Two royal decrees and an amendment to the Banking Act passed in December 2015 further implement the BRRD in Belgium, by adding the aspects pertaining to bail-in and the resolution of banking groups. We highlight the write down or conversion mechanism for relevant capital instruments and its articulation with resolution actions. This mechanism is not expressly covered by the "no creditors worse off" principle which governs resolution, but it does not give free rein to resolution authorities either, thanks to common law guarantees.
Distinction
Recital 81 of Directive 2014/59/EU establishing a framework for the recovery and resolution of credit institutions (the "BRRD") calls upon Member States to ensure that, if a credit institution reaches its point of non-viability, no resolution action will be taken before the relevant capital instruments are written down or converted into CET 1 capital.
A resolution authority has the option to write down or convert relevant capital instruments, either independently or in combination with a resolution action, where the conditions for resolution are met (article 250, § 1 of the Banking Act 2014 – "loi du 25 avril 2014 relative au statut et au contrôle des établissements de credit" / "wet van 25 april 2014 op het statuut van en het toezicht op kredietinstellingen"). Apart from a group context, such power can be used in three cases (article 250, §2 of the Banking Act):
- where the resolution authority determines that the conditions for resolution are met, before any resolution action is taken;
- where the resolution authority determines that, unless that power is exercised, the institution will no longer be viable; or
- where extraordinary public financial support is required by the institution.
The "point of non-viability" is the situation where:
"1) the institution is failing or likely to fail; and
2) having regard to timing and other relevant circumstances, there is no reasonable prospect that any action, […], other than the write down or conversion of capital instruments, independently or in combination with a resolution action, would prevent the failure of the institution […] within a reasonable timeframe" (article 251).
The situation where an institution is no longer viable almost coincides with the circumstances triggering the resolution procedure. Resolution actions are taken where (article 244, §1 Banking Act 2014):
"1) [it is] determined that the institution is failing or likely to fail;
2) having regard to timing and other relevant circumstances, there is no reasonable prospect that any alternative private sector or prudential measures, including the write down or conversion of relevant capital instruments, would prevent the failure of the institution within a reasonable timeframe; and
3) a resolution action is necessary in the public interest".
Before a resolution authority takes a resolution action in relation to an institution, it must be determined that the exercise of the power to write down or convert is insufficient to avoid the failing of the institution. This implies that resolution tools will only be applied after a write down and/or conversion of relevant capital instruments has taken place. However, it is conceivable, in exceptional circumstances, that the depreciation or conversion of relevant capital instruments will, by itself, suffice to prevent the institution from crossing the point of non-viability. In such a scenario, the operation would boil down to a balance sheet intervention on the liabilities side, whereby the losses are set off against CET 1 capital.
Valuation
No write down or conversion may take place, and no resolution tool may be utilised, before a "fair, prudent and realistic" valuation of the assets and liabilities of the institution has been carried out by a person independent of any public authority, including the resolution authority and the institution (article 246 Banking Act 2014). In urgent cases, a provisional valuation will allow resolution actions, or the write down or conversion power, to take place (article 248, §2 Banking Act 2014). This provisional valuation will, in all cases, be followed by a definitive valuation (article 248, §3, subparagraph 1).
Write down or conversion of relevant capital instruments
Only "relevant capital instruments" are written down or converted. Relevant capital instruments are Additional Tier 1 capital and Tier 2 instruments (article 242, 12° Banking Act 2014).
CET 1 capital, which basically consists of common shares, does not fall within the scope of relevant capital instruments, because these instruments are defined as absorbing "the first and proportionately greatest share of losses as they occur" (Article 28(1)(i) Regulation (EU) 575/2013 ("CRR")).
The valuation which is a precondition for the exercise of the write down or conversion power will most likely assess that the value of the common shares is zero.
The resolution authority may, on the basis of article 254, §1, "require the credit institution to issue new Tier 1 instruments to the holders of the relevant capital instruments", when the latter have seen their claims converted into CET 1 capital, i.e. common shares. This injunction will force the company to convene the appropriate corporate organs and let them issue the requested reports and follow, as a matter of urgency, the corporate law procedure for the operation. The action of these corporate organs allows formal compliance with the corporate law rule under which the right to alter capital is reserved for the general meeting of shareholders (Article 29 of Directive 2012/30/EU on corporate law of 25 October 2012 (consolidation), Pafitis, CJEU ruling of 12 March 1996 (C 441/93)). As far as Additional Tier 1 instruments are concerned, the write down or conversion will occur by operation of law when a trigger event occurs, for example when the CET 1 capital ratio drops below 5.125% (Article 54(1)(a) CRR).
This capital increase will, in Belgium, be preceded by a capital decrease to zero, if net assets are depreciated to zero or are negative, before the capital is then increased to recapitalise the institution. Such operation will be governed by section 614 of the Belgian Companies Code. If net assets are negative, the capital increase will not only be preceded by a capital decrease in order to wipe out the prior shareholders, but the procedure can also catch Additional Tier 1 and Tier 2 instruments, if deemed necessary to absorb the depreciation of assets.
The consequence of all this is that the value reduction of the old shares will not be the result of a sovereign decision, but rather the outcome of an accounting valuation, recorded prior to the recapitalisation. Conversely, the write down or conversion of Additional Tier 1 and Tier 2 instruments will, as a rule, follow from an injunction of the resolution authority.
Write down or conversion in a group context
Article 457 of the Banking Act 2014 provides for the write down or conversion of relevant capital instruments issued by a subsidiary (§1, 1°), or a parent company (§1, 2°), and recognised for the purposes of meeting own funds requirements on an individual and on a consolidated basis, if "the group will no longer be viable unless the resolution authority exercises this power".
If the write down or conversion takes place in such a context, section 457, §2 of the Banking Act 2014 provides that:
"a relevant capital instrument issued by a subsidiary, incorporated under Belgian law, shall not be written down to a greater extent or converted on worse terms […] than equally ranked capital instruments at the level of the parent"
This rule warrants that the relevant capital instruments of a subsidiary will not be disproportionately impacted, compared to equally ranked capital instruments issued at the level of the parent undertaking located in another member state.
Applicability of the resolution's general principles
Two areas of attention should be mentioned:
First, the "no creditor worse off" principle ("NCWO") mandates that shareholders and creditors do not incur greater losses under resolution than they would have incurred if the institution had been wound up. This principle is set forth in article 245, § 1, 8° of the Banking Act 2014, regarding the application of resolution tools and the exercise of resolution powers. It is further detailed in article 282, with reference to the application of partial transfer and bail-in tools. It is noteworthy that such a principle does not expressly apply in case of depreciation or conversion undertaken in accordance with article 250 of the Banking Act 2014. In that respect, shareholders and holders of relevant capital instruments are granted a right to a judicial remedy (article 296 of the Banking Act 2014), and might base their claim on the subsidiary protection offered by Article 1, Protocol 1 of the European Convention of Human Rights and Fundamental Freedoms.
Secondly, as opposed to the somewhat limited scope of NCWO, the rules governing the exclusion of certain contractual terms, found in article 287 of the Banking Act 2014, apply to recovery measures and the write down or conversion of relevant capital instruments. This implies that the application of the power of article 250 will not qualify as an "event of default" prompting the early termination of a contract, it being understood that "the substantive obligations under the contract […] continue to be performed".