Bank Recovery & Resolution Directive (BRRD)

The BRRD objectives are stated as ensuring the continuity of critical functions; avoiding significant adverse effects on the financial system; protecting public funds by minimizing reliance on extraordinary public financial support for failing entities; protecting insured depositors; and protecting client funds and client assets. These objectives are achieved by recovery and resolution plans, early supervisory interventions, and in the case of actual entity failure, by the application of resolution tools and powers, including so-called bail-in measures.

BRRD has 5 resolution tools to apply to a failing entity: i) bail-in to facilitate the allocation of losses to the shareholders and debt holders  by  writing down of debt or converting bonds into equity ii) sale of business to allow a swift transfer of shares, assets rights and liabilities to a purchaser on commercial terms, iii) asset separation to allow assets, rights and liabilities to be transferred to a publicly owned asset management vehicle (i.e. a bad bank) to work out of assets without a fire sale;  iv) bridge institution to allow the temporary transfer of assets, rights and liabilities to a publicly owned bridge bank in order to maintain critical functions and, as a last resort, v) government stabilization.

The main purpose is to avoid a liquidation under insolvency proceedings where all liabilities fall due automatically and can lead to fire sales, significant market stress, and contagion. If an entity is placed under resolution, it can be restructured, and losses allocated amongst creditors whilst maintaining access to deposits and critical functions. Provided that the resolution entity continues to perform its obligations, counterparties must continue to fulfil theirs, contractual termination rights are suspended (stayed) and central clearing systems must not prevent the resolution entity from trading. After the so-called resolution weekend, the entity can resume operations as non-failing and counterparties are prevented from closing out until midnight. These suspensions facilitate the transfer of derivatives and other financial contracts to solvent entities.

Contractual recognition of EU bail-in is applicable to a wide range of liabilities and debt incurred by a BRRD entity. Although bail-in itself does not apply to liabilities secured by collateral, Art. 55 of the BRRD requires a BRRD entity to obtain an explicit contractual recognition of bail-in from its counterparties under contracts which are governed by third country law (non-EU law such as New York and since 1 Jan 2021, English law) so as to ensure enforceability of bail-in. Details of the bail -in clause required is specified in a delegated regulation (the Art. 55 RTS).

BRRD II introduced the concept of impracticability of bail-in (a concept previously adopted under UK bail-in provisions) where it is unlawful for the counterparty to agree to a bail-in clause or where the agreement is on standardised terms and the BRRD has no power to amend.

BBRD II also required that BRRD entities must include a contractual recognition of stay clause into certain financial contracts which are governed by non-EU law so as to stop counterparties from immediately terminating key contracts and enforcing security interests under contractual provisions triggered by the BRRD entity going into resolution. These financial contracts include securities lending, repo, derivatives, and commodities agreements. Details of the stay clause required is specified in a delegated regulation (the Art. 71a RTS)

If the bail-in or stay clauses are not signed up to by the counterparty operating under third country law, the BRRD entity cannot fulfil its regulatory obligations and would have to terminate its trading contract with the counterparty.

ISLA has worked alongside ISDA and ICMA in responding to consultations on the bail-in and stay clause proposals. ISLA members required to include contractual recognition of bail-in or stay clauses into their financial contract generally do so by signing up to the ISDA protocols or by agreeing the clauses bilaterally with their counterparties, using the same standard wording. The ISDA protocols are available through the ISDA website.