Contractual Bail In Creates Monster Document Headache

Introduction

On 3 July 2015 the European Banking Authority (EBA) published final “Draft Regulatory Technical Standards on the contractual recognition of write-down and conversion powers under Article 55(3) of Directive 2014/59/EU” (the BRRD).

The requirement to include Write-Down Clauses

In order to guard against the possibility that a third country court may not recognise the write-down and conversion powers of EU resolution authorities – frustrating attempts to resolve a failing institution – Article 55(1) of the BRRD requires firms to include a contractual term in agreements creating a liability (an “Eligible Liability”) by which the creditor or party to the agreement recognises that the liability in question may be subject to the write-down and conversion powers within the BRRD and agrees to be bound by any reduction of principal or outstanding amount due, conversion or cancellation that is effected by the exercise of those powers (a “Write-Down Clause”).  The requirement applies to any agreement (a “Relevant Agreement”) which:

• is governed by the law of a third country; and
• is created or entered into:
  • after 1 January 2016; or
  • after 1 January 2016 under an agreement (including a master agreement) entered into before 1 January 2016; or
  • before 1 January 2016, but which is subject to “material amendment” (being any amendment which affects the substantive rights and obligations of a party) after 1 January 2016.

The form of a Write-Down Clause

Keen to avoid being overly prescriptive, the EBA does not specify an actual form of Write-Down Clause for use by firms.  Instead, it defines the key ‘boxes’ that any Write-Down Clause must ‘tick’, as set out below.  These requirements must also be satisfied if a liability is to qualify as “minimum requirement for own funds and eligible liabilities” (MREL) for the purposes of Article 45(5):

• an acknowledgement and acceptance that a liability may be subject to the exercise of write-down and conversion powers by a resolution authority;
• a description of the write-down and conversion powers of each relevant resolution authority;
• an acknowledgement and acceptance:
  • that the counterparty is bound by the effect of an application of write-down and conversion powers, including:
    • any reduction in the principal amount or outstanding amount due, including any accrued but unpaid interest; and
    • the conversion of an Eligible Liability into ordinary shares or other instruments of ownership;
  • that the terms of the Relevant Agreement may be varied as necessary to give effect to the exercise of write-down and conversion powers and such variations will be binding;
  • that ordinary shares or other instruments of ownership may be issued to or conferred on the counterparty as a result of the exercise of write-down and conversion powers; and
• an acknowledgement and acceptance that the contractual term is exhaustive on the matters described therein to the exclusion of any other agreements relating to its subject matter.

Are there any exclusions?

The requirement to include a Write-Down Clause within an agreement does not apply:

• if the liability is a:
  • “Covered deposit”;
  • Secured liability;
  • Client asset;
  • liability that arises by virtue of a fiduciary relationship;
  • certain type of liability with an original maturity of less than seven days;
  • certain type of liability owed to employees, trade creditors providing critical functions, tax authorities and deposit guarantee schemes; or
  • certain type of deposit held by natural persons and micro, small and medium-sized enterprises;
• where the relevant resolution authority determines that an Eligible Liability can be subject to write down and conversion by the resolution authority pursuant to the law of a third country or to a binding agreement concluded with that third country.  An EU resolution authority can only make such a determination if an administrative or judicial procedure exists which:
  • enables a third country authority, within a period which the EU resolution authority determines will not compromise the effective application of the write-down and conversion powers by that authority, to recognise and give effect to, or to support, the exercise of the write-down and conversion powers by the resolution authority; and
  • provides that the grounds on which a third country authority may refuse to recognise or support the exercise of write-down and conversion powers by an EU resolution authority are clearly stated and are limited to circumstances where they would:
    • have adverse effects on financial stability in the third country concerned;
    • result in third country creditors (particularly depositors), being treated less favourably than similar EU creditors;
    • have material financial implications for the third country concerned; or
    • have effects contrary to the public order of the third country concerned.