3.1 Definition and Scope

This directive deals with bank resolution and recovery, ie how to either wind down failing banks or ensure that they can recover in the shortest possible time so that their ability to lend is not more impaired than absolutely necessary. ‘Bank’ here is understood in a wider sense, including banking and mixed groups, and big local branches (Arts 1, 2). Every country must designate a resolution authority that is given the necessary powers under this directive. This can be the central bank or the regulator, or it can be some independent public authority associated with the finance ministry, given that provision of taxpayer money is often involved (Art 3).

The requirements under this directive depend on the size and importance of the institution within the financial systems of the countries in which they are operating. Small institutions can be subjected to a simplified set of obligations, at the discretion of the regulator. On the other hand, large institutions—in particular those that have more than €30bn in assets, or where those assets constitute more than 20% of a Member State's GDP—are subject to additional obligations (Art 4).

3.2 Preparation

Every institution must draw up a recovery plan. If a bank is subject to consolidated supervision at the group level, then the recovery plan is to be drawn up at the group level as well. Recovery plans must be updated annually or when there are significant changes, like changes to the company structure. Companies must not assume extraordinary public support in their plans, and they have to identify the assets that could be used to obtain financing at the central bank. They must define objective trigger indicators—based on either systemic or company‐level stress—for the various recovery options proposed in the plan (Arts 5, 7, 9).

The recovery plan is submitted to the regulator (not the resolution authority) for assessment. The regulator has 6 months to perform this assessment. If the plan is found to be unsatisfactory, the company has another 2–3 months to submit a new plan. If this is still found to be unsatisfactory, then the regulator can ask that the company make changes to its business that address the deficiencies in the plan. If this is found to be inadequate, the regulator can impose specific changes, for example require it to reduce risk (solvency or liquidity), or to recapitalise, or change the strategy, structure or governance (Arts 6, 8).

The resolution authority (not the regulator) draws up the resolution plan, possibly with the assistance of the institution, and shares it with the company and the regulator (Arts 10–14). A resolution authority must then assess the resolvability of an institution (Arts 15, 16; Annex C), and if it finds it not to be resolvable then it can demand that changes be implemented which are similar in nature but more far‐reaching than those the regulator can impose. The changes required can be substantial, including divestment of business and change of the group structure (Arts 17, 18), leading in particular to more pressure for companies to operate locally through subsidiaries, ie independently viable legal entities.

So to step back for a moment and to summarise the above: the company draws up a recovery plan allowing it to become viable again in the event of distress. This plan is assessed and approved by the regulator. The resolution authority draws up the resolution plan, specifying what happens if the recovery plan fails.

To strengthen resilience of specific entities within a group of companies, other group companies can enter into a support agreement. Support agreements must be entered voluntarily and gain shareholder approval, and cannot be a condition for gaining approval of the recovery plan. They might, however, make approval of the recovery plan easier, and allow for a risk profile in that entity that would otherwise not be possible. They must be approved by all relevant entities responsible for both the group and the relevant constituent companies, and certain conditions must be fulfilled, including disclosure (Arts 19–26).

3.3 Execution

When a company gets into distress—in particular when it reaches some of the triggers in its recovery plan—it gets into what is called the early intervention phase. In this case the regulator has a number of options. For example, they can require management to put in place some of the measures in the recovery plan, or remove members of management that have been found unfit. They can also require changes in strategy, or in the legal or operational structure of the company, or they can appoint a temporary administrator replacing the entire management, and they also can prepare to put a resolution plan in place (Art 27–30).

Either after the above actions were not sufficient to address the problems, or immediately if a number of conditions are fulfilled (eg institution likely to fail; resolution in public interest; no alternative private sector measures available), the resolution authorities can set in motion the resolution plan (Arts 31–33). In this case, the resolution should be based on a number of key principles (Art 34):

• the shareholders bear the first losses, then creditors in order of priority under normal insolvency proceedings; importantly, no creditor suffers greater losses than they would have suffered under normal insolvency proceedings
• management is replaced except where retention is necessary to achieve the resolution goals, and where appropriate, legal action is taken against management and others responsible
• covered deposits are protected, and safeguards are respected.

Resolution authorities appoint a special resolution manager who—under the control of the resolution authority—has the powers of both the institution's shareholders and the management. This appointment cannot last longer than one year (Art 35). Before proceeding there must be a valuation:

Before taking resolution action or exercising the power to write down or convert relevant capital instruments, resolution authorities shall ensure that a fair, prudent and realistic valuation of the assets and liabilities of the institution is carried out by a person independent from any public authority, including the resolution authority, and the institution (Art 36).

This valuation is important, as it will be the basis for apportioning losses to the different stakeholders. It has to follow certain specific requirements. If those requirements are not fulfilled it must be considered provisional, and an ex‐post definitive valuation shall be carried out as soon as practicable. Decisions taken based on a provisional valuation are valid, but the regulator can, for example, adjust the amount of consideration an acquirer paid if the provisional and definitive valuations differ (Art 36).

This directive defines a number of specific resolution tools that the resolution authorities can use either individually or in combination (Art 37):

• Sale of business tool. Using the sale of business tool, either the institution's shares, or (part of) its assets and liabilities can be sold to a third party, on commercial terms having regard to the circumstances (Arts 38, 39).
• Bridge institution tool. The bridge institution tool is similar to the sale of business tool, except that the purchaser is not a private sector third party, but a state‐sponsored bridge institution, with a view to either winding it down or selling it later (Arts 40, 41).
• Asset separation tool. Using the asset separation tool, some or all of an institution's assets and liabilities can be sold into an asset management vehicle (Art 42).
• Bail‐in tool. When the bail‐in tool is used, certain creditors' claims on the institution are reduced, taking into account their priority in the event of insolvency. Some creditors—eg insured depositors, covered bond holders, employees with respect to some claims—are protected (Arts 43, 44). When this tool is used, a number of detailed and highly specific rules apply (Arts 46–55).

For the bail‐in tool to work, an institution needs a sufficient amount of bail‐in‐able liabilities. In order to ensure an institution has those, institutions need to satisfy a certain Minimum Required own funds and Eligible Liabilities (MREL) (Art 45). Eligible liabilities are roughly defined as all capital securities with a remaining maturity of more than one year, plus all debt instruments that are subordinated to deposits, excluding covered bonds (Art 45.4). The amount of the MREL is determined by the regulator on an individual basis (Art 45.6). Note that terminology here is often confused: MREL in market lingo can refer to the requirement, or to the underlying instruments as a class, or to one specific instrument in the class.

In addition to the resolution tools described above, the directive also defines government financial stabilisation tools, which shall only be used as a last resort when the other tools have failed to avoid a significant adverse effect on the financial system and using them is in the public interest (Art 56):

• Public equity support tool. The public equity support tool allows Member States to provide capital to institutions under all possible forms, ie CET1, AT1 and T2 (Art 57).
• Temporary public ownership tool. The temporary public ownership tool allows memberships to temporarily transfer ownership of an institution (via its shares) to either a nominee, or a company that is 100% state‐owned (Art 58).

Independently of resolution actions—but possibly in conjunction with them if appropriate—resolution authorities have in the event of distress the power to write down capital securities, or to convert them into other, lower‐ranked ones (Art 59). This power is subject to certain rules and procedures (Arts 60–62).

In order to be able to fulfil their duty, the resolution authorities must be vested with a number of powers that are described in detail in the regulation (Arts 63–72), and a number of important safeguards (Arts 73–80) and procedural obligations (Arts 81–84) apply. In particular, a second independent valuation has to be carried out that determines what would have happened under normal bankruptcy proceedings without any resolution actions or state support, and the No Creditor Worse Off (NCWO) principle applies, meaning that no equity holders and creditors can be worse off under resolution than they would have been under insolvency (Arts 73–75).

Concerned parties have a right of appeal through the courts system; however, lodging an appeal does not entail automatic suspension, and decisions of the resolution authority are immediately enforceable (Art 85). Whilst under resolution, some other proceeding—notably bankruptcy proceeding—cannot be brought against an institution (Art 86). The directive contains a number of provisions regarding how to deal with cross‐border resolution of groups, both within the EU (Arts 87–92), and when third countries are involved (Arts 93–98).

3.4 Ancillary Regulations

The directive also establishes the European system of financing arrangements, which consists of the respective national financing arrangements. Those financing arrangements are meant to financially support resolution proceedings if and when they arise. They can lend to each other, which is important when used in a cross‐border context. Their respective minimum available funds are 1% of covered deposits, to be reached by the end of 2024, raised from the relevant institution in accordance with an established key. Contributions can also be requested ex‐post if the amounts raised ex‐ante prove to be insufficient (Arts 99–107).

The next paragraph is interesting, in that it directs Member States to change their insolvency law—that is most likely different from the law that implements the BRRD—in order to rank deposits in insolvency in a certain way, so as to ensure that their insolvency ranking is in line with their ranking in the event of resolution, notably bail‐in. Importantly, deposits not covered by a deposit protection scheme—including the portion of deposits above the limit—must rank junior to protected deposits (Art 108). If the bail‐in tool is being used, and if covered deposits would have been written down according to the tool's criteria, then the relevant protection scheme is to contribute the corresponding amount (Art 109).

The remainder of the regulation deals with penalties, specific provisions and other technical matters, such as the amendment of other regulations (Arts 110—132). It has a number of annexes, notably one on information to be included in recovery plans (Annex A), information that resolution authorities require to draw up the resolution plan (Annex B), and what a resolution authority must consider when assessing resolvability (Annex C).