Contractual recognition of bail-in: Brexit and other recent developments

Article 55 of the EU Banking Recovery and Resolution Directive (2014/59/EU) (BRRD) of 15 May 2014 requires EU Member States to implement legislation which requires EU financial institutions to include in certain agreements a contractual term requiring their counterparties to recognise the write down and conversion powers available to their regulators (bail-in).

The BRRD has now been supplemented by EU Regulation 2016/1075, which was issued on 08 July 2016 and sets out the mandatory contents for such a clause.

The requirement applies where the agreement relates to a liability which is not excluded and which is governed by third country law (ie non-EEA law). This article considers what impact Brexit may have on the requirement.

The impact of Brexit

The result of the referendum has had no immediate impact on law or regulatory requirements in the UK. The UK is and remains a Member State and will remain so until the Article 50 notice has been served and the exit process completed.

Until then, UK financial institutions will need to comply with the requirements and their counterparties can continue to expect to receive requests to include such a provision in relevant agreements. It is too early to say what will happen following Brexit but we consider it likely that the rule will continue to apply in some form or another.

English law currently remains EEA law and so there is no immediate need to start introducing provisions into contracts governed by English law. Absent any other agreement as part of the exit process, English law will become a third country law for the purposes of Article 55 and so it may in due course become necessary to include such a provision in English law contracts where the counterparty is a financial institution in one of the remaining Member States.

As the requirement to include such a provision applies not just to relevant liabilities under new agreements but also to new such liabilities under existing agreements and existing liabilities under agreements which are subject to material amendment, some EU financial institutions may now seek to include such a provision even in English law agreements. So far, market sentiment appears to suggest that participants are not yet venturing down that route.

The Prudential Regulation Authority (PRA)

Following the consultation process earlier this year, the final version of the amended PRA rule relating to the requirement for contractual recognition of bail-in came into force on 01 August 2016. The amended rule largely follows the draft rule published by the PRA in its Consultation Paper CP8/16, although the final rule contains some minor amendments.

There are changes to clarify that repurchase arrangements or other title transfer arrangements do not fall within the unsecured liability definition and minor changes to the definitions of “material amendment” and “excluded liability”. The PRA has published Policy Statement PS17/16 which contains clarifications in relation to the PRA’s approach to certain issues including the impracticability exemption and trade finance liabilities.

ISDA Bail-in Protocol

On 14 July 2016, ISDA launched the ISDA 2016 Bail-in Article 55 Protocol to enable market participants to sign up to a contractual recognition provision.

The Protocol operates in much the same way as other previously published protocols. ISDA has prepared a list of frequently asked questions and this includes sample language for the incorporation of the Protocol by reference into new master agreements.

For further information on the Article 55 Protocol, please see our more detailed article entitled ISDA 2016 Bail-In Article 55 BRRD Protocol published.

Mandatory requirements

On 08 July 2016, the EU published Regulation EU 2016/1075 which gives effect to the recommendations of the European Banking Agency in the draft Regulatory Technical Standards, which were published in July 2015. Amongst other things, the Regulation sets out certain mandatory requirements for inclusion in the relevant contractual term.

AFME model clauses

On 01 August 2016, AFME published its recommended model clauses for the purposes of satisfying the Article 55 requirements. In its press release, AFME also highlighted continuing concern over the breadth of the definition of liabilities, and therefore the scope of the Article 55 requirement, and the uncertainty and potential inconsistency in application which this creates.

Further information - Q&A

Please see our more detailed article here for further information on the contractual recognition of bail-in requirements which includes a series of questions and answers. The information contained in the article is intended to be a summary only and should not be regarded as a substitute for definitive advice. As ever, the position will depend on the facts.

Further, the information in the attached article relates to implementation of Article 55 in the UK and how it affects financial institutions regulated by the UK regulatory authorities. The position in relation to other Member States (and financial institutions subject to regulation by their regulatory authorities) should broadly be similar but it is important to remember that it is for Member States to decide how they incorporate BRRD into their own national law and so there may be differences in the detail of how they have done so.