific tasks related to financial stability and banking supervision to the ECB [2013] OJ L287/13. 4 Regulation (EU) 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) 1093/2010, [2014] OJ L225/1. 5 Herman Van Rompuy, ‘Towards a Genuine Economic and Monetary Union’ (EUCO 120/ 12, 26 June 2012) at 4; European Commission, ‘A Roadmap towards a Banking Union’ (COM 2012(510), 12 September 2012) at 6; B Cœuré (n 3). More recently also an effective common fiscal backstop is considered a further essential component to complete the Banking Union. See J C Juncker in close co-operation with D Tusk, J Dijsselbloem, M Draghi, and M Schulz, ‘Completing Europe’s Economic and Monetary Union’ (2015) (‘the Five Presidents Report’) at 4; European Commission, ‘Towards the Completion of the Banking Union (COM(2015) 587 final, 24 November 2015) at 3. See, on the common backstop, (n 54). 6 European Commission, Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European Deposit Insurance Scheme (COM(2015) 586 final, 24 November 2015) (‘Commission Proposal’). 7 European Parliament, ‘Draft Report on the Proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European Deposit Insurance Scheme’ (2015/0270(COD), 4 November 2016) (‘EP Draft Report’). 8 See further paragraphsn 14.31ff below.

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European Deposit Insurance System (EDIS) Research questions. In a context where it is, nevertheless, far from clear what the 14.03 final format of EDIS would be, the goal of this contribution is to answer the following questions: (i) why is there a need for a third pillar for the Banking Union; (ii) what are the reasons and possible solutions for the long-lasting deadlock; and (iii) what are the main features of the different formats of EDIS currently on the table. This contribution will be structured along the lines of those research questions, along the way providing a critical assessment and comparison of the Commission’s proposal and the amendments proposed in the EU Parliament’s report. To this end, we will draw from legal history, law and economics, legal analysis and policy analysis.

II. Why Is There a Need for a Fully-fledged Third Pillar in the Banking Union? 1. Goals of Deposit Insurance in General Goals of deposit guarantee systems in general. Deposit guarantee systems are 14.04 commonly said to serve two goals: protecting depositors against losses in case of insolvency of their credit institution, and, even more importantly,9 maintaining the stability of the financial system and avoiding systemic risk.10 Indeed, rumours that a credit institution is in financial trouble, easily become a self-fulfilling prophecy when these rumours trigger a bank run. A run leads to liquidity problems as a consequence of which the financial situation of the bank may deteriorate so severely that it can rapidly fall into bankruptcy. Due to direct and indirect spill- over effects, this could in an extreme case affect the whole financial market and lead to a systemic financial crisis. To avoid this course of events, a deposit guarantee system will step in to fulfil the credit institution’s obligations towards its depositors if a credit institution is unable to pay back deposits on demand, usually up to a certain amount, currently set at €100 000 in the EU.11 The ratio of the deposit guarantee system is that depositors, knowing that payout of their deposits is substantially guaranteed, will be less inclined to withdraw their deposits from

9 V Colaert, ‘Deposit Guarantee in Europe. Is the Banking Union in need of a third pillar?’ (2015) ECFR 372; European Commission, ‘Impact Assessment—Accompanying document to the Proposal for a Directive . . . / . . . /EU of the European Parliament and of the Council on DGSs [recast]’ (12 July 2010) SEC(2010) 834 final at 27, where the goals of the directive are described as: ‘maintaining financial stability by strengthening depositor confidence and protecting their wealth’; R Cerrone, ‘Deposit Guarantee Reform in Europe: does European Deposit Insurance Scheme increase Banking Stability’ (2018) Journal of Economic Policy Reform at 2. 10 Basel Committee on Banking Supervision—International Association of Deposit Insurers, ‘Core Principles for Effective Deposit Insurance Systems’ (2009), principle 1; A Campbell and P Cartwright, ‘Deposit Insurance: Consumer Protection, Bank Safety and Moral Hazard’ (1999) EBLR at 96. 11 Directive 2014/49/EU, art 6.

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Veerle Colaert and Gilian Bens the bank in case of financial turmoil.12 Depositor protection is therefore to a large extent a tool to improve banking stability. 2. Additional Goal of Deposit Insurance in the EU 14.05 Additional EU goal of deposit guarantee regulation. In addition to these goals of

deposit guarantee systems in general, EU regulation on this matter also serves an additional European goal, the realization of an internal market. This internal market goal proved particularly important during the 2007–2009 financial crisis (see n 7).

14.06 Directive 1994/19/EC. European intervention with regard to deposit guarantee

has a relatively long history. After previous attempts to regulate this field had failed,13 Recommendation 87/63/EEC14 urged all Member States to have a DGS in force by 1 January 1990. Since the Recommendation did not produce the desired result,15 and the European legislator considered that this situation could prove prejudicial to the proper functioning of the internal market,16 Directive 94/19/EC obliged Member States to introduce a deposit guarantee system with a minimum coverage level of €20 00017 and a maximum payout period of three months.18 The funding of the schemes was, however, not harmonized.19

14.07 Crisis intervention. The first real challenge for Member States’ deposit guarantee

schemes since the introduction of Directive 94/19/EC was the 2007 financial crisis, when bank runs evidenced both: (i) failures of EU DGSs to achieve their banking stability goal;20 and (ii) the dangers of minimum harmonization. In order to increase depositor confidence in the system, a number of Member States decided to increase the coverage level of their DGSs.21 Other Member States followed

12 V Colaert (n 10) at 372; D W Diamond and P H Dybvig, ‘Bank Runs, Deposit Insurance, and Liquidity’ (1983) The Journal of Political Economy 404; J Kerlin, The Role of Deposit Guarantee Schemes as a Financial Safety Net in the European Union (Palgrave MacMillan 2017) 35. 13 See for details: P Carlotti, ‘La directive relative aux sytèmes de garantie des dépots’ in Association Européenne pour le Droit Bancaire et Financier (ed), Mélanges Jean Pardon (Bruylant 1996) at 112. 14 Commission Recommendation 87/63/EEC of 22 December 1986 concerning the introduction of deposit-guarantee schemes in the Community [1987] OJ L033/16. 15 European Commission, ‘Proposal for a Council Directive on Deposit-Guarantee Schemes— Explanatory Memorandum’ (COM(92)188) at 3: ‘[d]‌espite this Recommendation, some Member States [were] not yet convinced of the need for all their credit institutions to be required to belong to a deposit guarantee scheme, and two Member States [had] not yet introduced one at all.’ 16 Recital 5 of Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on deposit-guarantee schemes [1994] OJ L135 (hereinafter ‘Directive 94/19/EC’). 17 Directive 94/19/EC, art 7(1) with some limited exceptions. 18 Directive 94/19/EC, art 10. 19 The directive only required that DGSs be funded by contributions of credit institutions. 20 Most notoriously the run on Northern Rock in the UK in September 2007. 21 The most notable example being Ireland, which provided for a full deposit guarantee as of 30 September 2008. See for a detailed list of other EU Member States with episodes of unlimited deposit insurance coverage regimes during the crisis: European Commission, ‘Impact Assessment— Accompanying document to the Proposal for a Directive . . . / . . . /EU of the European Parliament

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European Deposit Insurance System (EDIS) suit to avoid depositors moving their deposits to credit institutions established in Member States with higher DGS coverage levels.22 To deal with this particular problem and ‘promote convergence of deposit-guarantee schemes’23 Directive 94/ 19/EC was amended with urgency in 2009,24 increasing the minimum coverage level to €50 000 by 30 June 2009 and setting a maximally harmonized coverage level at €100 000 by 31 December 2010 (with limited exceptions).25 By the same token the payout period was reduced to twenty working days, with the intention to further reduce it to ten working days in the future.26 Directive 2014/49/EU. In the meanwhile the European Commission had al- 14.08 ready started preparing a fully-fledged revision of the 1994 directive and submitted a proposal for a new directive on 12 July 2010.27 After long and difficult negotiations, this proposal finally resulted in the adoption of DGS Directive 2014/49/EU on 16 April 2014.28 In view of the experiences during the crisis, DGS Directive 2014/49/EU puts even more emphasis on the internal market goal. A high level of harmonization was now considered ‘of the utmost importance in order to eliminate market distortions’.29 DGS Directive 2014/49/EU keeps the coverage level maximally harmonized at €100 000, except for temporary high balances on deposit accounts resulting from particular and exceptional circumstances, for which Member States should ensure a higher coverage level.30 The payout period on the contrary will be further reduced to 7 working days, after a transition period ending on 1 January 2024. The most important change brought by Directive 2014/49/EU is the introduction of harmonized rules on the funding of the DGS.31 Finally, apart from payout in case of a ‘payout event’,32 DGSs can now also be required to intervene in a resolution procedure (see n 13). and of the Council on DGSs [recast]’ (12 July 2010) SEC(2010) 834 final, annex I at 100–3. For a Cross-country comparison of deposit insurance measures taken during the financial crisis, see also FSB, ‘Thematic Review on Deposit Insurance Systems. Peer Review Report’ (8 February 2012) at 11 and 34–35. 22 FSB (n 22) 11; Impact Assessment (n 22) 9. 23 Recital 1 of Directive 2009/14/EC. 24 European Commission, Proposal for a directive of the European Parliament and of the Council on DGSs [recast] (COM (2010) 368, 12 July 2010), Explanatory Memorandum at 2. 25 Directive 2009/14/EC, art 7. 26 Directive 2009/14/EC, art 10. 27 European Commission, Proposal for a directive of the European Parliament and of the Council on DGSs [recast] (COM (2010) 368, 12 July 2010). 28 Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014 on DGSs (recast), [2014] OJ L173/149. 29 Recital 6 of Directive 2014/49/EC. 30 Article 6(2) and Recital 26 of Directive 2014/49/EU. 31 For a detailed overview and critical review of the Directive, see, among others, V. Colaert (n 10); and J Payne, ‘The Reform of Deposit Guarantee Schemes in Europe’ (2015) ECFR 539–62. 32 A DGS needs to ensure that the amount repayable to depositors is available within seven working days of the date on which the deposit has become unavailable (art 8(1) of Directive 2014/ 49/EU). An unavailable deposit is “a deposit that is due and payable but that has not been paid by a credit institution under the legal or contractual conditions applicable thereto, where either: (a) the relevant administrative authorities have determined that in their view the credit institution

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Veerle Colaert and Gilian Bens 3. Goals of the Banking Union 14.09 Goals of the Banking Union. The 2010–2011 public debt crisis had brought to

the fore a ‘vicious circle between banks and national finances’.33 The home bias of banks’ sovereign debt portfolios makes these banks vulnerable to downgrades of government debt. Downgrades of a Member State could therefore easily trigger distress in that Member State’s banking sector, increasing chances that governments feel the need to bail-out ailing banks, which would further increase government debt (so-called ‘doomloop’).34 To break this vicious circle the Banking Union has been launched, aiming at a stable and integrated financial system and increased resilience of the Economic and Monetary Union towards adverse shocks.35

14.10 Three pillars. The Banking Union was designed to rest on three pillars.36 The

Single Supervisory Mechanism (SSM) should ensure that the EU’s policy relating to prudential supervision of credit institutions is implemented in a coherent and effective manner, that the single rulebook is applied in the same manner to credit institutions in all Member States concerned, and that credit institutions are subject to supervision of the highest quality, unfettered by non-prudential considerations.37 The Single Resolution Mechanism (SRM) should ensure an orderly resolution of failing banks with minimal costs to taxpayers.38 The third pillar, finally, a European Deposit Insurance System (EDIS), would provide stronger and more uniform cover for all retail depositors in the banking union. The specific goals of EDIS are developed in more detail in the next section.

concerned appears to be unable for the time being, for reasons which are directly related to its financial circumstances, to repay the deposit and the institution has no current prospect of being able to do so; or (b) a judicial authority has made a ruling for reasons which are directly related to the credit institution’s financial circumstances and which has the effect of suspending the rights of depositors to make claims against it” (art 2(1) of Directive 2014/49/EU). 33 European Commission, ‘Memo: Banking union: restoring financial stability in the Eurozone’ (9 March 2015, updated version of Memo of 15 April 2014). 34 M K Brunnermeier et al, ‘The Sovereign-bank Diabolic Loop and ESBies’ (CEP Discussion Paper No 144, March 2016) at 2; A Beranger and L Scialom, ‘Banking Union: Mind the Gaps’ (2015) International Economics at 100; D Gros and D Schoenmaker, ‘A European Deposit Insurance and Resolution Fund’ (CEPS Working Document n° 364/2012, May 2012) at 1; D Schoenmaker, ‘Firmer Foundations for a stronger European Banking Union’ (Bruegel Working Paper 2015/13) at 3; J Arnal-Martinez and A Moreno, ‘The Sovereign-Bank Feedback Loop: Did European Policies Alleviate It?’ (Working Paper 2018) available at ssrn at 2; European Commission, ‘Report to the European Parliament and the Council on the Single Supervisory Mechanism established pursuant to Regulation (EU) No 1024/2013’ ((COM)2017/591 (final), October 2017) at 2. 35 Commission Report (COM)2017/591 (final)) (n 35) at 2. 36 See para 1, with references. 37 ECB, ‘Guide to Banking Supervision’ (November 2014), available online at at 39, para 85. 38 Recital 73 of Regulation (EU) 806/2014.

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European Deposit Insurance System (EDIS) 4. Goals of a European Deposit Insurance System as Third Pillar of the Banking Union Directive 2014/49/EU as an important first step towards European Deposit Insurance. 14.11 As mentioned above (n 8), DGS Directive 2014/49/EC maximally harmonizes key elements of Member States’ DGSs in Europe, which is indeed indispensable if those funds would someday need to be united. Harmonization of the funding requirements of Member States’ DGSs represents without any doubt the biggest step forward in this respect. In this section we will explore the added value of a European deposit insurance system over the highly harmonized Member States DGSs.39 A. Increased Efficiency Efficiency. A European Deposit Insurance System would be more efficient on many 14.12 accounts. First, the European Commission has calculated that a European system would represent a yearly decrease of administrative costs of about €40 million per year.40 However, this number seems to have been based on the idea that the national DGS would be abolished, which is not the case in the current Commission Proposal and even less in the most recent ideas on EDIS.41 Second, efficiency gains would result from the increased experience of a European scheme compared to national DGSs which are relatively rarely confronted with payout procedures. Third, a European scheme would be able to deal more efficiently with the failure of credit institutions with many cross-border depositors.42 Fourth, the remarkable asymmetry between a Single Supervisory Mechanism and a Single Resolution Mechanism for the Eurozone on the one hand and (a network of ) nationally operated DGSs is in itself an argument in favour of a European system, at least for the Eurozone. This argument goes beyond mere efficiency and will be developed in Section B below. Finally, and most importantly, a European Deposit Insurance System allows for risk-sharing and improved depositor protection and financial stability with the same level of funding. This argument is further developed in Section C below.

39 The arguments below are an updated version of argumentation developed in a previous contribution: Colaert (n 10) at 418, paragraphs 14.89ff. 40 European Commission, ‘Report to the European Parliament and the Council—Review of Directive 94/19/EC on DGSs’ (COM(2010)369 final, 12 July 2010) at 4–5. 41 European Commission, ‘Report to the European Parliament and the Council—Review of Directive 94/19/EC on DGSs’ (COM(2010)369 final, 12 July 2010) at 22. In the current debates in the European Parliament and the Council, national DGSs would retain an even larger role, which would further reduce the administrative cost reduction argument. 42 Article 14 (2) of the Directive provides that depositors at branches set up by credit institutions in another Member State shall be repaid by a DGS in the host Member State on behalf of the DGS in the home Member State. The DGS of the home Member State shall provide the necessary funding prior to payout and shall compensate the DGS of the host Member State for the costs incurred.

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Veerle Colaert and Gilian Bens B. Need for Three Pillars at Eurozone Level 14.13 Interaction between the pillars of the Banking Union. The relationship between the three pillars of the Banking Union can be described as follows. A strong first and second pillar of the Banking Union are a prerequisite for a well-functioning third pillar not producing adverse effects in two different ways. First, an improved mechanism of risk prevention and supervision should help containing the moral hazard problem typically associated with deposit guarantee systems: credit institutions may engage in overly risky behaviour, knowing that part of the loss will be borne by the DGS.43 Second, the supervision by the SSM should ensure that the risk level of the banking sector in one Member State is not systematically higher than the risk level of the banking sector in another Member State. This is necessary to create a European Deposit Insurance Scheme, without creating a ‘transfer union’. If a bank nevertheless faces difficulties which could endanger banking stability, early intervention and resolution by the SSM and SRM should prevent a disruptive and destabilizing failure. As a result, the need for depositor payout by DGSs should drastically decrease. On the other hand, the DGS of the credit institution under resolution should in certain circumstances, make a contribution to the resolution.44 Cooperation between the second and the third pillar is therefore also key. 14.14 Need for three pillars at the same level. Although prudential supervision in the

Eurozone is performed at Eurozone level,45 a ruling on unavailability of deposits is under the current DGS Directive 2014/49/EU made at national level. This asymmetry is conceptually unsound. Conflicts may indeed arise between the European supervisor and the national DGS, when the national DGS could blame the ECB for insufficient supervision, leading to a situation necessitating a pay-out at Member State level.46 Similarly, in the context of a resolution procedure, the national DGS could blame the SRM for not taking the necessary measures to prevent or intervene in a crisis, which can in the end result in the need for a payout by the national DGS. Moreover, the Single Resolution Fund, funded by all credit institutions of the Eurozone, will often need to co-operate with a national DGS, funded by the credit institutions of the home member state of the ailing credit institution only. This asymmetry is undesirable from an efficiency perspective.47 43 Colaert (n 10) at 382–384, paragraphs 16–17, with further references. 44 See Recital 110 and art 109 of Bank Resolution and Recovery Directive (2014/59/EU) and art 11(2) of Directive 2014/49/EU. 45 The Court of Justice of the European Union recently ruled that supervision by national competent authorities of less significant credit institutions should be qualified as ‘assistance’ of the ECB in carrying out the tasks conferred on it by Regulation N 1024/2013, by a ‘decentralised implementation of some of those tasks in relation to less significant credit institutions’ (See CJEU C-450/17 (8 May 2019) Landeskreditbank Baden-Württemberg, para 41). 46 D Schoenmaker and D Gros, ‘European Deposit Insurance and Resolution in Banking Union’ (May 2013) Vol 52 Issue 3 Journal of Common Market Studies at 535–6. 47 The following inefficiencies have been described: less efficient risk pooling, which would not effectively decouple sovereigns and banks; complexities in cost allocation and implementation in

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European Deposit Insurance System (EDIS) C. Improved Depositor Protection and Stability More capacity. First, and most importantly, the capacity of a European deposit 14.15 insurance system would be a multiple of national DGSs’ capacity. The ex ante funding level of DGSs under Directive 2014/ 49/ EC (0.8% of the covered 48 deposits ) is hardly sufficient to ensure pay-out of depositors of medium-sized entities,49 thus undermining the banking stability goal.50 Additional ex post funding and alternative financing arrangements only partially solve that problem. The capacity of a European scheme would be a multiple of a national DGS’s capacity. A European scheme should therefore be able to deal with payout for even the largest European banks.51 Second, in a European system ex post funding would be a burden shared by all credit institutions of the Eurozone, decreasing the impact on each of them and decreasing the procyclical effect of ex post funding.52 Third, a European scheme may inspire more confidence in the host state where a credit institution provides cross-border services or establishes a branch, since depositors would know that one and the same deposit insurance system would guarantee their deposits irrespective of the Member State of establishment of the credit institution.53 Fourth, while most Member States de jure (eg a credit line for the DGS) or de facto (by bailing-out failing credit institutions) provide a backstop for their DGSs, which in case of a severe banking crisis could threaten the solvency of that state, a European scheme would provide an external loss absorption mechanism, independent of the solvency of the state.54 A European system would, finally, the case of cross-border failures, requiring close co-ordination between national DGSs and the single resolution authority; and duplication of costs and administrative resources, as both funds would be assessed on the same banks. See R Goyal et al, ‘A Banking Union for the Euro Area’ (13/ 01 IMF Staff Discussion Note, February 2013) at 19–20; J. Pisani Ferry and G. Wolff, ‘The fiscal implications of a banking union’ (Bruegel Policy Brief, September 2012) at 5; D Schoenmaker and D Gros, ‘European Deposit Insurance and Resolution in Banking Union’ (2013) Vol 52 Issue 3 Journal of Common Market Studies at 535–6. 48 Article 10(2) of Directive 2014/49/EU. ‘Covered deposits’ means the deposits which are not excluded from protection pursuant to art 5 and do not exceed the coverage level of art 6 (in principle €100 000) (see art 2(1) of Directive/2014/49/EU). 49 Kerlin (n 13) at 205. 50 Five Presidents’ Report (n 6) at 11. 51 Schoenmaker and Gros, ‘European Deposit Insurance and Resolution in Banking Union’ (n 47) at  541–2. 52 Ex post funding is required if the deposit guarantee system does not have sufficient ex ante funds to ensure payout. Ex post funding is criticized for reinforcing a downward business cycle, since it encourages risk-taking in good times (no or fewer contributions to be made), but drains liquidity from banks in times of stress. See Impact Assessment (n 8) at 20; B Bernet and S Walter, ‘Design, Structure and implementation of a modern deposit insurance scheme’ (SUERF, The European Money and Finance Forum, Vienna 2009) at 37; to S Schich, ‘Financial Turbulance: Some Lessons Regarding Deposit Insurance’ (2008) OECD Financial Market Trends at 71. 53 Colaert (n 10) at 421, n 103. 54 A European system would nevertheless be stronger still if there would also be a backstop at EU-level. See Schoenmaker and Gros, ‘A European Deposit Insurance and Resolution Fund’ (n 47) at 4. Already in 2013 the Member States of the Eurogroup committed to set up a fiscal backstop for the Single Resolution Fund (‘Statement of Eurogroup and ECOFIN Ministers on the SRM Backstop’ (18 December 2013)). In 2016 the Council explicitly recognized that a common fiscal

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Veerle Colaert and Gilian Bens make deposit insurance coverage uniform for all depositors independently of their geographical location within the Banking Union.55 D. Level Playing Field 14.16 Level playing field. A European deposit insurance scheme would also further level the playing field and fair competition between credit institutions in the European Union. First, the fact that the Directive harmonizes the coverage level at €100,000 means that in Member States with a lower average income level a higher percentage of depositors will be fully covered. Credit institutions of these Member States will face relatively higher contributions, since contributions are calculated on the basis of covered deposits.56 A fixed coverage level in a system of contributions to a national DGS, may thus create an unlevel playing field between credit institutions established in different Member States. In a European system, this effect would be diminished. Second, under the Directive, in case a DGS needs to proceed to payout and ex ante funding is insufficient, ex post funding will be required only from the credit institutions of the Member State of establishment of the failing credit institution, even if the failing credit institution has a substantial number of depositors in other Member States. Again this leads to unfair competition. In a true internal market, ex post funding should be borne proportionally by all competitors in the market. This can however only be realized in the context of a European scheme.57 backstop is an important measure to ensure a uniform level of confidence in deposit protection under all circumstances and to enhance the internal market (Council, ‘Progress Report’ (2015/0270 (COD), 14 June 2016), at n 96). In this regard the European Commission launched a Proposal for a Council Regulation on the establishment of the European Monetary Fund (COM/2017/0827 final, 6 December 2017), which proposes to transform the European Stability Mechanism into EU secondary law (instead of being based on a treaty) and add a backstop function for the SRM. The Eurogroup, however, pronounced its preference for keeping the ESM an intergovernmental body, even though they agreed to add an SRM backstop function to the ESM. See Council, ‘Statement of the Euro Summit, 14 December 2018’ (Press Release EURO 503/18, 14 December 2018). See on the issue of a common backstop also IMF, ‘Towards a Fiscal Union for the Euro Area’, (Staff Discussion Note No 19, September 2013); D Schoenmaker, ‘On the Need for a Fiscal Backstop to the Banking System’ (DSF Policy Paper No 44, July 2014); D Schoenmaker, ‘A Macro Approach to International Bank Resolution (Bruegel Policy Contribution No 20, July 2017); D Gross and D Schoenmaker, ‘European Deposit Insurance and Resolution in the Banking Union (2014) JCMS 536; E Avgouleas and C Goodhart, ‘Critical Reflections on Bank Bail-ins’ (2015) Journal of Financial Regulation 15; T Philippon and A Salord, ‘Bail-ins and Bank Resolution in Europe: a Progress Report’ (Geneva Reports on the World Economy, Special Report No 4 2017) at 49; E Farhi and J Tirole, ‘Deadly Embrace: Sovereign and Financal Balance Sheets Doom Loops’ (2018) The Review of Economic Studies at 1794; A. Bénassy-Quéré et al, ‘Reconciling Risk Sharing with Market Discipline: A Constructive Approach to Euro Area Reform’ (2018) CEPR Policy Insight at 5. 55 Commission Communication (COM(2017)592 final, 11 October 2017) (n 3) at 9. 56 The ratio contribution/total deposits is higher and may be close to the ratio contribution/covered deposits. 57 Some authors have come up with an alternative, a two-tier European deposit (re-)insurance scheme, which would collect premia from all national DGSs and would pay out in case losses at the national level would exceed a certain threshold. See J Pisani-Ferry, A Sapir, N Véron, and G Wolff, ‘What kind of European Banking Union?’ (June 2012) 12 Bruegel Policy contribution at 13; R

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European Deposit Insurance System (EDIS) Third, Directive 2014/49/EC allows a reduced ex ante target level of funding of at least 0.5% of covered deposits for highly concentrated markets where most credit institutions are of a considerable size and degree of interconnection.58 This means that credit institutions in these Member States have to contribute less to their Member State DGS, giving them an advantage over their competitors in other Member States, which is not compensated for by increasing the ex ante target level of funding of the resolution fund in that Member State. This would no longer be the case in a European scheme. Finally, Directive 2014/49/EC contains a number of other exceptions to maximum harmonization. The coverage level and period for temporary high balances and the payout period in case one of the exceptions to the seven days payout period apply, for instance, are left to the Member States to determine.59 A European scheme would need to abolish the remaining differences in national deposit insurance legislation between the different Member States. E. Downsides? Systemic risk. A possible downside of a European system, on the other hand, is that 14.17 it may increase systemic risk. Mismanagement of the fund would indeed have a much bigger impact. A European system should therefore be subject to strict organizational and management rules.60 National DGS closer to the market it serves? Another argument in favour of 14.18 maintaining some competences for national DGSs would be that they are closer to the market they serve. Certain un-or incompletely harmonized elements of the Directive would allow national DGSs to adapt certain standards to the needs of the local market. One of the downsides mentioned with respect to a European system is exactly that it would be very difficult to develop objective numerical criteria for risk-based contributions, which are valid in all Member States, as the business models of small banks vary from country to country and even similar financial instruments may represent different risks in different Member States due to differences in payment habits or in the national legal system.61 The Commission Proposal for EDIS, and even more so the amendments suggested in the draft report of the European Parliament attempt to cater for this issue.

Goyal et al, ‘A Banking Union for the Euro Area’ (Working Paper 13/01, February 2013); IMF Staff Discussion Note (n 152) at 23, n 42; D Gros, ‘Principles of a Two-Tier European Deposit (Re-) Insurance System’ (CEPS Policy Brief, 17 April 2013) at 4–5. 58 So far only France has made use of this exception. See EBA, ‘Deposit Guarantee Schemes data’, available online at , consulted in March 2019. 59 Articles 6(2) and 8(2) of Directive 2014/49/EC. 60 V Colaert (n 10) at 422, no 105. 61 D Schoenmaker and D Gros, ‘European Deposit Insurance and Resolution in Banking Union’ (n 47) at 540.

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Veerle Colaert and Gilian Bens 14.19 Transfer Union. The main argument against EDIS in the ongoing debates,

however, is that the single rulebook and the SSM are insufficiently developed, meaning that today there are big differences in risk level in the banking sectors of different Member States. Member States with a lower risk level in their banking sector do not want to fund, via EDIS, the banking sector of other Member States with higher risk levels. This problem will be further developed in Section III(4) below.

III. Legislative Proposals for EDIS 1. First Ideas 14.20 De Larosière report. The idea of a ‘pan-European DGS’ is older than the first ideas

of a Banking Union in Europe. It was first launched, but rejected, in the so-called ‘De Larosière report’.62

14.21 Commission Report 2010. In 2010 the European Commission nevertheless exam-

ined three possibilities to improve cross-border co-operation among DGSs and overcome fragmentation of the system.63 It considered the creation of a twenty- eighth regime, but dismissed this as ineffective, since it would add complexity without resolving the inconsistencies stemming from the existence of almost forty schemes in the EU. A second option was the creation of a network of existing schemes (‘a European system of DGSs’). The Commission saw this as a structure ‘relatively easy to set up today . . ., which would strengthen depositor confidence if there was a mutual borrowing facility between schemes, making the risk of government intervention less likely’. The last option, a single pan-European DGS, was considered the most cost-efficient, since it would save administrative costs of about €40 million per year. The European Commission therefore considered the last option as an economically effective solution to overcome the fragmentation problem, but the idea was considered a longer-term project since there were still legal issues to be further examined.64 As explained above, the idea of a European deposit guarantee system gained momentum with the development the concept of Banking Union.

62 High Level Group on Financial Supervision in the EU, ‘Report’ (February 2009) at 35 para 136: ‘The idea of a pooled EU fund, composed of the national deposit guarantee funds, has been discussed by the Group, but has not been supported. The setting-up and management of such a fund would raise numerous political and practical problems. Furthermore, one fails to see the added-value that such a fund would have in comparison to national funds operating under well- harmonized rules (notably for coverage levels and the triggering of the scheme).’ 63 European Commission, ‘Report to the European Parliament and tot the Council—Review of Directive 94/19/EC on DGSs’ (12 July 2010) COM(2010)369 final at 4. 64 Ibid, at 4–5.

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European Deposit Insurance System (EDIS) 2. Commission Proposal 2015 DIF and Eurozone DGS to co-operate in EDIS. On 24 November 2015, the 14.22 European Commission issued a proposal to introduce a European Deposit Insurance Scheme.65 Directive 2014/49/EU would, however, not be abolished or amended. Instead, on top of Member States’ DGSs, which would continue to operate on terms of Directive 2014/65/EU, a new European ‘Deposit Insurance Fund’ (‘DIF’) would be created for the Eurozone. Since deposit guarantee and resolution are closely intertwined (see n 13) the Commission proposes to introduce the DIF by amending Single Resolution Mechanism Regulation 806/ 2014. The Eurozone Member States’ DGSs would become members of the DIF and co-operate with it in a ‘European Deposit Insurance Scheme’ (EDIS). In the Commission Proposal, EDIS would be gradually established in three stages, during which the role of the DIF would grow and the role of Eurozone Member State DGSs decrease. Reinsurance phase. In the first stage, the reinsurance phase, the available finan- 14.23 cial means of both the DIF and the national DGSs would increase. In case of a payout event or in case of intervention in resolution proceedings, the Member State DGSs would need to cover the payable amounts, with the DIF playing only a supporting role in case of insufficient funds in the Member State DGS. Co-insurance phase. In the second stage, the co-insurance phase, the available fi- 14.24 nancial means of the DIF would sharply increase whilst the means of the national DGSs would decrease. In case of a payout event or intervention in resolution proceedings, the Member State DGS and the DIF would each cover a percentage of the payable amounts. Over time the percentage covered by the DIF would increase and the percentage covered by the Member States’ DGSs would gradually decrease. Full insurance phase. In the third and final stage, the third pillar of the Banking 14.25 Union would be completed: the Member States DGSs would have no own funds left, but would remain in place as liaison between their affiliated credit institutions and the DIF. The DIF would by that time be fully funded and would fully cover the payable amounts in case of a payout or intervention in resolution proceedings. Single Resolution and Deposit Insurance Board. Even though the DIF would be cre- 14.26 ated as a fund separate from the Single Resolution Fund, they would be governed by the same board. To that end, the competences of the Single Resolution Board would be extended to also include deposit insurance. The name of the Board would change accordingly into ‘Single Resolution and Deposit Insurance Board’

65 European Commission, Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European Deposit Insurance Scheme (COM(2015) 586 final, 24 November 2015) (‘Commission Proposal’).

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Veerle Colaert and Gilian Bens (hereafter the ‘Board’) and also its composition would be changed by adding a representative of each Eurozone Member State’s designated deposit guarantee authority66 (see paragraphs 14.61ff). 3. European Parliament Draft Report 2016 14.27 Draft Report 2016. On 4 November 2016, the European Parliament’s rapporteur

on the Commission Proposal, Ms. Esther De Lange, presented her draft report, suggesting substantial amendments to the Commission Proposal.67 Even though this report has been discussed in the EU Parliament’s Committee for economic and monetary affairs (ECON) in January 2017, and the plenary vote had originally been scheduled for February 2017, the plenary vote has been postponed and the file is on hold ever since.

14.28 Reasons for the proposed amendments. Even though the Commission’s impact

analysis showed that a fully mutualized fund would achieve the best results, other less far-reaching measures would also significantly improve the current situation, but would be politically easier to achieve.68 Therefore, the proposed amendments reduce the third pillar of the Banking Union to more modest proportions.

14.29 Only two stages. In the Parliament Draft Report EDIS would be established in two

stages only, a reinsurance phase and an insurance phase, while the responsibilities of the DIF in each of those phases would be substantially diminished. Its name notwithstanding, even in the insurance phase EDIS would actually remain a mere reinsurance system: the DIF would only take up part of the payout duties if the Member States’ DGS would have insufficient funds to ensure a full payout. In contrast to the Commission Proposal, the insurance period could, moreover, only enter into force after severe conditions are fulfilled, ensuring, among other things, that the robustness of the banking sector has increased in the different Member States.69 4. Further Developments 2016–2019

14.30 Opposition to EDIS. Although the Commission Proposal dates back from November

2015 and the Parliament Draft Report from November 2016, no consensus has been reached on EDIS due to opposition from a number of Member States, led by Germany.70 Those Member States indeed doubt that EDIS would inspire more As meant in art 2(1)(18) of Directive/2014/49/EU. 67 European Parliament, ‘Draft Report on the Proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European Deposit Insurance Scheme’ (2015/0270(COD), 4 November 2016) (‘EP Draft Report’). 68 Explanatory Statement EP Draft Report, 57. 69 Explanatory Statement EP Draft Report, 57. For the conditions see EP Draft Report, Amendment 31. 70 Jim Brunsden, ‘Germany stands firm against EU bank deposit guarantee plan’ Financial Times (London, 11 October 2017). 66

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European Deposit Insurance System (EDIS) confidence than Member State DGSs or that it would increase financial stability.71 The main arguments against the introduction of a European deposit insurance system are the different risk levels of bank sectors in the different Member States. Opposing Member States fear that the introduction of a European deposit insurance system in such circumstances, would create a moral hazard effect: Member States’ incentives would decrease to reduce: (i) the risk level of their bank sector; and (ii) the nexus between the bank sector and their home member state since the risk of DGS payouts in case of bank insolvency would be transferred from Member State to EU level (so-called ‘transfer Union’).72 Therefore the opposing Member States are of the opinion that the risk level of credit institutions and the nexus between sovereigns and credit institutions should be further reduced before further risk-sharing measures, such as a European deposit insurance system, can be introduced.73 Council Ad Hoc Working Party. Within the Council an Ad Hoc Working Party on 14.31 the Strengthening of the Banking Union has been established on 13 January 2016, leading to a Roadmap to Completion of the Banking Union in June 2016.74 The presidency of the Council has regularly published progress reports since.75 The discussions in the Working Party are ongoing and while it is still unclear whether and how EDIS will finally land, one point has been made very clear from the start of the Working Party’s negotiations: agreement on further risk sharing measures,

71 Deutscher Bundestag, ‘Antrag der Fraktionen der CDU/CSU und SPD’, Drucksache 18/ 6548; Deutscher Bundestag, 'Antrag der Fraktionen der CDU/CSU und SPD‘, KOM(2015) 586 endg.; Ratsdok. 14649/15. Recently, however, the German Minister of Finance recognized the need for EDIS and came up with a plan to revitalize the third pillar of the Banking Union (see S. Fleming et al, ‘German Eurozone banking plan wins cautious backing’ Financial Times (London, 6 November 2019). His proposal was, however, met with fierce opposition, from Italy and within Germany. 72 Deutscher Bundestag, ‘Antrag der Fraktionen der CDU/CSU und SPD’, Drucksache 18/6548; D Howarth and L Quaglia, ‘The ‘New Intergovernmentalism in Financial Regulation and European Banking Union’ in C J Bickerton, D Hodson, and U Puetter, The New Intergovernmentalism: States and Supranational Actors in the Post-Maastricht Era (OUP 2015) at 153–54; L Quaglia, ‘The politics of an asymmetric Banking Union’ (EUI Working Paper RSCAS2017/48); L Schuknecht, ‘An Insurance Scheme that only Insures Problems’ (blog), available online at . 73 Deutscher Bundestag, ‘Antrag der Fraktionen der CDU/CSU und SPD’, Drucksache 18/ 6548; J Arnal-Martinez and A Moreno, ‘The Sovereign-Bank Feedback Loop: Did European Policies Alleviate It?’ (Working Paper 2018) available at SSRN, at 2. 74 Council, ‘Conclusions on a roadmap to complete the Banking Union’ (Press Release 353/16, 17 June 2016). 75 Council, ‘Progress Report’ (No 10036/16, 2015/0270 (COD) 14 June 2016). About the establishment of the ad hoc working party, see No 2. Council, ‘Progress Report’ (No 14841/16, 2015/ 0270 (COD) 25 November 2016); Council, ‘Progress Report’ (No 9484/17, 2015/0270 (COD), 2 June 2017); Council, ‘Progress Report’ (No 14808/17, 2015/0270 (COD) 24 November 2017); Council, ‘Progress Report’ (No 9819/18, 2015/0270 (COD), 12 June 2018); Council, Presidency Progress Report (No 144452/18, 2015/0270 (COD) 23 November 2018).

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Veerle Colaert and Gilian Bens such as a European deposit insurance system, would depend on the adoption of a number of risk reduction measures in the banking sector.76 14.32 Commission Communication October 2017. In October 2017 the European

Commission came up with a ‘Communication on completing the Banking Union’,77 in which it made a number of suggestions on EDIS to facilitate a compromise between the European Parliament and the Council. The Commission also explicitly recognized that ‘the Banking Union can only function if risk reduction and risk sharing go hand in hand’.78 It therefore also presented its plans to implement the 2016 Council Roadmap, including important risk reduction measures for credit institutions, actions to address non-performing loans, the completion of a backstop to the Banking Union,79 as well as an additional new measure, not yet mentioned in the 2016 Council Roadmap: an enabling framework for the development of Sovereign Bond-Backed Securities.80,81 The details of how those measures have been implemented in proposals since the October 2017 Commission Communication, are developed elsewhere in this book. For purposes of this chapter, it is important to note that substantial progress has been made in respect of risk reducing measures, with an agreement between the Council and Parliament in December 2018 on the so-called ‘banking package’ and on measures relating to ‘non-performing loans’,82 which have been adopted by Council and Parliament in April and May 2019.83 This creates hope for the future of EDIS. The Eurogroup indeed also decided on 4 December 2018 to establish a high-level working group with a mandate to work on next steps for EDIS, which should report by June 2019.84 76 See Council, ‘Progress Report’ (No 10036/16 (2015/0270(COD) 14 June 2016); Council, ‘Conclusions on a roadmap to complete the Banking Union’ (Press Release 353/16, 17 June 2016). 77 European Commission (COM(2017) 592 final, October 2017) (n 3). 78 Ibid, at 6. 79 See on this issue, n 54. 80 This idea recently resulted in a Proposal from the European Commission for a Regulation of the European Parliament and of the Council on sovereign bond-backed securities (COM(2018) 339 final, 24 May 2018). 81 Some measures aim at risk reduction in general (eg measures to reduce non-performing loans, the creation of a backstop); other measures aim at further reducing the link between credit institutions and their home Member States (eg proposed cap on government bonds of the same Member State and the idea to create Sovereign Bond Backed Securities). See on those measures, among others: European Commission, ‘Reflection Paper on the Deepening of the Economic and Monetary Union 31 May 2017’ (COM(2017) 291, 31 May 2017) at 22; A Bénassy-Quéré et al, ‘Reconciling Risk Sharing with Market Discipline: A Constructive Approach to Euro Area Reform’ (CEPR Policy Insight n° 91, January 2018) at 7. 82 Council, ‘Banking Union: Council endorses package of measures to reduce risk’ (Press Release 713/18, 4 December 2018); Council, ‘Non-performing loans: political agreement reached on capital requirements for banks' bad loans’ (Press Release 815/18, 18 December 2018). 83 Council, ‘Banking Union: Council adopts measures to reduce risk in the banking system’ (Press Release, 14 May 2018); Council, ‘Council adopts reform of capital requirements for banks' non-performing loans’ (Press Release 9 April 2019). 84 Council, ‘Eurogroup report to Leaders on EMU deepening’ (Press Release 738/ 18, 4 December 2018).

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European Deposit Insurance System (EDIS)

IV. Main Features of the EDIS Proposals 1. Introduction Coverage level and payout period governed by Directive 2014/49/EU. As explained 14.33 above, the Commission Proposal does not abolish DGS Directive 2014/49/ EU, which remains the basis on which national DGSs are harmonized. The Commission Proposal instead modifies the SRM Regulation ((EU) 806/2014), creating a new DIF on top of the existing Eurozone Member States DGSs. This means that important aspects of the current regulation of deposit guarantee systems in the EU remain untouched: the coverage level remains at €100,000 per depositor and the payout period remains the same (gradually reaching seven working days in 2024, with certain exceptions). In this contribution, we will not deal with those aspects, which have been dealt with in depth in other contributions.85 It should be noted, though, that the Commission has indicated that further harmonization of important remaining differences in Member States’ DGS in parallel with the establishment of EDIS is necessary to ensure a smooth functioning EDIS.86 Proposed changes. In the next sections we will first discuss the scope of ap- 14.34 plication of EDIS and then focus on those features that are changed by the Commission Proposal. For two of those features there are substantial differences in approach between the Commission Proposal and the Parliament Draft Report: (i) the funding of EDIS—even though the funding of national DGSs remains governed by the unchanged DGS Directive 2014/49/EU; and (ii) the interaction between the DIF and the Eurozone DGSs in case of a payout event or in case the deposit insurance scheme is requested to assist in a resolution procedure. For both features, we will compare the Commission Proposals and the amendments proposed in the Parliament Draft Report.87 Finally we will also discuss the governance structure created for EDIS, the Single Resolution and Deposit Insurance Board.

Among others: V Colaert (n 10); and J Payne (n 31). 86 For instance in relation to the conditions for declaring deposits unavailable, the eligibility of deposits and the funding of DGSs. See Commission Communication (COM(2015) 587 final) (n 6) at 9; Commission Communication (COM(2017)592 final, 11 October 2017) (n 3) at 12. However, the Commission has not yet made a proposal to change Directive 2014/49/EU. 87 The Council Presidency Progress Reports are very high level and, at this stage, highlight the differences between Member States delegations, rather than presenting agreed positions. The October 2017 Commission Communication also merely formulates a number of high level suggestions on the way forward. Therefore the discussion of EDIS below, will be based on the Commission Proposal and the EP Draft Report only, while we will mention the Working Party’s discussions and the suggestions in the Commission’s October 2017 Communication where relevant. 85

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Veerle Colaert and Gilian Bens 2. Scope of EDIS 14.35 DGSs and affiliated credit institutions. EDIS would apply to deposit guarantee

schemes as defined in Directive 2014/49/EU88 of participating Member States (ie Eurozone Member States) and the credit institutions affiliated to those schemes.89

14.36 Third country branches and credit unions. A number of Member States DGSs

currently also cover financial institutions which are not subject to the other pillars of the Banking Union. Credit Unions are currently covered by DGSs in Ireland and Lithuania,90 even though credit unions do not need to comply with the capital requirements for credit institutions.91 In respect of third country branches Directive 2014/49/EU requires that Member States should check whether such branches enjoy protection equivalent to the protection offered by DGS Directive 2014/49/EU.92 If not, the relevant Member State can oblige the branch to join a DGS in operation within its territory.93 In ninety-one of ninety-seven cases the relevant Member State deemed the third country branch’s home DGS non-equivalent and decided that those branches should join a DGS within its territory.94 Such third-country branches are, however, not subject to the SRM.95 If EDIS would include such extensions of the scope of application of Member States’ DGS, this would mean that certain entities would enjoy EDIS-coverage without being subject to the Single Rulebook or the SRM. This has led to some discussion in the Council’s Ad Hoc Working Party.96 In light of regulatory consistency and equal treatment certain delegations argue that third country branches and credit unions should be excluded from EDIS.97 The Commission’s Effect Analysis has, however, shown that in view of the limited amount of deposits in those entities, the impact of including them in EDIS would at present be small.98

88 Including statutory DGSs, officially recognized contractual DGSs and institutional protection schemes that are officially recognized as DGS (see art 1(2) of Directive 2014/49/EU). 89 See art 2(2) of Commission Proposal. Credit institutions are defined as: ‘an undertaking the business of which is to take deposits or other repayable funds from the public and to grant credits for its own account’ (art 2(9) of Directive 2014/49/EU; art 4 (1)(1) of Regulation (EU) 575/2013). 90 See the websites of the Irish and Lithuanian DGSs at ; and . 91 Council, ‘Progress Report’ (No 10036/16, 2015/0270 (COD), 14 June 2016) at 32. See art 2(5), (8), and (14) of Directive 2013/36/EU. 92 Article 15(1) of Directive 2014/49/EU. 93 Article 15(1) of Directive 2014/49/EU. 94 Council, ‘Progress Report’ (No 14841/16, 2015/0270 (COD) 25 November 2016) at 22. 95 Recital 28 of Council Regulation (EU) 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions. 96 Council, ‘Progress Report’ (No 14841/16, 2015/0270 (COD) 25 November 2016) at 5; Council, ‘Progress Report’ (No 9484/17, 2015/0270 (COD), 2 June 2017) at 17. 97 Council, ‘Progress Report’ (No 14841/16, 2015/0270 (COD) 25 November 2016) at 5. 98 Council, ‘Progress Report’ (No 9484/17, 2015/0270 (COD), 2 June 2017) at 17.

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European Deposit Insurance System (EDIS) 3. Funding of EDIS Four funding mechanisms. Directive 2014/49/EU provides for a four step fi- 14.37 nancing mechanism for Member States’ DGSs. First a minimum ex ante level of funding should be reached by yearly contributions of credit institutions which participate in the DGS. Second, if this does not suffice to fulfil a particular payout need, credit institutions are required to pay ex post contributions. The third line of defence against taxpayers’ involvement are ‘alternative funding arrangements’ (reinsurance mechanisms or credit lines from government). Finally, DGSs can also engage in voluntary mutual borrowing arrangements with other DGSs.99 The Commission Proposal does not alter this four step mechanism in principle, but it clarifies how those means of funding should be allocated between Eurozone Member States’ DGSs and the DIF. A. Ex Ante Funding i. Allocation of Funding Overview. Directive 2014/49/EU requires that the available financial means of 14.38 a DGS are at least 0.8% of the amount of the covered deposits of its members, to be gradually built up by 3 July 2024.100 The Commission Proposal requires that this amount would gradually over time be fully attributed to the DIF. The European Parliament Draft Report proposes two major amendments: gradually only half of the ex ante funding would be allocated to the DIF, keeping a larger role for the Eurozone Member States’ DGSs, and within the DIF two subfunds would need to be created. The details of the Commission Proposal and the Parliament Draft Report are set out below. Commission Proposal. In the Commission Proposal the first phase—the reinsur- 14.39 ance phase—coincides with the build-up period towards the target level of 0,8% provided by Directive 2014/49/EU. The Commission Proposal provides that the funding of Eurozone DGSs would need to gradually increase during the reinsurance period from 0.14% of the covered deposits in the first year (which was supposed to be 2017), to 0.21% in the second year (2018) and 0.28% in the third year (2019) of the reinsurance phase.101 During that period also the DIF’s funds would start to build up. By the end of the reinsurance period, the DIF’s available

99 Articles 10(2), (8), and (9) and 12(1) of Directive 2014/49/EU. 100 Article 10(2) of Directive 2014/49/EC. Article 10(6) provides for an exception to that target for highly concentrated markets, which, after approval by the Commission, can allow their DGS a lower target level of at least 0.5%. Since EDIS requires Eurozone DGSs to gradually cede funds to the DIF and in view of the equal treatment of all Eurozone DGS, the Commission Proposal implies that the possibility of a reduced target level, which was already heavily criticized (see V Colaert (n 10) at 4034, paragraphs 58–60), would no longer be available if the DGS wants to benefit from EDIS (see Recital 22 of the Commission Proposal). 101 Article 41(j). Obviously the initial time path is now impossible due to the long-lasting political deadlock over this proposal.

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Veerle Colaert and Gilian Bens financial means should have reached an initial target level of about 0.0711%102 of the sum of the covered deposits of the participating DGSs. During the co-insurance period the required available financial means of the Eurozone DGSs would decrease and eventually become 0 at the start of the full insurance period, while the DIF’s available financial means would gradually further increase up to 0.8% of the amount of the covered deposits of the Eurozone DGSs’ members-credit institutions at the start of the full insurance period (See Figure 2).103 14.40 Parliament Draft Report. The European Parliament Draft Report proposes im-

portant amendments to the Commission Proposal. First it proposes to keep a much more important role for Member States’ DGSs. The required available financial means of each Eurozone DGS would continue to build up until 2024, when it would reach 0.4% of the total amount of covered deposits of the credit institutions affiliated to that DGS.104 This means that only half of the target level of 0.8% would by that time be allocated to the DIF. Second, the Draft Report proposes to create two subfunds in the DIF: an individual risk-based subfund for each participating DGS and a joint risk-based subfund.105 Every DGS would need to fund its own individual risk-based subfund, whilst the joint risk-based subfund would be funded by all participating DGSs.106 Both the individual and the joint subfund would start with a funding level of 0.025% of the covered deposits each in the first year of the reinsurance period. This level of funding would gradually increase, so that by the end of the co-insurance phase (2024) the individual risk-based subfund of each DGS would reach 0.2% of the covered deposits of that DGS, while the joint risk-based subfund would also reach 0,2%, calculated on the basis of the aggregated covered deposits of all participating DGSs (See Figures 1 and 2).107 102 Ie ‘20% of 4/9 of the sum of the target level of 0,8% of the amount of the covered deposits of its members’ (art 74b(1) of the Commission Proposal). In the Commission Proposal all financial means of EDIS would be transposed to the DIF over a period of eight years. The reinsurance period takes three years, and on the basis of Directive 2014/49/EU already for one year contributions have been collected, explaining the 4/9. The ‘20%’ in the calculation is explained by the fact that during the reinsurance period the DIF would only be responsible to reinsure a maximum of 20% of the liquidity needs or excess loss of a Member State DGS. 103 Articles 41j(1) and 74b(2) of the Commission Proposal. 104 EP Draft Report, Amendment 38. 105 Both the individual and the joint subfunds would be risk- based, meaning that credit institutions which are exposed to higher risks, would need to pay higher contributions. As regards the individual risk-based subfund, participating DGSs would be allowed to collect the required amount of risk-based contributions from affiliated credit institutions using their own methodology. As regards the joint risk-based subfund, the Board would determine the required total amount of risk-based contributions to be raised by the participating DGSs, using an additional risk-based methodology to determine the share to be paid by each participating DGS in accordance (EP Draft Report, Amendment 68). 106 EP Draft Report, Amendment 57. 107 EP Draft Report, Amendment 62.

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European Deposit Insurance System (EDIS) 0,90% 0,80% 0,70% 0,60% 0,50% 0,40% 0,30% 0,20% 0,10% 0,00%

2017

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Figure 1 European Parliament Draft Report: Required available financial means of DGSs and the DIF ii. Calculation, Invoicing, and Collection of Contributions Overview. Under Directive 2014/49/EU each Member State has to develop its 14.41 own calculation method to determine the contributions of individual credit institutions. Such calculation method should be based on the amount of covered deposits and the degree of risk incurred by the credit institutions.108 Obviously each DGS needs to invoice and collect those contributions from their participating credit institutions. In the EDIS proposal, this remains the starting point. Over time, when more funding and pay-out responsibilities are proposed to be shifted to the DIF, also part of the calculation, invoicing and collection responsibilities are proposed to be shifted to the Board. Commission Proposal. In the Commission Proposal the calculation method would 14.42 no longer be a national competence, but be determined by a Commission delegated act.109 In the reinsurance phase contributions to EDIS would be calculated in two stages. First the Board110 would determine the total amount of ex ante contributions that each DGS may claim from its affiliated credit institutions.111 In a second stage, the DGS would calculate the exact individual contribution of each of its participating credit institutions,112 based on the amount of covered deposits and the degree of risk incurred by each credit institution relative to all other credit institutions affiliated to the same DGS.113 In the co-insurance period

108 Article 13 of Directive 2014/49/EU. EBA provides for further guidance on those calculation methods. See EBA, Guidelines on Methods for Calculating Contributions to Deposit Guarantee Schemes (EBA/GL/2015/10, 22 September 2015). 109 Article 74c(5) of the Commission Proposal. 110 After consultation of the ECB and the national competent authority and in close co-operation with the Member State DGSs. (art 74c(1) of the Commission Proposal). 111 Article 74c(1) of the Commission Proposal. 112 Article 74c(2) of the Commission Proposal. 113 Article 74c(5) of the Commission Proposal.

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Veerle Colaert and Gilian Bens this two-stage-process would be maintained, but the Board would also calculate individual credit institutions’ contributions to the DIF, based on the amount of covered deposits and the degree of risk incurred by each credit institution relative to all other credit institutions affiliated to participating DGSs.114 In the full insurance period, finally, no contributions would be due any more to the Member States’ DGSs and credit institutions would only still have to make contributions to the DIF (unless the Member State has set a higher target level than the minimum target level). From that moment on the two-stage-process would be abandoned and the Board would calculate directly the contribution of each individual credit institutions to the DIF.115 In all stages of EDIS, invoicing of contributions would remain the responsibility of the Member States’ DGSs’. Credit institutions would, nevertheless, need to pay their contributions to the DIF directly to the Board.116 14.43 Parliament Draft Report. The European Parliament Draft Report proposes a dif-

ferent approach. Credit institutions would not need to contribute directly to the DIF. Instead, they would make contributions to Member States’ DGSs up to the target level determined in accordance with the Directive, and DGSs would use part of those contributions to fund the two subfunds of the DIF.117 Contributions would be invoiced and collected from credit institutions by the Member States DGSs.118 In order to calculate the contributions of Member States’ DGSs to the DIF, the Parliament Draft Report proposes a calculation method in two stages. In a first stage the Board would calculate the contributions due by each participating DGS to each of the subfunds and would invoice these contributions to the DGSs.119 The share to be paid by each DGS in the joint risk-based subfund, would be based on a risk-based method to be established by the Commission.120 In a second stage Article 74c(2) of the Commission Proposal. 115 Article 74c(1), (2), and (5) Commission Proposal. 116 Articles 74a (1), last para and 74c(2) of the Commission Proposal. 117 EP Draft Report, Amendment 55. 118 EP Draft Report, Amendment 11. 119 EP Draft Report, Amendment 55. 120 EP Draft Report, Amendments 68(2), third para and 70. The calculation of these contributions would depend on the amount of covered deposits and the degree of risk incurred by each participating DGS relative to all other participating DGSs (Amendment 71). The Board would put all DGSs in one of the seven aggregate risk weighing (ARW) categories. These categories would reflect the degree of risk the DGS represents for the DIF, starting from 50% ARW of risk-based contributions, and adding 25% per category up to 200%. If a DGS would be put in the 50% ARW category, this would mean that it would need to pay four times less than if it would be placed in the 200% ARW category. Every category would need to contain at least one participating DGS (Amendment 73). The Report sets the interval at 50%–200%. However, the Board could broaden that range if this interval would insufficiently reflect the differences in business models and risk profiles of participating DGSs and would therefore treat DGSs with a very different risk profile equally (Amendment 74). Interestingly, next to a number of typical risk weighing criteria (Amendments 77–82 and 84), the methodology should also take into account the potential for a 114

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European Deposit Insurance System (EDIS) the DGS would calculate and invoice the risk-based contributions due by each of their affiliated credit institutions.121 For the individual risk-based subfunds the participating DGSs could use their own methodology to calculate the individual contributions of their affiliated credit institutions.122 B. Other Means of Funding Overview. As indicated in paragraph 14.37, DGS Directive 2014/ 49/ EU 14.44 provides three other means of funding of Member States DGSs other than ex ante funding: ex post funding, alternative means of funding and voluntary mutual borrowing arrangement. The Commission Proposal extends these other means of funding to the DIF, while the European Parliament Draft Report proposes to delete the DIF’s capacity to raise ex post contributions.123 Commission Proposal. In the reinsurance phase the Board would not be able to 14.45 raise ex post contributions from credit institutions for the benefit of the DIF. Only Member States’ DGSs could do so. As from the co-insurance phase the Board would receive the competence to raise ex post contributions when the available financial means of the DIF would be insufficient to cover the losses, costs or other expenses incurred following a pay-out event.124 The Board would calculate the required contribution of each credit institution affiliated to each participating DGS using a risk-based method adopted in a delegated act by the Commission.125 Another option for the DIF would be to establish alternative means of funding. These could only be used to meet payment obligations in the event the ex ante as well as the ex post contributions are insufficient or are not immediately accessible.126 Moreover, there would be a possibility for the DIF to voluntarily lend to and borrow from non-participating DGSs (of non-Eurozone Member States). The DIF could only make such a request when the ex ante contributions are insufficient, the ex post contributions are not immediately accessible and the alternative funding means are not immediately accessible on reasonable terms.127

participating DGS to achieve a full and timely recovery from insolvency procedures (Amendment 83). The amendment thus takes into account the difference in efficiency of national insolvency proceedings (on the latter problem, see n 143). 121 EP Draft Report, Amendment 68. It should be noted the Draft Report proposes to allow up to 30% of the contributions from participating DGSs to the DIF to consist of irrevocable payment commitments. This option was introduced to ensure budget neutrality, since Directive 2014/49/EU provides for a similar regime (see art 10(3) of Directive 2014/49/EU; EP Draft Report Amendment 68, last para; and the Explanatory Statement to EP Draft Report at 59). 122 EP Draft Report, Amendment 68. Since this amendment explicitly only relates to the individual subfund, one could assume that an EU harmonized method would need to used to calculate the contributions to the joint subfund. 123 EP Draft Report, Amendment 85. 124 Article 74d(1) of the Commission Proposal. 125 Article 74d(2) of the Commission Proposal. 126 Article 74g(1) of the Commission Proposal. 127 Article 74f(1) of the Commission Proposal.

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Veerle Colaert and Gilian Bens 14.46 Parliament Draft Report. The Parliament Draft Report proposes to delete the pos-

sibility for the DIF to raise extraordinary ex post contributions128 and the limitation on the use of alternative funding.129 The Draft Report instead proposes that whenever the Board decides to make a disbursement from the DIF to a participating DGS, the Board would have to raise temporary funding by alternative means, for instance from capital markets, in order for the DIF to maintain at all times its target level and lending capacity.130 4. Payout

14.47 Overview. Both the Commission Proposal and the Parliament Draft Report make

a distinction between the situation where a Member State DGS faces a temporary liquidity problem on the one hand, and the situation where a Member State DGS faces a longer term solvency problem on the other hand. Whereas the Commission proposes that only the DIF would over time be responsible for payouts, in the Parliament Draft Report, the DIF would never be anything else than a re-insurer (despite the name of the second phase being co-insurance period).

A. Liquidity 14.48 Overview. Directive 2014/49/EU provides that the funds of Member States’ DGS should be primarily used to repay depositors within seven working days after their covered deposits have become unavailable, but that those funds can, on certain conditions, also be used to finance the resolution of credit institutions.131 In the Commission Proposal the DIF would play an increasingly large role in both situations. In the first stage, the re-insurance period, the DIF would only provide limited funding when the relevant DGS’s required available financial means are insufficient. In the co-insurance period the DIF would provide part of the funding in any event, even if the financial means of the relevant DGS would suffice. In the full insurance period, finally, the DIF would provide 100% of the funding. In the Parliament Draft Report the DIF would at any time only play a reinsurance role and thus only intervene when the required available means of the relevant DGS are insufficient, even though the DIF’s reinsurance capacity would increase over time. i. Commission Proposal 14.49 Reinsurance period—’Liquidity shortfall’. As from the first phase of EDIS, the re-

insurance phase, the DIF would provide funding in case of liquidity problems of

128 EP Draft Report, Amendment 85. 129 EP Draft Report, Amendment 88. 130 EP Draft Report, Amendment 89. Such alternative funding would cover the period between the provision of liquidity shortfall to a DGS and the repayment of those funds by the DGS. The borrowing cost of the alternative funding should be borne by that DGS. 131 Article 11(1)–(2) of Directive 2014/49/EU.

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European Deposit Insurance System (EDIS) the DGS. This could, however, create a moral hazard problem: Member States’ DGSs may become less diligent in building up the required target level of funding knowing that the DIF will fund shortages. The Proposal therefore provides for two measures.132 First, the DIF would not intervene on the basis of actual needs, but on the basis of what has been labelled the ‘liquidity shortfall’. In a payout event the liquidity shortfall equals the total amount of covered deposits held by the failing credit institution minus the amount of available financial means the participating DGS should have had at the time of the payout event if it had raised its ex ante contributions correctly and the amount of extraordinary ex post contributions the participating DGS can raise within three days from the payout event. In the same vain, in the event of DGS intervention in resolution proceedings the liquidity shortfall equals the amount determined by the resolution authority minus the amount of available financial means the participating DGS should have at the time of the determination if it had raised its ex ante contributions correctly.133 The DIF would thus only provide coverage when the assumed financial means of the DGS are insufficient, incentivizing Member States’ DGSs to fully comply with the target levels of funding and reducing moral hazard. A second measure to reduce moral hazard is that funding by the DIF in case of a liquidity shortfall would be limited to only 20% of the DGS’s liquidity shortfall.134 The DIF’s intervention in resolution proceedings would in the reinsurance period moreover be limited to EU resolution proceedings conducted by the Board; the DIF would in this phase not intervene in purely national resolution proceedings.135 Co-insurance and full insurance period—‘Liquidity need’. In the co-insurance pe- 14.50 riod, the DIF would become a co-insurer: it will in any event provide part of the funds required, meaning that it will intervene whenever there is a ‘liquidity need’. In a payout event the liquidity need equals the total amount of covered deposits that the failing credit institution holds at the time of the payout event.136 In case of DGS intervention in resolution proceedings the liquidity need equals the amount determined by the resolution authority.137 The amount of support provided by the DIF would increase over the co-insurance period: whereas in the first year the DIF would only fund 20% of the liquidity need, this would increase to 80% of the liquidity need in the fourth year of the co-insurance period.138 In the full insurance period the DIF should provide funding for 100% of the liquidity

132 Explanatory Memorandum to the Commission Proposal, 5.2.1.1; G Wolff, ‘Getting Eurozone deposit insurance right promises benefits’ (Bruegel Opinion 01, 5 January 2016). 133 Article 41b(1) of the Commission Proposal. 134 Article 41a(2) of the Commission Proposal. 135 Explanatory Memorandum to the Commission Proposal, 5.2.1. 136 Article 41f(1) of the Commission Proposal. 137 Article 41f(2) of the Commission Proposal. 138 Article 41e of the Commission Proposal.

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Figure 2 Funding and Payout under EDIS –Comparison of Commission Proposal and EP Draft Report need,139 corresponding with the fact that Member States’ DGS would by that time in principle have no own funds left140 (See Figure 2). ii. Parliament Draft Report 14.51 Only ‘liquidity shortfall’. The European Parliament Draft Report proposes to

amend the definition of liquidity shortfall and to delete the notion of ‘liquidity need’. The intervention of the DIF, both in the reinsurance period and in the insurance period would be based on the notion of liquidity shortfall, meaning that Article 41h(1) of the Commission Proposal. 140 Except if national rules would require a higher target level of funding than 0.8% of the covered deposits. 139

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European Deposit Insurance System (EDIS) the DIF would only intervene if a Member State’s DGS has insufficient funding to ensure payout. The definition of liquidity shortfall would be amended by deleting any reference to ex post contributions which can be raised within three days in case of a payout event.141 The share of funding by the DIF during the reinsurance period would be 20% of the liquidity shortfall in the first year and would increase every year with 20%. From the fifth year onwards, the DIF would cover 100% of the liquidity shortfall.142 In the insurance period—in which the DIF would really only continue to ensure reinsurance—the coverage would remain at 100% (See Figure 2; see paragraph 14.56 in respect of the hierarchy of coverage by the Member State’s DGS and the different subfunds of the DIF).143 B. Who Bears Loss in the Long-term? Introduction. While the previous section focused on the funding of immediate 14.52 liquidity needs, this section focuses on who will bear losses in the longer term. In the Commission Proposal the DIF would, in the reinsurance period, only bear losses when the financial means of the relevant DGS remain insufficient in the long run, while in the co-insurance and full insurance periods, the DIF would share a part of the loss from the first euro. The Parliament Draft Report proposes to amend the Proposal so that the DIF would not bear any loss in the reinsurance period, whereas it would bear part of the loss in the insurance period. i. Commission Proposal Reinsurance Period—’Excess loss’. In the reinsurance period the DIF would only 14.53 cover a share of the ‘excess loss’ of the DGS. In case of a payout event, the proposal defines excess loss as the total amount the DGS has repaid to depositors in accordance with Article 8 of Directive 2014/49/EU minus: (i) the required ex ante financial means it should have had at the time of the payout event; (ii) the ex post contributions the participating DGS can raise within one calendar year; and (iii) the amount the participating DGS has recovered from subrogating into the rights of depositors in winding up or reorganization proceedings of the failing credit institution.144 In case of intervention of a DGS in a EP Draft Report, Amendment 27. 142 EP Draft Report, Amendment 24. 143 EP Draft Report, Amendment 34. 144 Article 41c(1) of the Commission Proposal. Differences in efficiency of national insolvency proceedings are, however, also an important impediment to the adoption of EDIS. Member States with an efficient national insolvency procedure will allow a fast recovery of funds by the DGS at low cost, speeding up the refunding of the DGS, and making it less dependent on funding by the DIF. Inefficient, slow and/or costly insolvency proceedings on the other hand would lead to higher funding needs from the DIF. Such discrepancies put an additional strain on the idea of a fully fledged EU-funded Deposit Guarantee System. Harmonized insolvency proceedings would further facilitate the idea of an EDIS funded at EU level. On 19 December 2018, the Council and Parliament reached an agreement on the Proposal (COM/2016/0723 final) from the European Commission on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures and amending Directive 2012/30/EU. (See Council, ‘EU agrees new rules on business insolvency ‘(Press Release 820/18, 18 December 2018). 141

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Veerle Colaert and Gilian Bens resolution proceeding, the excess loss equals the amount determined by the resolution authorities minus: (i) the required available financial means the participating DGS should have had at the time of determination; and (ii) the amount of any difference the participating DGS was paid because it incurred greater losses than it would have incurred in a winding up under normal insolvency proceedings.145 In the reinsurance period the DIF would only cover 20% of the excess loss of the participating DGS.146 Again, the concepts of ‘excess loss’ and the merely partial coverage of such excess loss by the DIF in this phase should reduce moral hazard (see paragraph 14.49). 14.54 Co-insurance and full insurance period—‘Loss’. In the co-insurance and full insurance

periods the DIF would cover (part of ) the ‘loss’ as from the first euro.147 In case of a payout event, ‘loss’ equals the total amount a participating DGS has repaid to depositors in accordance with Directive 2014/49/EU minus the amount the participating DGS recovered from subrogating to the depositors’ rights in winding up or reorganization proceedings.148 In the event of intervention in resolution proceedings, ‘loss’ equals the amount determined by the resolution authority minus the amount of any difference the participating DGS has received because it had incurred greater losses than it would have incurred in a winding up under normal insolvency proceedings instead of the resolution proceedings of Directive 2014/ 59/EU.149 In the co-insurance period the DIF would cover 20% of the loss in the first year, which would increase with 20% every year.150 In the fourth year of the co-insurance period the DIF would cover 80% of the loss, and in the full insurance period the DIF would ensure complete loss coverage (See Figure 2).151

ii. Parliament Draft Report 14.55 Insurance period—‘Excess Loss’. The Parliament Draft Report proposes to amend the Commission Proposal to ensure that the DIF would not cover any excess losses in the reinsurance period and to delete the concept of ‘loss’ in the other periods. Only in the insurance period part of the excess loss would be covered by the DIF, but the DIF would never become a co-insurer covering part of the loss even if the Member State DGS has sufficient funds. In the definition of excess loss the amount of ex post contributions would be removed from the calculation method.152 Moreover, the Parliament Draft Report proposes that the DIF would only intervene in case of payout events and not in case of resolution

Article 41c(2) of the Commission Proposal. 146 Article 41a(3) of the Commission Proposal. 147 Explanatory Memorandum to the Commission Proposal, 5.2.2. 148 Article 41g(1) of the Commission Proposal. Hence the importance of well-functioning insolvency proceedings in all participating Member States (on this issue, see n 143). 149 Article 41g(2) of the Commission Proposal. 150 Article 41e of the Commission Proposal. 151 Articles 41e and 41h(3) of the Commission Proposal. 152 EP Draft Report, Amendments 35 and 37. 145

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European Deposit Insurance System (EDIS) proceedings.153 In the first year of the insurance period the coverage of excess loss would be 20%, increasing every year with 20% until it reaches 100% in the fifth year of the insurance period (See Figure 2).154 Hierarchy. The Parliament Draft Report proposes a hierarchy of how a payout 14.56 would be financed in the event of a liquidity shortfall (reinsurance and insurance period) or an excess loss (insurance period) of the DGS. The relevant DGS would first need to exhaust its own national funds. Second, the individual risk-based subfund of the DGS at the DIF would be used. When that subfund is exhausted, the joint risk-based subfund would be addressed. In last instance and after all the previous (sub)funds are exhausted, the individual risk-based subfunds of all other participating DGSs (in proportion to the level of covered deposits of the participating DGSs) would need to intervene.155 iii. Further Developments Commission Communication October 2017. In its October 2017 Communication 14.57 the Commission moved much closer to the Parliament Draft Report, suggesting that the European Parliament and the Council could consider a more gradual introduction of EDIS, commensurate to progress achieved with regard to risk reduction (see paragraphs 14.30–14.32), starting with a more limited re-insurance phase and moving gradually to coinsurance. In the first phase, the re-insurance phase, EDIS would only cover an increasing amount of liquidity shortfall, but no (excess) loss. The transition to the co-insurance phase would no longer happen automatically, but would be subject to a risk and moral hazard reducing measures.156 C. Repayment Overview. Under Directive 2014/49/EU a few provisions deal with the replenish- 14.58 ment of the national DGS after a payout. First, the ex ante contributions must be set at a level allowing the target level to be reached again within six years.157 Second, if the DGS has made use of the voluntary borrowing option, loans from other DGSs must be repaid within five years158 and the contributions levied by the borrowing DGS should be sufficient to reimburse the amount borrowed and to reach the required target level again as soon as possible.159 Whilst the Directive EP Draft Report, Amendment 37. 154 EP Draft Report, Amendment 36. 155 EP Draft Report, Amendment 58. 156 European Commission (COM(2017) 592 final, 11 October 2017) (n 3) at 9–11. In the Council Ad Hoc Working Party several options have been discussed on how to provide liquidity support, including reinsurance by EDIS along the lines of the Commission Communication of October 2017, mandatory lending, and a ‘hybrid model’ combining reinsurance and mandatory lending (see Council, ‘Progress Report’ (No 14452/18, 23 November 2018) at 4, para 6-16). 157 Article 10(2) of Directive 2014/49/EU. This time limit only applies from the moment the target level has been reached for the first time and the available financial means of the DGS have decreased below two-thirds of this level. 158 Article 12(2)(a) of Directive 2014/49/EU. 159 Article 12(3) of Directive 2014/49/EU. 153

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Veerle Colaert and Gilian Bens only deals with the repayment plans in the relationships credit institution-DGS and DGS-DGS, EDIS would introduce another level: repayments to be made to the DIF. The Commission Proposal does not impose strict criteria in this respect, but does introduce a number of measures to encourage diligent behaviour of DGSs during insolvency procedures, since this would facilitate swift repayment to the DIF. The Parliament Draft Report on the other hand proposes stricter rules with minimum thresholds in repayment plans. 14.59 Commission Proposal. DGSs would need to repay the funding provided by the

Board minus the amount of (excess) loss cover. Every year the Board would determine the amount the participating DGS has recovered from the insolvency procedure; the DGS would pay to the Board a share of those amounts corresponding to the share of DIF-coverage.160 In case of a payout event the Board would monitor the insolvency procedure of the failed credit institution, focussing primarily on the efforts of the participating DGS to collect its claims resulting from subrogation in the rights of the depositors paid out by the DGS.161 The DGS should attempt to maximize its proceeds from the insolvency estate and would be liable towards the Board for amounts not recovered due to lack of diligence. In certain circumstances the Board itself could even exercise these subrogation rights.162 Still, discrepancies in the efficiency of national insolvency proceedings put an additional strain on the idea of a fully fledged EU-funded Deposit Guarantee System.163 In the reinsurance period the DGS would moreover need to pay to the Board by the end of the first calendar year after funding was provided the difference between the ex post contributions it can raise within one calendar year and the amount of ex post contributions it can raise within three days from the payout event.164

14.60 Parliament Draft Report. The Parliament Draft Report proposes to base the re-

payment plan to the largest extent possible on the expected recoveries from the insolvency or resolution procedures of the credit institution.165 Each year the level of expected recoveries would be reassessed and the repayment plan would be recalibrated in order to ensure its continuing accuracy. Again, much will depend not only on the diligence of national DGSs in pursuing their rights, but also on the efficiency of national insolvency proceedings. The plan would need to provide that the minimum annual repayment by the DGS is 10% of the funding provided by the Board.166 It would also need to contain the refunding path for the DGS to return to its minimum target level, with a minimum yearly refunding Article 41o(2) of the Commission Proposal. 161 Article 41q(1) of the Commission Proposal. 162 Article 41q(2) of the Commission Proposal. 163 See n 143. 164 Article 41o(3) of the Commission Proposal. 165 EP Draft Report, Amendment 46. 166 EP Draft Report, Amendment 47. 160

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European Deposit Insurance System (EDIS) of 0,05% of covered deposits (or the amount remaining until the target level has been reached). In the event of insufficient funds, repayment to the DIF would take priority over refunding the DGS.167 In terms of hierarchy of repayments to the DIF, alternative funding168 would need to be repaid first. After that, the funds repaid to the DIF would be allocated to the different subfunds in reverse order of financing of a liquidity shortfall (see n 56).169 5. Single Resolution and Deposit Insurance Board Overview. As mentioned in n 14, the current asymmetry in the three pillars of the 14.61 Banking Union, with an EU body competent for the first two pillars and a lack of EU co-ordination in the third pillar, is inefficient. The Commission Proposal would therefore transfer the competences relating to EDIS to a European body, the Single Resolution and Deposit Insurance Board. The Parliament Draft Report does not propose any amendments in this regard. Composition. The Board of the SRM is currently composed of the Chair, four- 14.62 full time members, and a member appointed by each participating Member State, representing their national resolution authorities.170 As mentioned above (paragraphs 14.61 and following), the Commission proposes to bring EDIS under the auspices of the Board, which would be renamed Single Resolution and Deposit Insurance Board. Therefore, a member appointed by each participating Member State, representing their designated DGS authority171 would be added to the Board.172 Different sessions. The Single Resolution and Deposit Insurance Board would have 14.63 different sessions corresponding with its different tasks. At joint plenary sessions the Board, composed of all members, would adopt the annual work programme for the following year, decide on its investments and adopt an anti-fraud strategy, among other tasks.173 At the plenary sessions relating to the SRM the Board would have the same composition as the current Single Resolution Board174 and would take critical decisions on the SRM, such as whether to use the Single Resolution Fund or to raise extraordinary ex post contributions for the Single Resolution EP Draft Report, Amendment 51. 168 As mentioned in n 46 the EP Draft Report does not limit the use of alternative means of funding. The priority in repayment only applies to the alternative means contracted for the purpose of providing funding to that particular DGS for an insolvency or resolution case. 169 EP Draft Report, Amendment 86. 170 Article 43(1) of Directive 2014/59/EU. 171 A body which administers a DGS pursuant to Directive 2014/49/EU, or, where the operation of the DGS is administered by a private entity, a public authority designated by the Member State concerned for supervising that scheme pursuant to Directive 2014/49/EU. See art 2(1) of Directive 2014/49/EU. 172 Article 43a of the Commission Proposal. 173 Article 49b(1) of the Commission Proposal. 174 Article 49 of the Commission Proposal. 167

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Veerle Colaert and Gilian Bens Fund.175 At plenary sessions concerning EDIS-matters, composed of the members of joint plenary sessions minus the members representing Member States’ national resolution authorities,176 the Board would evaluate the application of EDIS and decide on voluntary borrowing or alternative funding.177 Finally, the composition of the executive session of the Board would remain the same: the Chair and the four-full time members.178 Generally179 decisions in the different plenary sessions would be adopted by a simple majority of its members.180 14.64 Cooperation with first pillar. While co- operation between the second and the

third pillar of the Banking Union are institutionally formalized in the Board, the Commission Proposal also promotes co-operation between the first pillar and the other two pillars provides. First, all sessions of the Board could be joined by a representative of the ECB and a representative of the Commission as permanent observers.181 Second, the Board and ECB would conclude, where necessary, a memorandum of understanding describing how they will co-operate with each other.182

14.65 Tasks. The Board would own the DIF183 and would have decision-making, mon-

itoring and enforcement powers for EDIS.184 Nevertheless, one of the main conditions for triggering EDIS, to determine whether a payout event has taken place, is still in the hands of a national institution or judicial authority.185 6. Sanctioning Mechanism

14.66 Moral Hazard. National DGSs may be less inclined to fulfil their tasks (reaching

the funding targets, invoicing contributions, recovering funds from the insolvency estate of a failing credit institution), knowing that EDIS will bear part of the payout duties anyway. This moral hazard problem, as well as a number of

175 Article 50 of the Commission Proposal. 176 Article 49a of the Commission Proposal. 177 Article 50a of the Commission Proposal. 178 Article 53(1) of Regulation 806/2014. Some additional functions would be delegated to this session (art 54a and b of the Commission Proposal). 179 Exceptions: art 52(2)–(4) Commission Proposal. 180 Article 52 of the Commission Proposal. 181 Article 43c of the Commission Proposal. 182 This memorandum of understanding would be made, where necessary, between The Board, the designated authorities, the competent authorities, the ECB, and the resolution authorities, and describe in general terms how they will co-operate with one another in the performance of their respective tasks under Union law (see Recital 39 of the Commission Proposal). The European Parliament Committee on Constitutional Affairs proposed to add that also the national designated authorities under Directive 2014/49/EU be added to the authorities to be included in the MOU (the text of the amendment mentions Directive 2014/59/EU, but from the justification it is clear that this is to be understood as a reference to Directive 2014/49/EU). See Amendment 9a of the Report of the AFCO Committee. 183 Article 74a(3) of the Commission Proposal. 184 Recital 11 of the Commission Proposal. 185 See n 33.

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European Deposit Insurance System (EDIS) specific provisions to reduce the problem have been discussed in previous sections (see paragraphs 14.49 and 14.53). Disqualification. The EDIS proposal, however, also provide for a more general 14.67 sanctioning mechanism as ultimum remedium to contain this moral hazard problem. A participating DGS could be excluded from EDIS-coverage or could be obliged to repay (part) of the funding which the DIF had already provided, if that DGS would not comply with certain obligations, such as reaching the required target levels or violating the principle of sincere co-operation.186 The Board could, moreover, impose fines on credit institutions affiliated to that DGS if they had negligently or intentionally not complied with a decision of that DGS.187 Staggered Intervention Ladder. While the European Parliament Draft Report has 14.68 not proposed significant amendments to the sanctioning mechanism, almost all delegations in the Council’s Ad Hoc Working Party seem to agree on the principle that other, less far-reaching, sanctions should be available in case of non- compliance of a DGS, such as the possibility to convert EDIS support into a loan, when disqualification would be disproportionate. Disqualification would then be reduced to a last resort sanction, especially since it could negatively affect financial stability188 This is known as the ‘staggered intervention ladder’.

V. Conclusion Three pillars of Banking Union heavily interconnected. As discussed in paragraphs 14.69 14.13 and 14.14, the three pillars of the Banking Union are heavily interconnected. This contribution has shown that, indeed, the main reason why the realization of EDIS has been put on hold, are shortcomings in the single rulebook and the first pillar. Even though supervision by the SSM functions reasonably well,189 which should decrease the probability that credit institutions will fail and Article 41i(1) of the Commission Proposal. 187 Article 74e(3) of the Commission Proposal. 188 Council, ‘Progress Report’ (No 10036/16, 2015/0270 (COD), 14 June 2016) at 34–5; Council, ‘Progress Report’ (2015/0270 (COD) 24 November 2017) at 47. The exclusion of coverage means that a DGS falls back on its own limited funding, which may result in the impossibility to pay-out all covered deposits. Disqualification could therefore lead to financial instability and punishment of depositors for the behaviour of their DGS. One idea to (partially) remedy this, was that only deposits placed with an affiliated credit institution before the disqualification of the DGS would remain covered by EDIS; deposits placed with an affiliated credit institution after disqualification would no longer enjoy of EDIS coverage (See Council, ‘Progress Report’ (No 14841/16, 2015/0270 (COD) 25 November 2016) at 67). This would, in our opinion, not fundamentally solve the problem. 189 European Commission (COM(2017)592 final, 11 October 2017) (n 3) at 5; European Commission, ‘Report on the Single Supervisory Mechanism established pursuant to Regulation (EU) No 1024/2013’ (COM(2017) 591 final, 11 October 2017). Nevertheless, a recent report of the European Court of Auditors on the operational efficiency of the ECB’s crisis management for banks, pointed to a number of shortcomings, such as the lack of co-operation and co-ordination 186

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Veerle Colaert and Gilian Bens that deposit guarantee systems should proceed to payouts, the Single Rulebook on which the SSM is based, is incomplete. It still allows for unjustifiable differences in risk profile of the bank sectors in different Member States, making risk sharing via EDIS unacceptable for Member States with stronger banking sectors. Since a number of risk reduction measures to strengthen the first pillar have been adopted in April and May 2019, adoption of some version of EDIS is increasingly feasible. If a credit institution would, despite a well-functioning first pillar, face financial hardship, early intervention and resolution should prevent a disruptive and destabilizing failure. A well-functioning second pillar190 should therefore drastically reduce the occurrence of DGS payout events. The introduction of early intervention and resolution measures has indeed changed the nature of deposit guarantee systems in the Eurozone. DGSs no longer merely provide a safety net for depositors in case of failure of their credit institution, they have a broader responsibility in helping to ensure the availability of deposits at all times. To that end DGSs can be required to contribute to the funding of resolution proceedings.191 With the introduction of the Banking Union, bank resolution and deposit guarantee are therefore closely connected. The EDIS Proposal institutionally anchors this interconnectedness, by bringing the SRM and EDIS under the auspices of the same Board, while close co-operation with the first pillar is also ensured (see n 64). 14.70 Competing visions on EDIS—While it is generally accepted in the EU that DGSs

are indeed an indispensable safety net for the banking system, not everyone agrees on the need to create a European Deposit Insurance System or on the breadth of such a European system. This has resulted in competing visions on EDIS. The Commission’s original EDIS proposal aimed at creating a European deposit insurance system which would, in a final phase, be fully organized and funded at the European level. The European Parliament Draft Report has watered down those ambitions, proposing to keep the organization and funding of deposit guarantee at the national level to a much larger extent, and limiting the role of the European Deposit Insurance Fund to a mere emergency reinsurer. With a political agreement on risk reducing measures in the banking sector, also political with other authorities, the underdevelopment of current guidance on crisis identification, and the limited availability of ECB on-site inspection teams to carry out a detailed analysis of asset quality for crisis banks. See European Court of Auditors, ‘The operational efficiency of the ECB’s crisis management for banks’ (No 02/2018) at 46–9. 190 Even though the SRM is generally deemed to function well (Commission Communication (COM(2017)592 final, 11 October 2017) (n 3) at 5), a recent report found a number of flaws, including difficulties to recruit sufficient staff with appropriate skills, and incomplete and uncompliant resolution planning for credit institutions. See European Court of Auditors, ‘Single Resolution Board: Work on a challenging Banking Union task started, but still a long way to go’ (No 23/2017) paras 144 and 146. 191 Article 109 of Bank Resolution and Recovery Directive 2014/59/EU. See also Colaert (n 10) at 86.

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European Deposit Insurance System (EDIS) agreement on some version of EDIS becomes more feasible, even though other hurdles, such as differences in the efficiency of national insolvency proceedings, could cause further delay.192 In its 2017 Communication the Commission suggested a way forward largely based on the European Parliament Draft Report. . . . equally further banking stability . . . Such a more modest approach to the third 14.71 pillar of the Banking Union could be perceived as less ambitious and therefore less effective in reaching the goals of the Banking Union. From a bank stability perspective, however, such perception would not be correct. The main reason why EDIS would further banking stability, is that it would increase the payout capacity of DGSs of participating Member States. Whether EDIS would do so as a coinsurer, and ultimately a full insurer—as in the original Commission Proposal—or as a mere reinsurer, does not have much impact on payout capacity. Both proposals therefore equally further banking stability. . . . and equally allow efficient co-operation between the three pillars. . . A second 14.72 reason to create EDIS was to ensure that the three pillars of the Banking Union could co-operate at the same (EU) level. The idea that EDIS would be brought under the auspices of the Single Resolution Board—which would be renamed Single Resolution and Deposit Insurance Board—which would closely co-operate with the ECB, has not been challenged during the legislative process. Efficient co- operation and information flows between the three pillars of the Banking Union therefore seems—at present—independent of the version of EDIS that would finally make it. From a banking stability perspective, more important than the exact version of EDIS would be other measures to complete the Banking Union, such as the realization of a common backstop for the Single Resolution Fund and EDIS.

192 As explained in paragraphs 14.53–14.60 repayment of the European Deposit Insurance Fund by Member States’ DGSs would to a large extent depend on the DGS recovering funds paid out to depositors, by subrogating in the rights of those depositors in the bankruptcy estate of the failed credit institution (see also n 143).

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15 DOOM LOOP OR INCOMPLETE UNION? Sovereign and Banking Risk Giorgio Barba Navaretti, Giacomo Calzolari, José Manuel Mansilla-Fernández, and Alberto Franco Pozzolo*

I. Introduction 15.01 II. Are Sovereigns Risky? 15.13 III. What Was Done and Should Have Been Done? Banks and Sovereigns during the Crisis and the Specificities of a Monetary Union 15.22

IV. The Long Run Equilibrium: Sovereign Exposures under ‘Normal Conditions’ V. Summing-up, Transition, and Notes of Caution

15.46 15.77

I. Introduction The ‘deadly embrace’, the ‘vicious circle’, the ‘diabolic loop’, and finally, the 15.01 ‘doom loop’. These evocative expressions refer to the perverse effects of the interconnection between sovereigns’ and banks’ liabilities that emerged as a key feature of the financial crisis started in 2007–2008, and especially of the sovereign crisis in Europe between 2010 and 2015. In some countries, it was initially the severity of the banking crises that forced the government to support and

Paper prepared for Danny Busch and Guido Ferrarini (eds), European Banking Union (2nd * edn, OUP, forthcoming: 2020). This is a revised and updated version of the European Economy editorial, ‘Banks Regulation and the Real Sector’, issue 2016.1; The work of Giorgio Barba Navaretti for this draft was carried out within the Centro Studi Luca d’Agliano’s project on Banks and Global Stability. Contributor details are, respectively: Giorgio Barba Navaretti (University of Milan and Centro Studi Luca d’Agliano); Giacomo Calzolari (European University Institute, CEPR and Centro Studi Luca d’Agliano); José Manuel Mansilla-Fernández (Universidad Pública de Navarra and Centro Studi Luca d’Agliano); and Alberto Franco Pozzolo (Roma Tre University and Centro Studi Luca d’Agliano).

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo bail-out banks, causing a surge in the public deficit and contributing to the subsequent domestic sovereign bond crisis (in Ireland, for example). In other cases, it was the sovereign debt crisis that caused the instability and, sometime, the collapse of the domestic banking sector (for example, in Greece). Consequently, the sovereign credit default swap (CDS) premia and bank CDS premia soared between October 2009 and March 2015, creating a gap between the core countries (ie Germany and France) and the peripheral GIIPS (ie Greece, Ireland, Italy, Portugal, and Spain) until the beginning of the European Central Bank’s (ECB) Quantitative Easing programme. This two-way link is well known to investors which reports the high correlation between sovereign CDS and bank CDS premia, respectively. Although improvements have taken place in the last years, recent political tensions in Italy and the still very high exposure of Italian banks towards their sovereign have brought the diabolic loop issue back once more as a central concern of the Euro area, and of the European Union (EU) as a whole. 15.02 The Single Supervisory Mechanism (SSM), one of the pillars of the Banking Union,

was established precisely to cut this perverse link, as reported clearly in the Euro Area Statement from the 28–29 June 2012 Summit: ‘We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly.’

15.03 Yet, whereas the Banking Union (BU) covers one side of the loop—the risk that

banks’ crises end up on the shoulders of taxpayers—this is not the case for the other side of the loop, which considers how too much exposure towards home sovereign bonds weakens banks’ balance sheets.

15.04 The combined action of two of the three pillars of the BU, as yet fully or par-

tially implemented (enhanced and centralized supervision, higher capital requirements, a resolution framework with bail-in procedures) do effectively transfer a large share of bank risks and of the costs of banks’ resolution from taxpayers to investors. The third pillar, yet to be implemented, is a common European Deposit Insurance Scheme (EDIS) which introduces a risk sharing mechanism among Euro countries that partly reduces the direct link between national taxpayers and national failing banks. And although the Union is still incomplete and the risk of missteps during transition is high, nevertheless the institutional design is there, and, arguably, it will be fully implemented in the foreseeable future.

15.05 Nonetheless, the present regulatory framework in Europe still considers banks’

exposure towards domestic sovereign bonds as risk-free. It grants very favourable provisions in terms of large exposure limits towards these assets (a similar framework currently applies also to the US), even though measures concerning the 578

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Doom Loop or Incomplete Union? Sovereign and Banking Risk leverage ratio or the treatment of gains and losses in the sovereign bonds already impose some prudential containment.1 The debate on how to deal with this risk is fierce and very divisive. Several banks 15.06 and governments in the more vulnerable European countries are extremely reluctant to tightening the regulatory framework, which would raise capital requirements and limit the size of sovereign exposures. Others in less vulnerable countries, as well as a significant share of the academic and institutional community, argue instead that these steps are urgent and appropriate to enhance the financial stability of the EU. In this chapter we will discuss a few key ingredients to this debate. The first one 15.07 has to do with the time frame of the analysis: there is a distinction between what was done and should have been done during the very special times of the financial and the sovereign crisis from what can and should be done under more ‘normal’ circumstances. In fact, there are never normal circumstances, especially when countries have fiscally fragile sovereigns and or/banks with large exposures toward their sovereign. High interest rates on treasuries and large public debt are once more the case in Italy today, showing how any incident of political instability and not credible policy making can bring severe distress to financial markets in Italy and Europe as a whole. Yet, events between 2007 and 2014 were certainly exceptional, in terms of the geographic and time span of the crisis. We will therefore discuss first this period and then possible paths towards normalization and a long run equilibrium. The systemic implications and hazards of the diabolic loop are very different in 15.08 countries with their own central bank and currency, and in countries that belong to a Monetary Union, like the Euro area. In the latter case, the implicit mechanisms of risk and burden sharing among Member States (or the lack of explicit ones), and the constraints faced by the central bank in supporting sovereigns of single Member States, crucially affect the terms of the debate. At the inception of the crisis several countries were of course extremely vulner- 15.09 able because of the excessive deficits and debts and of the weak balance sheets of their banks. Yet, because of Euro system’s inability to act swiftly and thoroughly in supporting individual sovereigns, or in supporting economic activities— programmes like the Outright Monetary Transactions (OMT) or the Quantitative Easing (QE) had not yet been established—of the lack of a Banking Union and of an effective mechanism of fiscal support among Member States, the Euro area had no tools to tame the build-up of the vicious circle. The loop was indeed diabolic, but to a large extent unavoidable in such an institutional setting. 1 I Visco, ‘Banks’ Sovereign Exposures and the Feedback Loop Between Banks and Their Sovereigns’ Concluding Remarks presented at the Euro50 Group Conference on The Future of European Government Bonds Markets, 2 May 2016.

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo 15.10 Effective mechanisms of risk sharing have been implemented thereafter or are en-

visaged by the institutional reforms that took place during and in the aftermath of the crisis. These mechanisms make the loop less dangerous today than during the financial crisis.

15.11 Nonetheless, precisely because risk sharing mechanisms are in place at the mone-

tary and fiscal level, hence increasing burden sharing and moral hazard, it has now become topical to deal with the inherent different levels of riskiness of European Sovereigns. This is of course a task for ‘normal’ times, one that requires a careful institutional design and a sufficiently long transition period.

15.12 A crucial issue in this debate is understanding what constitutes a risk- free

asset. Therefore, in what follows we first discuss whether—and under what circumstances—sovereign liabilities should be considered as risky. We then discuss the high momentum of the crisis and what was and should have been done to tame the diabolic loop in the monetary union. Next, we examine the state of the debate on the optimal setting in normal times, and on the path towards such an equilibrium.

II. Are Sovereigns Risky? 15.13 Sovereign bonds can indeed be risky, even though their probability of defaulting

is low.2 Dramatic busts, like Argentina’s in 2002, remind us that mismanaged economic policies can lead countries to default on their sovereign debt, with dramatic consequences for the population. The 2011 partial default of Greece reminds us that they can occur also in Europe and within the Euro area.

15.14 The European banking crisis has cast doubts on the fragility of banks exposed to

mark-to-market losses and impairments on sovereign bonds issued by what became known as the peripheral GIIPS countries (Greece, Ireland, Italy, Portugal, and Spain).3 Since the outburst of the financial crisis, the amount of sovereign bonds held by banks, especially those based in such countries, increased considerably. The peripheral GIIPS banks hold an average share of domestic sovereign bonds to total assets ratio of 6.80% between January 2009 and September 2018, reaching its maximum in October 2014 (8.64%). On the other hand, the average share of domestic sovereign bonds to total assets ratio was of 2.40% for core country banks, with a maximum in June 2014 (2.85%).

2 No OECD country defaulted on its domestic debt between 1950 and 2010. See C M Reinhart and K S Rogoff, ‘The Forgotten History of Domestic Debt (2008) NBER Working Paper 13946. 3 See also V Acharya and S Steffen, ‘The ‘Greatest’ Carry Trade Ever? Understanding Eurozone Bank Risks’ (2015) Journal of Financial Economics 115, 215–36; and V Acharya, I Drechsler, and P Schnabl, ‘A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk’ (2014) 69 Journal of Finance 2689–739.

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Doom Loop or Incomplete Union? Sovereign and Banking Risk The riskiness of sovereigns does indeed vary considerably within the Eurozone. 15.15 Brunnermeier et al (2016) provide a thorough assessment of the heterogeneity of countries of the Euro area (as of December 2015).4 Averaging out and indexing Moody’s and S&P scores, they rank Euro countries on a scale from 1 (AAA) to 19 (CCC–). Only Germany, Netherlands, and Luxembourg have a score of 1. As for the GIIPS, Ireland has 6.5, Spain 9.0, Italy 9.5, Portugal 12, and Greece 19. The expected loss rates in a benchmark scenario range from 0.45 for safe countries to 34.16 for Greece. Even though this is to a large extent an inheritance of the crisis, it persists now that we are sailing in relatively calmer waters. The evidence that sovereign risk increased during the crisis and that a large share of 15.16 this risk is borne by banks, especially in vulnerable countries, is indeed strong. Several indicators support this view. First, the above-mentioned rapid and generally parallel rise in the price of CDS on sovereigns and banks. Second, the rapid rise of spreads between the interest rates paid on the sovereign of periphery countries, which was comparatively more accentuated in Greece. Third, the ‘home country bias’ of these assets, ie the dominant share of home 15.17 sovereigns on total sovereigns held by banks, once more especially in stressed GIIPs countries. In particular, Italian and Spanish banks grasped ratios above 90% since the beginning of the crisis. Surprisingly, Ireland displays comparatively lower levels of ‘home bias’ than the other GIIPS and Germany. Several papers have analysed the recent surge in sovereign risk econometrically, iden- 15.18 tifying a quite convincing causal spiral between the share of sovereign assets and the frailness of banks’ balance sheets.5 Altavilla et al (2017) calculate that in GIIPs countries a 100-basis-point increase in the domestic sovereign CDS premium translated into a 31.5-basis-point increase in the CDS premium of a bank with a median exposure to sovereigns.6 The empirical evidence also suggests that banks with a high exposure to sovereign 15.19 debt lend less to the real sector, with negative implications for economic growth, which fires back into reduced fiscal revenues, which in turn exacerbates sovereign vulnerability. Several papers have addressed this issue, showing that sovereign exposures crowd out credit to the private sector.7 Using aggregate data at country 4 M K Brunnermeier, L Garicano, P Lane, M Pagano, R Reis, T Santos, D Thesmar, S Van Nieuwerburgh, and D Vayanos, ‘The Sovereign-Bank Diabolic Loop and ESBies’ (2016) American Economic Review Papers and Proceedings 106. 5 See V V Acharya, T Eisert, C Eufinger, and C Hirsch, ‘Real Effects of the Sovereign Debt Crisis in Europe: Evidence from Syndicated Loans’ (2018) 31 Review of Financial Studies 2855–96; C Altavilla, M Pagano, and S Simonelli, ‘Bank Exposures and Sovereign Stress Transmission’ (2017) 21 Review of Finance 1–37; and M Bofondi, L Carpinelli, and E Sette, ‘Credit Supply During a Sovereign Debt Crisis’ (2018) 16 Journal of the European Economic Association 696–729. 6 See Altavilla et al (n 6). 7 Correa et al (2016) show that carry-trade strategies in Europe caused a reduction also in lending by the US branches of European banks, with a negative impact on US corporate investment.

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo level from the ECB, we find that the negative correlation between the sovereign debt holdings to total assets ratio and the loans to customers to total assets ratio became relatively more accentuated after the beginning of the sovereign debt crisis for the peripheral GIIPS. However, the ECB’s Quantitative Easing programme contributed to normalizing the impact of sovereign debt holdings on lending supply to levels prior to the crisis. 15.20 Acharya et al (2018) find that value impairment in banks’ exposures to the

European sovereign debt and the risk-shifting behaviour of weakly capitalized banks explains between 44% and 66% of lending reductions suffered by European non-financial firms.8 Bofondi et al (2018) show that Italian banks reduced credit supply and increased the price for loans more than foreign banks, which were comparatively less affected by the sovereign debt crisis. They argue that credit contraction is the consequence of a generalized increase in the cost of funding associated to country-specific effects instead of bank-heterogeneity characteristics.9

15.21 Altavilla et al (2017) also calculate that a 1-standard-deviation drop in the price

of government bonds reduced the loan growth of the median domestic bank by 1.4 percentage points, ie 20% of the standard deviation of loan growth.10 Using market information from Thomson Reuters Datastream, we estimate the cost of capital for banks.11 Increases in the ten years CDS on sovereign bonds also cause See R Correa, H Sapriza, and A Zlate, ‘Liquidity Shocks, Dollar Funding Costs, and the Bank Lending Channel During the European Sovereign Crisis’ (2016) 16–4 Risk and Policy Analysis Unit Working Paper RPA, Federal Reserve Bank of Boston; P Angelini, G Grande, and F Panetta, ‘The Negative Feedback Loop between Banks and Sovereigns’ (2014) Occasional Paper No 213, Banca d’Italia, Rome, Italy; C Arteta and G Hale, ‘Sovereign Debt Crises and Credit to the Private Sector’ (2008) 74 Journal of International Economics 53–69; N Battistini, M Pagano, and S Simonelli, ‘Systemic Risk, Sovereign Yields and Bank Exposures in the Euro Crisis (2014) 29 Economic Policy 203–51; Correa et al (n 8); F De Marco, ‘Bank Lending and the European Sovereign Debt Crisis’ (2018) Journal of Financial and Quantitative Analysis forthcoming; G Dell’Ariccia, C Ferreira, N Jenkinson, L Laeven, A Martin, C Minoiu, and A Popov, ‘Managing the Sovereign-Bank Nexus’ (2018) European Central Bank Working Paper Series No 2177; N Gennaioli, A Martin, and S Rossi, ‘Banks, Government Bonds, and Default: What Do the Data Say?’ (2014a) IMF Working Paper 14/120, International Monetary Fund, Washington, DC; N Gennaioli, A Martin, and S Rossi, ‘Sovereign Default, Domestic Banks, and Financial Institutions’ (2014b) 69 Journal of Finance 819–66; A Popov and N Van Horen, ‘Exporting Sovereign Stress: Evidence from Syndicated Bank Lending during the Euro Area Sovereign Debt Crisis’ (2015) 19 Review of Finance 1825– 66; T Williams, ‘Capital Inflows, Sovereign Debt and Bank Lending: Micro-Evidence from an Emerging Market’ (2018) Review of Finance forthcoming; and F Pietovito and A F Pozzolo, ‘Credit Constraints and Firm Exports: Evidence from SMEs in Emerging and Developing countries’ (2019) Centro Studi Luca D’Agliano. Development Studies Working Papers, University of Milan. 8 See Acharya et al (n 6). 9 See Bofondi et al (n 6). 10 Altavilla et al (n 6). See also De Marco (n 9); and A Popov and N Van Horen, ‘The Impact of Sovereign Debt Exposure on Bank Lending: Evidence from the European Debt Crisis’ (2013) DNB Working Paper No 382, for similar results. 11 The bank’s cost of capital is defined as the return required by investors for equity investment. We follow the standard CAPM model to compute the cost of capital (rit ) which is a direct function of the return of the risk-free asset (Ritf ) plus the compensation for bank i’s undiversifiable

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Doom Loop or Incomplete Union? Sovereign and Banking Risk a raise in banks’ cost of capital, which diminishes lending and liquidity supply.12 The influence of the CDS sovereign bonds premia on banks’ cost of capital is comparatively higher for the peripheral GIIPS countries than for the core countries.

III. What Was Done and Should Have Been Done? Banks and Sovereigns during the Crisis and the Specificities of a Monetary Union The first issue relates to the sustainability of sovereigns. Is a monetary union a special 15.22 case, if a fiscal union is absent? There are indeed crucial differences between the financial sustainability of sovereign debt in a country with its own currency and in a country that is part of a monetary union. The first one is that the role played by central banks is different. In the former, 15.23 even though Central banks are independent and do not finance sovereigns directly, they can still intervene in the secondary market and act as a sort of indirect lender-of-last-resort to governments in times of distress. In fact, during the crisis, the US Federal Reserve and the Bank of England rapidly adopted a program of quantitative easing (QE), purchasing large amounts of long-term bonds, including sovereign bonds. At the moment, they own 11.5% and 24.2% of all outstanding public domestic bonds, respectively.13 The Bank of Japan owns a similar share. Even though the final aim of QE was to act countercyclically against deflation and recession, in fact it also supported the price of sovereign debt in secondary markets. For example, Hoshi and Ito (2014) argue that the fact that a country like Japan with a debt to GDP ratio of over 230% has much higher credit ratings than Euro area members with less distressed public finances is not only due to the high saving ratio in the Japanese economy, but also to the home bias of domestic institutional investors, which have a strong aversion to exchange rate risk. Clearly this would be very different if Japan were a member of a monetary union.14

(

)

risk, namely equity market risk premium. The cost of capital is defined as: rit = Ritf + E ( Rtm ) − Ritf βit . We take the 10-years sovereign bond yield as the risk-free rate (Ritf ). The variable of interest is the Beta CAPM (βit ), which is calculated as the regression slope between bank i’s equity return (Ri ) and the EUROSTOXX Banks return (Rm) as given: βit =

Cov ( Ri , Rm ) Var ( Rm )

. The Beta CAPM is estimated

by using a 24- months rolling window for each bank i, since betas might change significantly over time. The equity market risk premium includes the historical mean of the realized EUROSTOXX Banks returns exceeding the contemporaneous Ritf over the past 60 months.. 12 G Chiesa and J M Mansilla-Fernández, ‘Disentangling the Transmission Channel NPLs-Cost of Capital-Lending Supply’ (2018) Applied Economics Letters, forthcoming. 13 Bruegel (2018). Bruegel database of sovereign bond holdings developed in Merler and Pisani- Ferry, ‘Who’s Afraid of Sovereign Bonds’ (2012) Bruegel Policy Contribution 2012|02. 14 T Hoshi and T Ito, ‘Defying Gravity: Can Japanese Sovereign Debt Continue to Increase Without a Crisis?’ (2014) 29 Economic Policy 5–44.

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo 15.24 However, in the case of a monetary union, especially at its start, as it was the case

of the Eurozone at the beginning of the crisis, any intervention by the central bank in support of distressed sovereigns can be seen as an unwarranted backing of some individual member country at the expense of others. For this reason, the institutional setting, and ability to reach the necessary consensus within the decision bodies limits the ability of the central bank to intervene in the government bond market. The Eurosystem’s long delay in implementing a QE program in comparison with the Federal Reserve, the Bank of England and the Bank of Japan, despite the low aggregate demand and the deflationary pressures, is a clear example of such difficulties.

15.25 The second difference is that a sovereign-bank crisis loop in one country can cause

severe negative externalities to other countries of a monetary union, and this calls for a stronger mutualization of sovereign risks, for example through mechanisms of fiscal solidarity. Fiscal risk sharing and the intervention by a monetary authority in the sovereign bond markets are complementary measures. The presence or even the presumption of a transfer from fiscally sound to fiscally vulnerable countries may compensate for the limited degrees of freedom of the central bank within a monetary union.

15.26 The explosion of the Euro area’s sovereign debt crisis is of course related to the

severe distress of banks and sovereigns’ financial conditions in several countries, but, to a large extent, it is also related to the fact that after the financial crisis of 2007–2008 neither of the two mechanisms—the intervention of the monetary authority in the bond market, and a fiscal risk/burden sharing—were active. Frisell’s account (2016) of the Irish crisis is especially explicit in this respect. In Ireland, there was an instantaneous build-up of bilateral banks-sovereign exposures, as banks were recapitalized with debt instruments (IOU notes for about 30bn, 15% of Irish GDP) issued by the Government. This bold policy choice, which simultaneously put public and bank’s balance sheets at hazard, had no alternative at the time, since Ireland also no longer had access to the security market.15

15.27 Eventually, the perverse spiral of the crisis was tamed through the implementation

of risk sharing mechanisms (the European Financial Stability Facility, EFSF, the European Stability Mechanism, ESM, the sequence of interventions in support of Greece), the activation of a large program of collateralized liquidity lending in support of banks by the ECB (the large Long-Term Refinancing Operations, LTRO, in December 2011 and February 2012, in which sovereigns were used as collaterals), the announcement of a program of direct purchase of bonds in the

15 L Frisell, ‘Europe’s Regulatory Treatment of Banks’ Sovereign Exposures—How a Flawed Framework was put to use in the Irish Financial Crisis’ (2016) 2016.1 European Economy—Banks, Regulation, and the Real Sector 105–17.

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Doom Loop or Incomplete Union? Sovereign and Banking Risk secondary market of countries in distress, joint with the interventions of the ESM (the Outright Monetary Transactions program, OMT, implicitly announced with the famous London speech by Mario Draghi in the Summer of 2012, and that as for now has never been used),16 and finally the activation of the QE program. The second issue is the perspective of banks. Was buying sovereigns a rational strategy? 15.28 Within a monetary union, banks’ perspective is also special, particularly in vulnerable countries. As shown in Altavilla et al (2017), thinly capitalized banks in the GIIPs held a higher concentration of their assets in the form of domestic sovereign bonds; and during the crisis the rise in the purchase of sovereign bonds was much more prominent in these countries than elsewhere. These banks made large carry-trade profits, especially after the ‘whatever it takes’ speech, funding the bond purchases with the liquidity windows provided by the ECB, and using those same bonds as collateral. Such strategies clearly made these banks even more exposed towards sovereign risk.17 Yet, what alternative strategies did these banks have during the unfolding of the 15.29 sovereign crisis? Could they have lent more to the private sector instead of the sovereign? This is unlikely, given that they had limited equity, and therefore had to contain investment in capital absorbing assets like loans to the private sector; and they were also constrained on the liability side, because of the large funding gap at the peak of the crisis, as well as the need of sovereign securities as collateral to access the liquidity provision by the ECB.18 But even if they had managed to increase their loan supply, would lending to the 15.30 private sector have improved their risk profile? Again, this is also unlikely, given the build-up of non-performing loans during recession. Finally, could banks have reduced the size of their balance sheets and the extent 15.31 of carry-trade in sovereign bonds? In fact, disintermediation did take place, at least to some extent: total assets of European banks declined in the aftermath of the sovereign debt crisis. But an even stronger deleveraging by more exposed banks would have further reduced their profitability, worsened their capital position and therefore reduced lending to the economy even more than what we have observed. In other words, even if a more stringent regulation had discouraged banks form 15.32 buying sovereigns in the aftermath of the crisis, it is far from obvious that the outcome in terms of financial stability would have been better.

16 ‘Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough . . . The short-term challenges in our view relate mostly to the financial fragmentation that has taken place in the euro area.’ Speech by Mario Draghi, President of the European Central Bank at the Global Investment Conference in London, 26 July 2012. 17 See Altavilla et al (n 6). 18 See Acharya et al (n 4).

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo 15.33 The third issue is the extent of the home bias in sovereign purchases. Was buying

domestic sovereign bonds a rational strategy for banks in vulnerable countries? Indeed, banks could have bought sovereigns issued by safer member countries. Why did banks in vulnerable countries concentrate such a large share of their investments in home sovereigns? The home bias was much larger for vulnerable than non-vulnerable countries.

15.34 There are several explanations for this behaviour. The first one is the ‘carry-trade’

motive:19 betting on resurrection by exploiting the larger price swings of sovereign bonds issued by vulnerable countries.20 Yet, this only justifies a bias towards debt issued by any GIIPs, not a home bias.

15.35 A complementary argument is a ‘nothing to lose’ one. If vulnerable home

sovereigns were to default, home banks would very likely go out of business, even if they held a diversified portfolio of safe bonds. As argued explicitly by Nielsen (2016) and Lanotte et al (2016), home banks cannot hedge the risk of a home sovereign defaulting.21 In the case of the default of their own sovereign, the downside for them would be the same whether they bet on resurrection, or they allocate their investment to safer assets. Using the words of Tabellini (2018), ‘any bank is unlikely to survive the default of its sovereign, irrespective of how much domestic debt it holds’.22 Hence, if banks survive only if there is resurrection, a rational strategy would be to bet on resurrection and hold a home-biased portfolio. Of course, this is not the case for banks in non-vulnerable countries, where incentives for carry-trade are weaker, and safer assets have largely a better risk/return ratio.

15.36 An alternative interpretation is the ‘moral suasion’ one, according to which

governments in vulnerable countries pressured domestic banks into buying domestic sovereign bonds, especially if these banks had been previously bailed-out with taxpayers’ money, and turned out to be owned by public entities.23 The Irish account by Frisell (2016) also confirms the case in point.24

19 See ibid; and Altavilla et al (n 6), 1–37; and C Buch, M Koetter, and J Ohls, ‘Banks and Sovereign Risk: A Granular View’ (2016) 25 Journal of Financial Stability 1–15. 20 See Battistini et al (n 9). 21 E F Nielsen, ‘Risk-Weighting Sovereign Debt is the Wrong Way to Go’ (2016) 2016.1 European Economy—Banks, Regulation, and the Real Sector 119–28; M Lanotte, G Manzelli, A M Rinaldi, M Taboga, and P Tommasino, ‘Easier Said Than Done? Reforming the Prudential Treatment of Banks’ Sovereign Exposures’ (2016) 2016.1 European Economy—Banks, Regulation, and the Real Sector 73–103. 22 G Tabellini, ‘Reforming the Eurozone: Structuring vs Restructuring Sovereign Debts’ (2018) Voxeu.org, 23 November. 23 See Acharya and Steffen (n 4); S Ongena, A Popov, and N V Horen, ‘The Invisible Hand of the Government: “Moral Suasion” during the European Sovereign Debt Crisis’ (2016) ECB Working Paper No 1937; F De Marco and M Macchiavelli, ‘The Political Origin of Home Bias: The Case of Europe’ (2015) Mimeo, show that government-owned and politically-connected banks displayed relatively stronger home bias in sovereign debt than privately owned banks between 2010 and 2013. 24 See Frisell (n 17).

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Doom Loop or Incomplete Union? Sovereign and Banking Risk Altavilla et al (2017) show that both the ‘carry-trade’ and ‘moral suasion’ motives 15.37 can explain the rapid rise of banks’ sovereign exposures in vulnerable countries, and that the latter is especially likely to be held into account when considering previously bailed-out banks.25 Additional mechanisms at play include the fact that banks might strategically un- 15.38 derwrite domestic sovereign debt to force governments to avoid actions that may lead to default. The ‘bail-out’ put through public interventions has a higher value to banks during riskier financial times, thus inducing them to increase the home bias in sovereign holding. At the same time, Governments might use the threat of the damages caused by a sovereign default to obtain assistance or debt forgiveness, and thereby sustained access to capital markets. These strategic interactions between banks and governments might introduce a beneficial disciplining device on sovereign management, and favour public support of defaulting banks, ie bail-outs.26 What can we say of these motives? The carry-trade option was a risky bet, but 15.39 it probably paid off, at least in part, giving weak banks additional profits that helped them stay afloat. And, in practice, it was not as risky as it might have first appeared, given that it was highly likely that some form of fiscal risk sharing would have been devised and that the Eurosystem would have finally acted as a buyer of last resort in the sovereign bond market to ‘preserve the euro’, and to guarantee a smooth transmission of monetary policy. In fact, carry-trade was funded by the ECB’s liquidity windows. Also, it took place especially after the establishment of the ESFS and the ESM moved the policy stance in the Euro area towards a higher degree of fiscal risk mutualization. Additionally, after the ‘whatever it takes’ speech, the monetary stance was changed. In other words, carry-trade was favoured by both enhanced fiscal backstops and less constrained monetary policy within the monetary union.27 As per the moral suasion motive, it should be examined within the policy context 15.40 of the time. Especially in the earlier stages of the crisis, when no mutualization was in place, the willingness of banks to buy sovereigns partly smoothed the severity of the sovereign problem.28 As recalled by Visco (2016), there is ample evidence that domestic banks sold sovereign bonds when markets overheated and bought them

See Altavilla et al (n 19). 26 E Farhi and J Tirole, ‘Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops’ (2018) 85 Review of Financial Studies 1781–1823. For another theoretical analysis of the risk-shifting incentives R Cooper and K Nikolov, ‘Government Debt and Banking Fragility: The Spreading of Strategic Uncertainty’ (2018) 59 International Economic Review 1905–25. 27 See M Pagano, ‘The Sovereign-Bank Nexus and the Case for European Safe Bonds’ (2016) 2016.1 European Economy—Banks, Regulation, and the Real Sector 129–38. 28 Of course, this was not the case for all countries: in Greece, the extent of the fiscal imbalances was such that local banks could indeed do very little to match the demand shortage of sovereign bonds. 25

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo when markets were excessively bearish and foreign investors were fleeing. Banks’ home bias thus helped reducing excessive volatility in financial markets.29 15.41 In Italy, for example, domestic banks had effectively been acting as buyers of last

resort, supporting weak demand in auctions.30 Had domestic banks not raised their investments in sovereigns, spreads might have increased even further, and probably pushed some countries towards insolvency. Hence, given that domestic frail banks would in any case be very severely affected by the bankruptcy of their sovereign, supporting it was a fully rational choice, even if it was the outcome of some degree of moral suasion.

15.42 The fourth issue is whether we are now in equilibrium, or if broader policy actions

are needed. The two-sided ‘lending of last resort’ between banks and sovereign can indeed smoothen unwarranted market shifts in the short term. Nevertheless, when crises are deeper, as they were between 2008 and 2012, fragile sovereign states sustaining fragile banks and fragile banks sustaining fragile sovereign states resemble a ping pong of mutual fragilities, a house of cards that can support the system only for a short time.

15.43 We have seen that what finally severed the diabolic loop in the Euro area were

the crucial institutional reforms, like the Banking Union, with the ESM and the SRB, and the direct intervention of the ECB in the market for sovereign debt. These reforms are crucial and provide an institutional framework that, once fully implemented, will make the reappearing of the loop less likely.

15.44 Nevertheless, we are not completely there yet. The Banking Union is still not

complete. The mechanisms for fiscal mutualization are being strengthened along the lines of the memorandum of understanding recently signed between the ESM and the European Commission, but it is still not clear how the memorandum will be implemented. And although the ECB has shown that within its mandate it can deploy a large range of monetary policy tools to avoid excessively unstable sovereign markets, monetary policy cannot do the whole job by itself.

15.45 The necessary and urgent completion of this institutional design makes a re-

thinking of banking regulations on sovereign exposures an inevitable step.

IV. The Long Run Equilibrium: Sovereign Exposures under ‘Normal Conditions’ 15.46 The debate on reforming the regulatory framework for sovereign exposures is in-

tense. The direction is that of restoring the spirit of the Basel agreements, with 29 See Visco (n 2). 30 See Lanotte et al (n 23).

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Doom Loop or Incomplete Union? Sovereign and Banking Risk any possible reform being applied to all countries at the same time and in similar ways, so as to level the playing field.31 The issue is especially topical within the Eurozone. We have argued that, fol- 15.47 lowing the deterioration of fiscal conditions and of banks’ balance sheets, the loop in the Euro area initially spiralled because the ECB had no option but that to support sovereigns, and because of limited manoeuvring space in mutualising fiscal costs and risks. We have also argued that, in this context, more stringent rules on banks’ sovereign exposures would not have necessarily limited the perverse systemic effects of the loop, nor would they have necessarily helped the stabilisation of credit towards the private sector. Nonetheless, the crisis has clearly reminded us that sovereigns can indeed be risky, 15.48 and that even within the Euro area there is a large heterogeneity in their degree of riskiness. Therefore, we may ask if, in a more relaxed world of lower spreads and fully working institutional umbrellas, there would be scope for changing the rules on sovereign exposures, to better account for heterogenous and intrinsic riskiness. Even when considering a regulatory reform to be implemented in normal times, 15.49 there are key differences between countries that are members of a monetary union and those that are not. If the absence of a risk-sharing framework made the Euro area so special, then in the long-run, and in ‘normal times’, the rational is reverted. It is precisely the implementation of a risk-sharing framework (if and when fully implemented) that makes the equalitarian risk-free treatment of sovereigns with different levels of inherent riskiness non-sustainable. It is it precisely the actual or potential existence of risk sharing arrangements that make the Euro area special and the call for reforms more impellent than for individual countries like Japan or the US. Therefore, the treatment of asymmetries and the actual implementation of risk 15.50 sharing mechanisms go hand in hand. Yet asymmetries make safer countries resist the implementation of the EDIS, unless the regulatory treatment of foreign exposures is reformed, and make vulnerable countries resist bank sovereign exposure reforms, unless a full risk sharing mechanism is in place. In principle, if all heterogeneity in risk levels were removed, and the full implemen- 15.51 tation of the Fiscal Compact had managed to make all Euro sovereign risk-free, there would be a fully integrated European financial market, like in the United States. Large European banks would autonomously follow an optimal diversification strategy, and would therefore not be linked to their sovereigns any longer.

31 BCBS, Regulatory Consistency Assessment Programme (RCAP): Assessment of Basel III LCR regulations—European Union (2017a) Basel Committee on Banking Supervision, Basel: Bank for International Settlements, July; BCBS, Instructions for Basel III monitoring (2017b) Basel Committee on Banking Supervision, Basel: Bank for International Settlements, July.

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo The rational but perverse incentive to bet on resurrection and hold a home-biased portfolio of sovereigns would not be present anymore. Risk weighting and large exposure provisions on banks’ holdings of sovereign debt would be non-binding. 15.52 However, the time when all sovereigns will have similar conditions of riskiness

is far in the future. Even the most optimistic projections of convergence of debt levels among Euro area Member States envisage a very long time-span. And full harmonization will likely never be achieved, for how effective harmonization mechanisms might be. Hence, we have to envisage a world where asymmetries are persistent, where effective incentives to reduce them are in place, and where the implementation of the Monetary and Banking Union and of Fiscal risk sharing devices keep moving ahead. Not an easy equation to solve.

15.53 Also, as the recent Italian political framework is showing, uncertainties related

to the credibility of governments and their economic policies can severely affect the inherent riskiness of sovereigns, especially in countries with high debt levels. And banks exposed to such sovereigns may face considerable devaluations of their assets, especially those which must be marked-to-market. Hence, it is difficult to reason in terms of ‘normal times’, because for highly indebted countries times are never completely normal and market reversals are always on the outlook.

15.54 In the following section, we discuss a few proposals that have emerged recently,

bearing in mind that these are long term solutions that would require a transition phase in any case.

15.55 The March 2015 Report of the European Systemic Risk Board expert group on

regulatory treatment of sovereign exposures suggests several possible measures that should be envisaged within a long-term horizon, when banks will have fully repaired their balance sheets and gradually reduced their sovereign exposures.

15.56 In broad terms, three main families of regulatory measures were put forward.

The first one assigns a non-zero risk weight to sovereign bonds, reflecting the effective risk of such exposures. The second implies partially or fully lifting the exception to the large exposure provision, which imposes extra capital surcharges on exposures larger than 25% of a bank’s total assets. The third one restricts the use of sovereigns to comply with liquidity requirements, for example in the computation of the Liquidity Coverage Ratio (LCR) or the Net Stable Funding Ratio (NSFR). Essentially, these reforms imply re-establishing the spirit of the Basel II framework, then revised in the Basel III, lifting the carve-out treatment.32

15.57 The papers by Frisell (2016) and Nielsen (2016) provide a detailed discussion

of these three families of measures. For example, they both suggest that risk weighting is not an effective measure to deal with this issue. Nielsen (2016)

32 For a thorough analysis of the pros and cons of the current proposals, see Visco (n 2).

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Doom Loop or Incomplete Union? Sovereign and Banking Risk also argues that risk weights raise a philosophical issue of potential loss of sovereignty. Sovereigns might indeed be—and in fact they are—very reluctant, to institutionalize the assessment of their riskiness through a mechanical implementation of risk weighting. Instead, both Nielsen (2016) and Frisell (2016) argue that caps on large exposures would be less distortionary and encourage effective diversification. Overall, these papers show that focussing just on one measure or single sets of measures might introduce unexpected distortions and side effects.33 Recent contributions have put forward three alternative strategies to combine 15.58 these different measures: Andritzky et al (2016), which reflects the position of the German Council of Economic Advisors;34 a set of papers by Brunnermeier et al (2011) and (2016), Corsetti et al (2016), and Pagano (2016); and a recent paper by Bénassy-Quéré et al (2018).35 The proposal by Andritzky et al (2016) is based on a principle of ‘horizontal dis- 15.59 crimination’ between sovereign bonds, whereby risk weighting, large exposure provisions or other regulatory measures should reflect the effective riskiness of Member States, as measured by different rating mechanisms.36 The ‘horizontal discrimination’ implicitly provides strong incentives for reducing 15.60 sovereign exposures of banks in peripheral countries (though the proposal does indeed envisage a long transition period). Nevertheless, it raises a series of issues which are not of simple solution even in normal times, and even if the issue of how to measure the effective relative riskiness of countries were resolved (rating agencies or else). The first problem is that it does not take into account the systemic dimension of the European Union. As far as there are large externalities within the Euro area, and asymmetries are to an extent persistent, risk-free sovereigns remain exposed to shocks from risky sovereigns. Vulnerable countries need financing. Lifting the risk-free status might make funding these sovereign problematic and very expensive, as banks’ portfolios would shift towards risk-free countries. This move would likely signal an increase in their vulnerability, amplify their distress and might impair the whole Union. See Frisell (n 17); and Nielsen (n 23). 34 J Andritzky, N Gadatsch, T Körner, A Schäfer, and I Schnabel, ‘A Proposal for Ending the Privileges for Sovereign Exposures in Banking Regulation’ (2016) voxeu.org 4 March. 35 A Bénassy-Quéré, M Brunnermeier, H Enderlein, E Farhi, M Fratzscher, C Fuest, P O Gourinchas, P Martin, J Pisani-Ferry, H Rey, I Schnabel, N Véron, B Weder di Mauro, and J Zettelmeyer ‘Reconciling Risk Sharing with Market Discipline: A Constructive Approach to Euro Area Reform’ (2018) CEPR Policy Insight No 91, Centre for Economic Policy Research, London; M K Brunnermeier, L Garicano, P Lane, M Pagano, R Reis, T Santos, D Thesmar, S Van Nieuwerburgh, and D Vayanos, ‘European Safe Bonds (ESBies)’ (2011) The Euronomics Group; Brunnermeier et al, ‘The Sovereign-Bank Diabolic Loop and ESBies’ (n 5); G Corsetti, L Feld, R Koijen, L Reichlin, R Reis, H Rey, and B Weder di Mauro, Reinforcing the Eurozone and Protecting an Open Society, Monitoring the Eurozone 2 (CEPR Press 2016); and Pagano (n 31). 36 See Andritzky et al (n 38. 33

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo 15.61 Second, even in the long- run, sovereign bonds issued by risk-free countries

may not be enough to fulfil the requirements of the Euro area banking system. Banks need risk-free assets for plenty of reasons: to use them as collateral in repo transactions or transactions with the central bank, to fulfil liquidity requirements, and as an asset class they can revert to in moments of distress. Indeed, according to this proposal, at the moment, only Germany, Luxembourg and the Netherlands would issue such assets in the Euro area.37

15.62 Of course, this does not imply that maintaining an artificial risk-free status for all

sovereigns would solve the problem. It only means that a mechanism that de facto ‘tranches’ risks based on ‘horizontal discrimination’ is likely to be unable to provide a sufficient amount of risk-free assets to the banking system.

15.63 An alternative mechanism is instead based on a combination of ‘horizontal’

and ‘vertical’ discrimination.38 The idea is to introduce different regulatory treatments based on the riskiness of the sovereigns—in line with the proposal of the German Council of Economic Experts—but, at the same time, to create a risk-free asset through pooling and tranching portfolios of sovereign bonds (‘vertical discrimination’).

15.64 The process to create European Safe Bonds (ESBies) would be split into two steps.

First, a private and market based financial entity would acquire a portfolio of bonds issued by all member countries of the Euro area, with the share of securities from each country defined on the basis of an objective parameter, such as their contribution to aggregate nominal GDP. Second, this entity would issue a set of securities, backed by the portfolio of sovereign bonds, using a tranching technique. The most subordinate tranche would suffer all losses on the value of sovereign securities held by the financial entity, up to its nominal value. Only if and when the value of the most subordinate tranche had fully absorbed losses, the owners of the next tranche would incur losses on their securities. Even with just two tranches, the most senior would have a larger size and similar or better risk characteristics than risk-free sovereign bonds.

15.65 Three aspects of this proposal are particularly appealing. First, it involves a mech-

anism of risk sharing, because it creates a portfolio of sovereigns issued by all Euro area member countries. Second, it introduces a ‘vertical’ risk discrimination among different tranches of the same diversified portfolio. This second characteristic is crucial, because it generates a large pool of low-risk assets, which are necessary to fulfil the needs of banks.39 Third, it reduces the risk of severe shortages 37 See Altavilla et al (n 6). 38 See Brunnermeier et al (n 39); Brunnermeier et al, ‘The Sovereign-Bank Diabolic Loop and ESBies’ (n 5); Corsetti et al (n 39); and Pagano (n 31). 39 Indeed, the same result would not be attained without tranching: using the level of risk of national sovereigns at the end of 2015, for example, see Brunnermeier et al, ‘The Sovereign-Bank Diabolic Loop and ESBies’ (n 5), calculate that a portfolio obtained by simply pooling sovereigns

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Doom Loop or Incomplete Union? Sovereign and Banking Risk in the demand of bonds in vulnerable countries, as might instead emerge under a pure horizontal mechanism. It may appear at first sight that the risk-sharing mechanism implicit in the ESBies 15.66 and other similar proposals would create moral hazard to countries with high public debt, allowing them to issue cheap government bonds. But this is not true. Sovereigns would first be issued at market prices, and only subsequently, would be bought by the financial entity described above. Moreover, a large enough share of the total amount of debt issued by each member State would be left for trading. In this way, the price of sovereign bonds would always reflect their degree of riskiness as perceived by market investors. The cost of unsustainable fiscal policies would therefore be priced in bonds issued by non-virtuous governments, even though, as argued, dramatic shortages in demand would be less likely to emerge than under pure ‘horizontal’ discrimination.40 Moreover, banks’ rational but perverse incentive to hold a home-biased portfolio 15.67 for the reason discussed above would be eliminated, because different regulatory treatments based on the riskiness of the sovereigns would be imposed. A possible drawback of the ESBies proposal is the allocation of the junior tranche. 15.68 As has become clear after the recent financial crisis, pooling and tranching does not eliminate risks, it only relocates them. Therefore, the question is if there is enough demand for about €1.2tn of assets with an estimated default probability of 9.30%. Moreover, if such a large amount of risky assets ended up concentrated in the hands of a small set of investors, huge contagion effects might emerge in case of default, especially if these investors were in the lightly regulated shadow- banking sector. Some degree of control on the holdings of the junior tranche, and a fiscal backstop in case of extreme events, should probably be considered anyway.

issued by Euro area countries according to their contribution to aggregate GDP would have an expected loss rate of 2.90%, nearly six times the expected loss rate of what is considered a safe asset (0.50%) and of German sovereign bonds (0.45%). Instead, if this risk were redistributed through tranching, even with just one junior tranche representing 30% of the pooled portfolio, this would have an expected loss of 9.30% (comparable to that of Portugal), the expected loss rate of the senior tranche representing the remaining 70% would be a mere 0.15%, one-third of that of Germany. 40 Precise computations should be made, but in fact, the cost of financing vulnerable sovereigns might be even higher than if only ‘horizontal’ discrimination were present (besides for extreme conditions). Consider a case in which there is a structural undersupply of safe assets, as in the case of the proposal of the German Council of Economic Experts. In these conditions, some investors would be forced to buy a larger share of sovereigns issued by vulnerable countries than they would prefer, simply because safe assets are not available. For these countries, the marginal cost of financing its debt would therefore be lower than if risk-free assets were in large supply. Assume now that an ESBies is issued in this market. With a much larger supply of risk-free assets, investors will be unwilling to purchase sovereigns of vulnerable countries at the margin. Neither the demand by the financial entity in charge of creating the ESBies could compensate for this, because the composition of its portfolio is constrained by the chosen objective parameter, for example the contribution to aggregate nominal GDP. In the end, the marginal cost of financing the debt of a vulnerable country would therefore be higher than if risk-free assets were in short supply.

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo 15.69 In our view, under ‘normal’ long run conditions a combination of ‘horizontal’ and

‘vertical’ risk discrimination along the lines of the proposals by Brunnermeier et al (2011 and 2016) and Corsetti et al (2015) is preferable to the simple ‘horizontal’ discrimination advocated by the German Council of Economic Experts.41 In fact, while both proposals guarantee identical results with respect to the ability to break the bank-sovereign loop and to create correct incentives for fiscal discipline, the former also solves the problems of an insufficient supply of risk-free assets and of an insufficient demand of government bonds in vulnerable countries. Both issues are rightly of great concerns to bankers and policy makers, especially in vulnerable countries.

15.70 A third proposal was put forward at the beginning of 2018 by a group of seven

French and seven German economists, who signed a common proposal in a paper known as the 7+7 report’s.42 The paper addresses the issue of risk-sharing versus market discipline in general terms, starting from the bank leg of the doom loop. The paper argues that, to favour the completion of the Banking Union and the capital markets union, a common deposit insurance scheme should be introduced, and at the same time sovereign concentration charges and tighter treatment of NPLs should be imposed on banks.

15.71 Considering the present institutional stalemate, the 7+7 proposal on EDIS is

pretty bold. It envisages the setting-up of a common scheme under a unique institutional umbrella. Yet the scheme would preserve national compartments that would initially cover national losses. Common resources would possibly be in a separate fund and tapped on only once the national compartment is exhausted, or following a systemic or cross-border event. The fact that countries keep skin in the game, combined with differentiated insurance premia based on country risk, aim at reducing moral hazard.43 The proposal also envisages a common fiscal backstop, possibly the ESM. A crucial aspect of the proposal is that all funding should be recouped from the industry. Moreover, new EU legislation should be passed that eliminates ring-fencing of capital and liquidity at the national level.

15.72 The treatment of sovereign concentration is especially relevant to our discussion.

According to the 7+7 proposal, whenever the balance sheet of a bank reaches a high concentration in the debt of a single sovereign issuer, the bank should be required to increase its capital, as part of a mandatory Pillar 1 requirement.44

41 See Brunnermeier et al, ‘European Safe Bonds (ESBies)’ (n 39); Brunnermeier et al, ‘The Sovereign-Bank Diabolic Loop and ESBies’ (n 5); and Corsetti et al (n 39). 42 See Bénassy-Quéré et al (n 39). 43 D Schoenmaker, Building a stable European Deposit Insurance Scheme (2018) Voxeu CEPR Policy Portal. Centre for Economic Policy Research, London, discusses the moral hazard issue concerning the design of EDIS. 44 L Bini Smaghi, ‘A stronger euro area through stronger institutions’ (2018) VoxEU CEPR Policy Portal, criticizes this aspect, arguing that it would be preferable to assign the responsibility of assessing excessive concentration to the Single Supervisory Mechanism instead (SSM), according to Pillar 2.

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Doom Loop or Incomplete Union? Sovereign and Banking Risk Although the proposal emphasizes that ‘the sovereign concentration charges for banks should be phased in gradually, announced at a time when the debts of all euro area countries that depend on market access are widely expected to be sustainable, as is currently the case if fiscal policies stay on track; and combined with other reforms that reduce sovereign risk’, its possible destabilizing effects should be carefully assessed.45 Along the same lines, a proposal for a Sovereign Concentration Charges Regulation (SCCR), jointly with EDIS, was put forward for discussion at the European Parliament by Véron (2017), one of the authors of the 7+7 paper.46 Another proposal in the 7+7 paper addresses the sovereign leg of the doom loop. 15.73 The suggestion is to set up a new common fiscal fund to address large economic disturbances, defined as those above a given threshold, for example in terms of the unemployment rate, leaving the management of smaller shocks at the national level. The fund should be financed by each country in proportion to the likelihood that it might draw from it, possibly measured by a simple expenditure rule guided by a long-term debt reduction target. Finally, along the line of the ESBies proposal, the 7+7 paper also supports the intro- 15.74 duction of a Euro area safe asset. However, though with some different features, even this proposal generates a series of concerns related for example to the liquidity of the junior tranche. Most of the proposals discussed have emerged in academic circles or at the European 15.75 Systemic Risk Board.47 The institutional debate at the European Union level is not very encouraging. On EDIS the stalemate of risk mutualization versus risk reduction is still freezing any further step. The European Commission (2017a), in its position paper on the deepening of the economic and monetary union, favours an agreement to implement EDIS by the end of 2019, but it does not propose changes on the treatment of sovereign exposures until 2020. Also, in the European Commission’s proposal released in November 2017 to update the capital requirement directive and regulation (CRD2 and CRR2), no significant modifications were included on the treatment of sovereign debt risk.48 In contrast, a recent document by the Council of the European Union (EU Council (2018)) takes a more

45 See M Messori and S Micossi, ‘Counterproductive Proposals on Euro Area Reform by French and German Economists’ (2018) CEPS Policy Insight No 2018/04, Center for European Policy Studies, Brussels, for a critical assessment of the proposal. 46 N Véron, ‘Sovereign Concentration Charges: A New Regime for Banks’ Sovereign Exposures’ (2017) Directorate for Internal Policies, European Parliament. 47 European Banking Association, ESBR report on the regulatory treatment of sovereign exposures (2015). 48 In particular, while the proposed changes to art 493 of the Capital Requirement Directive (CRD) (item 120 of the Commission’s CRR2 proposal of November 2016) aims at reducing EU banks’ future sovereign debt exposures, the modification is only transitional and does not cover the permanent exemption guaranteed by art 400.

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G B Navaretti, G Calzolari, J M Mansilla-Fernández, and A F Pozzolo restrictive view, arguing that any liquidity support initially provided by EDIS should be reimbursed by national deposits guarantee schemes, and any potential losses stemming from pay-outs would have to be borne at the national level.49 15.76 The seminal Five President Report of 2015 (EPSC (2015)) also makes two major

points concerning the doom loop: (i) that the zero risk weight and large exposures allowances on sovereign debt within the European Union require reconsidering; (ii) that it is necessary to review the treatment of large exposures to sovereign debt in the medium term. But concrete proposals are still lacking.50

V. Summing-up, Transition, and Notes of Caution 15.77 Reaching an agreement on EDIS would be a significant step forward to unlock

the bank-sovereign diabolic circle. Failing to do so might ignite renewed pessimism about the future of the banking union and the Eurozone itself.51 While lately the prospects of relatively stronger economic growth reduced the likelihood that any Eurozone country faced a sovereign debt crisis, the end of QE and increased political uncertainty makes the foreseeable scenario less optimistic.52

15.78 More in general, as argued by Bini Smaghi (2018), ‘there should in any case be

no illusion that rules are sufficient to eliminate the doom loop. Even if banks had limited holdings of government bonds, they would nevertheless suffer disproportionally from a shock affecting their country’. Creating a fully integrated financial market in the Euro area seems the only viable alternative, but achieving the level of integration necessary to fully eradicate the doom loop will require a long stretch of time. Unfortunately, such a luxury may not be in the cards. Policy makers and bankers therefore must start by addressing the legacy problems during the transition period towards full integration.53 See Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC. Directive 2009/111/EC (CRD2) of the European Parliament and of the Council of 16 September 2009 amending Directives 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certain own funds items, large exposures, supervisory arrangements, and crisis management. Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) 648/2012. 49 European Commission, ‘Reflection Paper on the Deepening of the Economic and Monetary Union’ (2017) Brussels, 31 May. 50 European Political Strategy Centre, ‘Further Risk Reduction in the Banking Union’ (2015) Five Presidents’ Report Series, Issue 3. 51 See European Commission (2017), ‘Communication on completing the Banking Union’, Brussels, 11 October; and Véron (n 50). 52 O Blanchard and J Zettelmeyer, Will Rising Interest Rates Lead to Fiscal Crises? PIIE Policy Brief 17-27 (Peterson Institute for International Economics 2017). 53 See Bini Smaghi (n 48).

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Doom Loop or Incomplete Union? Sovereign and Banking Risk Tabellini (2018) has a subtle discussion of the problems that 7+7 proposals would 15.79 face in their short-run implementation. He argues that removing shock absorbers such as banks purchases of weak sovereigns would make the system even more fragile.54 Visco’s concern (2016) of losing the role of banks when smoothing excessive variability in financial markets is especially relevant, in particular when asymmetries in the European monetary union are sizeable. Banks’ balance sheets still contain relatively high levels of risk in form of sovereign debt and non- performing loans (NPLs), although the recent issuance of NPLs and enhanced economic conditions begin improving access to finance. Since markets tend to frontload regulatory changes, even a slow path to a fully ‘horizontal’ risk discrimination could cause huge problems to banks and sovereigns.55 The magnitude of these effects will be large, specifically for vulnerable countries. 15.80 The effects of removing the zero weights on sovereign bonds in relatively vulnerable countries could become disruptive in case of worsening fiscal conditions. Furthermore, limits on large exposures might imply a considerable reduction in assets, or adjustments in the portfolio towards other countries than those vulnerable. Indeed, if it is not easy to find a consensus on the optimal long-run solution for the doom loop, shorter-run challenges appear even stronger. The lack of risk-sharing mechanisms at the beginning of the financial crisis has been 15.81 responsible for the acceleration of the bank-sovereign doom loop in the Eurozone. This problem can only be addressed by combining enhanced risk-sharing and a tighter regulatory frameworks to reduce risk asymmetries among sovereigns. We believe that the banking union, with an EDIS and the ESM acting as a fiscal backstop, should be completed swiftly. But this will work only if problems are tackled at their very root. While the cleaning of banks’ balance sheets is proceeding, what is still lacking is a credible commitment to debt reduction in highly indebted countries, possibly with the help of institutional constraints on national fiscal policies, which have proved more effective than it is commonly recognized in disciplining fiscal policies. The political feasibility of any alternative strategy— such as that advocated by Feld (2018) of addressing the legacy problems head on, even accepting some degrees of mutualization, with the aim of reducing the risks ahead—seems rather questionable (Pisani-Ferry, 2018).56 Indeed, if a broad theme can be found by looking at the debate on the doom loop, it is that, aside from reducing the link between banks and sovereign crisis, a final solution can be found only by reducing excessive debt.

See Tabellini (n 24). 55 See Visco (n 2). 56 L Feld, ‘Whither a Fiscal Capacity in EMU’ (2018) VoxEU CEPR Policy Portal; and J Pisani- Ferry, ‘Euro Area Reform. An Anatomy of the Debate’ (2018) CEPR Policy Insight No 95, Centre for Economic Policy Research, London. 54

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16 BANK RESOLUTION IN EUROPE The Unfinished Agenda of Structural Reform Jeffrey N Gordon and Wolf-Georg Ringe*

I. Introduction II. The Regulatory Aftermath of 2007–2008 and the Emergence of EU Bank Resolution III. The Path to Single Point of Entry Resolution in the US

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IV. The US Path to Holding Companies V. SPE for Europe: The Structural Reform Project VI. Conclusion

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I. Introduction This chapter argues that the work of the European Banking Union (‘EBU’) 16.01 remains incomplete in one important respect, the structural re-organization of large European financial firms that would make resolution of a systemically important financial firm a credible alternative to bail-out or some other sort of taxpayer assistance. Resolution is a critical piece of the EBU, because without a credible capacity to resolve a large financial firm, a supervisor is deprived of the ultimate disciplinary tool to control moral hazard and to constrain excessive risk-taking. As it now stands, the resolution procedure for EU firms will fail two critical tests for the preservation of systemic stability. Firstly, short-term credit claims will be insufficiently protected, meaning that

This is an updated version of Chapter 15 in the first edition of this book. We are grateful for * very helpful comments on prior presentations of this work by participants at the European Banking Union conference that preceded this book, the ESSET seminar in Gerzensee, and the EU Financial Architecture session at the World Bank Law, Justice and Development Week Conference, and various EU and other governmental officials who have given us informal reactions.

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Jeffrey N Gordon and Wolf-Georg Ringe financial distress could easily lead to an exacerbating spiral of runs, fire sale asset dispositions, and credit market freezes. Secondly, financial distress may have uneven impact along national dimensions, which will lead to national ring-fencing ex ante and ex post. The consequence will be an unacceptable risk of a disorderly resolution that will, in prospect, produce regulatory forbearance and may well lead to a more calamitous failure later, a bail-out or some other form of taxpayer rescue. 16.02 But there is an alternative: for EU financial firms to move to a holding company

structure so that the focus of resolution can be at the holding company level, minimizing disruption of the ordinary business of the operating financial subsidiaries. Such a holding company structure arose by accident in the United States but has provided the basis for the current implementation of Dodd- Frank’s mandate for orderly resolution of a failed financial firm, ‘Single Point of Entry’ (‘SPE’). Under this approach, losses at the bank subsidiary would be upstreamed to the holding company (‘HoldCo’), first to be charged against HoldCo’s capital and then, if necessary, to trigger a resolution in which HoldCo only is put into resolution—the ‘single point’—so that further losses can be charged to unsecured term debt held at the HoldCo level. This unsecured term debt, which is structurally subordinated to credit claims against the subsidiaries because held by HoldCo, is thus ‘bailed in’ and converted into equity. The objective is to reduce financial distress by protecting the value of the resolved firm, minimizing contagion throughout the financial sector, and minimizing jurisdictional competition for assets.The perceived credibility of this resolution approach has been reflected in the reduced funding advantage for large US final firms over smaller ones, suggesting that a credible resolution threat can mitigate ‘too big to fail’.1

16.03 In 2014, the EU had proposed a ‘Structural Measures Regulation’, which chiefly

considered whether to adopt a form of the US ‘Volcker Rule’ to limit proprietary trading by large credit institutions and to require a separately capitalized subsidiary for trading activities that remained permissible.2 Unfortunately, that proposal was eventually withdrawn in 2018.3 Our argument is that a vital addition to structural renovation is the requirement of a holding company form for systemically important financial institutions in the EU. It might be possible to achieve such an outcome via a number of different channels: through the ‘living wills’

1 US Government Accountability Office, ‘Large Bank Holding Companies—Expectations of Government Support’, July 2014, GAO-14-621. See generally on the connection between a credible resolution system and banks’ risk-taking, Magdalena Ignatowski and Josef Korte, ‘Wishful Thinking or Effective Threat? Tightening Bank Resolution Regimes and Bank Risk-Taking’ (2014) 15 Journal of Financial Stability 264. 2 Proposal for a Regulation of the European Parliament and of the Council on structural measures improving the resilience of EU credit institutions, COM(2014) 43 final (29 January 2014). 3 Withdrawal of Commission proposals (2018/C 233/05), [2018] OJ C233/6.

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Bank Resolution in Europe review process under the Bank Recovery and Resolution Direction (‘BRRD’)4 as the supervisor comes to decide that a holding company structure is essential for ‘feasibility of resolution’ of a particular firm; through capital requirements under the Capital Requirements Regulation (‘CRR’) and the Capital Requirements Directive IV (‘CRD IV’);5 through the assessment of extra capital charges for a firm without a holding company structure in the stress tests administered by the European Central Bank (‘ECB’) or the European Banking Authority, or a structurally-sensitive systemic risk assessment on a Global Systemically Important Bank (‘G-SIB’) as contemplated by Basel III. Concerns for the stability of the system as a whole—macroprudential considerations—would argue for a prescriptive adoption of an organizational structure for systemically important financial firms that would minimize a resolution shock. Precisely because the resolution of any systemically important financial firm carries the risk of systemic distress and of high externalities, G-SIBs should not have the option of persisting in an organizational form that increases such risks. Thus the mandatory structure should become a public HoldCo parent for the operating subsidiaries of the banking group, set up so that the assets of HoldCo consist of shares in its subsidiaries, and that its liabilities are confined to unsecured term debt. This was the missing piece of the proposed Structural Measures Regulation and remains a missing piece for a credible Single Resolution Mechanism (SRM) in the Banking Union. This chapter means to operate on two levels. It argues for the reorganization of 16.04 European G-SIBs away from the current universal bank structure into the holding company structure to facilitate SPE as an efficient resolution methodology. Yet there is more at stake than just a technology for minimizing the financial distress associated with the failure of an important financial firm, and a claim that an approach that happens to fit well in the US case ought to be transplanted elsewhere. The reason in a nutshell is this: The most effective possible resolution mechanism is necessary because the European-wide ambitions embodied in the Banking Union project are not matched by European resources than can reliably be counted on to protect the European financial sector in a crisis. Banking assets have been a multiple of some national budgets; few if any governments can offer

4 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/ 25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU, and 2013/36/EU, and Regulations (EU) 1093/2010 and (EU) 648/2012, of the European Parliament and of the Council, [2014] OJ L173/190 (‘BRRD’). 5 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/ 49/EC [2013] OJ L 176/338 (CRD IV); Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) 648/2012, [2013] OJ L 176/1 (‘CRR’).

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Jeffrey N Gordon and Wolf-Georg Ringe credible deposit guarantees. There is no agreement on how to pool resources at the EU federal level to mutualize failure risks. Thus large financial institutions must self-insure. Yet we need a mechanism that can minimize the costs of self-insurance so as not to unduly burden the European financial system. 16.05 The most effective possible resolution mechanism is also necessary to break the

link between sovereigns and banks. Without an effective resolution mechanism, the supervisors ultimately are at the mercy of Member State governments, who have resources, financial and political, and reason to shield national champions. Yet this will open the way to Member State insistence on supervisory forbearance. It will also sustain ties between national G-SIBs and Member States in which such prospective shielding is the quid pro quo for the bank’s finance of sovereign indebtedness beyond a margin of safety. Moreover, the complicated structure of EU federalism, in which Member States retain sovereignty in the set-up of their local financial system, in which governments will be strongly sensitive to national interests in a crisis, argues for a system that minimizes pressures and opportunities for value-destructive ring-fencing.

16.06 One consequence of the European financial crisis has been to undermine pop-

ular confidence in the management of the European financial system. An organizational form that convincingly demonstrates the non-taxpayer sources of loss-bearing in a subsequent crisis will help restore trust. Thus an advantage of the holding company structure with sufficient loss-bearing unsecured term debt in the public parent is the transparency of the private, not public, exposure to losses.

16.07 Finally, the Banking Union also bears an important relationship to the ongoing

Capital Markets Union project.6 Financial firms may become more complex; new forms of credit institutions may well arise. An organizational form that comprehends such changes, that is built to handle resolution from the start, is an important element.

II. The Regulatory Aftermath of 2007–2008 and the Emergence of EU Bank Resolution 16.08 The 2007 financial crisis triggered two major regulatory reform waves. The first

wave, near completion, has been generated by the most remarkable surge of global governance in the financial realm since Breton Woods in 1944. The hallmark has been a series of G-20 Leaders’ Summits that in turn catalysed an unprecedented regulatory outpouring. Shortly after the financial crisis exploded in September 2008 with the bankruptcy of Lehman Brothers, then US President

See Green Paper, ‘Building a Capital Markets Union’ COM (2015) 63 final, 18 February 2015. 6

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Bank Resolution in Europe George W. Bush convened a meeting of the leaders of the twenty most significant global economic players, both developed and emerging market countries, the so- called G-20.7 This particular multinational grouping was first assembled in 1999 to address the East Asian financial crisis but had not played a genuinely significant role in global economic co-ordination in the following decade. But the financial crisis showed the value of global financial co-ordinating bodies, even purportedly ineffectual ones, because they presented a pre-existing structure for collaboration. Beginning with the November 2008 Leaders’ Summit, and continuing through 16.09 many successive summits over the years, the G-20 has played a major role in driving the agenda for global financial reform. The G-20 transformed a toothless Financial Stability Committee into the Financial Stability Board (FSB), tasked with a major agenda-setting role.8 The Basel Committee on Banking Stability, the international standard-setting body of central bankers that had laboured for six years to produce the Basel II accords,9 quickly produced a revision, Basel 2.5, to control risk-taking in the bank’s trading book, and then, in December 2010, Basel III, which provided for comprehensive strengthening of the bank’s balance sheet. The various elements of the Basel III accord were filled out in December 2017.10 By the end of 2018, all global banks should have ‘fortress’ balance sheets, including at least 13% in risk-weighted capital (counting various buffers and minimum surcharges), a ‘supplementary leverage ratio’ of at least three per cent, and, to protect against run risks and other adverse effects of a liquidity squeeze, a suitable ‘liquidity coverage ratio’ and a ‘net stable funding ratio’.11 7 See Colin I Bradford, Johannes F Linn, and Paul Martin, ‘Global Governance Breakthrough: The G20 Summit and the Future Agenda’, Brooking Policy Brief No 168, December 2008 (available online at ). 8 See James R Barth, Chris Brummer, Tong Li, and Daniel E Nolle, ‘Systemically Important Banks (SIBs) in the Post-Crisis Era: “The” Global Response and Reponses Around the Globe for 135 Countries’ in Allen N Berger, Philip Molyneux, and John O S Wilson (eds), The Oxford Handbook of Banking (2nd edn, Oxford University Press, 2015) ch 26 (describing G20-FSB interaction and initiatives); Daniel E Nolle, ‘Who’s in Charge of Fixing the World’s Financial System? The Under-Appreciated Lead Role of the G20 and the FSB’ (2015) 24 Financial Markets, Institutions & Instruments 1. 9 Daniel K Tarullo, Banking on Basel: The Future of International Banking Regulation (The Peterson Institute for International Economics, 2008). 10 The particulars are spelled out online at https://www.bis.org/bcbs/publ/d424.htm. 11 For a general summary see Mark Carney, ‘The Future of Financial Reform’ Speech at the 2014 Monetary Authority of Singapore Lecture, 17 November 2014 (available online at ; Paul Tucker, ‘Regulatory Reform, Stability, and Central Banking’, Hutchins Center of Fiscal and Monetary Policy at Brookings, 16 January 2014 (available online at ); Jaime Caruana, ‘Building a Resilient Financial System’, keynote speech, 2012 ADB Financial Sector Forum on ‘Enhancing Financial Stability—Issues and Challenges’, Manila, 7 February 2012 (available online at ).The Basel Committee monitors transposition of the Basel III standards into domestic law on a semiannual basis. The May 2019 report is available online at . Most jurisdictions were found to have made progress in implementing regulatory requirements in a timely way, except for the Net Stable Funding Ratio (NSFR) (available online at . In the EU, the NSFR will

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Jeffrey N Gordon and Wolf-Georg Ringe 16.10 This reform wave has also produced an international consensus on the need for a

special mechanism: resolution rather than bankruptcy, for a large failing financial institution and an insistence that the costs of failure should be borne by the firm’s shareholders and creditors rather than taxpayers.12 The FSB produced a guidance document, ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’, adopted in 2011 and updated in 2014, reflecting and shaping this consensus.13 This influential guidance contemplated an administrative receiver with significant discretionary authority, modelled on the US Federal Deposit Insurance Corporation (FDIC). It also contemplated advance planning by large financial institutions that would facilitate an orderly resolution process, so-called ‘living wills’, modelled after comparable provisions of the US Dodd-Frank Act.14 The companion element of this consensus, so-called ‘bail-in’, is now reflected in the FSB’s Total Loss Absorbency Capacity (‘TLAC’) standard (roughly, equity plus subordinated term debt) scaled to a least twice the amount of required equity capital on both risk-weighted and leverage measures.15 The objective is to enable a resolution authority to recapitalize a failed systemically important financial firm by effecting the conversion of existing unsecured term debt into equity. The firm- specific required level of TLAC will vary, depending on the particular institution, from at least 16% up to 25% of risk-weighted assets.16 In effect each firm will ‘pre- fund’ its resolution costs. By taking taxpayers off the hook in recapitalizing the failed firm, the TLAC requirement will make the resolution threat more credible as well as reducing the knock-on effects from the resolution of any particular firm.

16.11 But there was a second major reform wave, with a European focus. This second

wave, generated by the urgent need to respond to the Eurozone-specific aftershock

be implemented, with a number of adjustments, as an amendment to the Capital Requirements Regulation by virtue of the 2019 Banking Package, see online at . 12 This two-sided consensus has been dubbed a ‘ “bookends’ strategy”: make financial institutions a lot more resilient but also make them resolvable without taxpayer solvency support’. See Tucker (n 11) 6. 13 FSB, ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’, 15 October 2014 (available online at ). See also FSB, ‘Understanding the Key Attributes: Guidance on the implementation of the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions’, 22 August 2016 (available online at ). 14 Dodd-Frank Act, §165(d). 15 FSB, ‘Total Loss-Absorbing Capacity (TLAC) Principles and Term Sheet’ (9 November 2015), available at . In Europe, the TLAC concept is implemented by virtue of the 2019 Banking Package (n 11). 16 FSB (n 15) 10. The threshold limits were based on calculation of losses during the recent financial crisis in an earlier consultation document. See FSB, ‘Issues for Consideration in the Development of a Proposal on Adequacy of Loss Absorbing Capacity in Resolution’, memo to Steering Committee, SC/2013/45, 18 December 2013.

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Bank Resolution in Europe of the financial crisis, resulted in the creation of the Banking Union. In the effort to mitigate the threat to European banks as the global financial crisis unfolded in autumn 2008, EU Member States provided sweeping forms of state support, ranging from direct state backing for recapitalization of particular banks to broad guarantees of the entire banking system.17 Because banking assets were commonly a multiple of some Member States’ GDP, such broad commitments threatened to exceed the funding capacity of the sovereigns that made them.18 Moreover, the financial crisis immediately put the Member States into recession, which placed additional stress on national budgets, sovereign creditworthiness, and the capacity to support an ailing banking sector. The problem was exacerbated by the heavy loading of own-sovereign and other EU-sovereign debt on bank balance sheets. This was partly a function of: (i) Basel rules that carried a ‘0%’ risk-weighting for OECD sovereign debt (which permitted banks to earn a ‘risky’ spread on purportedly risk-free assets19); and (ii) the implicit Eurozone guarantees behind all Eurozone member sovereign debt issued after European Monetary Union. Thus as sovereign credit came under attack (reflected in widening credit default swap spreads), banks faced a double whammy: (i) rising solvency risk because of the deterioration of both the sovereign portfolio and the private lending portfolio; and (ii) diminishing capacity of many Member States to provide financial support either through recapitalization or credible guarantees. To much-simplify a complicated scenario: the distinctly European financial crisis 16.12 came to a head over Greece, in two distinct episodes over the 2010–2012 period, an ongoing sovereign debt crisis that threatened to bring down large European banks that held large amounts of Greek sovereign debt. Moreover, the contagion from Greece’s fiscal troubles threatened to close down the sovereign debt markets for other Eurozone countries, initially Portugal and Ireland but spreading, which exacerbated the pressure on bank balance sheets. In short strokes: Greece faced the risk of sovereign default in mid-2010, but was ‘bailed-out’ through a package of loans from the International Monetary Fund (‘IMF’) and the EU and liquidity support from the ECB, in exchange for an austerity programme that would

17 The European Commission has estimated the level of state aid as €4.9tn (39% of EU GDP), of which €1.7tn (13.5% of EU GDP) was actually deployed. Guarantees and liquidity support maxed out in 2009 at €906bn (7.7% of EU GDP). See also ‘High-level Expert Group on Reforming the Structure of the EU Banking Sector: Final Report’, chaired by Erkki Liikanen, Brussels, 2 October 2012 (Liikanen Report) 20–5 (available online at ). The Liikanen Report also provides a useful account of the Eurozone crisis of 2010–2012 at 8–11. 18 See Alberto Gallo et al, ‘The Revolver—European Banks: Still too Big to Fail’, RBS Macro Credit Research, 23 January 2014 (available online at ); see also Liikanen Report (n 17), 11–19, 39–41,  119. 19 See Viral V Archarya and Sascha Steffen, ‘The “Greatest” Carry Trade Ever? Understanding Eurozone Bank Risks’ (2015) 115 Journal of Financial Economics 215; Daniel Gros, ‘Banking Union with a Sovereign Virus: The Self-serving Treatment of Sovereign Debt’ (2013) 2 Intereconomics 94.

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Jeffrey N Gordon and Wolf-Georg Ringe purportedly reduce debt burden as a percentage of GDP. Sovereign creditors were fully protected. As economic conditions continued to deteriorate, in 2011 Greece once again faced imminent sovereign default, unable to rollover its existing debt or undertake new issuances—Portugal and Ireland came under similar pressure in this time frame. The EU/IMF parties provided additional financial support to Greece (and others), accompanied by various sorts of economic conditionality. This time, however, Greece defaulted, albeit in an orderly manner, as private sovereign bondholders (but not the ECB) were required to take a 50% nominal haircut on their holdings, as high at 75% in real terms. The negotiations over the actual bail-out/haircut terms were protracted, a gruelling six months over the period October 2011–March 2012. 16.13 This was the crucible within which the EBU was formed.20 Its creation has been

described as a ‘revolution’ and the ‘most ambitious project since the creation of the euro’.21 What does ‘Banking Union’ entail? In critical part it means a ‘Single Supervisory Mechanism’ through which the ECB organizes the supervision of all ‘significant’ banks in the Eurozone, and a ‘Single Resolution Mechanism’ that prescribes a procedure for addressing the failure of large banks in the Eurozone. A common deposit guarantee scheme, which was planned initially, does not appear to be forthcoming in the near future. The SRM was a highly controversial element of Banking Union. This was for two reasons. Firstly, the SRM would put the fate of a national champion bank in the hands of federal Eurozone banking authorities at a time of financial distress. This would limit the capacity of governments to use the bank as an instrumentality of national purpose through, for example, concessionary loans to favored domestic borrowers that do not appear on the public balance sheet, and as an agent of public finance, as a guaranteed purchaser of government debt. Secondly, the SRM came packaged with a funding mechanism, the Single Bank Resolution Fund, which will comprise at least €55bn (ultimately 1% of deposits) available to support a failed bank during the resolution process, although it is not designed to take losses, to bail-out any bank creditors. In effect, the Eurozone Member States had agreed to mutualize the responsibility for reorganizing a large bank, at least to a limited extent. This apparently raised the specter of cross-government subsidies, even though the fund was to be filled through a levy on the banks themselves. To quiet political and constitutional concerns, the funding proposal was outsourced into a separate intergovernmental agreement.

20 The relevant history with supporting footnotes and more detail is described in Jeffrey N Gordon and Wolf-Georg Ringe, ‘Bank Resolution in the European Banking Union: A Transatlantic Perspective on What It Would Take’ (2015) 115 Columbia Law Review 1297. The following paragraphs draw from that paper. 21 Commissioner Michel Barnier, ‘The EU and US: Leading Partners in Financial Reform’, speech at the Peterson Institute for International Economics, Washington DC, 13 June 2014 (available online at ).

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Bank Resolution in Europe Precisely because resolution of a large bank touches on sovereignty, the enabling 16.14 legislation created an elaborate triggering mechanism that culminates with a final sign-off by the European Commission and Council. First, the legislation established a ‘Single Resolution Board’ which interacts with the ECB in deciding whether to initiate a resolution and how to manage it. The ECB (as supervisor) determines whether the bank is failing or likely to fail and notifies the Board. The Board then decides whether such a failure would present a systemic threat, whether there is a private alternative, and then whether to make an allocation from the Fund to support the resolution.22 The resolution scheme thus formulated is presented to the European Commission and Council, which has 24 hours to accept or reject the proposal. Because of the exigencies of time and circumstance, it is likely that the joint decision of the ECB and the Board will be determinative. The central move in the creation of a EBU is the federalization of key elements 16.15 of bank regulation even for entities that are regarded as ‘national champions’. The goal is to break apart the link between sovereigns and their banks that figured so prominently in the distinctly Eurozone phase of the global financial crisis. Breaking this linkage works only if a financial firm can be successfully resolved without sovereign support and only if the resolution itself does not trigger a follow-on wave of failures of other financial firms. This is where the structural dimension becomes critical. The core message of Basel III is that banks should not look to sovereigns for 16.16 rescue. At one level this is a response to taxpayer outrage at bail-outs (appreciating all the messiness in distinguishing a ‘bail-out’ from ‘liquidity support by a lender of last resort’). But even more importantly, Basel III is shaped for a global financial environment in which no sovereign (except for the US, as issuer of the world’s reserve currency) can credibly stand behind its banking system. Many banks, especially in Europe, are simply too large relative to the states that charter them. In the run-up to the crisis the US may have permitted financial firms that were ‘too big to fail’; Europe was filled with banks that were ‘too big to save’. The G20’s approach to this dilemma is TLAC: on top of a balance sheet structured to reduce the risk of failure—the capital and liquidity requirements described above—a bank must carry a level of bail-in-able term debt sufficient to recapitalize the bank even after the equity cushion is fully wiped out by losses.23 The previous 22 The Single Resolution Board consists of two tiers of members: an executive committee of four permanent members that decides specific cases and a ‘plenary’ consisting of representatives from the Eurozone Member States, which controls allocations from the Fund. 23 The concept of recapitalization through bail-in is already reflected, for the EU, in the Bank Resolution and Recovery Directive’s concept of Minimum Requirement for Eligible Liabilities (MREL). Some have questioned why TLAC should consist of subordinated term debt rather than equity, since equity is unambiguously loss-absorbing whereas debt is loss-absorbing only through operation of law. There are at least three reasons. Firstly, term debt will be cheaper than equity, both because of clientele effects as well as the tax preference for debt. Some financial intermediaries that can hold a bank’s subordinated term debt may be unable or unwilling to hold equity either

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Jeffrey N Gordon and Wolf-Georg Ringe mechanism of providing systemic stability through a crisis, deposit insurance—a scheme by which banks pool risks in a mutual insurance scheme run by a particular government and backstopped by the government as a ‘reinsurer’—plays no obvious role in this regulatory plan. The point is to take sovereigns out of the picture and, through bail-in, to require banks to self-insure.24 16.17 This setup will work only if the losses that are recognized in the resolution

process are less than TLAC, if the resolution does not trigger an own-firm run, and if the own-firm resolution process does not trigger runs by credit suppliers at other financial firms. It is also important for a resolution scheme to facilitate cross-border financial stability, meaning that for transnational financial firms, the resolution system should not encourage opportunistic intra-firm ‘runs’, designed to reallocate losses within the firm on a national basis, which will in turn spur pre-emptive host country ring-fencing. By these measures, the current structure of the EU’s banks will impede efficient resolution. Systemically important European banks, typically organized as ‘universal banks’,25 have a complex organizational structure in which various financial services are provided by divisions of the bank or through subsidiaries of the bank.26 Putting an operating bank or some other operating financial entity through a resolution procedure will have unpredictable effects on the solvency of other subsidiaries because of practical portfolio needs (matching payout obligations with term liabilities) or legal reasons (constraints on holding equity versus debt). The tax preference for debt is a separate (private) cost-reducer. Secondly, debt and equity will trade differently in ways that will provide regulators and other observers with useful signals. Changes in market prices net of interest-rate factors and credit default swap spreads will reflect useful assessments by market participants of the bank’s solvency. Thirdly, bail-in of term debt will effect an ownership change; existing shareholders are replaced by post-conversion shareholders; presumably new directors are installed. This is a more dramatic ‘resolution’ than just the dismissal and replacement of senior managers following a regulator’s determination that the equity has fallen below a target level and may give current equity holders a stronger incentives to monitor against excessive risk-taking. 24 On the development and shortcomings of bail-in legislation, see Wolf-Georg Ringe, ‘Bank Bail-In between Liquidity and Solvency’ (2018) 92 American Bankruptcy Law Journal 299. 25 See Jordi Canals, Universal Banking: International Comparisons and Theoretical Perspectives (Oxford University Press 1997). 26 See James R Barth, Daniel E Nolle, and Apanard Prabha, ‘Banking Structure, Regulation, and Supervision in 1993 and 2013: A Cross-Country Comparison’ (2014) 13 Journal of International Business and Law 231; World Bank, ‘Bank Regulation and Supervision Survey’ (2011) (available online at ); James R Barth, Daniel E Nolle, and Tara N Rice, ‘Commercial Banking Structure, Regulation and Performance: An International Comparison Office of the Comptroller of the Currency’, Office of the Comptroller of the Currency (OCC) Working Paper 97-6, March 1997, Tables 5, 6a, and 6b (available online at ). Richard J Herring and Anthony M Santomero, ‘The Corporate Structure of Financial Conglomerates’ (1990) 4 Journal of Financial Services Research 471, 481–9; Richard Herring and Jacopo Carmassi, ‘The Corporate Structure of International Financial Conglomerates: Complexity and Its Implications for Safety and Soundness’ in Allen N Berger, Philip Molyneux, and John O S Wilson (eds), The Oxford Handbook of Banking (Oxford University Press 2010).

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Bank Resolution in Europe which may not be put into resolution and will have unpredictable effects on the claims of various credit suppliers, counterparties, and customers of the bank or affiliated financial firm. Such uncertainty is the trigger for a destructive spiral that will destroy value for the bank under resolution with knock-on effects for the financial system. The potential for uncertainty and value destructivity is immediately apparent in 16.18 two places. First, in the BRRD the protection for short-term credit providers is incomplete. Insured deposits, €100,000 or less, are protected through national deposit guarantee schemes. Deposits that exceed the insurable amount may be given priority over other unsecured credit claims that are not in form deposits, the so-called ‘deposits first’ principle, under the BRRD. But many sources of short funding by a bank or its financial affiliates are not deposits and thus seem disqualified for special protection. Take the reach-in of the bail-in tool in Article 44(2) of the BRRD, which excludes from bail-in, beyond covered deposits, certain liabilities with a maturity of less than seven days. Apart from its limited scope,27 this exemption is not the same as protection from loss of value in the ultimate settling up of claims on the failed institution. Unlike insured deposits, those claims are at risk of a haircut and parties will respond accordingly. Whatever the justice of pari passu, as a practical matter short-term creditors, to avoid the prospect of such losses, can ‘run’ simply by refusing to roll over their credit claims. This will trigger the immediate need for a financially stressed bank or its financial affiliates to shrink their balance sheet to match the corresponding fall off in funding. This is how financial crises begin. A second source of uncertainty and value destructivity in the European approach 16.19 to resolution becomes apparent in the TLAC concept itself. One of the specifically identified areas of concern is the prepositioning of TLAC in the various material subsidiaries of the bank, based not only on line of business but also on home/host considerations, so as to assure that TLAC is reliably available to recapitalize subsidiaries as necessary to support resolution.28 Such efforts to place not just capital but also subordinated (by contract) term debt on the balance sheets of the different subsidiaries of a large bank is highly unlikely to lead to smooth resolution in a crisis. One host grabbing more TLAC than it strictly needs to resolve a failed subsidiary within its jurisdiction (meaning other subsidiaries of the banking group are now less secure), one court (mis)interpreting the complex subordinated provisions of a bond issuance—these are sufficient to inject uncertainty that will destabilize the entire system.

27 The exemption is limited in substance as follows: it does not apply to liabilities arising from a participation in certain payment systems (with a remaining maturity of less than seven days) and to liabilities to other credit institutions or investment firms (with an original maturity of less than seven days). The objective is to ‘reduce risk of systemic contagion’ (Recital 70). 28 FSB (n 15) s 18.

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Jeffrey N Gordon and Wolf-Georg Ringe 16.20 The traditional European approach to resolution is commonly referred to a

Multiple Points of Entry (MPE), a phrase that pastes a calm description on a process that will at best be ad hoc and at worst chaotic. ‘We take each financial firm as we find it’ is the exact opposite of the administrative predictability and maintenance of consistent expectations that becomes increasingly important as market conditions themselves become more stressed and less predictable. The contrast is Single Point of Entry (SPE), a strategy employed by the FDIC that is designed to minimize value destructivity during the resolution process. The difference between SPE and MPE is precisely structural: because the public parent, a top level holding company, owns and supports the operating subsidiaries, the resolution fire-power and the TLAC bail-in liabilities can be concentrated on a single target.

16.21 To return to the insurance analogy: the capital and the subordinated term debt

that constitute TLAC should be understood as self-insurance for the credit claims that cannot be allowed to default, namely deposits and other short-term credit claims. Avoiding default on such claims is a matter of practical necessity, not morality, because otherwise during times of financial distress, such default risk will produce runs, fire sales, and the negative spiral that transmutes distress into a financial crisis that damages the real economy. Governments are simply not in a position to provide such insurance both because of financial constraints at the single country level and, as the fierce resistance of Germany demonstrated, the inability to supply credible transnational support within the European Union. MPE, which looks to identify failing subsidiaries or affiliates within a banking group, will require prepositioning of TLAC throughout the group. This is bound to be highly inefficient and will lead to destabilizing forbearance on how TLAC will be provided. Think of an industrial concern with multiple plants, each one of which is required to carry separate fire insurance sufficient to rebuild the plant— and the size (and value) of any particular plant will vary over time, given that the plant’s business activities may decline or increase depending on the business environment. Yet not all the plants will catch fire at the same time. The excess costs of this scheme if complied with literally are likely to lead to underinsurance at the individual plant level—noncompliance—and/or some sort of transferrable insurance rights or guarantees within the group that will lead to haggling and shortfalls at crunch time. So it is likely to be with prepositioned TLAC throughout a complex banking group, except that the consequences will be more dire.

16.22 Put otherwise, MPE may be a successful strategy for banking groups that operate

in distinct functional or regional units, with little integration among the units, so that it is genuinely possible to address these units separately even in the heat of a crisis.29 As described by the Financial Stability Board, MPE is ‘suitable for firms 29 See Paul Tucker, ‘The Resolution of Financial Institutions Without Taxpayer Solvency Support: Seven Retrospective Clarifications and Elaborations’, 3 July 2014 (available online at ).

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Bank Resolution in Europe with a decentralized structure and greater financial, legal and operational separation along national or regional lines, with sub-groups of relatively independent, capitalized and separately funded subsidiaries’.30 This description obviously does not mean to fit the case of European banks. European banks operate in the Single Market, with the goal of achieving capital mobility and financial integration in the European Union, much as industrial or commercial firms operate throughout the EU. Indeed, the EBU project is equally about affirming the internal market in banking as it is about breaking the ties between sovereigns and the systemically important banks. A structural organizational change to the holding company form that enables SPE is a commitment to ‘European banking’ as well as a mechanism that will facilitate credible resolution. In sum, the SPE approach to resolution at the holding company level has a number 16.23 of distinct advantages.31 First, it makes resolution more transparent and credible, as the ‘bail-in-able’ debt at the holding company level is earmarked and effectively available for regulatory activation. Unlike the current situation, the bank, market participants, and the regulator would be aware of the liabilities available for bail-in, which would enhance transparency and foreseeability of resolution effects; besides, their specific separation for resolution purposes would make assets across the banking group more valuable for their specific purposes.32 Secondly, SPE works much better in cross-border situations, facilitating an effective regulatory solution by one resolution authority and bundling the responsibility in one center of control. Indeed, one of the main points of critique of an MPE approach is that it would empower several regulators in various jurisdictions and thus create co-ordination problems, frictions, and a race to grab assets for the purpose of protecting national creditors.33 Finally, and most importantly, the SPE approach

30 FSB, ‘Recovery and Resolution Planning for Systemically Important Financial Institutions: Guidance on Developing Effective Resolution Strategies’, 16 July 2013 (available online at ). 31 In many policy initiatives, SPE is given preference over MPE. See, eg, Finma, ‘Resolution of Global Systemically Important Banks—FINMA Position Paper’, 7 August 2013; FDIC, ‘Resolution of Systemically Important Financial Institutions: The Single Point of Entry Strategy—Notice and Request for Comments’ (2013) 78 Federal Register 76614, 76615; Martin J Gruenberg, FDIC Chairman, ‘Comments to the Volcker Alliance Program’, Washington DC, 13 October 2013 (available online at ); FDIC and Bank of England, ‘Resolving Globally Active, Systemically Important, Financial Institutions’, 10 December 2012 (available online at ); European Parliament, Directorate General for Internal Policies, ‘Single Resolution Mechanism— Note’, February 2013. For a helpful overview, see Scope Ratings, ‘Holding Companies: The Right Vehicle for European Bank’s SPE Resolution?’, 11 September 2014 (available online at ). For a recent academic analysis, see Patrick Bolton and Martin Oehmke, ‘Bank Resolution and the Structure of Global Banks’, CEPR discussion paper 13032/2018. 32 This may be part of the explanation for why the rating of the holding company wouldn’t normally be much different from the rating of an integrated banking structure. See Scope Ratings (n 31) 2. 33 See European Parliament (n 33) 13.

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Jeffrey N Gordon and Wolf-Georg Ringe ensures that the operating subsidiaries can carry on their business and thus avoids fatal disruptions, destructive runs that can produce fire sale liquidations, negative asset valuation spirals and other knock-on effects. The double advantage of this last point is that because of the large savings anticipated by an SPE regulatory framework, the overall creditor losses associated with the resolution will be much less than in an unco-ordinated resolution, let alone ordinary bankruptcy proceedings. This in turn will reduce the level TLAC required to achieve systemic stability. 16.24 This chapter now proceeds to sketch out the SPE approach and the happenstance

history in which large US financial firms came to have holding company structures. It then builds out the case for adoption of this structural innovation in the EU as the missing element of EBU.

III. The Path to Single Point of Entry Resolution in the US 16.25 Single Point of Entry evolved as the way to apply the authority granted to the

FDIC in the Dodd-Frank Act to resolve a systemically important financial institution. The FDIC’s 1930s vintage resolution authority extended only to banks, which did not easily extend to address solvency problems for financial holding companies that included not just a large bank but also other substantial non-bank financial subsidiaries providing financial services.34 Nor did such resolution authority cover the problem of investment banks and other financial firms that had no link to the regulated banking sector. These problems manifested themselves in the necessarily ad hoc rescues of Bear Stearns, an investment bank; AIG, an insurance company; and Citigroup, a financial holding company with a large bank at its core. And of course the FDIC had no authority to avoid the disorderly failure of Lehman Brothers once the Federal Reserve and the Treasury decided that their respective capacities had run out.35 The problem with the ad hoc approach was not just that it might omit important cases (for example, Lehman Brothers) but that the strategies to avoid bankruptcy would necessarily protect all creditors. Bankruptcy or bail-out is not an appealing set of options.

16.26 Title II of the Dodd-Frank Act gave new authority to the FDIC, ‘Orderly

Liquidation Authority’, which despite the nomenclature, provided broad capability to reorganize a systemically important financial firm and considerable discretion in the treatment of unsecured credit claims of nominally equal priority, so long as the claimants received at least what they would have received

34 For a fuller account of the FDIC’s authority and bank resolution practices before the financial crisis, see Gordon and Ringe (n 20). 35 The FDIC’s (and Fed’s) authority with respect to these rescues (and non-rescues) is discussed in Jeffrey N Gordon and Christopher Muller, ‘Confronting Financial Crisis: Dodd-Frank’s Dangers and the Case for a Systemic Emergency Insurance Fund’ (2011) 28 Yale Journal on Regulation 185.

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Bank Resolution in Europe in bankruptcy. The FDIC quickly realized that the most important feature of a successful resolution is to minimize the knock-on risks associated with the resolution itself. Broader systemic distress would reduce asset values at the failed firm and make it harder to reorganize successfully. But broader distress could also lead to insolvency at other firms, potentially engulfing the financial sector, with a sharp negative impact for the real economy. Lehman Brothers, the disorderly resolution of which resulted in losses to unsecured third party creditors of nearly 80%,36 not to mention global financial distress, was the example of all to avoid. The Dodd-Frank Act addressed some of this directly. Lehman’s failure had in- 16.27 volved such extensive losses in part because the firm was entangled in a web of 900,000 derivatives trades, most of which terminated by reason of the filing of the bankruptcy petition. The Act defined a category of ‘qualified financial contacts’ and both abrogated application of various immediate default triggers and permitted the FDIC to transfer such contracts (appropriately bundled) to a successor financial firm.37 But a major additional concern for systemic stability is the run risk of diverse forms of short-term credit, which include various money market instruments, conventional deposits above the insured amount, and ‘repo’, short- term borrowing often secured by long-term assets of uncertain value.38 Failure to protect such short-term credit claims in a resolution would have severe spillover effects, since creditors of other institutions not (yet) in resolution would see advantages in withdrawing their funds. This would put immediate strain on liquidity-pressed financial firms and could lead to fire sale asset dispositions to raise cash, which would damage balance sheets throughout the financial sector, raising solvency concerns and leading to liquidity hording. Dodd-Frank granted the FDIC authority to vary payouts within a class of similarly situated unsecured creditors, if necessary to maximize asset values or to facilitate the receivership or the transfers to a bridge bank, so long as the discriminated-against party received at least the bankruptcy liquidation amount.39 Against resistance, the FDIC has produced regulations with a ‘short-term creditors first’ credo.40 Nevertheless the FDIC’s intention is not necessarily binding in a particular case because of statutory provisions that seem to require recourse to creditor payouts before assessing

36 For a detailed analysis of the Lehman Bankruptcy, see Michael Fleming and Asani Sarkar, ‘The Failure Resolution of Lehman Brothers’, Economic Policy Review, 3 April 2014 (available online at ). 37 Dodd-Frank Act, §§210(c)(8), (9), and (13). 38 See Gary Gorton and Andrew Metrick, ‘Securitized Banking and the Run on Repo’ (2012) 104 Journal of Financial Economics 425. 39 Ibid, §210(c)(4). 40 See 12 CFR, §380.27; see Implementing Certain Orderly Liquidation Authority Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 75 Fed Reg 64,173, 64,181 (proposed 12 October 2010) (proposing 12 CFR, pt 380.2); Interim Final Rule, 76 Fed Reg 4207 (adopted 19 January 2011) (requiring FDIC board action for such a preference).

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Jeffrey N Gordon and Wolf-Georg Ringe other financial institutions for repayment of Treasury funds used in the resolution.41 The possibility of ex post litigation (however unlikely) by assessed financial institutions seeking to claw-back payments to short-term creditors not covered by deposit insurance would add to run risk. Thus in planning for its exercise of Orderly Liquidation Authority the FDIC has to bridge two quite different goals. On the one hand, the over-arching purpose of the resolution provisions of the Dodd-Frank Act is to protect the US economy from financial distress; this justifies a special administrative procedure rather than bankruptcy. Yet the Act not only empowers the FDIC to impose losses on creditors but insists that taxpayers come ahead of creditors and, at several turns, wants to avoid bail-outs. 16.28 An additional source of potential spill-over distress from a resolution under Dodd-

Frank is with respect to the foreign subsidiaries of US financial firms. Although the FDIC has authority to impose its receivership on subsidiaries that are ‘in default or in danger of default’, its resolution authority apparently does not extend to foreign subsidiaries of US financial firms.42 This means that a failed foreign subsidiary, for example, UK Lehman Brothers, would be subject to the bankruptcy (or other resolution regime) of the host country, with the consequence of destabilizing uncertainty.

16.29 SPE was devised as the way to square these several circles. SPE takes advantage

of the characteristic organizational form of the largest financial firms in the US, especially ones that own a bank: the financial holding company. In such a structure, the holding company, ‘HoldCo’, is a public entity the principal assets of which are shares in various operating financial subsidiaries—such as a large commercial bank, a broker-dealer, an insurance company, and an asset manager— including various foreign subsidiaries in these diverse financial services areas. The subsidiaries are likely to have complex financial arrangements with one another, entailing the intra-organizational transfer of funds and collateral subject to various regulatory limits. The subsidiaries will face different short-term credit claimants with immediate liquidity rights, whether depositors or brokerage customers, and will have different counterparty relationships with set-off and liquidation of collateral provisions.

16.30 Paul Tucker, the former Deputy Governor of the Bank of England and head of the

FSB during the period when the international consensus on resolution emerged, describes the SPE process as follows: The first step involves transferring losses exceeding a subsidiary’s equity to its parent [HoldCo]. In essence, the solution is for key subsidiaries—overseas and domestic— to issue super-subordinated debt (or extra equity) to [HoldCo] . . . The subsidiary’s ‘excess’ losses are covered and its solvency is restored by writing down and converting

41 Dodd-Frank Act, §§204, 210(n)(9), (o). 42 ibid §210(a)(1)(E)(i).

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Bank Resolution in Europe into equity as much as is needed of the intragroup debt. Thus, the subsidiary is recapitalized without going into default itself. That will at last make a reality of the long-standing doctrine—underpinning all consolidated supervision but without binding substance up to now—that groups should be a source of strength for their component parts. Losses having being transferred up to [HoldCo], the second step is to ensure that [HoldCo] can in turn be resolved in an orderly way if it is mortally wounded. This requires that [HoldCo] maintain a critical mass of bonds that can be ‘bailed-in’ to cover losses and recapitalize the group to the required equity level. The holders of those bonds become the new owners. (The previous owners lose their investment.) Through those two steps, a group-wide, global resolution can be executed without operations across the planet going into local liquidation or resolution. Compared with [dismembering the bank through ‘purchase and assumption’] it is liability reconstruction rather than an assets reconstruction.43

Because the Dodd-Frank Act speaks in terms of ‘orderly liquidation’ rather than 16.31 ‘orderly resolution’, the US variant of SPE has a twist: the FDIC will impose a receivership on the failed systematically important financial institution (SIFI) (HoldCo) and then transfer its assets to a successor bridge bank, ‘BridgeCo’. HoldCo will disappear into the FDIC’s receivership while BridgeCo continues. HoldCo’s shareholders will almost surely be wiped out. (Perhaps an equity stub remains, depending on the initial level of capital.) Based on the FDIC’s estimate of losses, HoldCo’s unsecured debt will be partly written off (to cover losses in the transferred subsidiaries not already covered by the write-down of HoldCo’s capital) and partly converted into equity in a fully recapitalized BridgeCo.44 As this process is unfolding, the FDIC can supply liquidity to BridgeCo, either through a direct cash infusion from the ‘Orderly Liquidation Fund’, generated through a drawdown on a Treasury line of credit, or through the guarantee of new debt obligations issued by BridgeCo, full faith and credit obligations of the US. Logically such liquidity support could be provided by the Fed as a lender of last

Tucker (n 29), 2–3. 44 See Resolution of Systemically Important Financial Institutions: The Single Point of Entry Strategy, 78 Fed Reg 76614 (18 December 2013). One important element clarified in the Dodd- Frank Act is the obligation of HoldCo to cover losses in its operating subsidiaries, even where such losses would exceed HoldCo’s equity in those subsidiaries, the so-called ‘source of strength’ doctrine by which a bank holding company is obliged to support its subsidiaries. Although it has been contested in the past, see Herring and Carmassi (n 23), Dodd-Frank, §616 mandates that the Fed ‘shall require’ the bank holding company ‘to serve as a source of financial strength’ for a bank subsidiary, which is defined as ‘the ability . . . to provide financial assistance . . . in the event of the financial distress of the insured depository institution.’ Presumably this means that HoldCo will be required to enter into the undertakings deemed necessary to assure that subsidiary liabilities can be upstreamed to the HoldCo parent and that HoldCo’s support can be downstreamed, as necessary to make SPE effective. The Fed adopted a TLAC implementation rule 15 December 2016; see 82 Fed Reg 8266 (24 January 2017) (adopting 12 CFR §252.60); see also 12 CFR §252.160. Compliance is required by 1 January 2019. The Fed estimated that banks will need to raise an addition $70bn in long-term debt to comply with the final rule. 43

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Jeffrey N Gordon and Wolf-Georg Ringe resort, but in line with criticism of the Fed’s role in the rescue of Bear-Stearns and AIG, the Dodd-Frank Act restricted single company loans that might be counted as a bail-out.45 16.32 The upshot of this approach is that the shareholders and debtholders of HoldCo

bear the losses of the operating subsidiaries. In effect, the TLAC of HoldCo, its capital and its unsecured term debt, is used to cover losses throughout the group and to re-equitize the BridgeCo successor. This approach should reassure depositors, other short-term credit suppliers, and counterparties of the operating subsidiaries (the bank or broker-dealer, for example) as to the financial stability of the relevant stressed subsidiaries and thus should avoid a run.46 The long-term creditors and shareholders of HoldCo cannot run in the face of impending financial distress because of the nature of their commitment. Because the subsidiaries’ businesses are not disrupted—because the systemic shock is contained—the ultimate creditor losses will be much less. This the FDIC regards as the lesson of Lehman Brothers. The losses were far greater than the intrinsic asset write-downs. Rather, most of the losses occurred because of value destructivity in the disorderly bankruptcy: fire sale liquidations and lost going concern and franchise value. To be sure, the SPE strategy depends upon a layer of unsecured debt in the liability structure of HoldCo, but the claim is that in expectation of a well-managed resolution process, losses can be contained to the point so that a reasonable level of unsecured debt (plus capital) can cover the losses.

16.33 An additional powerful feature of the SPE is the way it can solve the multiple res-

olution regime problem for firms that have operations in different jurisdictions. If only HoldCo is put into resolution, if BridgeCo can re-equitize the within-group obligations of foreign ‘SubCo’ as necessary to preserve SubCo’s solvency, and if the FDIC (or another lender of last resort) can flow liquidity support through BridgeCo to foreign SubCo, then Subco remains a solvent and functional entity throughout the resolution of the SIFI of which it is apart. This approach and its advantages are described in a joint FDIC-Bank of England paper that contemplates co-operation among two major regulators in the resolution of cross- border firms in their jurisdictions: The strategies remove the need to commence foreign insolvency proceedings or enforce legal powers over foreign assets . . . Liquidity should continue to be downstreamed from the holding company to foreign subsidiaries and branches. Given minimal disruption to operating entities, resolution authorities, directors, and creditors of foreign subsidiaries and branches should have little incentive to take action other than to co-operate with the implementation of the group resolution. In particular, host stakeholders should not have an incentive to ringfence assets or

Dodd-Frank Act, §1101 (restrictions to the Fed’s emergency lending authority). 46 It will also reassure longer-term creditors of the operating subsidiaries who might otherwise be concerned of disfavored treatment relative to short-term creditors. 45

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Bank Resolution in Europe petition for a preemptive insolvency—preemptive actions that would otherwise destroy value and may disrupt markets at home and abroad.47

To use the Lehman example, in an SPE world, Lehman UK would never have 16.34 faced UK insolvency proceedings, because the FDIC would have assured its solvency and liquidity.48 The Clearing House Association organized and conducted a comprehensive and sophisticated simulation exercise of the operability of SPE per the FDIC’s model in November 2012.49 This important test for the new system confirmed that SPE can be a viable mechanism for resolution of even large and complex SIFIs. The outcome of this exercise gave a boost to the credibility of the approach and supported its consideration in other jurisdictions. As we said earlier, the FDIC projected that in the case of Lehman Brothers, an OLA resolution would have resulted in losses of only 3% (approximately) versus disorderly bankruptcy losses of 79%.50 Even with the change in US administrations, the FDIC has signaled its recognition of the importance of advance planning and high-level cross-border co-operation among financial regulators.51 The US Treasury, in its presidentially-mandated review of Orderly Liquidation Authority, has endorsed those efforts.52

IV. The US Path to Holding Companies A critical institutional feature for the success of SPE is a top level holding company 16.35 whose assets consist primarily of equity and intra-company debt claims in its operating subsidiaries and whose liabilities consist principally of non-runnable term

47 FDIC and Bank of England, ‘Resolving Globally Active, Systemically Important, Financial Institutions’, 10 December 2012, para 49 (available online at ). The claims in the paragraph are made subject to the proviso that the resolving administrator has power ‘necessary to write down or convert debt [claims] at the top of the group that are subject to foreign law’. This power could be obtained by specific contractual provision in the debt instrument. 48 This is at least the hope. We cannot exclude the possibility that the FDIC in practice would be subject to practical considerations and political pressure that would taint its unilateral perspective and approach. 49 The Clearing House, ‘Report on the Orderly Liquidation Authority Resolution Symposium and Simulation’, January 2013 (available online at ). 50 See FDIC Press Release, ‘FDIC Report Examines How An Orderly Resolution of Lehman Brothers Could Have Been Structured Under the Dodd-Frank Act’ (available online at ). The main reason is that the main losses in the failure of a large financial institution will derive from disorderly failure; these losses can be avoided through an effective resolution process. 51 Jelena McWilliams, FDIC Chairman, ‘Preparing for Cross-border Resolution Together,’ Single Board Resolution Conference (Brussels), 15 October 2018 (observing ‘strong foundation’ of prior planning for co-operation); Martin J Gruenberg (then FDIC Chairman), ‘Progress on Cross-Border Resolution Cooperation,’ Single Resolution Board Conference (Brussels), 29 September 2017. 52 US Treasury, Orderly Liquidation Authority and Bankruptcy Reform: Report to the President (21 February 2018) 20–23.

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Jeffrey N Gordon and Wolf-Georg Ringe debt. Large bank-centred financial companies in the US are invariably organized in the holding company form, indeed, as bank holding companies (‘BHCs’). This result derives from regulatory path dependence rather than a prior view about the optimal form of financial firm organization.53 Until approximately twenty-five years ago, the US financial sector was highly balkanized. Bank expansion was limited by highly restrictive branching laws that limited interstate banking, even intrastate banking.54 The ‘business of banking’ was narrowly defined to exclude banks from the provision of many financial services55 and commercial banks were famously barred from engaging in securities underwriting and other investment bank activity by the Glass-Steagall Act.56 The result was a relatively small number of ‘money center’ banks, thousands of ‘unit banks’, and many thousands of different financial service providers.57 16.36 One way that banks attempted to navigate through these regulatory barriers was

through the creation of holding companies. Although a bank could not branch, a parent holding company could acquire banks in a particular geographic area and the sibling subsidiary banks could form a network that could provide many of the functional equivalents of branch banking. Although a bank might be unable to provide a particular financial service directly or through a direct subsidiary, a sibling subsidiary of the holding company could.58 In 1956 the holding company structure was both legitimated and regulated through the Bank Holding Company Act which limited (for a time) geographic expansion and which specified that the permitted subsidiaries of the BHC must be ‘closely related to banking’.59 When Glass-Steagall finally fell in 1999, the holding company structure was nevertheless

53 The following text draws from many sources, including Saule T Omarova and Margaret Tahyar, ‘That Which We Call a Bank: Revisiting the History of Bank Holding Company Regulation in the United States’ (2011) 31 Review of Banking and Financial Law 113; Arthur E Wilmarth, Jr, ‘The Transformation of the U.S. Financial Services Industry, 1975–2000: Competition, Consolidation, and Increased Risk’ [2002] University of Illinois Law Review 215; Charles C Calomiris, Bank Deregulation in Historical Perspective (Cambridge University Press 2000); Charles C Calomiris and Stephen H Haber, Fragile By Design (Princeton University Press 2014); Richard S Carnell, Jonathan R Macey, and Geoffrey P Miller, The Law of Banking and Financial Institutions (4th edn, Wolters Kluwer 2009). For some quantification, see Dafna Avraham et al, ‘A Structural View of U.S. Bank Holding Companies’, Federal Reserve Bank of New York Economic Policy Review, July 2012, 65–81. See also Jeffrey N Gordon and Kathryn Judge, ‘The Origins of Capital Market Union in the U.S.’ in Franklin Allen, Ester Faia, Michael Haliassos, and Katja Lagenbucher (eds), Capital Market Union and Beyond (MIT Press) (forthcoming 2019). 54 See, eg, the McFadden Act of 1933, 12 USC §36. 55 See 12 USC §23(7). 56 See §§16, 20, 21 and 32, Banking Act of 1933, codified respectively at 12 USC §§24 (Seventh), 377, 378, 78; Inv. Co. Instit. v Camp, 401 US 617 (1971) (providing capacious reading of Glass-Steagall). 57 See Omarova and Tahyar (n 54) 131–2. 58 Compare 12 USC §24 (Seventh). See generally Carnell, Macey, and Miller (n 49), 485–94. 59 Bank Holding Company Act of 1956, 12 USC §1841. See also Carl A Sax and Marcus H Sloan III, ‘The Bank Holding Company Act Amendments of 1970’ (1970) 39 George Washington Review 1200.

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Bank Resolution in Europe the vehicle through which financial services expansion took place. Banks remained barred from securities underwriting and related investment banking activities. However, banks could affiliate through the holding company structure with investment banks and full service broker dealers. Moreover, large, well-capitalized bank holding companies could become ‘financial holding companies’, which were permitted to engage in a broader set of activities that were ‘financial in nature’, or ‘incidental’ or ‘complementary’ to such activity, and that could include both insurance underwriting and merchant banking activity.60 All of these activities were to occur through subsidiaries of the bank holding company. Pre-existing rules limited extent to which the affiliated bank could provide financial support to these sibling subsidiaries.61 The point is this: the evolution of the US banking system has proceeded in such 16.37 a way that the largest banking groups are organized as bank holding companies. In general a public parent, HoldCo, sits astride a cluster of financial subsidiaries. Such a structure vastly facilitates a resolution strategy like SPE. We now explore how the EU banking framework could be turned in this direction.

V. SPE for Europe: The Structural Reform Project Returning to Europe, we can think of several ways of achieving the holding 16.38 company structure that would facilitate SPE resolution of G-SIBs. There are three possible mechanisms: first, supervisors could insist on such a structure for individual banks in the course of the ‘recovery and resolution planning’ exercise under the Bank Recovery and Resolution Directive (‘BRRD’).62 Secondly, incentives could be given by charging capital surcharges for non-holding company banking groups pursuant to the supervisory assessment of the systemic risks of particular G- SIBS, as contemplated by Basel III (as implemented in the Capital Requirements Regulation and Directive CRR/CRD IV).63 This is similar to the approach Swiss authorities have used to nudge UBS and Credit Suisse into holding company structures.64 Thirdly, supervisory assessment of extra capital charges for a firm without a holding company structure could be a result of the ECB’s stress tests,

60 See, generally, The Gramm-Leach-Bliley Act of 1999, Public Law 106–02 and, specifically, 12 USC §§843(k)(4)(H) and (I). 61 See §§23A, 23B of the Federal Reserve Act of 1913. See Saule Omarova, ‘Gramm-Leach- Bliley to Dodd-Frank: The Unfulfilled Promise of Section 23A of the Federal Reserve Act’ (2011) 89 North Carolina Law Review 1683. 62 See n 4. On this concept, see Jens Hinrich Binder, ‘Resolution Planning and Structural Bank Reform within the Banking Union’ in Juan Castañeda and others (eds), European Banking Union. Prospects and Challenges (Routledge 2018). 63 See n 63. 64 James Shotter, ‘Credit Suisse to Overhaul Structure’ Financial Times (London, 21 November 2013).

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Jeffrey N Gordon and Wolf-Georg Ringe another incentives-based approach. Nevertheless, concerns for the stability of the system as a whole—macroprudential considerations—would argue for a more prescriptive approach and an adoption of an organizational structure for systemically important financial firms that would minimize a resolution shock. Precisely because the resolution of any systemically important financial firm carries risk of a systemic shock and high externalities, G-SIBs should not have the option of persisting in an organizational form that increases such risks. There is a better structural alternative: a public HoldCo parent for the operating subsidiaries of the banking group, set up so that the assets of HoldCo consist of shares in its subsidiaries, and that its liabilities are confined to unsecured term debt. This is the missing piece for a credible Single Resolution Mechanism in the Banking Union. 16.39 Structural reform has been an important element in the financial crisis reform

agenda, although the particular structural proposals have varied. One variant has been a version of Glass-Steagall, the exclusion of some element of financial activity from banking. Perhaps the most notable version of this is the Volcker Rule,65 which prohibits a banking group either directly, or through an affiliate, from engaging in ‘proprietary trading’ or owning a significant interest in a hedge fund or private equity fund. The rationales are various: to divorce banks from especially risky activity (although proprietary trading losses were not a significant factor in the run-up to the financial crisis); to prevent banks from using insured deposits and other funding sources subsidized by the social safety net to engage in speculative activity; or to keep banks away from the risk-taking culture associated with proprietary trading (Paul Volcker’s preferred rationale).

16.40 A second structural reform, associated initially with the Vickers Report in the UK

in 2011, is a within-banking group separation: between retail banking activities— deposit-taking, payments, and lending to households and small-and medium- sized enterprise—and investment banking activities.66 In the UK model, ‘core’ banking activities are to be housed in a separately capitalized, separately governed ring-fenced bank; all the rest must be held in an affiliated but legally separate investment banking arm. The retail bank is not permitted to engage in proprietary trading and merchant banking activities, but such activity is permitted in the investment banking affiliate.

16.41 EU-level proposals for structural regulation of the banking sector began with the

so-called ‘Liikanen Report’ (named after the committee’s chair) in 2012.67 Part of

Dodd-Frank Act, §619. 66 For elaboration on the various structural reform proposals in the EU and US, see John Armour and others, Principles of Financial Regulation (Oxford University Press 2016) ch 22; Financial Stability Board, ‘Structural Banking Reforms—Cross-Border Consistencies and Global Financial Stability Implications: Report to the G20 Leaders for the November 2014 Summit’, 27 October 2014. 67 Liikanen Report (n 17). 65

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Bank Resolution in Europe what spurred the European Commission to initiate the Liikanen process was the adoption of different versions of ring-fencing and functional separation by other Member States, including France and Germany, which would add complexity and regulatory fragmentation to cross-border banking within the EU.68 The initial Liikanen proposals gave Volcker a spin: virtually the only activities for which separation from the deposit bank was required were proprietary and other trading activity, and hedge fund and private equity relationships; these activities need be housed in a separately capitalized subsidiary but could remain in the banking group. The Liikanen proposals would have permitted the location of sophisticated banking services in either the deposit bank or the investment (trading) bank. In January 2014 the European Commission proposed a Bank Structural Measures 16.42 Regulation that took more direct inspiration from the Volcker Rule.69 Following the initial Liikanen proposal, the proposed Regulation would require separation of the bank’s trading activities from the deposit bank. However, for the largest banking groups, principally the European G- SIBs, proprietary trading and investing in hedge funds would be banned. The Commission endorsed the ‘risky activity’ rationale.70 The Commission’s proposal was controversially discussed in the EU lawmaking 16.43 process. In June 2015, the Council reached agreement on its position at first reading (known as ‘general approach’) on the draft regulation.71 However, different approaches became apparent in the ensuing debates in the European Parliament, which failed to come to a common position on the text. In 2018, after no progress for a long time, the Commission decided to withdraw the proposal, stating as main reasons the lack of progress and foreseeable agreement on the project. However, interestingly, the Commission claims that the main objectives of the proposed regulation have already been addressed by other regulatory measures in the banking sector, most notably with the entry into force of the Banking Union’s supervisory and resolution arms.72 68 For an overview of national measures, see Chen Chen Hu, The Regulation and Supervision of Banks: The Post Crisis Regulatory Responses of the EU (2018) ch 3.2. 69 Proposal for a Regulation of the European Parliament and of the Council on structural measures improving the resilience of EU credit institutions, COM(2014) 43 final, 29 January 2014. 70 ‘These are generally highly risky speculative activities, alien to the traditional role of banks as intermediaries between borrowers and capital suppliers. Proprietary trading today represents only a limited part of banks’ activities/revenues but it was significant prior to the crisis. This proposal would prevent a reversal of this process in the future, when market conditions improve’: European Commission, ‘Structural Measures to Improve the Resilience of EU Credit Institutions—Frequently Asked Questions’, 29 January 2014 (available online at ). 71 Council of the European Union, ‘Proposal for a Regulation of the European Parliament and of the Council on structural measures improving the resilience of EU credit institutions – General Approach’ (Document number 10150/15), 19 June 2015, available online at . 72 European Commission, ‘Annex to the Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of

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Jeffrey N Gordon and Wolf-Georg Ringe 16.44 The proposed regulation was far from perfect. Its problem was that it was, in

a fundamental way, backwards looking. It contemplated that: (i) investment banking activity is the major threat to the stability of a banking group; (ii) that the deposit bank at the centre of the group will receive state support, ‘the social safety net’, which ought not be shared with the investment bank; and (iii) that resolution, perhaps bankruptcy, of the investment bank will have only limited impact on the real economy so long as the deposit bank is protected. Propositions one and three seem false as a factual matter. Banking groups generally fail the old fashioned way: because of ‘bad’ assets on the bank balance sheet, whether defaulting real estate loans or debt securities that are falling in value. As recent research has confirmed, Eurozone banking groups continue to be hampered by bad loans carried on the bank balance sheet, not investment bank trading losses.73 The failure of a separate investment banking subsidiary may seem to matter less in the EU than in the US, but that is only because of the much larger fraction of credit intermediation currently performed within European banks than in capital markets. But public issuance of debt securities by non-financial corporations in the Eurozone has increased, in absolute terms as well as a percentage of debt.74 Credit rationing by European banks may have stimulated this trend, but it is likely to grow over time, which means that the investment banks will become an increasingly important credit intermediation channel.

16.45 But the key anachronism of the proposed Structural Measures Regulation was the

backwards look to governments as the source of strength for G-SIBs as opposed to the self-insurance of TLAC. The point of the Banking Union, the point of the SRM, is to take governments out of the bail-out role for the largest banking groups. This is not just to control moral hazard by private actors but also to protect governments from providing guarantees and other forms of state support that they cannot sustain. Resolution will be credible only if resolution can, in prospect, resolve a large banking group, without sparking an own-firm run or a run elsewhere in the financial system. As we have explained previously, this means firstly, minimizing the disruption to the financial businesses within the group and, secondly, that TLAC must be perceived as sufficient to protect short-term credit suppliers throughout the banking group against loss. A holding company structure that permits an SPE style resolution offers greatest promise for these

the Regions –Commission Work Programme 2018: An agenda for a more united, stronger and more democratic Europe’, COM(2017) 650 final (24 October 2017) 2, available online at . 73 ECB (Banking Supervision), ‘Guidance to banks on non-performing loans’, March 2017 (available online at ). 74 ECB, ‘Report on financial structures’, October 2017 (available online at ).

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Bank Resolution in Europe pro-resolvability criteria. If only the public parent goes through the resolution procedure, business relations with the operating subsidiaries will be minimally disturbed. This mitigates adverse counterparty reactions and can minimize cross- border conflicts among regulators. If the unsecured term debt is issued by the public HoldCo entity, then putting only HoldCo through resolution will result in structural subordination of HoldCo debt to debt elsewhere in the group. Otherwise, subordination of TLAC debt will be a matter of contract and thus susceptible to contract interpretation. As explained by Paul Tucker, former Deputy Governor of the Bank of England, in arguing for bonds issued by HoldCo on the SPE model: It is a device to achieve structural subordination of bondholders, putting beyond doubt that they absorb losses after group equity holders but before anyone else. Everybody else would be a creditor of one or other of the various operating subsidiaries. They would have a prior claim on the cash flows generated by the underlying businesses. Equivalently, they would be bailed-in only if the holdco didn’t have sufficient bonds in issue to cover the group’s losses, so that ailing subsidiaries ended up going into resolution too.75

TLAC at the HoldCo level also maximizes its deployability throughout the group, 16.46 avoiding the problem that, in effect, the insurance is at the ‘wrong’ subsidiary, and, because of contractual limitations, cannot be used to provide bail-in coverage for a subsidiary whose problems exceed its own TLAC. In sum, the decision to withdraw the Structural Measures Regulation may not 16.47 be a disaster after all. It is certainly deplorable that the banking structure remains largely unaddressed on the European level. True, many of the larger EU Member States have meanwhile adopted their national versions of structural regulation,76 and the EU is on course to implementing the TLAC principles.77 But Elke König, head of the SRB, recently spoke out against mandating bank holding companies in Europe, preferring a ‘clean-up’ of group structures along functional lines to ensure separability, rather than imposing a holding company structure.78

75 See Tucker (n 11). 76 See n 69. 77 Directive (EU) 2019/879 of the European Parliament and of the Council of 20 May 2019 amending Directive 2014/59/EU as regards the loss-absorbing and recapitalisation capacity of credit institutions and investment firms and Directive 98/26/EC, [2019] OJ L150/296, which is to be implemented by Member States by the end of 2020. 78 Cecile Sourbes, ‘Q&A: SRB’s Elke König on resolution regimes’, Risk.net (1 July 2015): ‘[Y]‌ou might want to have these critical functions isolated in one or, at least, in a small number of companies, and not spread around the group. This does not call for the setting up of a holding structure, but a clean-up of the organisational structure –so functions are aligned with legal entities that can be easily separated’ (available at online .

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Jeffrey N Gordon and Wolf-Georg Ringe 16.48 Nevertheless some momentum may be on the way. A number of national

lawmakers have taken the initiative and have started to set incentives for structural conversion. Most importantly, Swiss rules on banking capital requirements lower those requirements for banks that adjust their organizational structure to make the bank more easily resolvable. This move has prompted the two Swiss SIFIs (UBS and Credit Suisse) to change their structure in a way that is very similar to the United States’ holding company structure.79 Once the new structure is in place, Credit Suisse plans to issue ample bail-in-able debt from its group holding company, in order to facilitate the SPE approach.80 Following new regulation in the United Kingdom, British banks are also beginning to issue debt at the holding company level.81 And more recently, the Italian banking group Unicredit as well as Irish banks (Bank of Ireland and Allied Irish Banks) have announced plans to reorganize their operations in a holding structure more amenable to resolution.82 At least in the case of the Bank of Ireland, this move was apparently requested by the SRB, in order to provide for a more effective framework for the bail-in of bondholders in the event of another financial crisis.83 All of these efforts may however be undermined by efforts in some key EU Member States, notably France and Spain, to continue issuing new forms of senior debt out of their operating companies rather than switching to a holding company structure, as endorsed by the European Commission.84

79 James Shotter, ‘Credit Suisse to Overhaul Structure’ Financial Times (London, 21 November 2013), available online at ; James Shotter, ‘Swiss Bank Creditors Face Bail-in Risk’ Financial Times (London, 8 August 2013), available online at . According to rating agency Fitch, it is likely that other European banks are under pressure to follow this example. See Shotter, ibid; see also James Shotter, ‘UBS Plans Dividend as Part of Overhaul to Ease a Crisis Break-up’ Financial Times (London, 6 May 2014), available online at (‘UBS is to overhaul its legal structure to make it easier to break up the bank in a crisis, in a move designed to lower its capital requirements and enable it to pay a special dividend.’). 80 Shotter, ‘Credit Suisse’ (n 80). 81 Sam Fleming, ‘Banks Address “Too Big to Fail” Question with Debt Shift’ Financial Times (London, 26 December 2013), available online at . 82 Fitch Ratings, ‘New UniCredit Structure Would Simplify A Resolution’ (20 November 2015), ; Joe Brennan, ‘Banks advance bond ‘bail-in’ plans under new European rules’ The Irish Times (Dublin, 3 February 2017), available online at . 83 Ciarán Hancock, ‘Bank of Ireland gets court approval to set up new holding company’, The Irish Times (Dublin, 23 June 2017), . 84 RTE, ‘Bank of Ireland and AIB set off down “holding company” road’ RTE (3 February 2017), available online at .

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VI. Conclusion Our conclusion is this: Bank resolution in the European regulatory framework is 16.49 missing one crucial element: consideration for the structure of European banks. Requirements or, at least, irresistible incentives for banks to operate in a holding company structure would greatly enhance the operability of the resolution framework, would make it more credible, and would reduce the likelihood of another taxpayer bail-out. As a by-product, it would also facilitate transatlantic co-ordination of resolution policies. No co-ordinated EU action appears forthcoming. The potential reform vehicle, 16.50 the Structural Measures Regulation, has been withdrawn.85 Hence, the EU must find other ways of tackling the problem. Legal and functional separation of the various financial activities in a G-SIB is important principally because of the impact on the resolvability of such a financial institution in the event of financial distress. A critical structural element is the separation of public equity and bail-in-able debt from the operating financial subsidiaries. Because it facilitates resolution, the holding company structure adds credibility to the supervisory mechanism and serves the Banking Union’s most important goal, to break the link between sovereigns and the EU banking system.

European Commission (n 73). 85

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17 FINANCIAL CONGLOMERATES IN THE EUROPEAN BANKING UNION Arthur van den Hurk and Michele Siri*

I. Introduction II. Consolidated Supervision in the Banking Sector

17.05 1. Scope 17.05 2. Mixed Activity Holding Companies 17.07

III. Group Supervision in the Insurance Sector

17.09 1. Insurance Groups Directive 17.09 2. Solvency II 17.10 3. Mixed Activity Insurance Holding Companies 17.13

IV. Consolidated Supervision vs Group Supervision V. Background of Financial Conglomerate Supervision

17.15

17.24 1. EU Financial Conglomerates Directive 17.24 2. Relevant Features of the Financial Conglomerates 17.25

VI. Institutional Framework for Conglomerate Supervision

1. Supplementary Nature of Conglomerate Supervision 2. ECB Supervised Conglomerates vs other Conglomerates

VII. Purpose, Content, and Design of Conglomerate Supervision

17.01

17.29 17.29

17.34 1. Joint Forum Principles 17.34 2. Conglomerate Specific Risks and Supervision 17.39 3. Content of Financial Conglomerate Supervision 17.41 4. Role of the ECB as Coordinator with Respect to Financial Conglomerate Supervision 17.56 5. Equivalent Provisions under Different Directives 17.59

VIII. Evolution of Financial Conglomerate Supervision 1. Revisions of the Financial Conglomerates Directive IX. Recovery and Resolution of Financial Conglomerates

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17.63

17.74 1. Bank Recovery and Resolution Directive/SRM 17.75 2. Developments in Recovery and Resolution of Insurance Undertakings 17.79

X. Conclusion

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17.33

The authors thank participants at the Banking Union conference held in Milan, organized * by European Banking Institute for their valuable comments and discussions during that conference and in particular Danny Busch, Guido Ferrarini, and Fabio Recine. The views and opinions expressed are in the personal capacity of the authors.

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I. Introduction 17.01 As a result of the entry into force on 4 November 2014 of the Single Supervisory

Mechanism (SSM), the European Central Bank (ECB) has obtained significant powers with respect to the prudential supervision of credit institutions, including consolidated supervision. Similar to many other parts of the European Union (EU) financial services regulation, the SSM has been developed essentially on a sectoral basis, with a primary focus on banking regulation and supervision. However, the scope of the SSM, and the authority of the ECB within the SSM, is not limited to the prudential supervision of credit institutions only, but extends as well to supplementary supervision of conglomerates in accordance with the EU Financial Conglomerates Directive, to the extent these conglomerates form part of the SSM. This means in practice that a significant number of conglomerates fall within the scope of the SSM and in many cases, under direct ECB supervision.

17.02 The Joint Committee of the European Supervisory Authorities (ESAs)—the

European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities Markets Authority (ESMA)—maintains a list of financial conglomerates identified under the financial conglomerate supervision, included those which benefit from waivers, for the purposes of EU law. The 2018 list of identified financial conglomerates includes seventy-eight financial conglomerates with the head of the group located in the EU or European Economic Area (EEA), one financial conglomerate with the head of a group in Switzerland, one in Bermuda, and one in the United States. It is worth noting that a financial conglomerate may also be qualified as a G-SIB (Global Systemically Important Bank, as identified by the FSB), a G-SII (Global Systemically Important Insurer, as identified by the FSB), or a G- SII (a Global Systemically Important Institution, following EBA classification. For twenty-six of the seventy-eight conglomerates on the 2018 list, the ECB has been identified as the co-ordinator, the supervisory authority that has been identified as the lead supervisory authority for the purpose of financial conglomerate supervision.

17.03 In addition, the ECB participates in the financial conglomerate supervision of a

number of the conglomerates that are not under direct ECB supervision.1

17.04 Although this means that there are strong links between the SSM and con-

glomerate supervision for a number of conglomerates, the remainder of the conglomerates on the list, that make up more than half of the conglomerates, have limited or no interaction with the SSM/ECB in respect of conglomerate supervision. As we describe below, conglomerates are a fairly diverse group, with a According to the list, this is the case for four conglomerates. 1

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Financial Conglomerates in the European Banking Union number of commonalities (sizeable cross-sectoral activities in particular), but may also have significant differences. In fact, the core of the activities of conglomerates may not be banking at all.2 Furthermore, the role of the ECB in respect of prudential supervision is limited in scope. The most notable limitation is the exclusion with respect to the supervision of insurance undertakings.3

II. Consolidated Supervision in the Banking Sector 1. Scope Credit institutions, as well as certain investment firms, are subject to consoli- 17.05 dated supervision pursuant to the EU Capital Requirements Directive (CRD) and the EU Capital Requirements Regulation (CRR), on the basis of their consolidated situation. The CRR and CRD IV provide detailed harmonized rules regarding prudential requirements for credit institutions and investment firms. These broadly cover areas such as counterparty credit risk, leverage, capital (own funds and capital requirements), large exposures, liquidity (stable funding and liquidity coverage), and institutional disclosure. The CRR4 sets out the principles for conducting supervision on a consolidated 17.06 basis, including procedures for identifying the consolidating supervisor and the coordination of supervisory activities by a consolidating supervisor. The prudential framework of credit institutions and investment firms5 sets out co-ordination and co-operation arrangements that are to be put in place in order to facilitate and establish effective supervision, and states that the consolidating supervisor must also establish colleges of supervisors in order to facilitate supervisory arrangements. The operational functioning of the colleges of supervisors is now governed by Regulatory Technical Standards6 and Implementing Technical Standards.7 Article 117 of CRD 2 For instance, this might be the case for insurance-led conglomerates, that may roughly be described as insurance groups with bank-subsidiaries or industrial groups. 3 It is included in art 127(6) of the European Treaty. 4 See Ch 3 (Supervision on a Consolidated Basis) of CRD IV. 5 Articles 115 and 116 of CRD IV. 6 Commission Delegated Regulation (EU) 2016/98 of 16 October 2015 supplementing Directive 2013/36/EU of the European Parliament and of the Council with regard to regulatory technical standards for specifying the general conditions for the functioning of colleges of supervisors. 7 Commission Implementing Regulation (EU) 2016/99 of 16 October 2015 laying down implementing technical standards with regard to determining the operational functioning of the colleges of supervisors according to Directive 2013/36/EU of the European Parliament and of the Council. With respect to financial conglomerates, subject to direct ECB supervision, see also: ECB, ‘SSM Supervisory Manual—European Banking Supervision: Functioning of the SSM and Supervisory Approach, March 2018, 34, available online at .

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Arthur van den Hurk and Michele Siri IV provides that competent authorities are required to co-operate closely with each other, and provide each other with any information which is essential or relevant for the exercise of the other authorities’ supervisory tasks. Holding Companies (financial holding companies, mixed financial holding companies, and mixed-activity holding companies) are included in consolidated supervision arrangements, and they and their effective managers are subject to administrative penalties or measures aimed at ending observed breaches (or the causes of such breaches) of CRD IV supervision rules. 2. Mixed Activity Holding Companies 17.07 Mixed activity holding companies are defined in CRD IV as parent

undertakings, other than financial holding companies or institutions or mixed financial holding companies, the subsidiaries of which include at least one institution.8 An ‘institution’ is defined as a credit institution or an investment firm. A mixed financial holding company is a holding company as defined in point (15) of the FCD.9 The key characteristic of mixed activity holding companies is that, while they do have an institution among their subsidiaries, its subsidiaries are not exclusively or mainly institutions. For example, these groups can be industrial groups, active outside the financial sector, owning a credit institution or investment firm. These groups are not financial conglomerates.10

17.08 Groups headed by a mixed activity holding company are not subject to con-

solidated supervision, pursuant to CRD IV/CRR. To these groups, 'general' supervision is exercised by the supervisory authority responsible for the supervision of the individual institution, over transactions between the institution and the mixed-activity holding company and its subsidiaries11 This is a requirement applicable to the institution, not to the mixed activity holding company itself. Furthermore, institutions are required to have in place adequate risk management processes and internal control mechanisms, in order to identify, measure, monitor and control transactions with the mixed-activity holding company and its subsidiaries, and are required to report significant transactions to the supervisory authority, responsible for the supervision of the individual institution.

8 Article 4(22) of the CRR. 9 A parent undertaking, other than a regulated entity, which, together with its subsidiaries—at least one of which is a regulated entity which has its registered office in the Union—and other entities, constitutes a financial conglomerate. 10 Because in that case, the holding would be qualified as a ‘mixed financial holding company.’ 11 —article 123(1) of CRD IV.

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III. Group Supervision in the Insurance Sector 1. Insurance Groups Directive Up until 31 December 31 2015, EU insurance companies and reinsurance com- 17.09 panies were subject supplementary supervision under the Insurance Groups Directive. This could not be considered to be ‘group’ or ‘consolidated’ supervision but had a more limited nature. It focused primarily on the reporting of intra- group transactions and risk-concentrations of EU licensed insurance and reinsurance undertakings with other entities in the group, the calculation of an adjusted solvency ratio of that insurance or reinsurance undertaking, taking into account its position in the group, internal control mechanisms for the production of data and information relevant for the purposes of supplementary supervision, and fit and proper requirements applied to the persons that effectively run the insurance holding companies heading the insurance group. 2. Solvency II As of 1 January 2016, most insurance groups in the EEA are subject to Solvency 17.10 II Group supervision. Effectively this means that many requirements that apply to individual EEA insurance and reinsurance undertakings, apply with the necessary adjustments at the group level.12 Solvency II Group supervision includes the calculation of capital requirements at group level (using either a standard model, an internal model or a combination), group own fund requirements, supervision of intragroup transactions and risk concentrations, and group governance requirements, a requirement to conduct an Own Risk and Solvency Assessment (ORSA) at group level, as well as reporting and disclosure requirements at group level. Group supervision takes place at the level of the group. In order to facilitate group 17.11 supervision, colleges of supervisors are established, that need to ensure there is sufficient and effective co-operation, exchange of information and consultation processes to promote the convergence of the decisions and activities of the insurance supervisors in the group. The colleges of supervisors are composed along sectoral lines, including the relevant insurance supervisory authorities, as well as EIOPA, but not the supervisory authorities from other sectors.

12 Such requirements apply mutatis mutandis at the group level. It appears to be a challenge to supervisory authorities to determine what that means in some instances, see EIOPA, 'Report to the European Commission on Group Supervision and Capital Management within a Group of Insurance and Reinsurance Undertakings, and FoS and FoE under Solvency II', EIOPA BoS-18- 485, 14 December 2018, 3.331–3.353.

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Arthur van den Hurk and Michele Siri 17.12 Solvency II Group supervision is still supplementary in nature, in the sense

that it does not replace supervision of the individual insurance and reinsurance undertakings in the group.13 3. Mixed Activity Insurance Holding Companies

17.13 The Solvency II Directive includes a definition, similar to the mixed activity

holding company, namely the definition of the ‘mixed activity insurance holding company.’ A mixed activity insurance holding company is defined in the Solvency II Directive as a parent undertaking other than an insurance undertaking, a third- country insurance undertaking, a reinsurance undertaking, a third-country insurance undertaking, an insurance holding company or a mixed financial holding company, which includes at least one insurance or reinsurance undertaking among its subsidiaries.14 Similar to mixed activity holding companies, these groups are, for instance, industrial groups, owning a (captive) insurance undertaking. General supervision is exercised over transactions between the insurance and reinsurance undertakings in the group and the mixed activity insurance holding company and its related undertakings.15 Groups held by mixed activity insurance holding companies are not financial conglomerates.

17.14 As a slightly different approach is taken in the Solvency II Directive, with re-

spect to mixed activity insurance holding companies, compared to mixed activity holding companies. As follows from the Solvency II Directive, groups held by a mixed activity insurance holding companies are subject to Solvency II group supervision (be it to a limited extent),16 Whereas groups held by a mixed activity holding company are not subject to CRD consolidated supervision. The

13 This does not, however, preclude the possibility for efficiencies within the group, such as the possibility of a single Group ORSA and centralized risk management, as well as, to some extent, the recognition of diversification benefits at the group level. Initial, further-reaching proposals for group supervision, contained in the initial Solvency II proposals, such as the concept of 'group support', were not adopted in the final text of the Directive. See elaborately on this topic, O J Erdélyi, Twin Peaks for Europe: State of the Art Financial Supervisory Consolidation—Rethinking the Group Support Regime under Solvency II (Springer International Publishing 2016). A review of the group supervision provisions in Solvency II, including an assessment of the benefit of enhancing group supervision and capital management within a group, is foreseen by 31 December 2018, in art 242(2) of the Solvency II Directive. This report was published on December 14, 2018: EIOPA, ‘Report to the European Commission on Group Supervision and Capital Management within a Group of Insurance and Reinsurance Undertakings, and FoS and FoE under Solvency II’, EIOPA BoS- 18-485, 14 December 2018, https://eiopa.europa.eu/Publications/Reports/Report%20on%20 Article%20242%20COM%20Request_FINAL%2014%20Dec%202018.pdf. 14 Article 212(1)(g) of the Solvency II Directive. 15 In accordance with art 265 of the Solvency II Directive. Article 265(2) furthermore states that a number of provisions (in particular relating to reporting, provision of information supervisory co-operation, exchange of information between supervisory authorities and enforcement apply with respect to supervision in accordance with art 265. 16 Article 213(2)(d) of the Solvency II Directive.

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Financial Conglomerates in the European Banking Union practical consequences of this different approach seem negligible since similar requirements apply in both cases.17

IV. Consolidated Supervision vs Group Supervision While there are many similarities between consolidated CRD supervision and 17.15 Solvency II Group supervision, there are also relevant differences. Obviously a very apparent difference is the current institutional structure of CRD 17.16 consolidated and Solvency II Group Supervision, whereby Solvency II Group Supervision is based on a supervisory structure in which national competent authorities co-operate in colleges of supervisors, with a group supervisor chairing the college, and CRD consolidated supervision obviously closely linked to the SSM and subject to direct European influence, resulting in what is sometimes referred to as ‘two-speed Europe.’18 As indicated above, CRD consolidated supervision takes place on the basis of the 17.17 consolidated situation of the institution. The consolidated situation means the situation that results from applying the requirements of the CRR in accordance with Part I, Title II, Chapter 2 of the CRR to the institution as if that institution formed, together with one or more entities, a single institution.19 Without going into detail, this results in the inclusion of only a specific group of entities within the group for capital purposes,20 Not the entire group to which the institution belongs. It is worth mentioning in this context that insurance and reinsurance

17 There appears to be, however, ambiguity concerning the definition of (e.g.) mixed activity insurance holding company, which, according to EIOPA, may potentially lead to competitive (dis) advantages for certain groups depending on the interpretation of the Solvency II Directive by the group supervisor and/or national transposition issues. EIOPA, Report to the European Commission on Group Supervision and Capital Management within a Group of Insurance and Reinsurance Undertakings, and FoS and FoE under Solvency II, EIOPA BoS-18-485, 14 December 2018, ch 3.9.2, in particular paras 3.268(c), 3.269–3.283, and 3.301. In its draft Opinion to the European Commission on the 2020 review of Solvency II, EIOPA advice, in paragraph 9.67, to clarify the definition of insurance holding company in order to distinguish this type of entity from the mixed activity insurance holding company, EIOPA, Consultation Paper on the Opinion on the 2020 review of Solvency II, EIOPA-BoS-19/465, 15 October 2019, https://eiopa.europa.eu/Publications/ Consultations/EIOPA-BoS-19-465_CP_Opinion_2020_review.pdf 18 See S Illegems, ‘Het Prudentieel Toezicht op Financiële Conglomeraten Onder het Single Supervisory Mechanism’ in R Houben and W Vandenbruwaene (eds), Het Nieuwe Bankentoezicht: The New Banking Supervision (Intersentia 2016); E Ferran, ‘European Banking Union, Imperfect, But It Can Work’ (2014) Legal Studies Research Paper Series No 30/2014, available online at . 19 Article 4(1) 47 of the CRR. 20 With a focus on the ‘institutions’, ‘financial institutions’, ‘ancillary services undertakings’, and certain holding companies.

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Arthur van den Hurk and Michele Siri undertakings, nor insurance holding companies, are included in the consolidated capital calculation.21 17.18 Holdings of own fund instruments of such entities by parent institutions, parent

financial holding companies or parent mixed financial holding companies are, by default, deducted, for the purpose of calculating the own funds in accordance with the CRR. However, the CRR does allow in certain strict circumstances,22 Not to deduct these holdings, but instead to apply risk weighting to these holdings. One of the conditions for this treatment is that the entity is included in the same supplementary supervision under Directive 2002/87/EC as the parent institution, parent financial holding company or parent mixed financial holding company,23 In other words, in the same scope of FCD supplementary supervision. This treatment is also known as the 'Danish compromise' referring to a compromise text reached under the Danish EU presidency in 2012. This treatment allows groups subject to CRR consolidated supervision, to take into account the insurance and reinsurance assets they hold in the group for own fund purposes, resulting in a positive contribution to their risk-weighted assets, compared to the default approach under the CRR, under which these assets are disregarded for own fund purposes.24

17.19 Depending on the group structure, including the funding structure of the group,

the default method under the CRR can result in potentially undesirable results.25 In particular, this is relevant for conglomerates. Due to the nature of a conglomerate, it obviously has significant cross-sectoral holdings.

17.20 At the same time, the treatment of insurance holdings under the arrangements

of the Danish Compromise continues to be subject of discussion. In the ECB Aggregate Report on the Comprehensive Assessment of October 2014, in which the option of Article 49(1) of the CRR has also been taken into account, the ECB noted that it intended to review the national options and discretions, included in the CRD/CRR framework. This has led to an ECB consultation on options

21 See on the scope of prudential consolidation in accordance with art 18 of the CRR Single Rulebook Q&A No 2013_383 and on the meaning of ‘consolidated prudential requirements in art 59(6) of the BRRD, Single Rulebook Q&A No 2016_2954, both available online at . 22 Article 49(1)(a)–(e) of the CRR. As a transitional measure, art 471 of the CRR temporarily extends the possibility for groups to use the option in art 49(1) of the CRR. 23 Article 49(1)(b) of the CRR. 24 Recently the application of the Danish compromise has been extended to at least 31 December 2024, see para 126 (revised art 471 of the CRR) of CRR 2, Regulation (EU) 2019/877, [2010] OJ L150, 7 June 2019. 25 For instance, if the funding is done through an entity within the group that is included in CRR consolidation and the subsidiary for which the funding is attracted is not included in the consolidation. Commission Staff Working Document on Directive 2002/87/EU on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a conglomerate (FICOD), 13 July 2017, SWD (2017)272 final, 35.

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Financial Conglomerates in the European Banking Union and discretions. In an ECB Guide on options and discretions of March 2016, the ECB sets out its approach with respect to the exercise of the option under Article 49(1) of the CRR, distinguishing between situations where permission not to deduct was granted prior to 4 November 2014 and situations where such permission was not yet granted.26 The Danish Compromise might be perceived as a way to allow double-counting 17.21 of capital.27 However, at the same time, we believe the Danish Compromise attempts to address a need to reflect cross-sectoral holdings in a sectoral framework, taking a more integrated view on banking groups. Rather than disallowing the use of the Danish Compromise altogether, we believe a more nuanced analysis of the Danish Compromise might be needed, in which it might be worth considering the manner in which the perimeter of Solvency II group supervision is determined. Solvency II Group supervision encompasses essentially the entire group to which 17.22 an EEA insurance or reinsurance undertaking belongs, including entities in the group that belong to other financial sectors, as well as non-regulated undertakings. The group Solvency is calculated on the basis of consolidated data, as described in Articles 235 and 236 of the Solvency II Delegated Regulation. Cross-sectoral holdings (e.g. holdings in credit institutions or investment firms) are usually28 not fully consolidated for group solvency purposes, acknowledging that not all own funds in these subsidiaries are available for group solvency purposes.29 As opposed to the CRR consolidated approach, the contribution to the group own funds of these subsidiaries is essentially based on their contribution to the group solvency capital requirement, which is in most cases the capital requirement,

26 In the latter case, the ECB indicates that a credit institution must submit a request to the ECB for such permission, and the ECB will grant permission provided that the CRR criteria and appropriate disclosure requirements are met; ECB Guide on options and discretions available in Union Law, March 2016, available online at . See on this topic also several responses to the ECB consultation, including a legal opinion, submitted by Assosim and delivered by Professor E Wymeersch, on the Regulations on options and discretions in the bank-insurance sector, available online at . Wymeersch challenges in this opinion, among others, the legal basis for the ECB to disallow the use of art 471(1) of the CRR through an ECB Regulation and argues that the use should be based on an individual assessment, respecting the Danish compromise text in the CRR. 27 Ed-Op, ‘Basel III-the case for the defence’ Financial Times (London, 23 January 2012), see also D Schoenmaker and N Véron, ‘A ‘Twin-Peaks’ Vision for Europe’ (2017) 30 Bruegel, Policy Contribution 6. 28 However, see art 228 of the Solvency II Directive, which allows in certain circumstances the accounting consolidation method to be used to related credit institutions, investment firms, and institutions. Please note that this did not lead to full consolidation of these subsidiaries (see art 335(1)(e) of the Solvency II Delegated Regulation). 29 These own funds might be subject to fungibility and transferability restrictions.

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Arthur van den Hurk and Michele Siri calculated in accordance with CRR requirements and is, in most cases, limited to that contribution. 17.23 As described above, pursuant to the default method under the CRR, insurance

holdings are either excluded or, under strict conditions, the own fund instruments of these holdings are included in the CRR calculation.

V. Background of Financial Conglomerate Supervision 1. EU Financial Conglomerates Directive 17.24 The rapid development in financial markets in the 1990s led to the creation of

financial groups providing services and products in different sectors of the financial markets, the so-called financial conglomerates. In 1999, the European Commission’s Financial Services Action Plan identified the need to supervise these conglomerates on a group-wide basis and announced the development of prudential legislation to supplement the sectoral legislation on banking, investment and insurance. On 11 February 2003, EU Directive 2002/87/EC of 16 December 2002 on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate (hereafter the Financial Conglomerates Directive)30 entered into force in the EU Member States, requiring them to bring into force legislation and/or administrative provisions to comply with the Financial Conglomerates Directive before 11 August 2004 and applying these provisions as of the financial year beginning on 1 January 2005 or during that calendar year. The principal reason for the development of the Financial Conglomerates Directive was the need to face the accelerating pace of consolidation in the financial sector and the intensification of links between the various categories of financial markets operators.31 This was based on the idea that laws and regulations dealing with different financial sectors were not able to deal with these developments as traditionally different approaches were adopted for each sector with different definitions of capital, different types of risks and different capital requirements.32

30 [2003] OJ L35/1, 11 February 2003. 31 See E O Wymeersch, ‘Conflict of Interest in Financial Services Groups’ (January 2008), available online at and . 32 See Bank of International Settlements, ‘The Supervision of Financial Conglomerates: A Report by the Tripartite Group of Bank, Securities, and Insurance Regulators’ (July 1995) para 104; M Gruson, ‘Supervision of Financial Conglomerates in the European Union’ (2004) J.I.B.L.R. 363– 81; and Recital 2 and 3 of the Financial Conglomerates Directive.

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Financial Conglomerates in the European Banking Union 2. Relevant Features of the Financial Conglomerates Financial conglomerates are typically large groups with significant activities in 17.25 more than one financial sector (banking, investment, insurance). They tend to be complex in structure, operate across borders and the wider group can contain unregulated entities (from a financial legislation perspective) and might also include entities that are not involved in financial services. The bancassurance business model has traditionally been the most important op- 17.26 erating model of financial conglomerates. Bancassurance groups are essentially banking groups that combine both banking and insurance business, in the sense that they are set up to cross-sell insurance products through their own distribution channel, (bank branches).33 Bancassurance groups are able to offer a full range of financial products in a one-stop shopping model—from traditional banking, through mutual funds to insurance products. The bancassurance model appears to be popular mainly in some countries: Portugal, Spain and Italy, as well as France, Belgium, and Austria. To the contrary, in Germany, the UK, and the Netherlands, it has never been the dominant model. In light of its dominance, the EU financial conglomerate supervision was developed with a focus on the bancassurance business model. Although EU financial conglomerate supervision focuses on the bancassurance 17.27 model, other financial sectors beyond banking and insurance have gained prominence in recent years, for example, the asset management industry and the shadow banking sector. These changes also have to do with the increased regulatory pressure on regulated sectors that led some activities to migrate to the unregulated territory. In addition, an increasing number of non-banking non-financial groups own banks. Among the non-bank non-insurance firms holding banks, there are not only financial companies such as asset managers and private equity, but there can also be financial market utilities as well as industrial sector firms (automotive and utilities) or retail sector companies. Another important aspect of characterising financial conglomerates is their level 17.28 of complexity. Not only can they be huge in terms of the size of their balance sheet, but they are also very entrenched in terms of their group structure, comprising a large number of legal entities, sometimes in many different jurisdictions. Complexity also derives from the way different financial and non-financial activities are intertwined, from the interaction between regulated and unregulated entities, from the localization of operations both domestically and on a cross- border basis. All this complexity may drive to spillover outcomes either from, for

33 The opposite model is also possible, that is also referred to as 'assurfinance', an insurance group cross-selling banking products through its distribution channels (the insurance company, or insurance intermediary channel. See, e.g., L A A van den Berghe and K Verweire, Creating the Future with All Finance and Financial Conglomerates (Kluwer Academic 1998) ch 1.

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Arthur van den Hurk and Michele Siri example, the industrial part to the financial component and vice versa; from unregulated entities to regulated ones; and definitely from one country to another. From a regulatory and supervisory perspective, it also naturally leads to hurdles concerning corporate governance and supervision.

VI. Institutional Framework for Conglomerate Supervision 1. Supplementary Nature of Conglomerate Supervision 17.29 The framework for the supervision of financial conglomerates is intended to target

additional prudential risks related to the existence of a financial conglomerate and address loopholes in sectoral supervision without prejudice to sectoral supervision. The Financial Conglomerates Directive does not replace the existing supervision of the different, regulated sectoral parts of a financial conglomerate (banks and investment firms, asset management companies, alternative investment fund managers, and insurance and reinsurance undertakings) but introduces a layer of supplementary supervision of the regulated entities in the group on top of the sectoral legislation. This allows supervisors to look across sectors—addressing any blind spots in the sectoral legislation and avoiding the circumvention of prudential requirements set out in sectoral legislation. It should be added that financial conglomerates can also contain an industrial component (un-regulated from a financial legislation perspective and non-financial), which also affects the overall risk situation of the financial conglomerate.

17.30 Financial conglomerates and constituent parts of financial conglomerates are sub-

ject to supervision supplementary to sectoral supervision on a stand-alone, consolidated or group basis. Supplementary supervision aims mainly at: (i) avoiding the double gearing or multiple use of capital, whilst ensuring it is appropriately allocated in the group according to sectoral rules; and (ii) monitoring group risks, which are those arising from the structure of a group as a financial conglomerate, ie risks of contagion, structure complexity, risk of concentration, and conflicts of interest.

17.31 Procedural arrangements are needed for the co-operation between the co-ordinator

and the relevant competent authorities to fulfil the supervisory assessment of the financial conglomerate and to enhance co-operation between the competent authorities on a cross-border and cross-sectoral basis and to supplement the functioning of sectoral colleges (if any) where a cross-border group has been identified as a financial conglomerate. To this aim, the Joint Committee of the ESAs has elaborated guidelines to enhance the level playing field in the financial market and reduce administrative burdens for firms and supervisory authorities.

17.32 A supervisory co-ordination arrangement pertaining to any financial conglom-

erate aims to: (a) ensure there is adequate capital at the level of the financial 638

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Financial Conglomerates in the European Banking Union conglomerate itself, and in particular, that regulatory capital—(i) is available across legal entities; and (ii) is at least equal to the supplementary capital adequacy requirements calculated pursuant to Annex I of Directive 2002/87/EC;— (b) monitor risk concentration at the level of the financial conglomerate as well as the significant intra-group transactions between the regulated entities; and (c) ensure that the financial conglomerate has adequate risk management processes and internal control mechanisms in place. We refer to VII.D for a further discussion on the co-ordination arrangements in the Financial Conglomerates Directive, as well as the role of the ECB as co-ordinator.34 2. ECB Supervised Conglomerates vs Other Conglomerates As indicated above, many of the banking groups, subject to direct ECB supervi- 17.33 sion, are, at the same time, financial conglomerates. In these cases, the ECB may, as indicated above, also assume the role of coordinator. Other conglomerates are not subject to direct ECB supervision and have a co-ordinator from among the supervisory authorities in the Member States, such as an insurance supervisory authority. As we have indicated, the current landscape of conglomerates displays a large variety of conglomerates, ranging from banc-assurance groups to conglomerates with predominant insurance, banking or asset management character.

VII. Purpose, Content, and Design of Conglomerate Supervision 1. Joint Forum Principles The Financial Conglomerates Directive can be considered the European translation 17.34 of the Joint Forum35 Principles for the supervision of financial conglomerates.36

34 See also, European Central Bank, ‘SSM Supervisory Manual— European Banking Supervision: Functioning of the SSM and Supervisory Approach’, March 2018, 34, available online at . 35 The Joint Forum was established in 1996 under the aegis of the Basel Committee on Banking Supervision (BCBS), the International Association of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors (IAIS) to deal with issues common to the banking, securities and insurance sectors, including the regulation of financial conglomerates. 36 Bank of International Settlements, February 1999, Supervision of Financial Conglomerates, papers prepared by the Joint Forum on Financial Conglomerates. Initially prepared as a number of papers dealing with matters, relating to financial conglomerates, jointly referred to as the 1999 Principles, the 1999 Principles were subsequently reviewed and updated in 2012, as recommended in a report following the Joint Forum Review of the Differentiated Nature and Scope of Financial Regulation, January 2010 (the ‘DSNR report’). This has resulted in the current version of the Joint Forum Principles for the supervision of financial conglomerates of September 2012. These updated principles are a broader and more consolidated set of internationally agreed principles than the preceding documents. In the Financial Conglomerates Directive, reference is made to the work of, among others, the Joint Forum: see Recital 4 of the Financial Conglomerates Directive.

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Arthur van den Hurk and Michele Siri The aim of the Joint Forum Principles is to provide national authorities, standard setters, and supervisors with a set of internationally agreed principles that support consistent and effective supervision of financial conglomerates, and in particular those active across borders. The Joint Forum’s aim was to focus on closing regulatory gaps, eliminating supervisory ‘blind spots’, and ensuring effective supervision of risks arising from unregulated financial activities and entities. According to the Joint Forum, the principles should be applied in a proportionate manner to the risks posed and at least be applied to large internationally active financial conglomerates.37 This last observation might raise the question to what extent financial conglomerates are, per se, systemically relevant (see para 6). 17.35 The Joint Forum Principles define a financial conglomerate as any group of com-

panies under common control or dominant influence, including any financial holding company, which conducts material activities in at least two of the regulated banking, securities or insurance sectors.38 This definition is broader than the narrower definition used in the Financial Conglomerates Directive, as we will discuss in paragraph 17.72 below.39

A. Target Additional Prudential Risks Related to the Existence of a Financial Conglomerate 17.36 As pointed out in the introductory part of the Joint Forum Principles, the financial crisis, that began in 2007, highlighted the significant role that financial groups, including financial conglomerates, play in the stability of global and local economies. Due to their economic reach and their mix of regulated and unregulated entities, financial conglomerates present challenges for sector-specific oversight.40 As referred to in the recitals of the Financial Conglomerates Directive, as summarized by Gruson, combined financial operations may create new prudential risks or exacerbate existing ones.41 Some of the conglomerates that were intended to be covered by the Financial Conglomerates Directive belong to the biggest financial groups that are active in the financial markets and provide services on a global basis. If such conglomerates, and in particular credit institutions, investment firms, and insurance undertakings that are part of such a conglomerate, were to 37 Joint Forum 2012 Principles, ch 2, 2. See also H E Jackson and C Half, Background Paper on Evolving Trends in the Supervision of Financial Conglomerates (2002), available online at . 38 Joint Forum 2012 Principles, ch 3, 5. Groups with activities in only one of the regulated sectors, combined with commercial (i.e. non-financial) activities, do not fall within that definition. These groups are assumed to be covered by the supervisory framework of the relevant sector (see n 10). 39 See also S Illegems, ‘Het Prudentieel Toezicht op Financiële Conglomeraten Onder het Single Supervisory Mechanism’ in R Houben and W Vandenbruwaene (eds), Het nieuwe Bankentoezicht, the New Banking Supervision (Intersentia 2016) 148. 40 Joint Forum 2012 Principles, ch 1, 1. 41 Recital 2 of the Financial Conglomerates Directive. See also M Gruson, ‘Supervision of Financial Conglomerates in the European Union’ (2004) J.I.B.L.R. 363–81.

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Financial Conglomerates in the European Banking Union face financial difficulties, these could seriously destabilize the financial system and affect individual depositors, insurance policyholders and investors.42 B. Address Loopholes in Sectoral Supervision As pointed out by the Joint Forum, international financial regulation is sector- 17.37 specific, as is evidenced by the independent development of core principles or standards in each financial sector. A sector- specific approach to supervision comes with the potential for increasing regulatory gaps, which causes supervisory challenges and presents opportunities for regulatory arbitrage.43 Differences exist in the nature of financial regulation among the banking, insurance, and securities sectors. These differences are warranted in some cases due to specific attributes of each financial sector but, in other cases, these differences may contribute to gaps in the regulation of the financial system as a whole.44 In order to address these loopholes, the 1999 Joint Forum Principles dealt with: (a) techniques for assessing the capital adequacy of conglomerates, including detecting excessive gearing; (b) facilitating the sharing of information among supervisors; (c) co-ordination among supervisors; (d) testing the fitness and propriety of managers, directors, and major shareholders of the conglomerate; (e) the prudent management and control of risk concentrations and intra-group transactions and exposures.45 These topics still form the core of the 2012 Joint Forum Principles, but following 17.38 an internal review of the 1999 principles, the principles dealing with capital adequacy, risk concentrations, and intra-group exposures were updated to reflect industry developments and to provide greater focus on special purpose entities and the holding companies of financial conglomerates. In addition, the principles dealing with fit and proper requirements were updated to encompass broader areas of corporate governance.46 2. Conglomerate Specific Risks and Supervision The purpose of the Financial Conglomerates Directive and financial conglomerate 17.39 supervision is to address specific group risks, that could occur within financial

Recital 2 of the Financial Conglomerates Directive. 43 European Commission, Commission Staff Working Document on Directive 2002/87/EU on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a conglomerate (FICOD), 13 July 2017, SWD (2017)272 final, 9, mentions the following specific group risks: double gearing; size and complexity; contagion risk; risk concentrations; and conflicts of interests. In this respect, reference can be made to a research project, and forthcoming book: V Colaert, D Busch, and T Incalza (eds), Regulating Finance: Levelling the Cross-Sectoral Playing Field. 44 Joint Forum, ‘Review of the Differentiated Nature and Scope of Financial Regulation: Key Issues and Recommendations’, January 2010, 3, available online at . 45 Joint Forum, ‘Principles for the Supervision of Financial Conglomerates’, September 2012, 1. 46 Ibid. 42

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Arthur van den Hurk and Michele Siri conglomerates. These risks mainly consist of contagion risk, concentration risks, and the complexity of financial conglomerates. Furthermore, a crucial area of attention in conglomerate supervision is the double or multiple uses of capital within the group, referred to as double or multiple gearing of capital. Lastly, the management of conflicts of interests is an area of attention as well. 17.40 The Financial Conglomerates Directive also provides for a structure of super-

vision of the requirements pursuant to the Financial Conglomerates Directive. In particular, procedures are included in the directive for the appointment of a coordinating supervisor and the tasks of this co-ordinator. In broad terms, the coordinator is responsible for, as the name indicates, co-ordination and exercise of supplementary supervision on the conglomerate. 3. Content of Financial Conglomerate Supervision

A. Supplementary Capital Requirements 17.41 Article 6(2) of the Financial Conglomerates Directive provides that the Member States should require regulated entities within the conglomerate to ensure that own funds are available at the level of the financial conglomerate that is always at least equal to the capital requirements, as calculated in accordance with the methods set out in the Financial Conglomerates Directive.47 While in Article 6(2) the regulated entities within the conglomerate are addressed, some Member States, such as the Netherlands, have gone further by appointing the holding of the conglomerate as the addressee of the supplementary capital requirement of the conglomerate.48 The mechanism included in the Financial Conglomerates Directive itself is somewhat complex, because a regulated subsidiary within a conglomerate may not necessarily be capable of complying with a capital requirement, imposed at the level of the conglomerate. De Vuyst49 argues that, while holdings are not directly included in conglomerate supervision through Article 6(2), they are included indirectly, through an extended scope of application, in case of the holding, an ‘upward’ scope of application. In addition to compliance with the capital requirements itself, the conglomerate also needs to have adequate capital adequacy policies at the level of the conglomerate.50

47 Annex I of the Financial Conglomerates Directive contains the technical principles for that calculation, as well as three technical calculation methods: accounting consolidation, deduction and aggregation and a combination. A fourth method, originally included in the Annex, was removed as part of the 2011 revision of the directive. 48 Article 3:296(1) of the Dutch Financial Supervision Act. In addition, the regulated entities remain responsible as well, in line with art 6(2) of the Financial Conglomerates Directive. 49 V de Vuyst, Internal Governance bij Financiële Conglomeraten (Intersentia 2009) 303. 50 Article 6(2), 2nd para of the Financial Conglomerates Directive.

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Financial Conglomerates in the European Banking Union B. Risk Concentrations and Intra Group Transactions and Positions Regularly, and at least yearly, regulated entities or mixed financial holding compa- 17.42 nies51 are required to report to the co-ordinator any significant risk concentration at the level of the conglomerate, as well as significant intra-group transactions of regulated entities within the financial conglomerate.52 Supervision of intra- group transactions and risk-concentrations also takes place in accordance with sectoral requirements. Both the CRD framework and the Solvency II framework contain such requirements. The Financial Conglomerates Directive contains specific requirements for the alignment between the sectoral frameworks and the cross-sectoral Financial Conglomerates Directive, in case the conglomerate is led by a mixed financial holding company. In that case, the sectoral requirements regarding risk concentrations and intra-group transactions respectively, with respect to the most important financial sector in the financial conglomerate, are applied to that sector as a whole, including the mixed financial company.53 C. Risk Management and Internal Controls The Financial Conglomerates Directive requires that adequate risk management 17.43 processes and internal control mechanisms, including sound administrative and accounting procedures, are in place at the level of the financial conglomerate.54 The risk management processes shall include: (a) sound governance and man- 17.44 agement with the approval and periodical review of the strategies and policies by the appropriate governing bodies at the level of the financial conglomerate with respect to all the risks they assume; (b) adequate capital adequacy policies in order to anticipate the impact of their business strategy on risk profile and capital requirements as determined in accordance with Article 6 and Annex I of the Financial Conglomerates Directive; (c) adequate procedures to ensure that their risk monitoring systems are well integrated into their organization and that all measures are taken to ensure that the systems implemented in all the undertakings

51 In this case, the Financial Conglomerate Directive leaves the option that the reporting requirement is imposed on the holding company (art 7(2) of the Financial Conglomerates Directive). 52 Contrary to 'risk concentrations', a threshold is set in the directive for the significance of intra- group transactions, that applies in so far as no definition of thresholds has been drawn up, as referred to in Annex II to the Directive. An intra-group transaction shall be presumed to be significant if its amount exceeds at least 5% of the total amount of capital adequacy requirements at the level of the conglomerate (art 8(2) of the Financial Conglomerates Directive). On 22 May 2019, the Joint Committee of European Supervisory Authorities launched a consultation on draft implementing technical standards on the reporting of intra-group transactions and risk concentration under art 21a(2b) and (2c) of Directive 2002/87/EC, JC/CP/2019/01, available online at . The aim of these ITS is, according to the Joint Committee, to fully align the reporting under FICOD in order to enhance supervisory overview regarding group specific risks, in particular, contagion risk. 53 Articles 7(4) and 8(4) of the Financial Conglomerates Directive. 54 Article 9(1) of the Financial Conglomerates Directive.

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Arthur van den Hurk and Michele Siri included in the scope of supplementary supervision are consistent so that the risks can be measured, monitored, and controlled at the level of the financial conglomerate; and (d) arrangements in place to contribute to and develop, if required, adequate recovery and resolution arrangements and plans. Such arrangements shall be updated regularly.55 17.45 The internal control mechanisms shall include: (a) adequate mechanisms as

regards capital adequacy to identify and measure all material risks incurred and to appropriately relate own funds to risks; and (b) sound reporting and accounting procedures to identify, measure, monitor, and control the intra- group transactions and the risk concentration.56 Furthermore, it is required that in all undertakings included in the scope of supplementary supervision, there are adequate internal control mechanisms for the production of any data and information which would be relevant for the purposes of the supplementary supervision.57

17.46 In addition, regulated entities, are required, at the level of the financial con-

glomerate, to regularly provide the co-ordinator with details on their legal structure and governance and organizational structure including all regulated entities, non-regulated subsidiaries and significant branches. The regulated entities should also disclose, publicly, at the level of the financial conglomerate, on an annual basis, either in full or by way of references to equivalent information, a description of their legal structure, and governance and their organizational structure.58

D. Fit and Proper Requirements 17.47 Persons who effectively direct the business of a mixed financial holding company should be of sufficiently good repute and have sufficient experience to perform those duties.59 E. Stress Testing 17.48 In 2011, the possibility was introduced in the Financial Conglomerates Directive60 for the Member States to require regular stress testing of financial conglomerates by the co-ordinator. This possibility is in line with Principle 25 of the 2012 Joint Forum Principles, pursuant to which supervisors should require, where appropriate, that the financial conglomerate periodically carries group-wide stress tests and scenario analyses for its major sources of risk.

55 Article 9(2) of the Financial Conglomerates Directive. 56 Article 9(3) of the Financial Conglomerates Directive. 57 Article 9(4), 1st para of the Financial Conglomerates Directive. 58 Article 9(4) of the Financial Conglomerates Directive. 59 Article 13 of the Financial Conglomerates Directive. 60 Article 9b of the Financial Conglomerates Directive, included through Directive 2011/89/EU.

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Financial Conglomerates in the European Banking Union In addition, the Financial Conglomerates Directive opens the possibility for the 17.49 European Supervisory Authorities, through the Joint Committee, and in co- operation with the ESRB, to develop supplementary parameters to capture specific risks, associated with financial conglomerates.61 The Financial Conglomerates Directive does not include a requirement to per- 17.50 form stress tests on a regular basis. So far, the Joint Committee has not made use of the possibility to develop conglomerate-specific parameters either. Instead, EU-wide stress tests have taken place, but on a sectoral basis for the 17.51 banking sector and the insurance sector.62 It should be noted that these sectoral stress tests are different in nature and purpose for the different sectors.63 Obviously, if stress testing would be used as an additional supervisory tool to ensure the early and effective monitoring of risks in the conglomerates, it is essential to determine appropriate parameters for that specific purpose. Given the different purposes of the sectoral stress tests, the parameters used for these stress tests, may not be suitable for stress testing of conglomerate risks even if they may furnish useful information on potential vulnerabilities of the conglomerate in itself.64 F. Co-ordination Provisions A central role in supplementary supervision in accordance with the Financial 17.52 Conglomerates Directive is played by the co-ordinator.65 The co-ordinator is responsible for the: (a) co-ordination of the gathering and dissemination of relevant or essential information in going concern and emergency situations, including the dissemination of information which is of importance for a competent authority's supervisory task under sectoral rules; (b) supervisory overview and assessment

Article 9b(2) of the Financial Conglomerates Directive. 62 However, the stress tests are typically performed on a group basis. 63 The stated objective of the EBA, EU-wide, stress tests for banks is to assess, in a consistent way, the resilience of banks to a common set of adverse shocks. The stated objective of the EIOPA EU-wide stress tests for insurance companies is to assess the vulnerabilities of the European insurance sector to severe but plausible scenarios with potentially negative implications for the European insurance sector and the real economy, but is not a pass or fail the test. Whereas the EBA stress test results are an input to the supervisory decision-making process and aimed to promote market discipline, the EIOPA stress test results should identify vulnerabilities of the sector and lead to a discussion on preventative measures and potential management actions to address these vulnerabilities, should they materialize. See online at and . 64 For example, EIOPA In light of the individual results obtained from the insurance groups participating in the 2018 insurance stress test exercise, observed that some of the insurers that are more negatively affected are part of bank-led financial conglomerates. Some of these groups appear to be vulnerable either to low yields and longevity risk, or to a sudden and abrupt reversal of risk premia combined with an instantaneous shock to lapse rates and claims inflation: see further EIOPA, 'EIOPA's Insurance Stress Test 2018 Recommendations', EIOPA-BoS-19/144, 26 April 2019 at n 5. 65 Article 10ff of the Financial Conglomerates Directive. 61

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Arthur van den Hurk and Michele Siri of the financial situation of a financial conglomerate; (c) assessment of compliance with the rules on capital adequacy and of risk concentration and intra-group transactions; (d) assessment of the financial conglomerate's structure, organization and internal control system; (e) planning and co-ordination of supervisory activities in going concern as well as in emergency situations, in co-operation with the relevant competent authorities involved; and (f ) other tasks, measures and decisions assigned to the co-ordinator by this Directive or deriving from the application of the Financial Conglomerates Directive.66 17.53 In terms of supervisory co- operation, the Financial Conglomerates Directive

makes a distinction between competent authorities and relevant competent authorities. The latter group of supervisory authorities consists of the co-ordinator, the supervisory authority responsible for group-wide sectoral supervision,67 as well as any other supervisory authority that the sectoral group supervisor and co-ordinator consider relevant for the purpose of supplementary conglomerate supervision.68 The relevant competent authorities have a more prominent role in supplementary supervision than (potential) other supervisory authorities in the conglomerate.69

17.54 The Joint Committee of European Supervisory Authorities has developed

guidelines on the convergence of supervisory practices relating to the consistency of supervisory co-ordination arrangements for financial conglomerates.70 The purpose of these guidelines is to clarify and enhance co-operation between competent authorities on a sectoral and cross-sectoral basis and to supplement the functioning of sectoral colleges (if any) where a group has been identified as a financial conglomerate.71 The guidelines cover the following areas: (a) mapping of the conglomerate structure and written agreements; (b) co-ordination of information exchange in going concern and emergency situations; (c) supervisory assessment of financial conglomerates; (d) supervisory planning and co- ordination of supervisory activities in going concern and emergency situations; and (e) decision-making processes among the competent authorities.

17.55 The guidelines clarify that the planning and co-ordination activities for the su-

pervision of the conglomerates should, as far as possible, be incorporated by the

Article 11(1) of the Financial Conglomerates Directive. 67 The Solvency II group supervisor or the supervisor responsible for consolidated CRD supervision. 68 Article 21a(1)(b) of the Financial Conglomerates Directive provides that the European Supervisory Authority may develop draft regulatory technical standards to establish procedures or specify criteria for the determination of 'relevant competent authorities.' So far, such RTS has not been developed. 69 See, e.g., arts 9b; 11(1), 2nd para; 18(1a) and (3). 70 In accordance with art 11 of the Financial Conglomerates Directive, JC/GL/2014/01, 22 December 2014. 71 Guidelines, 4. 66

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Financial Conglomerates in the European Banking Union co-ordinator into the colleges' process that has already been established pursuant to Article 116 of CRD IV or Article 148 of the Solvency II Directive.72 If colleges are already established under these sectoral guidelines, items relating to supplementary conglomerate supervision may be placed on the agenda of these colleges.73 In many instances, cross-sectoral conglomerate supervision will be integrated into sectoral supervision. Interestingly, European Commission Staff observes that there might be issues with respect to the role of the co-ordinator, where the designated supervisory authority has only powers to oversee one sector of the group. This may lead to difficulties in obtaining information for the supervisory authorities in the other arm of the conglomerate.74 Perhaps not so surprising, in particular in the Member States where sectoral supervision is carried out by different institutions, co-ordination arrangements in the Financial Conglomerates Directive are perceived as one of the keys added values of the Financial Conglomerates Directive, more so than in the Member States where (prudential) sectoral supervision is integrated.75 This might be equally true in case the ECB will be appointed as co- ordinator, given the limitations in its powers to supervise insurance companies.76 4. Role of the ECB as Coordinator with Respect to Financial Conglomerate Supervision Pursuant to Article 4(1)(h) of the SSM Regulation, the ECB can 'participate in 17.56 the supplementary supervision of a financial conglomerate with respect to the credit institutions included in it and to assume the tasks of a co-ordinator where the ECB is appointed as the co-ordinator for a financial conglomerate in accordance with the criteria set out in relevant Union law. In particular, the role of co-ordinator raises questions with respect to Article 127(6) of the TFEU. To the extent the ECB participates in the supplementary supervision with respect to the credit institutions included in the conglomerate, this seems a logical role, in line with the role it has as the prudential supervisor of the credit institutions in the conglomerate. Formally the assumption of the role of co-ordinator should not conflict with 17.57 Article 127(6) of the TFEU either. The ECB does not assume tasks with respect to the prudential supervision of insurance undertakings; it 'only' assumes a role with respect to supplementary supervision of the conglomerate. However, the role of co-ordinator will require substantial expertise with respect to the activities of the conglomerate, including insurance activities, as well as with respect Guidelines, 5. 73 Guidelines, 6. 74 Commission Staff Working Document on Directive 2002/87/EU on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a conglomerate (FICOD), 13 July 2017, SWD (2017)272 final, 49. 75 Ibid. 76 Article 127(6) of the European Treaty. See para 17.56 and 17.57. 72

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Arthur van den Hurk and Michele Siri the supervision of such activities, and will require the expertise of conglomerate- specific risks and the supervision of such risks. The ECB currently does not focus on these specific competences in its role as prudential supervisor of credit institutions within the SSM. Furthermore, it might be that the ECB has a natural bias towards the supervision of credit institutions, due to its role as prudential supervisor of credit institutions. 17.58 In the context of the supplementary supervision of financial conglomerates, it is

interesting to note that Article 3(1) of the SSM Regulation does not refer specifically to the need for close co-operation of the ECB with the national competent authorities in the insurance sector nor makes the SSM Regulation refers specifically to the need to enter into memoranda of understanding with these authorities, although Article 3 does leave room to enter into such agreements. In order to achieve effective conglomerate supervision, this does seem a crucial element.77 5. Equivalent Provisions under Different Directives

17.59 Relevant provisions in the sectoral requirements of Solvency II and CRD IV, as

well as the Financial Conglomerates Directive, are contained in Article 120 of CRD IV and Article 213(3) to (6) of the Solvency II Directive.78 These provisions offer the possibility to apply, where a mixed financial holding company is subject to equivalent provisions under different sectoral directives, or under a sectoral directive and the financial conglomerates directive, to apply only one set of requirements to that mixed financial holding company.

17.60 A recent EIOPA report provides some insight into the use of these provisions.

EIOPA is not aware of cases where group supervisors only apply the relevant provisions of the Financial Conglomerates Directive to a mixed financial holding company that is subject to equivalent provisions under Solvency II rules and the rules of the Financial Conglomerates Directive. In one Member State, one mixed financial holding company applied for such a total waiver, but this request was refused by the group supervisor, and subsequently, this decision was confirmed by the Administrative Court in that country. On the other hand, another Member State79 hasHas applied Article 213(5) of the Solvency II Directive.80 In this case,

77 See also S Illegems, ‘Het Prudentieel Toezicht op Financiële Conglomeraten Onder Het Single Supervisory Mechanism’ in R Houben and W Vandenbruwaene (eds), Het Nieuwe Bankentoezicht: The New Banking Supervision (Intersentia 2016) 148. 78 Introduced as part of the technical review of the Financial Conglomerates Directive, 2011/89/EU. 79 In this particular Member State,, an integrated supervisory model is applied. Consequently,, the supervisory authority exercising consolidated CRD supervision and the Solvency II group supervisor is the same. 80 According to which, a mixed financial holding company that is subject to equivalent provisions under Solvency II and CRD, in particular in terms of risk-based supervision, allowing for, in agreement with the CRD supervisor, the application of only the relevant provisions of Solvency II to that mixed financial holding company.

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Financial Conglomerates in the European Banking Union the supervisory system of the EU Member State was established as an integrated framework, and the insurance activities were predominant activities in the group, and therefore, Solvency II group supervision was most appropriate. EIOPA has also identified two cases, based on Article 213(3) of the Solvency II 17.61 Directive, in which the supervisory authority81 decided to require the reporting of intra-group transactions and risk concentrations only at the broader scope and level of the financial conglomerate that encompasses the reporting at the insurance group level.82,83 EIOPA points out in the report that difficulties in understanding how the equiv- 17.62 alence assessment of the of these provisions have been raised in some Member States, which emphasizes the need for further guidance in case of the assessment as guidelines and regulatory technical standards envisaged in Article 213(6) are still not developed.84 On the other hand, it might even be more appropriate to determine, in the directives themselves, which provisions in the various directives are equivalent to each other, instead of leaving that to the discretion of the supervisory authorities in the Member States, to ESA guidelines and the regulatory technical standards.

VIII. Evolution of Financial Conglomerate Supervision 1. Revisions of the Financial Conglomerates Directive A. Technical Review of the Financial Conglomerates Directive in 2011 Since the adoption of the Financial Conglomerates Directive in 2002, the di- 17.63 rective so far has been revised once to a notable extent,85 in 2011.86 The main purpose of this revision was to better align various types of group supervision, resulting from different directives, in order to avoid that the application of one

81 of the ultimate insurance parent. 82 EIOPA, ‘Report to the European Commission on Group Supervision and Capital Management within a Group of Insurance or Reinsurance Undertakings, and FoS and FoE under Solvency II’, EIOPA BoS-18-485, Frankfurt, 14 December 2018, paras 3.102 and 3.106. 83 In both cases, the head of the insurance group is the same as the head of the financial conglomerate. In one of the cases, the Solvency II group supervisor needed to ensure that the information was fit for the purpose of Solvency group supervision. The requested information was provided in a different format than requested for in accordance with Implementing Regulation (EU) 2015/2450, but prevented a double flow of information: see EIOPA, 'Report to the European Commission on Group Supervision and Capital Management within a Group of Insurance or Reinsurance Undertakings, and FoS and FoE under Solvency II', EIOPA BoS-18-485, Frankfurt, 14 December 2018, paras 3.103 and 3.107. 84 Ibid, para 3.287. 85 Leaving aside a number of smaller, technical amendments, resulting from amendments to other, sectoral directives. 86 Directive 2011/89/EU, [2011] L326/113.

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Arthur van den Hurk and Michele Siri regime would exclude the application of another regime87 and to prevent that a financial conglomerate would become subject to similar requirements from different directives. As a result of the revisions, the co-ordinating supervisor in the conglomerate, in co-operation with the other relevant sectoral supervisors, can decide which provisions will then apply exclusively to a specific conglomerate.88 17.64 As a result of this review, a number of other amendments have been made to the

Financial Conglomerates Directive, be it all of a relatively technical nature.89 The most significant are the following: (a) Financial conglomerates became obliged to provide the co-ordinating supervisor more information about the legal structure, governance and organizational structure of the group. This information also needs to be disclosed; (b) AIF managers became subject to a similar treatment under the Financial Conglomerates Directive as UCITS managers; (c) One of the calculation methods for supplementary capital adequacy was removed from the Directive;90 (d) The co-operation provisions between supervisory authorities were changed in order to avoid duplication. A separate 'conglomerate' college of supervisors is only needed in the absence of a comparable banking or insurance college of supervisors; (e) The possibility to require regular stress testing for financial conglomerates.91

B. 2012 Review Report, Fundamental Review 17.65 Apart from the 2011 technical review of the Financial Conglomerates Directive, also a more fundamental review of the directive was envisaged in the 2011 review directive. Pursuant to Article 5 of Directive 2011/89/EU, the European Commission needed to report to the European Parliament and the Council on the Financial Conglomerates Directive, in particular on the scope, expansion to non-regulated entities, criteria to identify conglomerates that form part of a larger, non-financial group systemic relevant financial conglomerates and compulsory stress-testing for conglomerates. Accordingly, the European Commission published a report in December 2012,92 That demonstrates the complexity of potential revisions to the Financial Conglomerates Directive amidst all other

87 Which might result in regulatory gaps. 88 See, e.g., art 213(3)–(6) of the Solvency II Directive; and art 120 of CRD IV. 89 The limited approach to this technical review was partially based on the anticipation of the Joint Forum’s revised principles, published in September 2012 by the IAIS, which were expected to be addressed in the 2012 review by the European Commission. 90 The book value/requirement deduction method. 91 However, to date, common criteria for such stress tests have not been developed. 92 European Commission, Report on the review of the Financial Conglomerates Directive 2002/ 87/EC, December 20, 2012, COM(2012) 785 final, available online at .

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Financial Conglomerates in the European Banking Union developments in the financial sector and financial sector regulation. Despite the fact that the 2012 report identifies a number of areas in which the FCD could be improved, a further review was put on hold pending the further development of sectoral regulatory regimes (e.g. CRD IV/CRR and Solvency II).93 Scope Inclusion of Non-Regulated Entities The revised Joint Forum Principles of September 17.66 2012 addressed two main issues: the inclusion of unregulated entities within the scope of supervision to cover the full spectrum of risks to which a financial group is or may be exposed and the need to identify the entity ultimately responsible for compliance with the group-wide requirements.94 The original aim of the Financial Conglomerates Directive, as well as of the Joint 17.67 Forum Principles, was to cover all entities in the group that are relevant for the risk profile of the regulated entities in the group. This includes any entity in the group, not directly prudentially regulated, even if it carries out activities outside the financial sector, including non-regulated holding and parent companies at the top of the group. Furthermore, according to the Commission, each unregulated entity may present different risks to a conglomerate and may require separate consideration and treatment. In the Commission Staff Working Document accompanying the 2012 report, it is flagged that the lack of a harmonized approach towards unregulated entities may have caused uncertainty and inconsistencies in the application of the requirements by supervisory authorities.95 Specifically highlighted by the European Commission are special purpose entities 17.68 (SPEs), of which the number and complexity have increased significantly before the financial crisis, in conjunction with the growth of markets for securitization and structured finance products. The Commission underlines that the use of SPEs is not inherently problematic, but poor risk management and a misunderstanding of the risks of SPEs can lead to disruption and failure. Therefore, the need for enhanced monitoring of intra-group relationships with SPEs was highlighted in the Joint Forum’s 1999 SPE report.96,97

93 European Commission, Report on the review of the Financial Conglomerates Directive 2002/ 87/EC, December 20, 2012, COM(2012) 785 final, available online at , 4. 94 See 17.34 and further above. See also European Commission, Report on the review of the Financial Conglomerates Directive 2002/87/EC, December 20, 2012, COM(2012) 785 final, available online at  at 3. 95 Commission Staff Working Document on Directive 2002/87/EU on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a conglomerate (FICOD), 13 July 2017, SWD (2017)272 final, 6. 96 European Commission, ‘Report on the review of the Financial Conglomerates Directive 2002/87/EC’, December 20, 2012, COM(2012) 785 final, available online at  at 5. 97 Available online at .

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Arthur van den Hurk and Michele Siri 17.69 Systemically Relevant Financial Conglomerates Financial conglomerates are typ-

ically large groups with significant activities in more than one financial sector (banking, investment, insurance) and tend to be complex in structure, operate across borders, and the wider group can contain unregulated entities and also entities not involved in financial services.98 It may, therefore, seem logical to conclude that conglomerates are, per definition, also systemically relevant or to equate group risks with systemic risks. However, we agree with the Commission that systemic risks are not necessarily the same as group risks and, although most systemically important financial institutions are also conglomerates, this is not always the case.99 In the Commission Staff Working Document, accompanying the 2012 report, it is noted that ‘too big to fail’ has less to do with size than with structure,100 and that the ESAs, in their advice,101 note that group risk and resolution issues have less to do with size than with complexity and underline that even in small conglomerates apparently, non-correlated risks might interact to produce negative effects, especially in times of stress.102 In addition, in its 2012 report, the European Commission notes that the discussions at the international level are still continuing on insurance SIFIs, and the sectoral legislation, including the treatment of banking SIFIs, is not yet stable.103 This observation of the European Commission still seems valid today.104 A relevant development in the discussions 98 European Commission,’ Staff Working Document on Directive 2002/87/EU on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a conglomerate (FICOD)’, 13 July 2017, SWD (2017)272 final, 5. 99 European Commission, ‘Report on the review of the Financial Conglomerates Directive 2002/87/EC’, December 20, 2012, COM(2012) 785 final, available online at at 5. See also European Commission, ‘Staff Working Document on Directive 2002/87/EU on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a conglomerate (FICOD)’, 13 July 2017, SWD (2017)272 final, 7, as well as the tables at 6 and 53–4. In this Commission Staff Working Document, the Commission Services suggest that financial conglomerates are institutions of systemic importance. This statement should be supported by the fact that the list conglomerates (2015) include eleven of the thirty G-SIBs, three of the nine G-SIIs, and twenty-four of the thirty- four G-SIIs as identified by EBA. However, it should be noted that the total number of G-SIBs and G-SIIs, compared to the full list of identified conglomerates is significantly longer. 100 Reference in the report is made to Blundell-Wignal et al, ‘The Elephant In The Room—The Need To Deal With What Banks Do’ (2009) 2 Financial Market Trends 1–26. 101 EBA, 'EIOPA and ESMA's response to the European Commission's Call for Advice on the Fundamental Review of the Financial Conglomerates Directive' (JC/2012/88), 2 October 2012. 102 European Commission, ‘Staff Working Document, Technical analysis accompanying the document Report from the Commission to the European Parliament and the Council, Report on the review of the Directive 2002/87/EC of the European Parliament and the Council on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate’, SWD(2013) 71 final, paragraph 3.4.2, 15 March 2013. 103 European Commission, ‘Report on the review of the Financial Conglomerates Directive 2002/87/EC’, December 20, 2012, COM(2012) 785 final, available online at , 5. 104 For instance, on 14 November 2018, The International Association of Insurance Supervisors (IAIS) launched a consultation on a holistic framework for systemic risk in the insurance sector: available online at .

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Financial Conglomerates in the European Banking Union on systemic risk in the insurance sector in this respect is also that the framework for systemic risk in the insurance sector might evolve from an entity-based approach to an activities-based approach (or a combination of both) and it is possible that this framework may not anymore include a list of globally systemically relevant insurers or measures may apply to a different group of insurers than is currently the case. Recently, EIOPA has reflected, inter alia, in the context of systemic risk in the 17.70 insurance sector, on the possibility to request systemic risk management plans to financial conglomerates and concludes that this raises several operational issues which require further work.105 As regards supervision of financial conglomerates, because there is in general separation of responsibilities at the supervisory level, which often results in a multiplicity of authorities, with occasionally limited communication between with each other, this raises the issue of whether measures should be applicable to all conglomerates, or only to a subset of conglomerates (eg insurer-led conglomerate. With respect to the use of the supervision on conglomerates for macroprudential purposes, it would require that plans are elaborated at the consolidated level. This is the case for the G-SIIs that already have elaborated systemic risk management plans (SRMPs). According to EIOPA, as regards financial conglomerates, there is the issue of the 17.71 differences in respect to the scope of consolidation. Indeed, both Solvency II and the Capital Requirements Regulation (CRR)/CRD IV differ from the Financial Conglomerates Directive (FICOD) when considering the scope of consolidation (group vs conglomerate). Hence, to appropriately detail the degree of internal and external interconnectedness, as well as the systemic risks involved in the financial system, the SRMP should be drafted using the perimeter of consolidation deriving from the FICOD. In essence, this means that usually, it is preferable that an SRMP is developed at the level of the mixed financial holding company (which sits at the top of the financial conglomerate and is the ultimate parent undertaking in the group). However, given that mixed financial holding companies are not always supervised,106 This could mean that the preparation and elaboration of the SRMP would be borne by the parent undertaking directly underneath the mixed financial holding company, which in essence will be an insurance or banking group. Thresholds for Identification of a Financial Conglomerate As indicated above, the 17.72 Joint Forum Principles define a financial conglomerate as any group of companies

105 EIOPA, ‘Other potential macroprudential tools and measures to enhance the current framework’ (2018), 56; available online at . 106 In this context, we point out that with the entry into force of the CRD V/CRR 2 Banking package, art 21a of the CRD will require supervisory approval of the (mixed) financial holding company, heading a consolidated CRD group: art 21a of Directive (EU)2019/878, [2019] OJ L150, 7 June 2019.

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Arthur van den Hurk and Michele Siri under common control or dominant influence, including any financial holding company, which conducts material activities in at least two of the regulated banking, securities or insurance sectors.107 The Financial Conglomerates Directive uses a narrower definition.108 The FCD distinguished essentially distinguishes between two main types of conglomerates, conglomerates headed by a regulated entity109 or conglomerates that do not have a regulated entity at the head of the group or of the subgroup. In order to be a conglomerate within the meaning of the FCD, at least one of the entities in the group or subgroup has to be within the insurance sector and at least one entity within the banking or investment services sector. Furthermore, the consolidated or aggregated activities in both parts of the financial sector (insurance and banking/investment services) both have to be significant.110 Consequently, whereas the definition in the Joint Forum Principles requires activities in two regulated sectors, in addition, the FCD requires these activities to take place in at least two different entities. Moreover, where the Joint Forum Principles use an unspecified concept of ‘materiality’, the FCD is specific in its definition of ‘significance’, defining thresholds in the directive. 17.73 Coverage of Industrial Groups Owning Financial Conglomerates The European

Commission acknowledges that regulated financial entities are exposed to group risks from the wider industrial groups to which they may belong, but so far has refrained from reaching any conclusions on the need for the European Supervisory Authorities to issue guidelines on this topic.111 As described above, under the sectoral regimes, such groups are not subject to a full group or consolidated supervision either.

IX. Recovery and Resolution of Financial Conglomerates 17.74 So far, this chapter has covered the supervision of conglomerates under the

EU Financial Conglomerates Directive primarily. An additional level of complexity is introduced if we focus on the resolution of conglomerates.112 The Financial Conglomerates Directive itself is silent on the resolution of

107 Joint Forum 2012 Principles, ch 3, 5. Groups with activities in only one of the regulated sectors, combined with commercial (i.e. non-financial) activities, do not fall within that definition. These groups are assumed to be covered by the supervisory framework of the relevant sector (n 10). 108 The definition of Financial Conglomerate is contained in art 2(14) of the FCD. 109 As defined in art 2(4) of the FCD as a credit institution, insurance or reinsurance undertaking, investment firm, asset management company or an alternative investment fund manager (all as defined in the FCD). 110 In the meaning of art, 3(2) or (3) of the FCD. 111 European Commission, ‘Report on the review of the Financial Conglomerates Directive 2002/87/EC’, December 20, 2012, COM(2012) 785 final, available online at  at 6. 112 For a comparative overview, see J Sarra, ‘Bank Groups and Financial Conglomerates, Retooling Resolution Regimes’ (2014) 30 Law in Context 7.

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Financial Conglomerates in the European Banking Union conglomerates113 and, due to the sectoral approach of EU financial services regulation, the starting point for this paragraph is formed by discussing sectoral resolution regimes. 1. Bank Recovery and Resolution Directive/SRM The Single Resolution Mechanism, as part of the European Banking Union, en- 17.75 tered into force as per 1 January 2016 and offers a resolution framework for credit institutions.114 The Single Resolution Board, together with national resolution authorities,115 is responsible for the resolution of credit institutions, established in participating Member States. Not only credit institutions are covered in the scope of the resolution, but also parent undertakings, subject to consolidated supervision by the ECB and investment firms and financial institutions, established in participating Member States, covered by the ECB’s consolidated supervision of the parent undertaking. For the purpose of this chapter, it is important to bear in mind that the concept of parent undertaking in the SRM Regulation includes mixed financial holding companies, to the extent these entities are subject to consolidated supervision in accordance with Article 4(1)(g) of the SSM Regulation. In addition, mixed financial holding companies are included in the scope of the BRRD.116 In this manner, the scope of the SRM is aligned with the scope of the SSM, and 17.76 similarly, the scope of the BRRD is aligned with the scope of the CRR, with respect to consolidated supervision. This seems to assume the global oversight of the ECB/ consolidating supervisor of the risks to which a group is exposed,117 even if there is no direct supervision of the individual entities in the group. This might be true for certain conglomerates, in particular, bank-led conglomerates, but this is less obvious for conglomerates that have significant insurance activities in their group or are even insurance-led conglomerates. In the latter situation, it is likely to be the Solvency II group supervisor that is best positioned to have the global oversight of the conglomerate, rather than the supervisory authority exercising consolidated banking supervision.118 In any case, the ECB will not be the supervisory authority 113 With the exception of a reference in art 9(2)(d) of the Financial Conglomerates Directive, that risk management processes shall have arrangements in place to contribute to and develop, if required, adequate recovery and resolution arrangements and plans (emphasis added). 114 See D Busch and M van Rijn, ‘Towards Single Supervision and Resolution of Systemically Important Non-Bank Financial Institutions in the European Union’ (2018) 19 Eur Bus Org Law Rev 301–63. 115 The latter with responsibility for non-significant entities, and groups and entities that do not operate cross-border. 116 Article 1(c) of the BRRD. 117 See D Busch and M van Rijn, ‘Towards Single Supervision and Resolution of Systemically Important Non-Bank Financial Institutions in the European Union’ (2018) 19 Eur Bus Org Law Rev 301–63. 118 To the extent that consolidated banking supervision is exercised at all at the level of the mixed financial holding company.

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Arthur van den Hurk and Michele Siri exercising direct supervision of the insurance entities in the conglomerate,119 and is therefore in any case dependent on co-operation with the insurance supervisors in the group to exercise conglomerate supervision.120 17.77 Resolution of the mixed financial holding company can take place, assuming the

following conditions are met:

(1) Resolution conditions are met with respect to both a financial institution and with respect to the mixed financial holding company subject to consolidated supervision. (2) Resolution conditions are met with respect to the mixed financial holding company and with regard to one or more subsidiaries which are institutions (credit institutions or investment firms). (3) A subsidiary which is an institution meets the resolution conditions and its assets and liabilities are such that its failure threatens an institution or the group as a whole and resolution action with regard to that parent undertaking is necessary for the resolution of such subsidiaries which are institutions or for the resolution of the group as a whole. (4) the insolvency law of the Member State provides that groups are treated as a whole and resolution action with regard to the parent undertaking is necessary for the resolution of such subsidiaries which are institutions or for the resolution of the group as a whole. 17.78 It should be noted that the scope of group resolution is limited, in the sense that

it extends to the entities mentioned in Article 12(1) of the BRRD. This might be a challenge in case the mixed financial holding company would be included in the resolution of the institutions or financial institutions of the conglomerate and, at the same time, other entities in the group, such as insurance or reinsurance undertakings also rely on that same entity, either to continue in going concern, or as part of resolution of that insurance or reinsurance undertaking. 2. Developments in Recovery and Resolution of Insurance Undertakings

17.79 Thus far, at the European level, there is not a European recovery and resolution

framework for insurance companies, comparable to the BRRD/SRM. This has various reasons, which we will not discuss in detail in this chapter. A number of developments can be mentioned in this context.

17.80 In November 2018, the International Association of Insurance Supervisors (IAIS)

has published a consultation document for a ‘holistic framework for systemic risk in the insurance sector.’121 While the proposed framework encompasses more 119 Article 127(6) of the European Treaty prevents this. 120 Furthermore, the ECB is not entitled to exercise the supervision of the insurance sector. 121 IAIS, ‘Holistic Framework for Systemic Risk in the Insurance Sector, Public Consultation Document’, 14 November 2018.

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Financial Conglomerates in the European Banking Union topics than just recovery and resolution and, at the same time, focuses on systemic risk in the insurance sector only, not specifically on financial conglomerates,122 the consultation document does include considerations with respect to supervisory policy measures (that may or may not relate specifically to recovery and resolution), as well as specific considerations on supervisory co-ordination, recovery and resolution planning123 and powers of intervention for supervisors. Interestingly, the IAIS notes that in its view, the implementation of the holistic framework should remove the need for an (annual) G-SII identification process by the FSB and national authorities. At the same time, an enhanced set of policy measures and supervisory powers of intervention would be applied in a proportionate manner to a broader set of insurers by integrating these measures into the holistic framework.124 At European level, recently, primarily EIOPA and the ESRB have been vocal on the 17.81 need for (more) harmonization in the area of recovery and resolution frameworks for (re)insurers across the Member States. In particular, an EIOPA opinion of 5 July 2017 to the Institutions of the European Union is worth mentioning.125 EIOPA is of the view that a minimum degree of harmonization in the field of recovery and resolution for insurers would contribute to policyholder protection, as well as maintaining financial stability in the European Union. According to EIOPA, minimum harmonization entails the definition of a common approach to the fundamental elements of recovery and resolution (e.g. objectives for resolution and resolution powers which national authorities should address while leaving room for additional local measures.126 In its Opinion, EIOPA advises to carefully assess the application of recovery and resolution framework to insurers that are part of a financial conglomerate.127 The potential application of a harmonized recovery and resolution framework to insurers that are part of a financial conglomerate has not been analysed by EIOPA, but it considers that a consistent approach is followed, taking into account the already existing framework for

122 In fact, the framework has a sectoral, insurance-focus. However, it should be noted that IAIS workplan on systemic risk in the insurance sector does include a workstream with the aim to address cross-sectoral aspects in systemic risk assessment: see IAIS, ‘Holistic Framework for Systemic Risk in the Insurance Sector, Public Consultation Document’, 14 November 2018 at 8. 123 The IAIS has also launched, simultaneously, a separate consultation for an application paper on recovery planning, with the aim of providing guidance with respect to draft supervisory material related to recovery planning in the IAIS Insurance Core Principles and in the draft Common Framework for the Supervision of Internationally Active Insurance Groups, available online at . 124 IAIS, ‘Holistic Framework for Systemic Risk in the Insurance Sector, Public Consultation Document’, 14 November 2018 at 6. 125 EIOPA, ‘Opinion to Institutions of the European Union on Harmonisation of Recovery and Resolution Frameworks for (re)insurers Across the Member States’, 5 July 2017, EIOPA-BoS/ 17-148. 126 Ibid at 4. 127 Ibid at 6

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Arthur van den Hurk and Michele Siri banks. EIOPA does not express an opinion about which legislative tool should be employed for a potential harmonization process.128 17.82 In 2017 and 2018, EIOPA has published a series of three reports on systemic risk

and macroprudential policy in insurance.129 In the third paper, EIOPA identifies ex-ante recovery and resolution planning, while applying proportionality, as a potential measure to enhance the current toolbox for systemic risk in the insurance sector. This series was followed by an EIOPA Discussion Paper on Systemic Risk and Macroprudential Policy in Insurance, in which EIOPA considers the development of such plans as well as potential macroprudential tools.130 In another recent paper, EIOPA has aimed to provide a better understanding of the leading causes of insurers’ failures and near misses, aiming to enhance supervisory knowledge on the prevention and management of insurance failures.131

17.83 In addition to EIOPA, the ESRB has published two reports as well on systemic

risk in the insurance sector, in which it identifies a need for a comprehensive and harmonized recovery and resolution framework for insurers to complement micro-and macroprudential policies.132 The ESRB stresses the importance of consideration of cross-sectoral aspects as well. According to the ESRB, recovery and resolution framework should be targeted at the (re)insurance sector, thereby taking its specificities into account. At the same time, alignment of certain principles across the different sectoral frameworks would be helpful to, for example, guide the setting-up of recovery and resolution frameworks for financial conglomerates.133 Furthermore, the ESRB considers that work on recovery and resolution frameworks should go hand in hand with a discussion on how resolution should be funded.134 128 Ibid at 11. In particular, whether a separate (sectoral) directive should be promoted or whether the main elements should be embedded in the Solvency II framework. 129 EIOPA, ‘Systemic Risk and Macroprudential Policy in Insurance’ (2017); EIOPA, ‘Solvency II Tools with Macroprudential Impact’ (2018); and EIOPA, ‘Other Potential Macroprudential Tools and Measures to Enhance the Current Framework (2018)’: all available online at . 130 EIOPA, ‘Discussion Paper on Systemic Risk and Macroprudential Policy in Insurance’, EIOPA-BoS-19/131, 29 March 2019, available online at . 131 EIOPA, ‘Failures and Near Misses in Insurance— Overview of the Causes and Early Identification’ (2018), available online at . It should be noted that the data used by EIOPA in this paper covers the period 1999–2016, and therefore does not really cover the period in which the Solvency II framework is in force (as of 1 January 2016). 132 ESRB, ‘Recovery and Resolution for the EU Insurance Sector: A Macroprudential Perspective’, August 2017; ESRB, ‘Macroprudential Provisions, Measures and Instruments for insurance’, November 2018. In the annex of the 2018 report, reference is made to cross-sectoral aspects, interconnectedness and exposures of the insurance sector, in which specific mention is made to certain aspects of financial conglomerates (such as interconnectedness, contagion risk and complexity. 133 ESRB, 2018, 38. 134 EIOPA has recently held a consultation on a discussion paper on resolution funding and national insurance guarantee schemes: EIOPA, ‘Discussion Paper on Resolution Funding and

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Financial Conglomerates in the European Banking Union Pursuant to Article 242(2) of the Solvency II Directive, the European Commission 17.84 has requested EIOPA to report on group supervision and capital management, as well as on freedom to provide services and freedom of establishment under the Solvency II Directive.135 As part of the request, the European Commission has also requested EIOPA to report on certain aspects, relating to early intervention, in particular on early intervention measures at group level136 Amongst others, EIOPA is requested to update the European Commission, if relevant developments have occurred since the release of the EIOPA opinion of 5 July 2017, on potential difficulties, if any, in applying early intervention measures to an insurance or reinsurance group which is also a financial conglomerate or which belongs to a financial conglomerate. In addition, the European Commission requested to report on the level of protection of policyholders and beneficiaries of the undertakings in the group.137 On 14 December 2018, EIOPA has published a report,138 addressing a request 17.85 from the European Commission139 pursuant to Article 242(2) of the Solvency

National Insurance Guarantee Schemes’, EIOPA-CP-18-003, 30 July 2018, available online at and is expected to publish an opinion on this topic in the second half of 2019 or in 2020. 135 Formal Request of the European Commission to EIOPA dated 7 June 2018, FISMA/ D4/ MH/ lh/ ARES(2018)330175, available online at . 136 The European Commission notes that arts 136 and 138(1)–(4) of the Solvency II Directive shall apply mutatis mutandis at group level, but the Solvency II Directive, unlike the BRRD, does not define these measures. 137 EIOPA was requested, inter alia, to make an assessment of the benefit of enhancing group supervision and capital management under Solvency II, including possible measures to enhance sound cross-border management of insurance groups notably of risks and asset management. The report should, inter alia, take into account developments and progress concerning a number of topics, including a harmonized framework on early intervention; a harmonized framework on asset transferability, insolvency and winding-up procedures which eliminates the relevant national company or corporate law barriers to asset transferability; an equivalent level of protection of policyholders and beneficiaries of the undertakings of the same group particularly in crisis situations; a harmonized and adequately funded EU-wide solution for insurance guarantee schemes; a harmonized and legally binding framework between competent authorities, central banks and ministries of finance concerning crisis management, resolution and fiscal burden-sharing which aligns supervisory powers with fiscal responsibilities. 138 EIOPA, ‘Report to the European Commission on Group Supervision and Capital Management within a Group of Insurance and Reinsurance Undertakings, and FoS and FoE under Solvency II’, EIOPA BoS-18-485, 14 December 2018, available online at . 139 Formal request to EIOPA for a report on group supervision and capital management, as well as on the freedom to provide services and freedom of establishment under Directive 2009/138/EC (Solvency II Directive), Brussels, 7 June 2018, FISMA/D4/MH/lh/ARES(2018)3301175, available online at .

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Arthur van den Hurk and Michele Siri II Directive to report on certain provisions in the Solvency II Directive. In this report, EIOPA observes that there is a fragmented landscape with respect to recovery and resolution with diverging national legislation and approaches. As a result, according to EIOPA, these different powers may not guarantee an equivalent level of protection of policyholders and beneficiaries of the same group involving undertakings in the different Member States. There is a risk that in crisis situations, diverging interests occur, potentially prioritising policyholders at the local level, and hindering cross-border co-operation.140 EIOPA reiterates its view, as stated in the EIOPA Opinion of 5 July 2017141 that there is a need for a minimum harmonized framework for the recovery and resolution of (re)insurers. According to EIOPA, this would facilitate cross-border management of insurance crises. 17.86 At the time of writing of this chapter, it is not yet fully clear what the next steps

of the European Commission might be. Elements of the EIOPA report might be taken into account in the Solvency II 2020 review142 or may lead to some level of (minimum) harmonization of national recovery and resolution frameworks at European level.

17.87 In the absence of a European framework, the resolution of insurance and reinsur-

ance companies remains a matter of primarily local regulation. The same is true for insurance and reinsurance companies that form part of a financial conglomerate. Some EU Member States have recently amended their national recovery and resolution frameworks for insurers143 or may do so in the near future. It is clear that the level of convergence of national frameworks across the EU Member States, for the time being, remains limited. This can lead to challenges, in particular with respect to the application of recovery and resolution measures at the group level, both on a sectoral, insurance basis and on a cross-sectoral, conglomerate basis.144

140 EIOPA, ‘Report to the European Commission on Group Supervision and Capital Management within a Group of Insurance and Reinsurance Undertakings, and FoS and FoE under Solvency II’, EIOPA BoS-18-485, December 14, 2018, paras 3.232 and 3.233. 141 EIOPA, ‘Opinion to Institutions of the European Union on Harmonisation of Recovery and Resolution Frameworks for (re)insurers across the Member States’, 5 July 2017, EIOPA-BoS/ 17-148. 142 See, e.g., European Commission request to EIOPA for technical advice on the review of the Solvency II Directive, 11 February 2019, Ref. Ares(2019)782244-11/02/2019, paras 3.11 and 3.12, available online at https://eiopa.europa.eu/Publications/Requests%20for%20advice/RH_ SRAnnex%20-%20CfA%202020%20SII%20review.pdf and EIOPA.Consultation Paper on the Opinion on the 2020 review of Solvency II, October 15, 2019, EIOPA-BoS-19/465, available at https://eiopa.europa.eu/Publications/Consultations/EIOPA-BoS-19-465_CP_Opinion_2020_ review.pdf, paragraph 12.46. 143 , e.g. The Netherlands and France. 144 See, for instance above, on the application of the BRRD/SRM to mixed financial holding companies.

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Financial Conglomerates in the European Banking Union It seems clear that recovery and resolution measures for financial conglomerates 17.88 add another layer of complexity to an already complex area of financial regulation. Currently, the BRRD/SRM framework may represent the most advanced sectoral framework at European level with a high level of convergence at the European level. Significant work is being undertaken in the insurance sector as well. Rightly so, the specific characteristics of the insurance sector are taken into account in this work, which may lead to a sectoral framework with fundamentally different specificities and approaches. For instance, it remains to be seen if minimum harmonization of national recovery and resolution frameworks at EU level can be achieved, to which group of insurance companies and groups these measures may apply, if an entities-based approach (such as under the BRRD) will be taken or, as might be more appropriate, in particular for systemic insurance companies, an activities-based approach or a hybrid approach. Furthermore, discussions on insurance guarantee schemes and resolution funding at EU level or still at a relatively embryonic stage. Nevertheless, in particular, for financial conglomerates, it is important that recovery and resolution frameworks do justice to the specificities of each financial sector in the conglomerate. At the minimum, this merits more developed cross-sectoral co-ordination and co-operation arrangements, including, as appropriate, memoranda of understanding that extends beyond regular supervision to also include resolution. Indeed, as the US regulation clearly shows, one of the most elegant legal innovations to emerge from the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is the FDIC's single-point-of- entry (SPOE) initiative, whereby regulatory authorities will be in a position to resolve the failure of large financial conglomerates, and allowing the government to resolve the entire group without disrupting the business operations of operating subsidiaries or risking systemic consequences for the broader economy.145

X. Conclusion This chapter describes the complex regulatory framework for financial 17.89 conglomerates, and the position of EU financial conglomerate supervision amidst the sectoral regulatory frameworks in Europe, in particular, the banking and insurance frameworks. The landscape of financial conglomerates in Europe has evolved significantly since the rise of conglomerates in significant parts of Europe in the 1990s and keeps evolving. Sectoral regulatory frameworks have evolved as well, on the banking side the European Banking Union, as well as the evolution of the Capital Requirements Directive and the Capital Requirements Regulation are notable, as well as the development of Bank Recovery and Resolution Directive 145 H E Jackson and S Massman, ‘The Resolution of Distressed Financial Conglomerates’ (2017) 3(1) Russell Sage Foundation Journal of the Social Sciences; Harvard Public Law Working Paper No 17–14, available online at SSRN: .

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Arthur van den Hurk and Michele Siri and the Single Resolution Mechanism. On the insurance side, Solvency II, that entered into force as per 1 January 2016, has been a major step forward in insurance regulation and supervision. Regulation and supervision of groups on a sectoral basis has, as part of these initiatives, also undergone significant changes in recent years, resulting in more developed forms of group and consolidated supervision on a sectoral basis. 17.90 Since the inception of the Financial Conglomerates Directive, various evaluations

of the framework have been undertaken, and some amendments have been made, be it of a relatively modest nature. That is understandable, amidst the major reforms to the sectoral rules in recent years, it would have been a challenge for the conglomerate framework to keep pace.

17.91 The Financial Conglomerate Directive's rules are supplementary in na-

ture. They supplement the requirements that credit institutions, insurance undertakings and investment firms are subject to according to the respective prudential regulations. Since the adoption of the original Directive, sectoral legislation is being overhauled in a major way, and the regulatory environment is still continuing to evolve.

17.92 Moreover, the first revision of the Financial Conglomerates Directive was adopted

in November 2011146 taking into account, the lessons learnt during the financial crisis of 2007–2009. This review amended the sector-specific directives to enable supervisors to perform consolidated banking supervision and insurance group supervision at the level of the ultimate parent entity, even where that entity is a mixed financial holding company. Moreover, the revision updated the rules for the identification of conglomerates, introduced a transparency requirement for the legal and operational structures of groups, and brought alternative investment fund managers within the scope of supplementary supervision in the same way as asset management companies.

17.93 These developments raise the question if the need for supplementary conglom-

erate supervision is still similar to the need as initially was envisaged when the Financial Conglomerates Directive was adopted.

17.94 In particular, the evolution of the group and consolidated supervision on a

sectoral has enabled supervisors to have a complete view of financial groups, including parts of the groups beyond the sectoral perimeter, and might have diminished the need for supplementary conglomerate supervision to some extent. Still, the complex interaction between the different sectoral frameworks, limitations in the scope of sectoral supervision, differences and inconsistencies between

146 Directive 2011/89/EU of the European Parliament and of the Council 16 November 2011 amending Directives 98/78/EC, 2002/87/EC, 2006/48/EC and 2009/138/EC as regards the supplementary supervision of financial entities in a financial conglomerate.

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Financial Conglomerates in the European Banking Union the different frameworks, suggest that there might still be a need for conglomerate supervision going forward. The complexity of financial conglomerate supervision, in the ever-changing regu- 17.95 latory environment does merit a thorough assessment of the conglomerate framework, as well as an assessment of the interaction with sectoral frameworks, in order to make sure the frameworks continue to add value, regulatory gaps, and inconsistencies between the frameworks are being addressed, while respecting sectoral specificities.147 The European Union's financial supervisory architecture is based on a sectoral model with separate authorities for banking, insurance and securities and markets. New developments in the EU financial sector make this sectoral structure increasingly complex to develop further, opening to the question of a radical reshape based on a twin peaks approach.148 A different path of the evolution of supervision could follow the current trend of the enlarging the scope of prudential supervision of the ECB, as the case of the direct prudential supervision of systemic investment firms within the Eurozone.149 For the time being, it is worthwhile to mention that it is a challenge to fit con- 17.96 glomerate supervision in itself into a framework that is essentially developed on a sectoral basis while taking into account the specificities of the different sectors. This is exacerbated by the European Banking Union, which creates an EU wide supervisory framework for banks and banking groups, including a substantial number of conglomerates, but is essentially developed from only one sector, the banking sector, while the insurance sector is evolving in a different pace/direction. While for some (bank-dominated) conglomerates it might be justifiable to take a bank-centric approach and improve the SSN/SRM to allow more effective conglomerate supervision within the SSM/SRM, for other conglomerates (in particular insurance-led conglomerates) conglomerate supervision within the SSM is less obvious, but still supervisory arrangements should be improved (for instance

147 An example of such an assessment can be found in the European Commission request to EIOPA for technical advice on the review of the Solvency II Directive, 11 February 2019, Ref Ares(2019)782244-11/02/2019, para 3.14, second bullet, where the European Commission requests EIOPA, inter alia, technical advice on certain aspects of the rules governing the calculation of group solvency and the interactions with Directive 2002/87/EC (FICOD), available online at https:// ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/ 190211-request-eiopa-technical-advice-review-solvency-2.pdf, and EIOPA Consultation Paper on the Opinion on the 2020 review of Solvency II, October 15, 2019, EIOPA-BoS-19/465, available at https://eiopa.europa.eu/Publications/Consultations/EIOPA-BoS-19-465_CP_Opinion_2020_ review.pdf, chapter 9. 148 D Schoenmaker and N Véron, ‘A “twin peaks” Vision for Europe’ (2017) 30 Bruegel Policy Contribution. 149 Proposal for a Regulation of the European Parliament and of the Council on the prudential requirements of investment firms and amending Regulations (EU) 575/2013, (EU) 600/2014 and (EU) 1093/2010, COM(2017) 790 final 9 (20 December 2017); Proposal for a Directive of the European Parliament and of the Council on the prudential supervision of investment firms and amending Directives 2013/36/EU and 2014/65/EU, COM(2017) 791 final (20 December 2017).

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Arthur van den Hurk and Michele Siri co-operation between Solvency II group supervisor, CRD consolidated supervisor and Financial Conglomerate co-ordinator. The multiplicity of Authorities involved in financial conglomerates supervision portrays a complex supervisory landscape, in which EBA and EIOPA should have an information-exchange role on the related financial conglomerate supervision. A further increase in the co-operation and information exchange among national competent authorities concerned with prudential supervision on a group-wide basis of financial conglomerates and banking groups with major insurance subsidiaries, such as the ECB Single Supervisory Mechanism or other relevant national authorities would better promote the resilience of financial institutions, in particular the systemic risk posed by financial institutions.

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INDEX

Accountability European Central Bank (ECB) 3.86 Single Resolution Board (SRB) 3.86, 9.39–9.40 Supervisory Board (SB) 4.123–4.135 Administrative review see review of decisions Agencies see EU agencies and institutions Applicable law ECB powers in relation to credit institutions 3.10–3.15 fit and proper assessments CRD IV and national law 7.23 EBA Guidelines 7.24–7.27 SSM EU law 4.18–4.24 national law 4.15–4.17 Single Rulebook 4.25–4.30 Assessments see fit and proper requirements Asset management companies (AMCs) Commission blueprint 8.10 conglomerate supervision 17.29, 17.92 NPL disposal 8.27–8.30 shortcomings of BRRD and the SRMR 10.02 Spain 12.65 Swedish style state backing 8.07 Bail-ins content of resolution schemes bail-in tools 9.87–9.91 exclusions from bail-in 9.81 general tools 9.84 use of SRF 9.95–9.96 controversial tool 11.02–11.03 credibility as effective tool 11.11 eligible liabilities 11.43–11.45 epitome of policy goals 11.01 execution data requirements 11.50–11.51 FSB Principles 11.49 interaction with securities laws 11.56–11.59 valuations 11.52–11.55 general principles 12.04–12.06 initial impact of EBU 1.14–1.19 investor protection 11.48 main features forced write down and conversion of capital instruments 11.06–11.07 rules for access to State aid 11.08 ultimate effect of WDCCI 11.10 WDCCI as a precondition 11.09

market discipline 11.46–11.47 possible further developments to watch 1.38 TLAC/MREL requirements cross-border banking 11.34–11.42 key element of resolution 11.12–11.14 overview of regime 11.15–11.33 transposition of the BRRD into national law 11.04 UK approach 13.33–13.36 Bail-outs burden sharing 10.95–10.97 core message of Basel III 16.16 fear of cost-sharing 8.53 goals of EBU 14.09 impact of banking nationalism 1.17–1.19 impact of European financial crisis 16.12–16.13 increasing hostility towards 8.07 interconnection between sovereigns’ and banks’ liabilities 15.01, 15.38 legislative innovation in UK and Germany 12.19, 12.15 moment of truth for EU 8.05 need for supervisory mechanism 4.05 recovery and resolution policies 16.49, 16.45 SBRF 9.42, 12.63 shift of policy 1.05 United States 16.27, 16.31, 16.25 unsustainability 11.04 Balance sheets see capital requirements Bank failures see bail-ins; bail-outs; recovery and resolution Bank resolution see recovery and resolution Banking union see European Banking Union Basel Committee Basel IV reforms 6.107 corporate governance standards 6.05–6.06 disclosure requirements 11.23 ECB membership 1.63, 2.22–2.24 minimum capital standards 10.56 risk-taking in bank’s trading book 16.09 Boards of directors board decisions and 'business judgment' 6.82–6.86 board members' duties CRD IV provisions 6.22 risk governance 6.28–6.32 sound remuneration policies 6.23–6.27 board structure under CRD IV 6.11–6.13 fit and proper assessments see fit and proper assessments

665

6

Index Boards of directors (cont.) functional concerns of CRD IV board organization and composition 6.93–6.96 remuneration policies 6.97–6.101 volume and complexity of CRD IV 6.102–6.105 personal requirements of board members CRD IV provisions 6.14 diversity 6.21 individual and collective qualities 6.15–6.19 limitations on directorships 6.20 over-emphasis on board members' character 6.79–6.81 Brexit continuing challenge to EBU 2.141 home-host oversight of Eurozone-based banks 2.86 impact on corporate governance standards 6.108 impact on UK bank resolution regime 13.77–13.81 jurisdictional issues with resolution planning 10.72 source of uncertainty 1.65 voting reforms in the EBA 2.41 Burden sharing bail-ins forced write down and conversion 11.11, 11.07–11.08 Italy 12.38 minimum Pillar 1 subordination requirement 11.32 Spain 12.66 complex issues arising from resolution planning 10.95–10.97 sovereign debt 15.11, 15.26, 15.08 state aid 8.07, 10.61 Capital Markets Union (CMU) changing role of banks within more diverse system 1.51–1.55 hindering of harmonization 2.12–2.14 part of new institutional order 1.62 Capital requirements conglomerates 17.32, 17.41 consequences of high NPL ratios 8.15–8.18 consolidated and group supervision compared 17.15–17.23 CRD reform package (CRD IV) 2.24–2.30 emerging single rulebook 5.14–5.16 group companies in insurance sector 17.10–17.12 part of three-stage approach to institutional overhaul 5.08–5.13 precautionary recapitalization burden sharing 10.95 confidentiality issues 10.86 Greek banks 12.23 impact of EU state aid policies 10.64 Italian Banks 12.50, 12.36–12.39, 12.44–12.46 resolution planning 10.11

resolution at holding company level 16.03 reversal of fragmentation of system 1.34 Switzerland 16.48 Central Securities Depositaries 4.62 Clearing and settlement see payment systems Commission adoption of a resolution scheme 9.107–9.118 blueprint for AMCs 8.10 European Deposit Insurance Scheme (EDIS) Commission Communication October 2017 14.56–14.57 Commission Proposal 2015 14.22–14.26, 14.49–14.54 Commission Report 2010 14.21 overview of historical harmonization 6.08 Venetian bank crisis 12.51–12.53 Confidentiality accountability of ECB 3.74–3.75, 4.126 bail-in execution 11.56, 11.59 boards of directors 6.64, 6.60–6.61 ECB's access rights 3.17 EU institutions, committees and officials 3.74–3.75 issues arising with resolution planning market abuse 10.89–10.92 sine qua non for effective resolution 10.85–10.88 procedure before the ABoR 4.137 SRB procedural rules 3.65 SRM Regulation 3.51, 3.47 Conglomerates see also group companies challenge to fit supervision in EU framework 17.95–17.96 evolution of financial landscape 17.89 gap in ECB's relationship with EU institutions 2.44 impact of Financial Conglomerate Directive 17.90–17.92 impact of SSM 2.07 need for supplementary supervision 17.93–17.94 recovery and resolution Bank Recovery and Resolution Directive/ SRM 17.75–17.78 concluding remarks 10.27 insurance sector 17.79–17.88 resolution plans 10.15 unknown unknowns 10.66 role of ECB 2.11 shadow banking 4.63 SRBs's powers 2.64, 2.85 SSM mechanism 4.19 Supervisory Colleges and Joint Supervisory Teams 2.74 supervisory powers ECB role 17.33 EU Financial Conglomerates Directive 17.24 institutional framework 17.29–17.33 Joint Forum Principles 17.34–17.38 overview 17.03–17.04

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67

Index relevant features 17.25–17.28 revisions of Financial Conglomerates Directive 17.63–17.73 Corporate governance ambiguous regulatory objectives board decisions and 'business judgment' 6.82–6.86 content and scope of some provisions 6.69–6.72 over-emphasis on board members' character 6.79–6.81 public-interest requirement for other decisions 6.78 public-interest requirement for remuneration decisions 6.73–6.78 banking structures in EU effect of harmonization 6.03 varied structures among Member States 6.04 conceptual concerns conflicts associated with the Directive’s regulatory model 6.48–6.50 consequence of inconsistencies 6.51–6.52 divergences in scope and application 6.46–6.47 reliance on one-tier board model 6.53–6.55 fit and proper assessments see fit and proper assessments functional concerns board organization and composition 6.93–6.96 failure contributing to financial crisis 6.88–6.90 overview 6.87 remuneration policies 6.97–6.101 risk governance 6.91–6.92 volume and complexity of CRD IV 6.102–6.105 fundamental transformation under CRD IV 6.01 implementation principles of CRD IV generous approach to domestic company law 6.56–6.57 options at national level 6.58–6.59 remuneration policies and risk governance 6.60–6.68 key features of CRD IV board members' duties 6.09 board structure of institutions 6.11–6.13 personal requirements of board members 6.14–6.21 management of NPLs building organizational capacity 8.37–8.42 ex ante defences 8.46–8.48 processes 8.43–8.45 neutrality of CRD IV regarding governance structures 6.34–6.35 overview of historical harmonization Commission’s Green Paper 6.08 current CRD IV framework 6.09 EBA Guidelines 6.07 first amendment to CRD I 6.06

first recast Banking Directive 6.05 preliminary review of CRD IV’s achievements 6.106–6.110 regulatory concept 6.33 relationship between CRD IV and shareholders 6.36–6.37 supervisory powers EBA Guidelines 6.39–6.41 importance 6.38 role of ECB 6.45 sanctions regime 6.42–6.44 Court of Justice of European Union (CJEU) appeals against ex ante measures 10.37 review of decisions consequences of illegality and invalidity 3.84–3.85 infringement of procedural rules 3.71–3.81 lack of competence 3.69–3.70 manifest errors of assessment 3.83 misuse of power 3.82 overview 3.66–3.68 Crisis management see also recovery and resolution Cross-border banking continuing issues 2.139 cross border resolution strategies 11.35–11.37 impact of EBU on banking industry 2.130–2.131 ‘too big to fail’ (TBTF) financial institutions 1.46 total loss absorbing capacity (TLAC) legislative rigidity 11.34 non-resolution entities 11.38–11.42 SPE/MPE approaches compared 11.35–11.37 Cyprus crisis management during transition to new EU regime 12.24–12.27 first proposal of a BRRD 1.18 impact of EBU on banking industry 2.135 non-performing loans 1.25 NPL crisis 2010-17 8.03–8.04 Supervisory Review and Evaluation Process (SREP) 1.25 Denmark bilateral loan to Ireland 12.17 interaction with NCAs 2.97 voluntary membership of SSM and SRM 1.65 Deposit insurance see European Deposit Insurance System (EDIS) Directorate-General for Competition (DG COMP) 1.61 Discretions see options and discretions (O & Ds) EU agencies and institutions see also ‘significant institutions’ (SIs) confidentiality 3.74–3.75 conglomerate supervision 17.29–17.33 consolidated and group supervision compared 17.15–17.23

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68

Index EU agencies and institutions (cont.) European Banking Authority (EBA) closer co-operation over governance 2.38–2.43 creation 2.31 interaction with SSM 2.33–2.37 specific tasks and responsibilities 2.32 evolutionary dynamics of regulatory framework pending reforms 5.53–5.56 possible future developments 5.62–5.67 regulatory approach of ECB 5.57–5.61 history of EU framework emerging institutional structure 5.14–5.16 three-stage approach to institutional overhaul 5.08–5.13 impact of EBU 2.136 lack of meaningful participation between ECB and ESMA and EIOPA 2.44–2.45 possible further developments to watch 1.56–1.63 scope of SSM credit institutions 4.57–4.65 SIs and LSIs 4.72–4.82 subsidiaries and branches 4.66–4.71 three-stage approach to institutional overhaul 5.08–5.13 European Banking Authority (EBA) allocation of rule-making 5.25 centralized rule-setting 5.17 closer co-operation over governance 2.38–2.43 corporate governance board members' duties 6.09 board structure of institutions 6.11–6.13 overview of historical harmonization 6.07 personal requirements of board members 6.14–6.21 supervision 6.39–6.41 creation 2.31 interaction with SSM 2.33–2.37 non-performing loans 8.36 part of new institutional order 1.59 part of three-stage approach to institutional overhaul 5.08–5.13 pending reforms 5.53 resolution planning ex ante measures 10.31 Joint Guidelines 10.22 ‘resolvability’ assessments 10.32–10.34 theoretical approach to future planning 10.03 specific tasks and responsibilities 2.32 Valuation Handbook 11.52–11.55 European Banking Union (EBU) approach to recovery and resolution Liikanen Report 2012 10.55–10.57 necessity of insulating risky 10.60 separation of proprietary trading activities 10.58–10.59 banking structures in EU effect of harmonization 6.03

varied structures among Member States 6.04 collective term 4.09–4.10 complexity of the regulatory system 4.11 continuing challenges 2.141–2.142 creation 16.11 dramatic changes in institutional structures 2.136 emergence of EU measures after financial crisis 16.13–16.15 euro Member States 4.12 goals 14.09 impact on banking industry Germany 2.122 Italy 2.125 market structures 2.129–2.135 mergers 2.126–2.128 Supervisory Review and Evaluation Process (SREP) 2.123–2.124 initial economic impact declaration of intent by ECB 1.03–1.06 establishment of 'bail-in' regime 1.14–1.19 policy commitments by euro area Member States 1.07–1.13 need for structural re-organization of large firms 16.01–16.02 non-euro Member States 4.13–4.14 possible further developments to watch changing role of banks within more diverse system 1.50–1.55 consistent approach to banking crises 1.36–1.43 increasing role of institutions 1.56–1.63 integration of euro area banking system 1.44–1.49 overview 1.20–1.22 reversal of fragmentation of system 1.31–1.35 strengthening of ECB 1.23–1.30 widespread consequences 1.64–1.67 Single Supervisory Mechanism (SSM) see Single Supervisory Mechanism (SSM) sovereign debt 15.03 three pillars 14.10 underlying purpose 2.01 European Central Bank (ECB) see also Single Supervisory Mechanism (SSM) Single Supervisory Mechanism (SSM) appointments to SRB 9.20 choice as prudential supervisor 4.31–4.37 conglomerate supervision 17.33 as coordinator for conglomerates 17.56–17.58 decoupling of regulatory and supervisory powers ECB as a quasi-national authority with micro- prudential supervisory tasks 5.34–5.38 ECB as EU Institution with central banking tasks 5.32–5.33 division of tasks within SRM 9.09–9.14 effect of SSM impact on bank supervision 17.01–17.02 impact on conglomerate supervision 17.03–17.04

668

69

Index evolutionary dynamics of regulatory framework 5.57–5.61 fit and proper assessments assessments of key function holders 7.22 assessments of management body members 7.17–7.21 Guidelines 7.24–7.27 key responsibilities 7.15–7.16 general background to SRM 9.05 initial impact of EBU 1.04, 1.07–1.13 institutional conflict with ESMA 2.140 integration of euro area banking system 1.44–1.49 interaction between EBA and SSM 2.33–2.37 judicial protection in relation to credit institutions administrative review 3.20–3.23 applicable law 3.10–3.15 judicial review 3.24–3.28 procedural rules 3.16–3.18 review of indirect ECB decisions/ instructions 3.29–3.36 specific tasks conferred 3.07–3.09 substantial review by CJEU 3.66–3.85 lack of meaningful participation with ESMA and EIOPA 2.44–2.45 liability for maladministration attribution of liability problem 3.90 contractual and non-contractual liability 3.87 cost-sharing 3.91 exclusive jurisdiction of CJEU 3.92–3.93 individual claimants 3.88 specific form of accountability 3.86 supervisory tasks 3.89 limits to rule-making legal nature of NPL Guidance 5.43–5.49 options and discretions (O & Ds) 5.50–5.52 role of Guidelines 5.40–5.42 liquidity windows 15.39 new institutional order 1.56–1.63 part of Banking Union 4.09 possible future developments 1.23–1.30, 5.62–5.67 shift of legal supervisory competences under SSM 2.07 Spanish Banco Popular 12.71 status in international financial standard setting bodies 2.22–2.24 supervision of corporate governance 6.45 supervision of non-performing loans 8.34–8.35 supervision of ‘significant’ credit institutions 2.72–2.73 supervisory tasks under SSM Regulation 2.11, 5.19 theoretical approach to future planning 10.03 Venetian bank crisis 12.47–12.48 vetting of mergers and acquisitions 10.22 European Court of Auditors 2.46–2.48 European Deposit Insurance Scheme (EDIS) 4.10 additional goals 14.05–14.08 background Commission Proposal 2015 14.22–14.26

Commission Report 2010 14.21 De Larosière report 14.20 developments 2016–2019 14.30–14.32 European Parliament Draft Report 2016 14.27–14.29 cornerstone of EBU 2.01, 4.10, 14.01–14.03 creation 1.41 downsides 14.17–14.19 funding alternative means of funding 14.44–14.46 contributions 14.41–14.43 ex ante funding 14.38–14.40 four funding mechanisms 14.37 further developments Commission Communication October 2017 14.56–14.57 repayment 14.58–14.60 general goals 14.04 goals as third pillar of EBU improved depositor protection and stability 14.15 increased efficiency 14.12 level playing field 14.16–14.17 need for three pillars at Eurozone level 14.13–14.14 main features of proposal Commission proposal 14.49–14.54 coverage level and payout period 14.33 funding 14.37–14.46 Parliament Draft Report 14.55–14.56 payout 14.47–14.48 proposed changes 14.34 scope 14.35–14.36 need for agreement 15.77 one of three pillars of EBU 2.01, 14.10 possible further developments to watch 1.41 reasons why EDIS on hold competing visions 14.70–14.72 shortcomings in single rulebook 14.69 sanctioning mechanism disqualification 14.67 moral hazard 14.66 staggered intervention ladder 14.68 Single Resolution and Deposit Insurance Board 14.61–14.65 stalemate of risk mutualization 15.75 European Insurance and Occupational Pension Authority (EIOPA) co-ordinated supervision of conglomerates 17.60–17.62 interaction between EBA and SSM 2.33–2.34 recovery and resolution 17.79–17.88 revisions of Financial Conglomerates Directive 17.70–17.71 European Insurance and Occupational Pensions Authority (EIOPA) lack of meaningful participation with ECB 2.44–2.45 part of new institutional order 1.59

669

670

Index European Safe Bonds (ESB) 15.64–15.68 European Securities and Markets Authority (ESMA) interaction between EBA and SSM 2.33–2.34 lack of meaningful participation with ECB 2.44–2.45 part of new institutional order 1.59 European Stability Mechanism (ESM) higher degree of fiscal risk mutualization 15.39 initial policy commitments by euro area Member States 1.07–1.13 possible further developments to watch 1.39 European System of Financial Supervision (ESFS) creation 2.31 higher degree of fiscal risk mutualization 15.39 interaction between EBA and SSM 2.33–2.37 European Systemic Risk Board (ESRB) non-performing loans 8.49–8.51 part of new institutional order 1.59 part of three-stage approach to institutional overhaul 5.08–5.13 pending reforms 5.53 sovereign exposures 15.55 Ex ante measures see also resolution planning appeals against 10.35–10.38 failure of Fortis Bank Nederland 10.20, 10.22 failure of SNS Bank 10.24 funding of SRF 9.47–9.54 key issues level playing field issue 10.47–10.48 timing of measures 10.40–10.45 which measures are appropriate 10.40–10.45 macroprudential backstops 2.97 non-performing loans 8.10, 8.46 summary of general measures in US 10.51–10.54 supervisory powers 10.29–10.34 theoretical approach to future planning 10.07 will plans actually be used 10.13 Executive pay see remuneration policies Financial conglomerates see conglomerates Financial crisis 2007-12 background to SSM 4.05–4.06 driving force for EBU 2.01 emergence of EU bank resolution creation of Banking Union 16.11 importance of G-20 16.09 international consensus on need for special mechanism 16.10 two major regulatory reform waves 16.08 emergence of EU bank resolution after financial crisis absence of one crucial element 16.49–16.50 advantages of SPE 16.23 core message of Basel III 16.16–16.17 creation of Banking Union 16.11 shortcomings of MPE 16.22 SPE/MPE approaches compared 16.20

SSM under ECB 16.13 TLAC as self-insurance for credit claims 16.21 two distinct episodes involving Greece and Portugal 16.12 uncertainty and value destructivity 16.18–16.19 failure of corporate governance 6.88–6.90 impact of banking nationalism 1.17 link between banking union and CMU 1.53 moment of truth 8.05 need for urgency and speed with regard to supervisory and resolution decisions 3.99 Spanish bank restructuring 12.64–12.67 Financial Stability Board (FSB) ECB membership 2.22 Key Attributes of Effective Resolution 2.51 ‘Key attributes of Effective Resolution' 10.03, 16.10 major agenda-setting role 16.09 Principles on bail-in execution 11.49 systematically important banks 1.63 Finland initial policy commitments by euro area Member States 1.12 penetration of foreign banking groups 1.44 Fit and proper assessments board members 6.15 conglomerates 17.47 convergence assessment process 7.76–7.77 key function holders 7.75 management body members 7.29–7.74 ECB achievements 7.96 ECB Guide 5.41 governance arrangements 3.09, 6.45 key function holders 7.75 key governance task 7.06–7.10 key terms and definitions ‘key function holders’ 7.05 ‘management bodies’ 7.02–7.04 management body members collective suitability 7.68–7.74 five assessment criteria 7.29–7.31 independence of mind 7.52–7.60 knowledge, skills and experience 7.32–7.48 reputation 7.49–7.51 time commitment 7.61–7.67 national banking law 4.17 national variations and limits application of national law by ECB 7.88–7.95 limits of harmonization through EBA Guidelines 7.85–7.87 transposition of CRD IV requirements 7.80–7.84 overview 7.01 role of banks 7.11 role of supervisors division of tasks and responsibilities between NCA's and ECB 7.14–7.22 general principles 7.12–7.13

670

671

Index sources of law CRD IV and national law 7.23 EBA Guidelines 7.24–7.27 SSM 4.97 Forced write down and conversion of capital instruments (WDCCI) bail-in  tools general overview 9.87 liabilities excluded per se 9.88 liabilities which may be excluded 9.89–9.91 main feature of bail-ins 11.06–11.07 precondition of bail-in 11.09 UK approach 13.39–13.42 ultimate effect 11.10 France burden sharing 10.96 perspective of SSM 2.118 systematically important banks 1.63 Germany crisis management pre-BRRD 12.14–12.15 impact of EBU on banking industry 2.122 initial policy commitments by euro area Member States 1.09 perspective of SSM 2.114–2.117 riskiness of sovereign debt 15.14–15.16 Global financial crisis see financial crisis 2007-12 Globally systematic important banks (G-SIBs) see also conglomerates banning of proprietary trading and hedge fund investments 16.42 identification of financial conglomerates 17.02 importance of legal and functional separation of activities 16.50 need for structural re-organization of large firms at holding company level 16.04–16.05 possible mechanisms for resolution 16.38 promise of SPE style resolution 16.45 scope of remit 13.73 systemic risk assessment under Basel III 16.03 TLAC requirement 13.72, 11.12 Governance see corporate governance Greece crisis management during transition to new EU regime 12.21–12.23 emergence of EU bank resolution after financial crisis 16.12 impact of EBU on banking industry 2.135 initial policy commitments by euro area Member States 1.09 non-performing loans 1.25 NPL crisis 2010-17 8.03–8.04 precautionary recapitalization 12.23 riskiness of sovereign debt 15.14–15.16 Supervisory Review and Evaluation Process (SREP) 1.25 Group companies see also conglomerates

consolidated and group supervision compared 17.15–17.23 consolidated CRD supervision 17.15–17.23 consolidated supervision in bank sector effect of SSM 17.01–17.02 mixed activity holding companies 17.07–17.08 scope 17.05–17.06 exchange of data and information 6.31, 6.61 need for structural re-organization of large firms at holding company level 16.01–16.02 risk governance 6.107, 6.65–6.68 scope of SRM 9.08 single point of entry resolution in US 16.25–16.34 SPE reform for Europe 16.38–16.48 ‘substantive impediments’ for resolution 10.33 supervision in insurance sector Insurance Groups Directive 17.09 mixed activity holding companies 17.13–17.14 Solvency II 17.10–17.12, 17.10–17.14 UK approach 13.49–13.54 Guidelines corporate governance 6.07, 6.39–6.41 fit and proper assessments 7.24–7.27, 7.85–7.87 general role 5.40–5.42 ‘less significant institutions’ (LSIs) 2.37, 6.13 NPL Guidance 8.10 resolution planning 10.22 significant institutions’ (SIs) 4.72–4.82, 6.13 Holding companies see group companies Insolvency see also bail-ins; bail-outs; recovery and resolution CMU agenda 1.55 ex ante measures 10.49 fragmentation of the banking market 1.35 impact of financial crisis 4.05 Italian bank insolvency procedure 12.33–12.35 NCWO principle 10.74–10.75 policy for tackling NPLs 8.20–8.22, 8.08 relationship with EU resolution 12.10–12.12 risk governance 6.97 SRB powers 3.49 supervisory convergence and harmonization 2.15 UK approach 13.11–13.15 Venetian bank crisis Commission approval for compulsory liquidation 12.51–12.53 foreseeable impact of liquidation 12.54–12.63 insolvency proceedings 12.47–12.50 Institutions see EU agencies and institutions Insurance sector CMU agenda 1.55 consolidated and group supervision compared 17.20–17.23 deposit-taking authorizations in UK 13.05 European Insurance and Occupational Pension Authority (EIOPA)

671

672

Index review of indirect ECB decisions/ instructions 3.29–3.36 specific tasks conferred 3.07–3.09 substantial review by CJEU 3.66–3.85 SRB decisions affecting credit institutions administrative review 3.57–3.59 applicable powers 3.46–3.54 indirect SRB decisions/instructions 3.62–3.65 judicial review 3.60–3.61 procedural rules 3.55 specific tasks conferred 3.37–3.45 substantial review by CJEU 3.66–3.85 underlying difficulties 3.94 Judicial review see review of decisions

Insurance sector (cont.) co-ordinated supervision of conglomerates 17.60–17.62 interaction between EBA and SSM 2.33–2.34 recovery and resolution 17.79–17.88 revisions of Financial Conglomerates Directive 17.70–17.71 resolution on Netherlands 10.02 SPE resolution in US 16.29, 16.25 Ireland crisis management pre-BRRD 12.16–12.19 impact of SSM 2.137 NPL crisis 2010-17 8.03–8.04 riskiness of sovereign debt 15.14–15.16 Italy bail-ins as effective tool 11.11 crisis management under new regime background 12.31–12.32 insolvency procedure 12.33–12.35 Monte dei Paschi di Siena 12.36–12.39 overview 12.30 Venetian banks 12.40–12.63 establishment of 'bail-in' regime 1.16 impact of EBU on banking industry 2.125 initial policy commitments by euro area Member States 1.08 non-performing loans 1.25 NPL crisis 2010-17 8.03–8.04 perspective of SSM 2.120 riskiness of sovereign debt 15.14–15.16, 15.53 Supervisory Review and Evaluation Process (SREP) 1.25 Venetian bank crisis background to Veneto Banca and Banca Popolare di Vicenza 12.40–12.46 Commission approval for compulsory liquidation 12.51–12.53 foreseeable impact of liquidation 12.54–12.63 insolvency proceedings 12.47–12.50

‘Key function holders’ defined 7.05 fit and proper assessments 7.75

Joint Forum Principles additional risk of combined financial operations 17.36 capital requirements 17.41 co-ordination provisions 17.52–17.62 conglomerate supervision 17.34–17.35 fit and proper assessments 17.47 internal risk management 17.43–17.46 loopholes on sectoral supervision 17.37–17.38 risk concentrations 17.42 specific risks 17.39–17.40 stress testing 17.48–17.51 Joint supervisory teams 2.74–2.79 Judicial protection ECB powers in relation to credit institutions administrative review 3.20–3.23 applicable law 3.10–3.15 judicial review 3.24–3.28 procedural rules 3.16–3.18

Lamfalussy regulatory framework 4.04, 5.25 ‘Less significant institutions’ (LSIs) see also ‘significant institutions’ (SIs) close co-operation agreement 4.42 compliance with MiFID II 2.83 criteria for determining 4.72–4.82 different opt-outs or delegations 2.87 direct supervision by NCAs 4.51, 4.84 EBA Guidelines and Recommendations 2.37 EBA Guidelines on Internal Governance 6.13 ECB responsibility 2.67–2.68 ‘mechanism' of SSM regime 4.51 Member State's perspectives of SSM 2.114 rigour of supervision 2.77–2.79 structural and individual co-operation 4.88–4.103 supervision by ECB 4.48 supervision in practice 4.83–4.87 Level playing field application of national law by ECB 7.89 bail-ins 11.08,  11.27 developments to watch 1.21 ECB monetary and supervisory roles 7.27, 5.58 ECB policies 7.27 European Deposit Insurance Scheme (EDIS) 14.16–14.17 ex ante measures 10.47–10.48 resolution planning 10.44, 12.12 SRM governance 9.69 SSM legal framework 2.114, 4.23, 2.87, 4.03 two-level judicial review system 3.96 Luxembourg burden sharing 10.96 fall-out from Banco Popular Espanyol 10.26 participation in SSM 1.57 riskiness of sovereign debt 15.14–15.16 Macroprudential tools interaction between SSM and NCAs 2.97–2.108 operational issues raised by EIOPA 17.82, 17.70

672

673

Index ‘Management bodies’ defined 7.02–7.04 fit and proper assessments collective suitability 7.68–7.74 five assessment criteria 7.29–7.31 independence of mind 7.52–7.60 knowledge, skills and experience 7.32–7.48 reputation 7.49–7.51 time commitment 7.61–7.67 Market abuse bail-in execution 11.59 issues arising with resolution planning 10.89–10.92 Mediation panel 2.18, 4.140–4.141 Member States application of single rule book 5.02 appointments to SRB 9.19 banking structures in EU 6.04 crisis management during transition to new EU regime Cyprus 12.24–12.27 Greece 12.21–12.23 Portugal 12.28–12.29 crisis management pre-BRRD Germany 12.14–12.15 Ireland 12.16–12.19 United Kingdom 12.12–12.15 early approaches to resolution 13.02–13.03 ex ante measures 10.31 failure of single rulebook to reflect national diversity 4.11 funding of SRF ex ante contributions 9.47–9.54 extraordinary ex post contributions 9.55–9.57 general arrangements 9.46 transfer and mutualization of contributions 9.58–9.63 historical difficulties with SSM 4.04 implementation of CRD IV 6.47 implementation principles of CRD IV generous approach to domestic company law 6.56–6.57 options at national level 6.58–6.59 remuneration policies and risk governance 6.60–6.68 membership of Banking Union euro Member States 4.12 non-euro Member States 4.13–4.14 membership of SSM 2.09 perspectives of SSM France 2.118 Germany 2.114–2.117 Italy 2.120 Spain 2.119 Mergers see takeovers and mergers Minimum requirements and eligible liabilities (MREL) BRRD provisions 11.25–11.33 UK approach 13.72–13.76

Moral hazard 7+7 proposal 15.71 Bank of Italy response 12.50 effect of Article 25 of SSM Regulation 2.17 establishment of 'bail-in' regime 1.14–1.19 four resolution tools 12.04 impact of EU state aid policies 10.61–10.62 introduction of a deposit insurance system 14.30, 14.49, 14.53, 14.57, 14.66–14.67 key anachronism of the proposed Structural Measures Regulation 16.45 mitigation by collateral recovery and liquidation 8.20 need for risk prevention and supervision 14.13 ‘normal’ insolvency proceedings 12.10 problem of ‘too big to fail’ (TBTF) financial institutions 1.46 Sovereign risk 15.66, 15.11 unfinished agenda of structural reform 16.01 Multiple points of entry resolution (MPE) cross border resolution strategies 11.35–11.37 'resolution entities' 11.18 shortcomings 16.22 SPE/MPE approaches compared 10.78–10.84 traditional European approach 16.20 National Competent Authorities (NCAs) appointments to SRB 9.24 co-operation with SRB 9.15–9.16 competence 4.03 direct supervision of LSIs 4.51, 4.84 division of tasks within SRM 9.09–9.14 ex ante measures authority to ‘take additional measures under national law’ 10.31 level playing field issue 10.47–10.48 fit and proper assessments application of national law by ECB 7.88–7.95 assessments of key function holders 7.22 assessments of management body members 7.17–7.21 ECB responsibilities 7.15–7.16 limits of harmonization through EBA Guidelines 7.85–7.87 transposition of CRD IV requirements 7.80–7.84 interaction with SSM home-host supervisory arrangements 2.80–2.86 macroprudential tools 2.97–2.108 overview 2.67–2.71 role of ECB 2.72–2.73 smooth operation of payment system 2.109–2.113 uncertainties regarding the allocation of powers 2.87–2.96 ‘mechanism' of SSM regime 4.47–4.49 notification of substantial impediments 2.66 part of Banking Union 4.09 remit 2.53 shift of legal supervisory competences under SSM 2.07

673

674

Index Netherlands bank failures Fortis Bank Nederland 10.18–10.22 SNS Bank 10.23–10.25 consolidated and group supervision compared 17.21 establishment of 'bail-in' regime 1.16 first proposal of a BRRD 1.18 initial policy commitments by euro area Member States 1.12 jurisdictional issues with resolution planning 10.69 limitations on usefulness of resolution plans 10.10 ‘no creditor worse off’ (NCWO) principle 13.62 recovery and resolution in insurance sector 10.02 riskiness of sovereign debt 15.14–15.16 use of macroprudential tools 2.97 ‘No creditor worse off’ (NCWO) principle general principle of fairness 10.74–10.75 UK approach 13.15–13.19, 13.33, 13.40, 13.62 Non-performing loans (NPLs) announcement of Action Plan 8.09 asset management companies 8.27–8.30 build-up during recession 15.30 building a market for distressed bank debt 8.31–8.33 causes 8.12–8.14 consequences of high NPL ratios 8.15–8.18 Council Roadmap 2016 14.32 defined 8.01 easing of pressure after 2017 8.04 EU crisis between 2010–2017 8.03 fear of burden sharing 8.53 impact on risk profiles 4.58 Italy 12.43 key policy decisions 5.03 link with bank solvency and viability 8.06 macroprudential backstops 8.49–8.51 micro prudential measures corporate governance 8.37–8.45 EBA Guidelines 8.36 supervisory policies 8.34–8.35 move towards more centralized policy 8.08 pockets of fragility 1.25 recovery and resolution disclosure and data standardization 8.23–8.26 legal measures to facilitate recovery 8.19–8.22 reduction in importance 8.52 special attention by SSM 5.43–5.49 taxonomy of EU measures 8.10 true measure of bank losses 8.02 NPL Guidance 8.10 Options and discretions (O & Ds) Danish Compromise 17.20 limits to ECB rule-making 5.50–5.52 need for further harmonization 2.114 role of national banking law 4.17 supervisory standards 4.52

Outright Monetary Transactions (OMTs) programme initial impact of EBU 1.04, 1.11–1.12 Payment systems interaction between SSM and NCAs 2.109–2.113 liabilities excluded from bail-in 16.18 Points of entry cross border resolution strategies 11.35–11.37 pathway to SPE in US 16.25–16.34 'resolution entities' 11.18 SPE/MPE approaches compared 10.78–10.84 structural reform for Europe 16.38–16.48 traditional European approach 16.20 US approach 16.02 Portugal crisis management during transition to new EU regime 12.28–12.29 emergence of EU bank resolution after financial crisis 16.12 impact of EBU on banking industry 2.135 NPL crisis 2010-17 8.03–8.04 riskiness of sovereign debt 15.14–15.16 Precautionary recapitalization burden sharing 10.95 confidentiality issues 10.86 Greek banks 12.23 impact of EU state aid policies 10.64 Italian Banks 8.06, 12.36–12.39, 12.44–12.46,  12.50 resolution planning 10.11 Procedural rules ECB powers in relation to credit institutions 3.16–3.18 Single Resolution Board (SRB) 9.38 SRB decisions affecting credit institutions 3.55 substantive review by CJEU compliance with EU secondary legislation 3.76–3.81 duty of confidentiality 3.74–3.75 duty to give reasons 3.73 general powers 3.71 right to be heard 3.72 Recovery and resolution bail-ins bail-in execution 11.49–11.59 eligible liabilities 11.43–11.45 epitome of policy goals 11.01–11.05 investor protection 11.48 main features 11.06–11.11 market discipline 11.46–11.47 TLAC/MREL requirements 11.12–11.42 bank failures Banco Popular Espanyol 10.26 Fortis Bank Nederland 10.18–10.22 possible intermediate conclusions 10.27–10.28 SNS Bank 10.23–10.25

674

675

Index bank intervention under BRRD and SRM Regulation adoption of a resolution scheme 9.97–9.119 complexities of decision-making 9.121–9.133 content of resolution schemes 9.81–9.96 execution of resolution scheme 9.120 four stage process 9.75 principles 9.78–9.80 resolution objectives 9.75 conglomerates Bank Recovery and Resolution Directive/ SRM 17.75–17.78 insurance sector 17.79–17.88 cornerstones of the bank crisis management regime 12.01–12.02 crisis management during transition to new EU regime Cyprus 12.24–12.27 Greece 12.21–12.23 Portugal 12.28–12.29 crisis management in Italy background 12.31–12.32 insolvency procedure 12.33–12.35 Monte dei Paschi di Siena 12.36–12.39 overview 12.30 Venetian banks 12.40–12.63 crisis management in Spain Banco Popular 12.68–12.80 restructuring after financial crisis 12.64–12.67 crisis management pre-BRRD Germany 12.14–12.15 Ireland 12.16–12.19 United Kingdom 12.12–12.15 emergence of EU measures after financial crisis absence of one crucial element 16.49–16.50 advantages of SPE 16.23 core message of Basel III 16.16–16.17 creation of Banking Union 16.11 importance of G-20 16.09 international consensus on need for special mechanism 16.10 shortcomings of MPE 16.22 SSM under ECB 16.13 TLAC as self-insurance for credit claims 16.21 two distinct episodes involving Greece and Portugal 16.12 two major regulatory reform waves 16.08 uncertainty and value destructivity 16.18–16.19 ex ante measures appeals against 10.35–10.38 failure of Fortis Bank Nederland 10.22, 10.20 failure of SNS Bank 10.24 level playing field issue 10.47–10.48 macroprudential backstops 2.97 non-performing loans 8.10, 8.46 supervisory powers 10.29–10.34 theoretical approach to future planning 10.07 timing of measures 10.40–10.45

which measures are appropriate 10.40–10.45 will plans actually be used 10.13 first proposal of a BRRD 1.18 general background to SRM 9.04–9.07 governing principles 12.03 how bail-in may work 1.38 importance 2.49 introduction of BRRD 2.50 link between NPLs and bank solvency and viability 8.06 need for special regimes on crisis management of banks 12.81–12.82 need for structural re-organization of large firms at holding company level 16.01–16.02 non-performing  loans disclosure and data standardization 8.23–8.26 legal measures to facilitate recovery 8.19–8.22 ‘normal’ insolvency proceedings 12.10–12.12 objectives of SRF 9.42 overview 10.01–10.02 points of entry cross border resolution strategies 11.35–11.37 pathway to SPE in US 16.25–16.34 'resolution entities' 11.18 SPE/MPE approaches compared 10.78–10.84 structural reform for Europe 16.38–16.48 traditional European approach 16.20 US approach 16.02 possible further developments to watch balance between national and European sources of funding 1.42 consistent approach to banking crises 1.37 reversal of fragmentation of system 1.35 resolution planning benefits 10.07–10.08 complex issues arising 10.65–10.97 complications which need to be addressed 10.98 limitations on usefulness 10.09–10.11 ‘one size fits all’ planning standards 10.12 theoretical approach to future planning 10.03–10.06 UK approach 13.45–13.48 will plans actually be used 10.13–10.16 resolution tools 12.04–12.09 Single Resolution Board (SRB) see Single Resolution Board (SRB) Single Resolution Mechanism (SRM) see Single Resolution Mechanism (SRM) Single Supervisory Mechanism (SSM) see Single Supervisory Mechanism (SSM) summary of general measures in use EBU approach 10.55–10.60 impact of EU state aid policies 10.61–10.64 implementation of Volcker Rule into Dodd- Frank Act 10.51–10.54 UK approach alternatives to bail-ins 13.25–13.32

675

67

Index Recovery and resolution (cont.) appointment of administrators 13.55 bail-ins 13.33–13.36 banks operating in Eurozone 13.57 capital instrument write-downs 13.39–13.42 costs of harmonization 13.82 depositor preference 13.67–13.71 financial collateral 13.56 impact of Brexit 13.77–13.81 intervention triggers 13.53–13.54 intra-group financial support 13.49–13.52 powers and instruments 13.37–13.38 recovery plans 13.45–13.48 solvency support 13.60–13.66 termination rights 13.43–13.44 third-country resolution 13.58–13.59 TLAC 13.72–13.76 valuation mechanisms 13.20–13.23 UK perspective background 13.01–13.03 general safeguards 13.15–13.19 group companies 13.05–13.06 investment firms 13.07–13.08 pre-resolution intervention 13.09–13.10 resolution as alternative to insolvency 13.11–13.15 withdrawal of proposed ‘Structural Measures Regulation' 16.03 Regulatory powers see also supervisory powers allocation of rule-making 5.24–5.27 ambiguous objectives of CRD IV board decisions and 'business judgment' 6.82–6.86 content and scope of some provisions 6.69–6.72 over-emphasis on board members' character 6.79–6.81 public-interest requirement for other decisions 6.78 public-interest requirement for remuneration decisions 6.73–6.77 complexity of the SSM 4.11 concluding remarks 5.68–5.70 corporate governance 6.33 decoupling of supervisory powers in SSM legal nature of NPL Guidance 5.43–5.49 limits to the ECB’s regulatory powers 5.31–5.38 options and discretions (O & Ds) 5.50–5.52 role of Guidelines 5.40–5.42 rule-making 5.28–5.30 evolutionary dynamics of institutional framework pending reforms 5.53–5.56 possible future developments 5.62–5.67 regulatory approach of ECB 5.57–5.61 failure of single rulebook to reflect national diversity 4.11

history of EU framework emerging single rulebook 5.14–5.16 single banking licences and minimum harmonization 5.04–5.07 three-stage approach to institutional overhaul 5.08–5.13 polycentrism 5.17–5.19 reasons for harmonization 5.20–5.23 Remuneration policies board members' duties 6.23–6.27 failure of corporate governance 6.89 functional concerns of CRD IV 6.97–6.101 implementation principles of CRD IV 6.60–6.68 public-interest requirement for remuneration decisions contents 6.73–6.75 scope 6.76–6.77 single rulebook 5.30 Resolution see recovery and resolution Resolution planning see also ex ante measures adoption of a resolution scheme amending and updating scheme 9.119 conditions for adoption 9.101–9.107 general principles 9.97 involvement of Commission and Council 9.107–9.118 normal decision-making procedure 9.98 special decision-making procedure 9.99–9.100 state aid 9.118 benefits 10.07–10.08 complex issues arising burden sharing 10.95–10.97 confidentiality 10.85–10.92 ex ante determination of critical functions 10.76–10.77 foreign jurisdictions and courts 10.67–10.72 ‘no creditor worse off’ (NCWO) principle 10.74–10.75 regulatory issues 10.93–10.94 SPE/MPE approaches compared 10.78–10.84 third party private law rights 10.73 unknown unknowns 10.66 complexities of decision-making 9.121–9.133 complications which need to be addressed 10.98 content of resolution schemes asset separation tools 9.86 bail-in tools 9.87–9.91 bridge institution and sale of business tools 9.85 exclusions from bail-in 9.81 general tools 9.84 relevant considerations 9.82–9.83 use of SRF 9.92–9.96 execution of resolution scheme 9.120 Joint Guidelines 10.22 limitations on usefulness 10.09–10.11 ‘one size fits all’ planning standards 10.12

676

67

Index ‘resolvability’ assessments 10.32–10.34 theoretical approach to future planning 10.03–10.06 UK approach 13.45–13.48 will plans actually be used 10.13–10.16 Review of decisions appeals against ex ante measures 10.35–10.38 ECB powers in relation to credit institutions administrative review 3.20–3.23 judicial review 3.24–3.28 review of indirect ECB decisions/ instructions 3.29–3.36 SRB decisions affecting credit institutions administrative review 3.57–3.59 indirect SRB decisions/instructions 3.62–3.65 judicial review 3.60–3.61 SSM administrative review 4.136–4.139 judicial review 4.142 mediation panel 4.140–4.141 substantive review by CJEU consequences of illegality and invalidity 3.84–3.85 infringement of procedural rules 3.71–3.81 lack of competence 3.69–3.70 manifest errors of assessment 3.83 misuse of power 3.82 overview 3.66–3.68 underlying difficulties 3.95–3.99 Risk see also burden sharing board members' duties 6.28–6.32 conglomerates additional risk of combined financial operations 17.36 internal risk management 17.43–17.46 risk concentrations 17.42 specific risks 17.39–17.40 downside of EDIS 14.17 EBU approach to recovery and resolution 10.60 functional concerns of CRD IV 6.91–6.92 implementation principles of CRD IV 6.60–6.68 intra-group activity 6.107, 6.65–6.68 management of NPLs 8.43–8.45 non-performing loans (NPLs) 4.58 sovereign debt 15.13–15.21 Rulebook see single rulebook Shadow banking 4.63, 10.02 Significant institutions’ (SIs) see also ‘less significant institutions’ (LSIs) common supervisory review 2.78 compliance with MiFID II 2.83 different opt-outs or delegations 2.87 diversity policy 6.21 EBA Guidelines and Recommendations 4.72–4.82 EBA Guidelines on Internal Governance 6.13

fit and proper assessments assessments of key function holders 7.22 assessments of management body members 7.17–7.21 ECB responsibilities 7.15–7.16 home-host supervisory arrangements 2.80–2.85 latest NPL progress report 8.04 outsourcing 2.91 public auditing 2.46, 4.129 structural and individual co-operation 4.88–4.103 supervision by ECB 2.74, 4.48 supervision in practice 4.83–4.87 supervisory O&Ds 5.51 Single banking licences 5.04–5.07,  5.23 Single point of entry resolution (SPE) advantages 16.23 cross border resolution strategies 11.35–11.37 pathway to SPE in US 16.25–16.34 'resolution entities' 11.18 SPE/MPE approaches compared 10.78–10.84 structural reform for Europe 16.38–16.48 US approach 16.02, 16.20 Single Resolution and Deposit Insurance Board 14.26, 14.34, 14.61–14.65, 14.72 Single Resolution Board (SRB) accountability and liability 9.39–9.40 adoption of a resolution scheme amending and updating scheme 9.119 general principles 9.97 normal decision-making procedure 9.98 special decision-making procedure 9.99–9.100 appeals against ex ante measures 10.35–10.38 benefits of resolution planning 10.07 broad powers and legal uncertainty 2.60–2.61 central decision-making body of SRM 9.17 co-operation with NCAs 9.15–9.16 co-ordination with SSM 2.62–2.66 composition 9.18–9.24 decision-making executive sessions 9.31–9.34 plenary sessions 9.35–9.37 rules of procedure 9.38 division of tasks executive sessions 9.27–9.29 plenary sessions 9.30 division of tasks within SRM 9.09–9.14 effectiveness of the single resolution mechanism 2.138 integration of euro area banking system 1.45 judicial protection to credit institutions administrative review 3.57–3.59 applicable powers 3.46–3.54 indirect SRB decisions/instructions 3.62–3.65 judicial review 3.60–3.61 procedural rules 3.55 specific tasks conferred 3.37–3.45 substantial review by CJEU 3.66–3.85 liability for maladministration attribution of liability problem 3.90

677

678

Index Single Resolution Board (SRB) (cont.) contractual and non-contractual liability 3.87 cost-sharing 3.91 exclusive jurisdiction of CJEU 3.92–3.93 individual claimants 3.88 specific form of accountability 3.86 supervisory tasks 3.89 possible further developments to watch 1.40, 1.43 remit 2.53 resolution scheme for Banco Popular 12.71–12.77 scope of discretionary powers 2.57–2.59 theoretical approach to future planning 10.03 Venetian bank crisis 12.48, 12.54–12.56 Single Resolution Fund (SRF) establishment 2.56 extension of initial time period 9.44–9.45 funding 9.55–9.57 borrowings or other forms of support 9.64–9.70 ex ante contributions 9.47–9.54 extraordinary ex post contributions 9.55–9.57 general arrangements 9.46 transfer and mutualization of contributions 9.58–9.63 voluntarily borrow between arrangements 9.71–9.74 objectives 9.42 overview 9.41 possible further developments to watch 1.43 target funding level 9.43 use as part of resolution scheme 9.92–9.96 Single Resolution Mechanism (SRM) see also Single Resolution Board (SRB); Single Resolution Fund (SRF) badly needed resolution regime 2.54 Banco Popular 12.78–12.80 bank intervention under BRRD and SRM Regulation adoption of a resolution scheme 9.97–9.119 complexities of decision-making 9.121–9.133 content of resolution schemes 9.81–9.96 execution of resolution scheme 9.120 four stage process 9.75 principles 9.78–9.80 resolution objectives 9.76–9.77 co-ordination with SRB 2.62–2.66 decision-making structure co-operation between SRB and NCAs 9.15–9.16 division of tasks 9.09–9.14 overview 9.02–9.03 role of SRB 9.17–9.40 emergence of EU measures after financial crisis 16.13 entities to which it applies 9.08 establishment of SRF 2.56 general background 9.04–9.07 implementation of BRRD 2.52

interaction with SSM 2.55 one of three pillars of EBU 2.01, 14.10 political agreement 2014 9.01 possible further developments to watch 1.37, 1.43 Single Resolution Fund (SRF) funding 9.46–9.74 role 9.41–9.45 Single rulebook application 5.02 emerging institutional structure 5.14–5.16 executive pay 5.30 failure to reflect diversity of national regulations 4.28 fit and proper assessments assessment process 7.76–7.77 key function holders 7.75 management body members 7.29–7.74 meaning 5.01 need for change 4.30 political rather than legal concept 4.25 publication of ‘Interactive Single Rulebook’ 4.26 significant omissions 4.27 Single Supervisory Mechanism (SSM) see also European Central Bank (ECB); supervisory powers applicable law EU law 4.18–4.24 national law 4.15–4.17 Single Rulebook 4.25–4.30 the Banking Union collective term 4.09–4.10 complexity of the regulatory system 4.11 euro Member States 4.12 non-euro Member States 4.13–4.14 centralization and co-ordination mechanism 4.02 conglomerates 17.75–17.78 convergence and harmonization under SSM Regulation 2.11–2.15 CRD reform package (CRD IV) 2.24–2.30 debilitation of banking systems of much of southern Europe and Ireland 2.137 decoupling of regulatory and supervisory powers legal nature of NPL Guidance 5.43–5.49 limits to the ECB’s regulatory powers 5.31–5.38 options and discretions (O & Ds) 5.50–5.52 role of Guidelines 5.40–5.42 rule-making 5.28–5.30 ECB as prudential supervisor 4.31–4.37 effectiveness based on institutional and legal framework 2.06 effectiveness of the single resolution mechanism 2.138 emergence of EU measures after financial crisis 16.13 EU agencies and institutions European Banking Authority (EBA) 2.31–2.43 European Court of Auditors 2.46–2.48

678

679

Index lack of meaningful participation with ESMA and EIOPA 2.44–2.45 first legally binding transnational system 2.05 fit and proper assessments see fit and proper assessments general background to SRM 9.04–9.07 historic shift of legal supervisory competences 2.07 historical difficulties from Member States 4.04 impact of financial crisis 4.05–4.06 impact on bank supervision 17.01–17.02 impact on conglomerate supervision 17.03–17.04 initial policy commitments by euro area Member States 1.07 interaction with NCAs home-host supervisory arrangements 2.80–2.86 macroprudential tools 2.97–2.108 overview 2.67–2.71 role of ECB 2.72–2.73 smooth operation of payment system 2.109–2.113 supervisory colleges and joint supervisory teams 2.74–2.79 uncertainties regarding the allocation of powers 2.87–2.96 interaction with SRM 2.55 judicial protection of ECB powers in relation to credit institutions administrative review 3.20–3.23 applicable law 3.10–3.15 judicial review 3.24–3.28 procedural rules 3.16–3.18 review of indirect ECB decisions/ instructions 3.29–3.36 specific tasks conferred 3.07–3.09 major new development 4.01 ‘mechanism' of SSM regime complex set of relations 4.48 ‘consistent application of high supervisory standards’ 4.53–4.56 ECB tools 4.52 introduction 4.46 ‘less significant institutions’ (LSIs) 4.51 National Competent Authorities (NCAs) 4.47–4.49 role of ECB 4.50 structural and individual co-operation 4.88–4.103 two-tier supervisory system 4.49 Member States perspectives France 2.118 Germany 2.114–2.117 Italy 2.120 Spain 2.119 membership 2.09 new institutional order 1.57 one of three pillars of EBU 2.01 overriding objectives 2.08

pillar of EBU 14.10 political factors in creation 2.02 possible further developments to watch 1.23–1.30,  1.37 restoration of confidence in banking 4.143 review of decisions administrative review 4.136–4.139 judicial review 4.142 mediation panel 4.140–4.141 role of ECB and NCAs 4.03 role of SB 2.16–2.21 scope 4.57–4.65 credit institutions 4.57–4.65 SIs and LSIs 4.72–4.82 subsidiaries and branches 4.66–4.71 supervision in practice 4.83–4.87 shortcomings and points of concern 4.144–4.152 single rulebook see single rulebook sovereign debt 15.02 status in international financial standard setting bodies 2.22–2.24 Supervisory Board (SB) see Supervisory Board (SB) system of ‘close co-operation’ with non-euro states 4.38–4.45 viewed as effective supervisory network 2.10 Sovereign debt core message of Basel III 16.16 crisis management Greece 12.21 Italy 12.31 Spain 12.64 ECB's OMT programme 1.12–1.13, 1.04 emergence of EU bank resolution after financial crisis 16.11–16.12 goals of EBU 14.09 impact of CRR 1.34 impact of EBU on banking industry 2.135 implementation of Fiscal Compact 15.51 implementation of SSM 2.135, 2.01–2.02, 5.09 key issues are broader policy actions needed 15.42–15.45 banks’ perspective and rational strategy 15.28–15.32 home bias in sovereign purchases 15.33–15.41 sustainability of sovereigns 15.22–15.27 lack of risk-sharing mechanisms 15.81 need for agreement on EDIS 15.77 need for reforms 15.46–15.53 need to address legacy issues 15.78–15.80 perverse effects of interconnection with bank liabilities 15.01–15.12 proposals for reform 7+7 reports 15.70–15.74 alternative strategies 15.58–15.59 creation of European Safe Bonds 15.64–15.68 different regulatory treatments based on riskiness 15.63

679

680

Index Sovereign debt (cont.) Five President Report of 2015 15.76 ‘horizontal discrimination’ 15.60 lack of institutional debate 15.75 preferred option 15.69 requirements of Euro area banking system 15.61–15.62 three main families of regulatory measures 15.55–15.57 reversal of fragmentation of system 1.33 riskiness 15.13–15.21 Spain Banco Popular background to difficulties 12.68–12.70 resolution scheme by SRB 12.71–12.77 successful outcome under SRM 12.78–12.80 crisis management under new regime Banco Popular 12.64–12.67 restructuring after financial crisis 12.64–12.67 establishment of 'bail-in' regime 1.16 failure of Banco Popular Espanyol 10.26 initial policy commitments by euro area Member States 1.08 limitations on usefulness of resolution plans 10.10 NPL crisis 2010-17 8.03–8.04 perspective of SSM 2.119 riskiness of sovereign debt 15.14–15.16 State aid see also bail-ins adoption of a resolution scheme 9.118 asset management companies 8.30 evolution of control framework 1.43 impact on recovery and resolution 10.61–10.64 move to burden sharing 8.07, 10.95 new competition rules 1.19 new legal hierarchy for ECB 5.36 requirement for an NCWO evaluation 10.75 role of DG COMP 1.61 UK approach 13.31–13.32 Venetian bank crisis 12.52 Subsidiaries see group companies ‘Supervised entities’ 4.64–4.65 Supervisory Board (SB) accountability 4.123–4.135 governance of the SSM 2.16 independence 4.115–4.122 legal position 4.104–4.114 oversight of NCAs 2.68 role 2.16–2.21 Supervisory colleges 2.74–2.79 Supervisory powers see also regulatory powers; Single Supervisory Mechanism (SSM) allocation of rule-making 5.24–5.27 centralization ECB role 5.19 underlying rationale 5.20–5.23 concluding remarks 5.68–5.70

conglomerates 17.21 challenge to fit supervision in EU framework 17.95–17.96 ECB role 17.33 EU Financial Conglomerates Directive 17.24 evolution of financial landscape 17.89 impact of Financial Conglomerate Directive 17.90–17.92 institutional framework 17.29–17.33 Joint Forum Principles 17.34–17.38 need for supplementary supervision 17.93–17.94 overview 17.03–17.04 relevant features 17.25–17.28 revisions of Financial Conglomerates Directive 17.63–17.73 consolidated and group supervision compared 17.15–17.23 corporate governance EBA Guidelines 6.39–6.41 importance 6.38 role of ECB 6.45 sanctions regime 6.42–6.44 decoupling of regulatory powers in SSM legal nature of NPL Guidance 5.43–5.49 limits to the ECB’s regulatory powers 5.31–5.38 options and discretions (O & Ds) 5.50–5.52 role of Guidelines 5.40–5.42 rule-making 5.28–5.30 group companies in bank sector effect of SSM 17.01–17.02 mixed activity holding companies 17.07–17.08 scope 17.05–17.06 group companies in insurance sector Insurance Groups Directive 17.09 mixed activity holding companies 17.13–17.14 Solvency II 17.10–17.12 non-performing loans 8.34–8.35 three-stage approach to institutional overhaul 5.14–5.16 Supervisory Review and Evaluation Process (SREP) EBA responsibility 2.43 impact of EBU on banking industry 2.123–2.124 possible further developments to watch 1.23–1.30 Sweden asset management companies 8.07 bilateral loan to Ireland 12.17 ‘close co-operation’ regime 4.43 Switzerland capital requirements 16.48 systematically important banks 1.63 Takeovers and mergers failure of Fortis Bank Nederland 10.18–10.22 impact of EBU on banking industry 2.126–2.128 Termination rights foreign jurisdictions and courts 10.68

680

681

Index SRB powers 3.50 UK approach 13.43–13.44 ‘Too big to fail’ (TBTF) financial institutions bail-ins 11.01 objections to cross-border acquisitions 1.46 Total loss absorbing capacity (TLAC) core message of Basel III 16.16–16.17 cross-border banking legislative rigidity 11.34 non-resolution entities 11.38–11.42 SPE/MPE approaches compared 11.35–11.37 emergence of EU measures after financial crisis 16.10 key element of bail-ins 11.11 MREL requirement 11.25–11.33 overview of regime 11.15–11.18 self-insurance for credit claims 16.21 SPE reform for Europe 16.46 TLAC requirement 11.19–11.24 UK approach 13.72–13.76 United Kingdom ‘close co-operation’ regime 4.43 crisis management pre-BRRD 12.12–12.15 recovery and resolution alternatives to bail-ins 13.25–13.32 appointment of administrators 13.55 background 13.01–13.03 bail-ins 13.33–13.36 banks operating in Eurozone 13.57 capital instrument write-downs 13.39–13.42 costs of harmonization 13.82 depositor preference 13.67–13.71 financial collateral 13.56 general safeguards 13.15–13.19 group companies 13.05–13.06

impact of Brexit 13.77–13.81 intervention triggers 13.53–13.54 intra-group financial support 13.49–13.52 investment firms 13.07–13.08 powers and instruments 13.37–13.38 recovery plans 13.45–13.48 resolution as alternative to insolvency 13.11–13.15 solvency support 13.60–13.66 termination rights 13.43–13.44 third-country resolution 13.58–13.59 TLAC 13.72–13.76 valuation mechanisms 13.20–13.23 systematically important banks 1.63 United States fall-out from Banco Popular Espanyol 10.26 fully integrated financial market 15.51 implementation of Volcker Rule into Dodd-Frank Act 10.51–10.54 intellectual template for resolution 13.03 jurisdictional issues with resolution planning 10.68 single point of entry resolution path to resolution 16.25–16.34 strategy employed by FDIC 16.20 systematically important banks 1.63 Valuation mechanisms bail-ins 11.52–11.55 EBA Valuation Handbook 11.52–11.55 requirement for an NCWO evaluation 10.75 UK approach 13.20–13.23 Write-downs see forced write down and conversion of capital instruments (WDCCI)

681