The Single Resolution Mechanism in the European Banking Union

With the adoption of the Single Resolution Mechanism (SRM) the European Union (EU) established the second crucial pillar of the European Banking Union (EBU), further promoting the financial stability and efficiency of the European banking system. The EU made this significant progress not by design but by the force of necessity – the crisis rendered compelling the centralization of powers for the supervision and resolution of banks at the EU (‘federal’) level. This article briefly introduces the structural components of SRM, as well as discusses the decision-making process for the placement of a bank under resolution and the financing of resolution actions.

The SRM consists of the Single Resolution Board (SRB) – established as an EU agency, with significant powers during the various stages of the resolution process – and the Single Resolution Fund (SRF), to be used for the funding of resolution actions. The adoption of the SRM went through tumultuous negotiations. While the European Parliament and the European Central Bank (ECB) supported the Commission proposal for the establishment of the SRM, some EU governments raised various objections. In order to accommodate these Member States’ concerns, it was agreed that the SRM would include two interwoven measures: a) a Regulation on the SRM (Regulation (EU) No 806/2014, which differs significantly from the original Commission proposal); and b) an intergovernmental agreement, i.e. an agreement outside the EU legal framework, regulating the transfer and mutualisation of contributions to the SRF.

The key body in the SRM is the SRB, where independent experts and National Resolution Authorities (NRAs), which are established under the Bank Recovery and Resolution Directive (Directive 2014/59/EU), will participate. The SRB (a quasi-FDIC) is endowed with important powers, including regarding the adoption of a resolution scheme with respect to a distressed bank, the placement of the bank under resolution, and the selection of resolution tools and use of the SRF. At the same time, the SRB may delegate tasks to the NRAs and may coordinate their actions when executing and implementing the adopted resolution schemes. Due to the institutional boundaries laid down in the EU treaties and the case-law of the Court of Justice of the EU (in particular the Meroni case[1]), the EU legislator was obliged to strictly frame the powers conferred on the SRB for the resolution process and to introduce various checks and balances. Thus, the final architecture of the SRM is a mixture of a centralized model, where important powers are exercised at the EU level, with a decentralized execution of decisions, carried out by the NRAs.

TRIGGERING OF THE RESOLUTION PROCESS

The powers to trigger the resolution procedure and to place an entity under resolution are the most critical ones within the SRM. As these decisions may have a significant impact on the assets of banks, shareholders, bondholders, depositors and potentially the entire financial system, the SRB’s powers are subject to certain conditions that limit substantially its discretion. The SRB can trigger the resolution process with a decision of the Executive Board, either after having received a communication from the ECB or on its own initiative. The ECB has a central role in assessing whether a bank is likely to fail, after consulting the SRB, a task that is consistent with the ECB’s role as the main banking supervisor under the Single Supervisory Mechanism. Given its extensive supervisory powers and availability of information, it is valid to assume that the ECB will be well-placed to assess the risks that a bank is exposed to and, thus, to assess whether there is a likelihood of failure. The SRB is awarded a rather supplementary role in this regard since it can, in its executive function, conduct this assessment and trigger the resolution process only if the ECB does not undertake this assessment within 3 days of the SRB communicating its intention to do so to the ECB.

DECISION-MAKING PROCESS FOR THE PLACEMENT OF A BANK UNDER RESOLUTION–A COMPLEX ARCHITECTURE?

A number of EU institutions will be involved in a decision to place a bank in resolution under the SRM, particularly where SRF funding is being used.

  1. The European Commission’s role

The Commission proposal for the SRM Regulation conferred upon the Commission the power to decide, in urgent circumstances, to place a bank under resolution on its own initiative or taking into account a communication by the ECB or an NRA that a bank is failing or likely to fail or that there is no private sector alternative. Furthermore, the Commission could decide on which resolution tools to use and whether to obtain funding from the SRF to support the resolution action. The conferral of these powers could be justified on the grounds that the Commission, as an EU institution, could validly exercise discretionary powers that could not be conferred upon an EU agency (like the SRB) in view of the Meroni jurisprudence; therefore, the SRB was granted with mainly executive functions. However, as these powers were one of the sources of the intense political debate in the legislative process, in the final text of the SRM Regulation the Commission’s role was significantly altered; as briefly presented below, its role now mainly consists in: a) an ex-post control of the discretionary aspects of the decision of the SRB on the resolution scheme; b) the control of the compatibility of any State aid/Fund aid with the EU internal market rules.

 a) The European Commission and the ex-post control of the discretionary aspects of the SRB decision on the resolution scheme

The SRM Regulation provides that, as soon as the SRB adopts a resolution scheme it should transmit the scheme immediately to the Commission. The Commission then has 24 hours to adopt a decision either: a) endorsing the scheme, which is then deemed as adopted; or b) presenting objections concerning its discretionary aspects (except with respect to the assessment of whether the resolution is in the public interest or in case of material modification in the use of the SRF, in which case the Council must be involved). The Commission’s objections to the proposed resolution scheme should be sent back to the SRB, which must within eight hours modify the scheme according to the reasons/motivations provided by the Commission; otherwise the resolution procedure cannot proceed.

 b) The European Commission as Competition Authority controlling State aids and Fund financing

 Before any resolution scheme involving use of the SRF is adopted by the SRB, the Commission must first adopt a decision on the compatibility of the SRF financing with the internal market, applying the same criteria as used in assessing the compatibility of State aid with the Treaty on the Functioning of the European Union (TFEU); this means that the Commission will assess whether the use of the Fund would distort, or threaten to distort, competition by favouring the beneficiary or any other undertaking insofar as it would affect trade between Member States. This decision will then be sent to the SRB and to the NRAs of the Member States concerned and it may be contingent on conditions, commitments or undertakings with respect to the beneficiary, as well as requirements for the appointment of a trustee or independent person to assist the monitoring of the institution. If the Commission issues a negative decision on the compatibility of the use of the SRF with the TFEU, the SRB is obliged to reconsider the resolution scheme and prepare a revised scheme.

This procedure is of crucial importance: it enables the Commission to essentially block the resolution procedure if it considers that the use of the SRF, as proposed by the SRB, is incompatible with the internal market; furthermore, it empowers the Commission to impose conditions on the restructuring of the bank. However, one may wonder how this could work in practice given that any publication of a negative decision adopted by the Commission objecting to the SRF aid could – in the context of a crisis situation -potentially hamper the assets’ value and thus compromise the efficacy of the resolution procedure.

  1. The ECB’s role

The ECB, the EU institution which has an overall view of the European banking market, will play a major role in determining the crucial aspect of the viability of the bank and will contribute to the assessment of any alternative private solution. As the center of the European bank supervisory system, with important links to the national supervisory authorities, the ECB will be one of the first to be alerted of and to detect any problems regarding the viability of a bank. Furthermore, even in the extreme case that its assessment and communications were not to be followed, the ECB has the power to force a bank to increase its capital and, if needed, can withdraw its authorization for the bank to continue its operations should it consider that the bank no longer fulfils the authorization criteria.

THE COUNCIL’S ROLE

The main source of the intense political debate which preceded the establishment of the SRM was Member States’ hesitation to leave the adoption of resolution decisions solely to the Commission or an EU agency; Member States asserted that resolution decisions may have (at least in the transitory phase of the SRM) some impact on their fiscal sovereignty and thus the Council should maintain some control over them. Indeed, Member States have managed to increase their control over the resolution process in three ways: a) through their participation (through the National Resolution Authorities) in the SRB plenary session, which decides on the use of the SRF if it exceeds a certain threshold; b) by enabling the Council to object to a resolution action proposed by the SRB if the Council (upon the Commission’s proposal) considers that it is not in the public interest; and c) by awarding to the Council the power to adopt the final decision if the Commission suggests materially modifying the SRB proposal on the SRF financing.

The Council’s political choice to not fully acknowledge the democratic legitimacy of the Commission, and thus entrust it with a more robust role in the conduct of EU resolution policy, is not immune to critisism. The involvement of the Council, alongside the involvement of national experts and representatives in the decision-making structure of the SRB (i.e. in its executive and plenary sessions) challenges the institutional balance by granting the SRB – an EU agency, with crucial powers which unavoidably involve the balancing of competing interests and the making of policy choices – powers which, under the EU institutional framework, can be granted only to EU institutions. The adoption of resolution decisions at the EU level indeed constitutes a big step forward and dramatically reverses the subsidiarity assumption that bank resolution decisions should be taken at the national level; however, this advance could be hampered in practice if the Council acts solely on the basis of dominant national interests rather than the general EU interest.

THE SRF, THE EUROPEAN STABILITY MECHANISM (ESM) AND PUBLIC BACKSTOPS

The SRB has the power to decide on the use of the SRF to the extent necessary to ensure the effective application of the resolution tools; in this respect, the SRF will be endowed with EUR 55 billion by 2018. One of the most important criticisms regarding the SRF concerns its limited financial capacity when seen in the context of the potential failure of a major EU bank or financial institution and the scale of the EU banking sector. To this is frequently added that the SRM lacks a credible fiscal backstop that could support a systemically significant failing bank falling within the ambit of the SSM when other financial sources are insufficient. It could also be observed that the borrowing capacity of the SRF depends critically on the existence of a credible guarantee, like the one that could be provided by the ESM. However, it should not be overseen that the SRF is only one of the crisis management instruments at the disposal of the EBU, which includes a large number of other instruments (e.g. CRD IV) that will render the European banking sector more resilient. Furthermore, in order to increase its credibility, synergies between the SRF and the ESM (which disposes a direct recapitalization instrument with EUR 60 billion) could and should be developed in the long-term.

CONCLUSION

There can be no doubt that any project of this magnitude and complexity will be tested by the markets, in the courts and politically. The SRM involves several actors (the SRB, the ECB, the Commission, the Council, the NRAs, the ESM) whose cooperation is of paramount importance for the EBU. The SRM will have to earn credibility the hard way by delivering promptly and efficiently on its objectives at the time of a crisis (i.e. the breaking of the vicious circle between sovereigns and their banks, ensuring the financial stability of the European markets and avoiding the use of taxpayers’ money for bail-outs), guided by the European public interest. However, the SRM should be judged as an integral part of a new structure, the EBU, which remains to be completed with a mechanism for deposit guarantee systems and credible European public backstops. Furthermore, the orderly resolution of large European banks is linked to the simplification of their complex corporate structures. As the US experience has shown with the adoption of the Volcker Rule and the recent acknowledgement by US financial authorities of the shortcomings of the ‘living wills’ of significantly important financial institutions, a long-term effort is required to ensure the successful implementation of these measures.

The immediate task of the newly established mechanisms, such as the SRM, is to build new structures and culture in an area where there is no significant international experience, except for the FDIC in the US. It is realistic to envision that the newly built EU supervisory and resolution structures will go through a painful learning process and will need additional time before they function smoothly. In the mid-term, from an institutional point of view, one could envisage as the next step the integration into the EU legal order of the SRF and the ESM which, in our view, is still possible without the revision of the current EU Treaties; such a move would add to the democratic legitimacy, efficiency and market certainty of the EBU. At a later stage, and if all Member States have the political will to agree on some Treaty changes, the EU could reinforce the trend towards the centralization of powers in the area of supervision and resolution, thus avoiding the uncertainty created by fragile legal constructions. Besides, as the EU’s Blueprint on a Genuine Economic and Monetary Union has acknowledged, Treaty changes could concern not only the clear separation between the monetary and supervision powers of the ECB but could also include a move to a fiscal union and more democratically legitimate European institutions – which are preconditions for the establishment of a true European Political Union. These remain the EU’s political challenges in the years to come.

ENDNOTES

[1] Case 9/56 Meroni v High Authority [1957 – 1958] ECR 133 (‘Meroni case’), decided in 1958, concerned a challenge against the delegation of powers to two private law entities (the ‘Brussels agencies’, with distinct legal personalities) to administer the financial arrangements for the ferrous scrap scheme, a measure introduced to stabilize Community. It is a landmark case in the EU institutional framework since the Court elaborated on the constraints imposed on Community institutions when delegating their powers to other EU bodies as follows:

  1. The delegating authority cannot confer to another body powers different from those that the delegating authority received itself from the Treaty.
  2. Agencies (i.e. the delegate) must exercise their powers under the same rules to which the delegating authority would be subject to if it was exercising them directly.

iii.    The delegation of powers to an agency must be expressly provided in the delegating act.

  1. The powers conferred upon agencies must not involve a wide margin of discretion; the conferral must refer to clearly defined executive powers, the use of which must be entirely subject to the supervision of the delegating authority. This restriction derives from the principle of balance of powers (or ‘institutional balance’, currently explicitly recognized in Article 13(2) TEU) under which each institution must act within the limits prescribed by the EU Treaties.

The preceding post comes to us from George Zavvos and Stella Kaltsouni. Mr. Zavvos serves as Legal Adviser at the Legal Service of the European Commission. Ms. Kaltsouni is an attorney licensed in New York and Thessaloniki, Greece, and is a Ph.D. candidate at Leiden Law School in The Netherlands. This post is based on their recent article, The Single Resolution Mechanism in the European Banking Union: Legal Foundation, Governance Structure and Financing, available here. The article will be published as a separate chapter in Matthias Haentjens & Bob Wessels (eds.), Research Handbook on Crisis Management in the Banking Sector, Edward Elgar Publishing Ltd, Cheltenham, UK, 2015 (Forthcoming).