Living wills: don’t lose the will to live

Another month, another draft Recovery and Resolution Directive. The text is the centrepiece of EU plans for rules and mechanisms which will make banks resolvable without taxpayer bail-outs. However, five years after the crisis the rules have yet to be finalised.

The March version of the text shows that EU legislators are challenged to define the operating principles for a financial institution and will need to give national discretion over implementation to the supervisors. Moreover, the text also indicates that the implementation window will be squeezed.

This is not good news for large firms as they will now have to make their own judgements about what good recovery plans look like. This could mean continued uncertainty as to the scale of the data and governance demands firms are facing, and highlights the need for collaboration to be sought on these issues.

UK and US experience with recovery plans has shown that it is no trivial matter to pull together an ‘evergreen’ picture of how firms operate and what procedures will be necessary, should the need for regulatory surgery arise. There are many challenges to overcome, including intimate mapping of the legal structures and stress testing of recovery options, as well as reporting financial interdependencies (which will have to be aligned with new reporting obligations under the CRR).

A survey conducted by JWG in 2011 found that, at the time of asking, 66% of firms had difficulties with the timely provision of data required by RRPs, with 59% forced to make investments in new systems and controls. This is not being made easier by the changing demands in the laws as they are drafted.

Resolution plans require authorities to have access to detailed data on financial contracts on an ad hoc basis. The February draft directive added text specifying that firms ‘must be capable of producing those records within 12 hours of a request’ – not an insignificant task, considering these reports can measure over a foot in height.

Luckily for firms, in March, the 12-hour data requirement was removed, and responsibility for setting time limits shifted to national supervisors. However, this does not mean that the rule won’t be reintroduced. The latest draft will also leave it up to each resolution authority to ‘decide to set different time limits for different types of financial contracts’. The result is greater regulatory flexibility, but less certainty as to what demands will ultimately be placed on firms.

Another cause of concern to the middle and back office will stem from disagreement over bail-in tools being discussed at ECOFIN, which may lead to more discretion for national regulators to decide, on a case-by-case basis, the asset classes excluded from bail-in. This adds further legal uncertainty to RRPs, which may only be clarified as regulators begin to put their new powers into practice.

These developments, along with others – such as the flexibility given to firms in the last draft RRD over the triggering of recovery plans – suggest a trend emerging in regulatory thinking towards shifting the responsibility for certain aspects of recovery and resolution planning away from the European stage and towards national regulators and firms. There is evidence of increasing leeway being given to national authorities and the industry to work out best practice, and recognition by the EU, as it considers certain details, that a prescriptive regime may be impossible to achieve.

The need for clarity is made all the more urgent by the accelerating pace of implementation for RRD provisions. Whereas in the February draft the RRD was to be transposed within 18 months of adoption and implemented within 24, the rules now have to be both transposed and applied within just 12 months of the directive being agreed upon. This leaves firms with just half of the time previously envisaged to prepare for the requirements.

As the text is set to be agreed upon late this year, or early 2014, this makes full application of the rules by 2015 likely. This means that key operational issues, such as on-demand data requirements and the scope of bail-in powers, will likely be left up to firms and their national authorities to work out through dialogue. While this may undermine harmonisation, it does allow for firms to shape what key areas of recovery and resolution planning implementation will look like.

This approach may be replicated across other issues on the structural and resolution reform agenda, making it imperative that firms open up the conversation as early as possible.