Sunday, April 20, 2014

E.U. Parliament Enacts Orderly Resolution Authority Similar to Dodd-Frank Title II

The European Parliament has enacted legislation establishing a single resolution mechanism to orderly resolve failed and failing financial institutions and investment firms. The resolution authority is backed by an appropriate resolution funding arrangement and a robust decision-making process. A single resolution fund would be constituted to which all the financial institutions in the participating European Union Member States would contribute. The orderly resolution regime would enter into force on January 1, 2015, while bail-in and resolution functions would apply one year later, as specified under the Recovery and Resolution Directive. The legislation was approved by 584 votes to 80, with 10 abstentions.

The legislation creates a resolution regime similar to that created in Title II of the Dodd-Frank Act, with a main exception being that Dodd-Frank did not set up an pre-existing resolution fund. But like Dodd-Frank, the Directive would allow authorities to put financial institutions into an orderly resolution in which their critical functions would be preserved by, for example, a sale to a third party or the creation of a bridge bank, while the non-critical parts of the failed institution would be wound down.

E.U. Commissioner for the Internal Market Michel Barnier noted that in the case of a cross-border failure of a major financial firm, the single resolution mechanism will be more efficient than a network of national resolution authorities, and it will help avoid risks of contagion. While the single resolution mechanism might not be a perfect construction, he continued, it would allow for the timely and effective resolution of a cross-border financial institution, thus meeting its principal objective.

Resolution Board. Centralized decision-making would be built around a strong Single Resolution Board (Board) and would involve permanent members as well as the European Commission, the Council, the European Central Bank (ECB), and the national resolution authorities. In most cases, the ECB would notify the Board, the Commission, and the relevant national resolution authorities that a financial institution is failing. If the Board finds that there is a systemic threat and no private sector solution in sight, it would adopt a resolution scheme including the relevant resolution tools and any use of the resolution fund.

The Commission is responsible for assessing the discretionary aspects of the Board's decision and endorsing or objecting to the resolution scheme. The Commission's decision is subject to the Council’s approval or objection only when the amount of resources drawn from the single fund is modified or if there is no public interest in resolving the financial firm. Where the Council or the Commission object to the resolution scheme, the Board would have to amend the resolution scheme, which the national resolution authorities would then implement. If resolution entails state aid, the Commission would need to approve the aid prior to the Board’s adoption of the resolution scheme.

The concept of bail-in is enshrined in the resolution legislation, which means that shareholders and creditors, primarily bondholders, will be first in line to absorb losses the financial firm could incur, before outside sources of finance may be called upon.

Resolution Fund. The resolution fund has a target level of €55 billion and can borrow from the markets if decided by the Board in plenary session. The Board would own and administrate the fund. The single fund would reach a target level of at least one percent of covered deposits over an eight-year period. During this transitional period, the single fund would comprise national compartments corresponding to each participating member state.

The resources accumulated in those compartments would be progressively mutualized over a period of eight years, starting with 40 percent of these resources in the first year. The regulations would govern the establishment of the single fund, its national compartments, and decisions about its use. An inter-governmental agreement, which the participating member states established in the single resolution mechanism, will provide for transferring national funds towards the single fund and for activating the mutualization of the national compartments.