Article 55 and the ISDA 2016 Bail-in Article 55 BRRD Protocol | White & Case LLP International Law Firm, Global Law Practice
Article 55 and the ISDA 2016 Bail-in Article 55 BRRD Protocol

Article 55 and the ISDA 2016 Bail-in Article 55 BRRD Protocol

Introduction

ISDA published on 14 July 2016 the "ISDA 2016 Article 55 BRRD Protocol (Dutch/French/German/Irish/Italian/Luxembourg/Spanish/UK entity-in-resolution)" (the "Bail-in Protocol"). The Bail-in Protocol aims to facilitate market participants compliance with Article 55 of the Bank Recovery and Resolution Directive ("BRRD"). This article discusses the background and the key legal and practical aspects of the Bail-Protocol.

 

What is the background to the Bail-in Protocol?

From 1 January 2016, BRRD Entities[1] (excluding (e) as per the definition) are required under Article 55 to include certain contractual terms in any agreements governed by the laws of non-EU Member States to recognise the bail-in tool under the BRRD, subject to certain exclusions. This contractual recognition requirement is designed to ensure the effectiveness of the bail-in tool in a cross-border resolution and to promote equal treatment between EU and third-country creditors.

The contractual recognition consists of a contractual term by which the creditor or party to an agreement creating the liability: (a) recognises that such liability may be subject to bail-in (write-down and conversion powers); and (b) agrees to be bound by any reduction of the principal or outstanding amount due, conversion or cancellation that is effected by the exercise of those powers by a resolution authority (a "RA").

Under Article 55 the obligation to include the contractual recognition of bail-in applies to any liabilities that meet all of the following criteria:

(i) not excluded under Article 44(2) of the BRRD;

(ii) not a deposit referred to in point (a) of Article 108 of the BRRD;

(iii) governed by the law of a third country; and

(iv) issued or entered into after the date on which a Member State transposes into national law the provisions of the BRRD (1 January 2016 at the latest or earlier).

Non-EU incorporated firms and their EU branches are out of scope for the purposes of Article 55. Amongst the list of "excluded liabilities" listed in Article 44(2) of the BRRD, the most relevant to derivative markets is "secured liabilities", provided they meet the relevant requirements.[2]

The contractual recognition requirement will not apply where the RA determines that the law of a third country or a binding agreement concluded with that third country allows the RA to exercise its write down or conversion powers. For example, if a third country (e.g. Brazil) implemented a law or entered into an agreement with the RA, which recognized and gave effect to the exercise of write-down and conversion powers by such RA, Brazilian entities would not be affected by this contractual recognition.

Article 43(2) of the Contractual Recognition RTS[3] clarifies that in point (iv) above, the reference to "liabilities issued or entered into after the relevant transposition date" includes:

(i) liabilities created after that date, regardless of whether they are created under relevant agreements entered into before that date, including under master or framework agreements between the contracting parties governing multiple liabilities;

(ii) liabilities created before or after that date under relevant agreements entered into before that date and which are subject to a material amendment;

(iii) liabilities under debt instruments issued after that date; and

(iv) liabilities under debt instruments issued before or after that date under relevant agreements entered into before that date and which are subject to a material amendment.

Article 55 applies therefore to a very broad range of payment and other contractual and non-contractual liabilities. It includes any loan agreements, guarantees, certain derivatives (which are not excluded liabilities), repos and stock lending arrangements, letters of credit and other similar facilities entered into by BRRD Entities and governed by a third country law, and may extend to intercreditor and security agreements where a liability in respect of a BRRD Entity may arise.

RAs may require BRRD Entities to provide them with a legal opinion relating to the legal enforceability and effectiveness of the contractual recognition.

 

What is the scope of the Bail-in Protocol and which agreements does it cover?

As set out in further detail below, the Bail-in Protocol covers any agreements which are entered into by the two parties that have adhered to the Bail-in Protocol[4] (the "Adhering Parties") and which are documented by either an ISDA Master Agreement[5] ("Covered ISDA Master Agreements") or by any other form of master agreement trade terms which is not an ISDA Master Agreement ("Covered Other Agreements", and together with the Covered ISDA Master Agreements, the "Protocol Covered Agreements"). The Bail-in Protocol applies to a wide range of agreements, the main difference being whether they are documented by an ISDA Master Agreement or a different agreement.

By adhering to the Bail-in Protocol all Protocol Covered Agreements between CBA and any other Adhering Party that are entered into on or prior to the Implementation Date will be captured.

Covered ISDA Master Agreements

Covered Other Agreements

  • An ISDA Master Agreement that arises pursuant to a long form confirmation[6] between two Adhering Parties (other than a client)
  • An ISDA Master Agreement executed between two Adhering Parties (other than a client)
  • Any umbrella ISDA Master Agreement that is executed directly or arises by execution of a long form confirmation, which in each case is signed by an agent and an Adhering Party, where in respect of the agent, the relevant client on whose behalf the agent acts is a Protocol BRRD Entity[7] and/or the other Adhering Party is a Protocol BRRD Entity (an "Agent Covered ISDA Master Agreement").
  • Any other Agreement[8] that arises pursuant to a long form confirmation between two Adhering Parties (other than a client)
  • Any other Agreement executed between two Adhering Parties (other than a client)
  • Any other Agreement that is executed directly or arises by execution of a long form confirmation, which in each case is signed by an agent and an Adhering Party, where in respect of the agent the relevant client on whose behalf the agent acts is a Protocol BRRD Entity and/or the other Adhering Party is a Protocol BRRD Entity (an "Agent Covered Other Agreement").

in each case:

  • entered into by such Adhering Parties on or prior to the Implementation Date[9]
  • governed by the law of a non-EU member state or a non-EEA[10] member
  • at least one of the two Adhering Parties is a Relevant BRRD Entity
  • the parties have neither addressed these issues by way of alternative written arrangements nor have excluded any matters included in the Bail-in Protocol[11]

Where agreements are secured, guaranteed or otherwise supported by a third party and consent, approval, agreement, authorization or other action by a third party is required for amendments to be made to such agreements, such agreements will not be Protocol Covered Agreements unless such consent, approval, agreement, authorization or other action has been obtained.

In particular, if:

(1) any consent, approval, agreement, authorization or other action of any third party is expressly required, under the terms of such third party credit support document or such agreement, to amend or otherwise modify such agreement;

(2) such third party credit support document or such agreement includes express terms to the effect that any amendment or modification of such agreement without the consent, approval, agreement, authorization or other action of any such third party would void, impair or otherwise adversely affect existing or future obligations owed under such third party credit support document; or

(3) such agreement, if amended or modified in accordance with the Bail-in Protocol without the consent, approval, agreement, authorization or other action of any such third party would void, impair or otherwise adversely affect existing or future obligations owed under such third party credit support document,

then such agreement shall not be a Protocol Covered Agreement unless such consent, approval, agreement, authorization or other action has been obtained.

 

What are the implications and consequences of adhering to the Bail-in Protocol?

As described above, BRRD Entities must comply with the obligations imposed by the BRRD and in particular (excluding subparagraph (e) in the above definition) with Article 55, which requires BRRD Entities (excluding subparagraph (e) in the above definition) to include a contractual term in agreements creating any relevant liability governed by a third country law.

The Bail-in Protocol aims to permit Protocol BRRD Entities to comply with the Article 55 requirement in relation to their Covered ISDA Master Agreements and Covered Other Agreements. The Bail-in Protocol enables Adhering Parties to amend the terms of each such Protocol Covered Agreements to reflect the requirements of Article 55 of the BRRD.

It is important to note that the Bail-in Protocol only covers jurisdictions that have published implementing legislation with respect to Article 55 of the BRRD at the time the Bail-in Protocol was drafted, i.e. The Netherlands, France, Germany, Ireland, Italy, Luxembourg, Spain and the UK (each a "Relevant Jurisdiction"). Therefore, the Bail-in Protocol does not impact on any jurisdictions which are not a Relevant Jurisdiction.[12]

The Bail-in Protocol will incorporate into each Covered Protocol Agreement a provision whereby the parties acknowledge and accept that the liabilities arising under the relevant Protocol Covered Agreement may be subject to the exercise of bail-in by the RA of the Relevant Jurisdiction. In particular, with effect from the Implementation Date, each Protocol Covered Agreement will incorporate the document defined in the Bail-in Protocol as "the Attachment"). In particular, the Attachment contains the contractual recognition that the liabilities arising under the relevant derivative contract may be subject to the exercise of bail-in.

In order to capture the Relevant Jurisdictions, you will note that in Schedule 4 there are references to Dutch Regulations, French Regulations, German Regulations, Irish Regulations, Italian Regulations, Luxembourg Regulations, Spanish Regulations and UK Regulations. Each of these definitions contains specific references to the relevant domestic law of each Relevant Jurisdiction.

 

Does the Bail-in Protocol capture affiliates of the counterparty or only the entity that adheres to the Bail-in Protocol?

No. The Bail-in Protocol captures only Protocol Covered Agreements entered into between two Adhering Parties. Affiliates will also need to adhere to the Bail-in Protocol.

 

Does the Bail-in Protocol apply to existing agreements prior to the Adherence Letter or only to agreements entered into after such date?

The Bail-in Protocol will only capture the Protocol Covered Agreements entered into by the Adhering Parties on or prior to the Implementation Date provided that such agreements are governed by the law of a non-EU member state (or, if the implementation of Article 55 of the BRRD in the relevant jurisdiction extends to liabilities governed by non-EEA law, such agreements are governed by non-EEA law). Future Protocol Covered Agreements will not be amended unless the parties agree bilaterally to make them subject to the terms of the Bail-in Protocol[13].

 

Does the status of the liabilities change if a party adheres to the Bail-Protocol?

No. Article 55 states that if a BRRD Entity fails to include the contractual acknowledgement required under Article 55, such failure will not prevent the RA from exercising its bail-in powers in relation to that liability. Therefore, whether a party adheres or not to the Bail-in Protocol will not change the BRRD status of the relevant liabilities.

 

If I am a third country entity, do I need to adhere?

If a third country entity decides not to adhere to the Bail-in Protocol, any existing ISDA Master Agreement (and/or any other relevant agreement subject to a third country law) entered into with BRRD Entity counterparties will not be BRRD compliant and its BRRD Entity counterparties will be in breach of Article 55. Provided that the liabilities that arise out of the agreement with its BRRD Entity counterparties are "bail-inable", its BRRD Entity counterparties will need to comply with Article 55. So failure to of the third country entity to adhere to the Bail-in Protocol will not affect the third country entity directly but its BRRD Entities counterparties will be directly affected.

 

THE DELTA REPORT
Derivatives Newsletter
May 2017

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[1] BRRD Entity means:
(a) credit institutions and investment firms that are established in the EU;
(b) financial institutions that are established in the EU when the institution is a subsidiary of a credit institution or investment firm (or of a company referred to in (c) and (d) below) and is covered by the supervision of the parent undertaking on a consolidated basis;
(c) financial holding companies, mixed financial holding companies and mixed-activity holding companies that are established in the EU;
(d) parent financial holding companies in a Member State, EU parent financial holding companies, parent mixed financial holding companies in a Member State, EU parent mixed financial holding companies; and
(e) EU branches of institutions that are established outside the EU in accordance with specific conditions laid out in the BRRD.
[2] Article 44(2)(b) of the BRRD excludes "secured liabilities including covered bonds and liabilities in the form of financial instruments used for purposes which form an integral part of the cover pool and which according to national law are secured in a way similar to covered bonds". Pursuant to Article 43(1) of the Contractual Recognition RTS for the purposes of Article 55, a secured liability will not be considered as an excluded liability where, at the time at which it is created, it is:
(a) not fully secured;
(b) fully secured but governed by contractual terms that do not oblige the debtor to maintain the liability fully collateralised on a continuous basis in compliance with regulatory requirements of EU law or of a third country law achieving effects that can be deemed equivalent to EU law.
[3] The Commission Delegated Regulation (EU) 2016/1075 of 23 March 2016 supplementing Directive 2014/59/EU of the European Parliament and of the Council. Available at: eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R1075&from=EN
[4] ISDA members and non-members can adhere to the Bail-in Protocol by submitting an online Adherence Letter through the ISDA Protocol Management section available at its website. Each Adherence Letter will be published by ISDA on its website. Parties will pay a one-time fee of USD 500 to ISDA to adhere to the Bail-in Protocol. There is no cut-off date to the Bail-in Protocol. Please see relevant link for submission: www2.isda.org/functional-areas/protocol-management/submit-adherence-letter/28
[5] It includes a 2002 ISDA Master Agreement, 1992 ISDA Master Agreement (Multicurrency – Cross Border), 1992 ISDA Master Agreement (Local Currency – Single Jurisdiction), or 1987 ISDA Interest Rate and Currency Exchange Agreement, in each case, (i) as published by ISDA, (ii) governed by the law of a non-EU member state (or, if the implementation of Article 55 of the BRRD in the jurisdiction of the Relevant BRRD Party extends to liabilities governed by non-EEA law, governed by non-EEA law), and (iii) including, without limitation, where such agreement has been amended (whether by addendum or otherwise) to provide for client clearing.
[6] A long form confirmation is a document that specifies the terms of a derivative transaction that functions as both an ISDA Schedule and a transaction confirmation. Parties to a derivatives transaction may use a long-form confirmation if they wish to enter into a transaction but have not executed an ISDA Master Agreement (or ISDA Schedule) therefore have no umbrella agreement in place that governs their trading relationship. The long-form confirmation typically states that it supplements, forms a part of and is subject to the terms of, a standard form ISDA Master Agreement without any ISDA Schedule thereto except for limited terms as specified therein.
[7] Any entity that may become subject to the exercise of any bail-in power by the resolution authority of The Netherlands, France, Germany, Ireland, Italy, Luxembourg, Spain or the United Kingdom.
[8] This may include: any master agreement, framework agreement or master netting or set-off agreement, or any agreement that incorporates master trading terms by reference where such terms may cause all transactions relating to one or more netting sets, as applicable, to terminate (in each case, other than an ISDA Master Agreement), that sets out and/or governs (or has one or more underlying agreements which set out and/or govern) the terms and conditions of such transaction(s), including, without limitation, where such agreement has been amended (whether by addendum or otherwise) or is designed to provide for client clearing (and which includes, for the avoidance of doubt, any compensation agreement or execution agreement relating to give-up arrangements or the trading of cleared derivatives).
[9] Or in the case of an Agent Covered ISDA Master Agreement or Agent Covered Other Agreement, executed by the agent and the counterparty prior to adherence by both the counterparty and the agent on behalf of the relevant client (and including all outstanding transactions thereunder and outstanding credit support documents, if any and if applicable, entered into by such Adhering Parties in connection therewith),
[10] The European Economic Area ("EEA") unites the EU Member States and the three EEA EFTA States (Iceland, Liechtenstein and Norway) into an internal market governed by the same basic rules.
[11] If the parties to a Protocol Covered Agreement have:
(a) entered into alternative written arrangements that document the substance of the issues covered in the Attachment to the Bail-in Protocol (including the case where a Protocol Covered Agreement already includes a provision documenting the substance of the issues covered in the Attachment); or
(b) expressly stated in such agreement or otherwise agreed in writing that the Bail-in Protocol shall not apply, then, in either case,
such agreement shall not be a Protocol Covered Agreement.
[12] Please note that on 19 April 2017, ISDA announced the launch of a second Bail-in Protocol to help market participants meet the requirements of Article 55 under the BRRD. The second Bail-in Protocol will allow Austrian, Belgian, Danish and Swedish in-scope entities to meet the requirements of Article 55 of the BRRD. This extends coverage to 12 countries, following the launch of the Bail-in Protocol.
[13] To do so, parties may consider including language in their relevant document (i.e. ISDA Schedule, long form confirmation, etc.) that incorporates the Bail-in Protocol by reference.

 

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