Comment Piece
Recovery & Resolution Plans and the European Recovery & Resolution Directive
By Selwyn Blair-Ford, Head of Global Regulatory Policy, Wolters Kluwer Financial Services
One of the consequences of the 2008 financial crisis was the
realization that taxpayers, governments and society as a whole,
could not afford to have financial institutions that were so large,
connected and essential to the workings of the economy, that to
allow them to fail would threaten the well-being of all. This has
been called the “too-big-to fail” problem. The result of having such
institutions was that taxpayers across Europe and North America
were obliged to dig deep into the public purse to rescue failed
financial firms, sparking a prolonged economic downturn.
The response of this problem has been varied. Firms have had to
strengthen balance sheets, address contingent liquidity issues,
and have been subject to more stringent stress testing. Regulators
have also identified the most influential firms (Systemically
Important Financial Institutions (SIFIs) and Globally Systemically
Important Banks (G-SIBs)) and requires them to reserve additional
capital as a result of their importance. These firms must have in
place a ‘recovery’ plan for situations where events have
significantly damaged the firms business. However, where the
damage to a firms business is so severe that it cannot be recovered
and thus subject to fail, then it will need to enact its ‘resolution’
plan in an orderly fashion so as to minimise the damage to the
economy of its demise.
In October 2011, the Financial Stability Board (FSB) issued a paper
entitled “Key Attributes of Effective Resolution regimes for
Financial Institutions” which was subsequently endorsed and
accepted by the G-20. In this paper the FSB set out the core
elements that need to be in place for authorities to establish an
effective resolution regime. Key features include:
Ensuring authorities have appropriate resolution powers
Establishing appropriate funding for firms in resolution
Correct legal framework for cross-border cooperation
Establishment of crisis management groups (CMGs)
Recovery and resolution planning
Information access and sharing
In November 2012 the FSB published another consultative
document entitled “Making the Key Requirements Operational”.
This paper focussed on the need for on-going recovery and
resolution planning by firms and the authorities. In this paper
draft guidance was given to CMGs on:
Recovery triggers and stress scenarios
Developing resolution strategies and resolution plans
Identification of critical functions and shared services
The European Union in October 2010, recognizing that the current
EU framework would not be adequate, set out plans for an EU
framework for crisis management in the financial sector. The idea
being that the authorities would be given the effective tools and
powers to tackle a financial crisis in a pre-emptive manner. The
directive establishes three pillars, namely:
1. Prevention: Banks and investment firms are required to develop
and maintain robust recovery plans at both firm and group level
(living wills). These will be used by the national authorities to
construct credible resolution plans.
2. Early intervention: This is taking action before the onset of
insolvency. National authorities will be able to appoint a ‘special
manager’ to work alongside or replace existing management to
restore an institutions financial condition and improve its
business.
3. Resolution: This will be funded partly by national arrangements
to which the financial firm will contribute to, via a levy set in
proportion to their deposit base. In the case of resolution,
national bodies will have a choice of using one or more of the
following tools:
a. Sale of business tool: allowing authorities to sell the
whole or part of the business
Wolters Kluwer Financial Services
b. Bridge Institution: the national resolution authority will have
the ability to transfer an institution’s rights, assets and
liabilities to a temporary publically controlled entity. The
institution may continue as a going concern. Eventually the
transferred portion will be sold back to the private sector.
c. Asset Separation tool: this allows for the transfer of problem
assets from an institution where normal insolvency
procedures would adversely affect the market.
d. Bail-In tool: National authorities will be able to restructure
liabilities of distressed institutions by writing down unsecured
debt or converting debt to equity. This is to be used where a
financial firm is failing or about to fail with the intention of
restoring the firm back to viability. The debt holder will not be
allowed to lose more than if the firm had been made
insolvent.
At present it is the bail-in tool which is due to come into force as of
1st January 2018. However the European Central Bank president,
Mario Draghi, believes that this tool should come into force by
2015.
So what should firms be doing?
Financial firms need to focus on developing and maintaining their
recovery plans and to ensure resolution plans are workable. The
European Banking Authority (EBA) issued a discussion paper on 15
May 2012 titled “A template for recovery plans”, where it outlines
its thinking on what a recovery plan should cover. According to the
EBA, a resolution plan should contain a general overview, the core
of the recovery plan and a follow-up section.
The general overview consists of a plan summary, a general
description of the group or institution, and a discussion of the
firm’s internal governance.
The core of the recovery plan needs to contain a description of all
recovery options and measures available along with what actions
would be needed to execute these measures. Details of early
warning and triggers relating to the recovery plan need to be
given as well as a clear presentation of the assumptions and
scenarios used. Recovery measures where the firm assess the
recovery options, operational contingency plan, communication
plan and information management should also be included as
part of the core plan.
The follow-up section relates to changes firms will need to make in
the way they currently run their business to ensure that the
recovery options can be pursued when they need to be. It will also
highlight areas of possible improvement.
We can contrast this with the more comprehensive template
issued by the now defunct FSA as part of its Feedback Statement
12/1Information Pack issued in May 2012. In this document a
Recovery and Resolution Plan is split in seven modules
1.
2.
3.
4.
5.
6.
Executive summary
Recovery Plan
Group structure and key legal entity information
Economic function identification matrix
UK critical function contingency analysis
Debt and equity in issue information
The FSA pack has detailed templates associated with each section
breaking down the key factors in each module and guidance on
the data and detail required. Although it is in a different format to
the EBA paper, it is clear that two papers are both aligned.
What is clear is that the resolution and recovery planning is an
extension of a firms business/strategic planning process. Firms
should already have in place a complete capital and liquidity stress
testing process, where each type of stress test informs the other. In
addition, firms will also have implemented a reverse stress testing
framework to test business models under severe stress. All of these
should link to inform and validate the recovery plans. If the stress
tests are realistic then the output from the test should coincide
with the plans.
A well-functioning process should see firms actively managing and
changing their contingency resources and processes in line with
the risks considered. There will also be a documented and
reasoned argument why they have chosen their particular course
of action. The danger is always that as concern of failure fades the
rigour needed in this process will fade also. Through looking at the
vigour that the contingency is actively tested and adjusted,
observers can gauge the health of this process.
The recovery and resolution framework, when working effectively,
should make institutions more risk aware and less likely to
participate in highly risky behaviour. However firms need to build
effective infrastructure and processes and this change is only
something we are beginning to see now.
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