The European Commission has released a new package of proposals aimed at eliminating that pesky rule-of-law thing with respect to insolvent banks.
The press release emphasizes that the decisions have been made:
Currently, there are very few rules at EU level which determine which actions can and should be taken by authorities when banks fail and, for reasons of financial stability, cannot be wound up under ordinary insolvency rules. This consultation seeks input on the technical details underpinning the policy issues identified in the Communication of 20 October 2010.
For instance, they are going to give themselves:
resolution tools which empower authorities to take the necessary action, where bank failure cannot be avoided, to manage that failure in an orderly way such as powers to transfer assets and liabilities of a failing bank to another institution or to a bridge bank, and to write down debt of a failing bank to strengthen its financial position and allow it to continue as a going concern subject to appropriate restructuring
Well, I guess we should be pleased that they’re only going to take “necessary” actions, and that all restructurings will be “appropriate”. We can also celebrate the assurance that all burden sharing will be fair:
Fair burden sharing by means of financing mechanisms which avoid use of taxpayer funds. This might include possible mechanisms to write down appropriate classes of the debt of a failing bank to ensure that its creditors bear losses. Any such proposals would not apply to existing bank debt currently in issue. It also includes setting up resolution funds financed by bank contributions. In particular the Consultation seeks views on how a mechanism for debt write down (or ‘bail-in’) might be best achieved, and on the feasibility of merging deposit guarantee funds with resolution funds.
The published FAQs note:
9. What is the proposal to write down creditors (‘bail in’) and how would it work?
The objective is to develop a mechanism for recapitalising failing institutions so that it can continue to provide essential services, without the need for bail out by public funds. Fast recapitalisation would allow the institution to continue as a going concern, avoiding the disruption to the financial system that would be caused by stopping or interrupting its critical services, and giving the authorities time to reorganise it or wind down parts of its business in an orderly manner. In the process, shareholders should be wiped out or severely diluted, and culpable management should be replaced. The consultation seeks views on two broad approaches to achieving this objective.
The first approach would involve a broad statutory power for authorities to write down or convert unsecured debt, including senior debt (subject to the possible exclusions for certain classes of senior debt that may be necessary to preserve the proper functioning of credit markets). It is not envisaged that such a power would apply to existing debt that is currently in issue, as that could be disruptive.
The second approach would require banks to issue a fixed amount of ‘bail-in’ debt that could be written off or converted into equity on a specified trigger linked to the failure of the bank. This requirement would be phased in over an appropriate period and, again, it is not envisaged that any existing debt already in issue would be subject to write down.
Unsurprisingly, the arbitrary nature of this plan is under attack:
In one scenario under consideration, regulators may get the power to write down or convert senior debt, with possible exceptions “to ensure proper functioning of credit markets.” These exceptions may include deposits, secured debt such as covered bonds, short-term debt, and well as trades in derivatives and certain other financial instruments, the commission said.
Another option is to force banks to issue a fixed amount of bonds with contracts stating that they could be written down or converted if certain conditions are met.
‘Danger’
This second option “will give much more clarity and certainty, as banks, regulators and investors will have to address the issues explicitly in advance,” PricewaterhouseCoopers LLP director Patrick Fell said. “There is a danger otherwise that we wait until problems emerge” to clarify how so-called bail-ins, in which investors contribute to shoring up banks in difficulty, would work in practice.
Writedowns or conversions would apply only to debt issued after the measures become law, the commission said.
The idea of bail-ins of all senior debt holders is “an incredibly complicated, difficult and ultimately very politically sensitive thing to do,” Bob Penn, a lawyer at Allen & Overy LLP in London, said in a telephone interview. “It feels to me like an entirely unworkable option,” he said.
Lapdog Carney will be pleased: he’s been urging the elimination of bondholder rights for some time.
What will be most interesting is to see how the European banks finance themselves after these measures become law. I, for one, would be a little leery of investing in financial instruments subject to arbitrary write-down, and that don’t have three hundred years of bankruptcy law behind them – and demand a spread to compensate for the extra uncertainty.