Should the resolution authority assess the possibility of bail-in even for a small non-systemically important institution without critical function before making a decision about liquidation?

Please specify whether in the scope of Article 31(2)(e) "client funds and client assets" should be included also moneys of bank's depositor (creditor) exceeding the covered deposit?

The question is based on the estimated situation, when a small-sized institution does not perform any critical functions, its failing cannot cause a negative effect on the financial system of the member state and respectively, this institution would have no access to the single resolution fund or other public support, therefore liquidation under normal insolvency proceedings seems the most reasonable solution. On the other hand on the day, when operations of the bank have been suspended because of insolvency, the bank would have a sufficient amount of liabilities eligible for bail-in.

In accordance with the BRRD Article 32(1)(c) one of three mandatory conditions to perform resolution actions is that: "a resolution action is necessary in the public interest pursuant to paragraph 5".

Article 32(5) provides that "a resolution action shall be treated as in the public interest if it is necessary for the achievement of and is proportionate to one or more of the resolution objectives referred to in Article 31 and winding up of the institution under normal insolvency proceedings would not meet those resolution objectives to the same extent."

Article 31(1) provides that when applying the resolution tools and exercising the resolution powers, resolution authorities shall have regard to the resolution objectives. One of the resolution objectives established in Article 31(2)(e) is "to protect client funds and client assets".

Article 44(2)(c) excludes from the scope of bail-in such client assets or client money, which are held by the institution, including assets or money held on UCITS or AIFs.

Article 31(2)(e) does not provide any reference to Article 44(2)(c) or any other article, specifying what is meant by "client funds and client assets" in the scope of Article 31 about resolution objectives. It seems that Article 31(2)(e) term "client funds and client assets" is broader than Article 44(2)(c) term "client assets or client money".

Please specify whether in the scope of Article 31(2)(e) "client funds and client assets" should be included also moneys of bank's depositor (creditor) exceeding the covered deposit?

In this case, to avoid claims from creditors, to meet one of resolution objectives and to comply with non-creditor-worse principle, should the resolution authority assess the possibility of bail-in even for a small non-systemically important institution without critical function before making a decision about liquidation?

Based on previous experiences, in case of winding up of the institution under normal insolvency proceedings, a client most probably would lose much more funds and assets than in resolution (due to a very long liquidation process, high fees paid to an administrator, litigation with creditors, unpredictably great decrease in asset value etc).

In this situation, facing the fact that a bank is already insolvent, any creditor with deposits exceeding covered deposits, most probably will be interested to lose or freeze part of his money, participating in bail-in and obtaining shares of the bank in place of deposit, rather than to receive almost nothing at the end of years-long liquidation process. Accordingly, such a creditor would look for legal solution to claim that NRA, based on BRRD Article 31(2)(e), Article 31(1)(c), Article 31(5) and Article 34(1)(g), should choose bail-in tool to protect his, as a client's, funds and assets, instead of liquidation, that most probably, would deliver the worst result for him.

Above this, if bail-in turns out successful and new shareholders find the way to recover the bank and ensure its growth in a long perspective, it helps to save the money for the Deposit Guaranty Fund, which would be paid out for covered–depositors in case of liquidation of the bank. Taking into account that DGS money is considered as public money, bail-in could be considered as preferable resolution strategy, compared with liquidation, even for small non-significant banks, and meets public interest, saving DGS assets.

Purpose of the question is to receive legal interpretation of "client funds and client assets" in scope of Article 31(2)(e) to plan correct resolution action for small institutions and, at the same time, to avoid litigation risks.

Recitals (45) and (46) of Directive 2014/59/EU (BRRD) make clear that “in order to avoid moral hazard ….[a] failing institution should in principle be liquidated under normal insolvency proceedings”. Therefore “the winding up of a failing institution through normal insolvency proceedings should always be considered before resolution tools are applied”. Therefore, the BRRD imposes strict conditions around the use of resolution tools.

The resolution tools and powers, including but not limited to bail-in, can be applied to a small non-systemically important institution with no critical functions only if the conditions specified in Article 32(1) of Directive 2014/59/EU (BRRD) are satisfied.

One of the conditions is the public interest test (Article 32(1)(c) of the BRRD); the public interest is further defined in Article 32(5) of the BRRD. A resolution action is in the public interest if it is necessary for the achievement of and is proportionate to one or more of the resolution objectives and winding up of the institution under normal insolvency proceedings would not meet those resolution objectives to the same extent. According to Article 31(3) of the BRRD, “subject to different provisions of this Directive [BRRD], the resolution objectives are of equal significance and resolution authorities shall balance them as appropriate to the nature and circumstances of each case”.

In this context value preservation for the generality of creditors in itself is not an objective of the resolution regime according to Article 31(2) BRRD and cannot on its own justify the use of resolution tools in the public interest. However, under Article 31(2) of the BRRD when applying resolution tools authorities must seek to minimise the cost of resolution and avoid any unnecessary destruction of value.

As regards the resolution objective to protect client funds and client assets (Article 31(2)(e) of the BRRD) – the BRRD does not include a definition of client assets or funds. The reference to these terms must however be read in context of the legal distinction made throughout the BRRD between covered deposits, deposits that exceed the coverage level (uncovered deposits) and other types of liabilities that arise by virtue of the holding by an institution of ‘client assets or client money’ (e.g. see recital (111), Article 44(2)(a) and (c), as well as the last but one subparagraph of the same Article, and Article 108 of the BRRD) and the broader financial regulatory regime that protects assets and funds belonging to clients in connection with investment business (in particular Directive 2014/65/EU on markets in financial instruments (“MiFID II”)¹).

Therefore, deposits exceeding the covered deposit limit do not qualify as client funds or assets. See also Q&A 2111. Accordingly, the impact of insolvency on deposits above the covered deposit limit is not a relevant consideration for the purpose of determining whether the client assets objective is met for the purposes of the public interest test. However, these deposits do benefit from priority ranking as defined under Articles 48(1)(e) and 108 of the BRRD and may be excluded from the application of the bail-in tool in exceptional circumstances under Article 44(3)(c) of that Directive.

In the theoretical case described by the submitter where there would be no resolution objectives to be achieved by the resolution procedure better than through the winding up under normal insolvency proceedings, the  public interest test to justify the use of resolution in this case would not have been satisfied and consequently the resolution tools could not be applied.

¹ Member States shall apply national measures implementing MiFID II from 3 January 2018.