A single recovery and resolution planning (RRP) framework for Europe is seen as crucial to banking union and effective macroprudential oversight. In the latest draft directive, legislators appear to be relenting on the idea of automatic triggers for recovery plans, while simultaneously strengthening the powers of resolution authorities to request at short notice the data needed to assess resolvability. If the draft is passed, firms will have to think about how their data systems will meet these added requests.
European legislators are in the process of drafting a new directive on recovery and resolution planning for systemically important financial institutions – the RRD. This is an important EU-level plank in the post-crisis macroprudential framework for managing systemic risk by limiting contagion from major banking failures. It is seen as crucial to reducing the problems of moral hazard and ‘too big to fail’ which were raised by the response to the global financial crisis, by making systemically important firms resolvable without resort to public funds for bail-outs (use of tax-payers money cannot be considered in the plans).
While the text is not yet finalised, an updated version was drafted in February under the Irish presidency of the European Council. There are two clear themes: greater discretion for firms as to when to implement their recovery plans; and greater powers for regulators to demand resolvability data.
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- Will regulators give as much discretion to firms as their move from recovery plan ‘triggers’ to ‘indicators’ suggests?
- How will firms operationalise new short-notice reporting requirements?
- Can RRD compliance be incorporated into existing regulatory projects?
The nature of stress indicators used to guide recovery planning is one major issue. In earlier, more prescriptive, drafts there was no room for qualitative judgement; once a crisis was diagnosed, recovery measures were automatically triggered. To remedy this, policymakers have built more scope for pragmatism and discretion into the law. This approach is unusual, as it runs counter to the current preference for non-discretionary solutions across other areas of financial regulation (e.g. benchmark submissions).
Successive drafts of the law are moving away from the idea of automatic triggers. The previous version removed all mention of ‘triggers’ in favour of the term ‘recovery plan indicators’, describing the point at which action ‘may be’ taken, as opposed to where it ‘must be’ taken. The most recent draft goes even further in this regard, adding a section which makes it explicit that institutions may refrain from implementing recovery plan actions even where indicator thresholds have been reached, ‘where the management does not consider it appropriate due to the circumstances’. These changes suggest that European legislators are becoming more responsive to the need for a pragmatic compromise between the use of quantitative stress indicators as early warning systems, and the need for flexibility within this framework. This is good news for firms, as rigid thresholds could also have a negative impact on the flexibility of lending activities and business lines.
On the other hand, this move is being accompanied by greater powers to gather data in order to make rapid resolution possible at shorter notice. In turn, this may raise the day-to-day costs of compliance. The latest draft law sees an increase in the data gathering powers which are being given to resolution authorities. In particular the timeframes in which firms are expected to be able to respond to information requests on resolution are being shortened. Firms will now have to meet requests for transaction data within a 12-hour window, a power which was only added in the most recent February draft of the law.
This is relatively short by current industry standards, and raises a host of issues for firms: Who has responsibility for meeting these requests? How will firms make up for the time taken over manual processes? And how will this be aligned with other change programmes, such as the BCBS’ Principles for Risk Data Aggregation, which requires firms to submit ‘timely’ data in response to ‘ad hoc’ requests from the regulator?
Other minor trends are also evident in the latest draft of the RRD. There are much clearer provisions for how to resolve groups with systemically important branches in different countries, with the EBA assuming a more central mediating role and authorities in third countries given more powers over subsidiaries in their jurisdiction. The EBA has also been given an expanded mandate to develop further technical standards for several elements of the directive, for instance specifying exactly when resolution authorities can cancel or dilute shares – and the methodology used for calculating rates when converting debt to equity – during bail-in.
These issues have come into sharper focus following the recent crisis in Cyprus, where the nature of bail-in mechanisms deployed proved controversial. Attention here has focused on the powers resolution authorities have to draw on uninsured deposits to recapitalise in times of turmoil. But as well as set-piece banking crises, these laws will also affect the daily operations of healthy banks.
The bottom line seems to be this: legislators are increasingly willing to give firms’ management more discretion over the decision to put recovery plans into action, but the trade-off for this is rapid access to the firms’ intimate data so that, if firms misuse this discretion, they are better prepared to resolve them. While firms will be pleased that they have been given back control of their own organisations, the new reporting requirements may necessitate significant improvements to tired procedures and legacy systems.
- Officially, banks can no longer rely on bailout but they can rely on bail-in
- Elsewhere firms are losing discretion over their risk practices rather than gaining it
- Global institutions still present a resolvability problem for regulators