By Robert Lyddon

Oppression is the exercise of authority in a burdensome, cruel, or unjust manner. The EU Bank Recovery and Resolution Directive 2014/59 and its predecessors fit that bill, as they have enabled authority to expropriate private assets (holdings of Tier 1 and Tier 2 capital instruments in banks), applying powers electively, inconsistently without demonstrating due cause, and in a framework where the subject is denied access to full rights of redress.

A law, to be a proper law, needs to state who or what it applies to, the preconditions for its being brought to bear, and clear outcomes as to what actions can be taken and what cannot. The target of the application must have rights of redress, enabling them to continue as if the authorities had not intervened. The Directive fails on all counts, with political expediency and national interest playing as large a role as any higher objectives. The result is burdensome and unjust.

The Directive’s aim is to harmonise the way in which failing banks are dealt with in the EU, and, with the Single Supervisory Mechanism, to be a further step on the road to banking union. The Directive was enacted after the main Eurozone banking crisis of 2011-2013 and built on pre-existing legislation in some, but not all, Member States.

Pre-existing UK legislation was used to deal with Northern Rock in 2007, resulting in public ownership. Emergency legislation was needed in Cyprus in 2013 for the resolution of Bank of Cyprus and Laiki Bank, resulting in majority ownership by the Russian oligarchs who had been the largest depositors with amounts over €100,000, the excess being “bailed in” and converted to capital instruments.

The Directive is clear as to who or what it applies to: the bank must be “systemically-important”. It must be a major supplier of the payment and day-to-day banking services in the country concerned.

In mid-2017 Veneto Banca and Banca Popolare di Vicenza were resolved by their being “sold” to Intesa SanPaolo with state support of €5 billion in cash and €12 billion of guarantees. Both banks had been deemed systemically important as they were supervised within the EU Single Supervisory Mechanism. But this was reversed by the Single Supervisory Board, allowing the matter to be dealt with under local Italian legislation.

Monti dei Paschi di Siena is systemically-important but has not been resolved, despite its demonstrated insolvency. Retail investors hold shares in this bank, which would be expunged under resolution, a politically unacceptable outcome. Instead, securitisation and other, state-backed measures are used to ensure the bank stays alive.

In the case of all three of these Italian banks the retail depositors with more than €100,000 in their accounts have been spared a bail-in, and there has been no claim on the Italian deposit compensation scheme, saving the Republic of Italy from a cash pay-out it can ill afford.

On the other hand in Cyprus a small branch of a foreign bank – FBME – was resolved in 2014 by the Central Bank of Cyprus (“CBC”), using the law specifically passed to resolve Bank of Cyprus and Laiki Bank, even though it was not systemically-important on any objective standard.

Authorities thus flex the definition of “systemically-important” to suit themselves, and diverge from the Directive as to who it can be applied to.

The second point is the preconditions to be met for the Directive to be brought to bear. The Directive is absolutely clear that a bank needs to satisfy three criteria cumulatively in order for the authorities to be entitled to apply the Directive to it:

• It must be systemically-important to begin with; and
• It must be insolvent in the sense of having negative Shareholders’ Funds; and
• It must have a current or prospective shortage of liquidity.

These calculations need to be the result of a proper study which concludes that the liquidation of the subject bank will either fail to cover its liabilities or will cause disruption to local banking services.The liquidation option must be studied, and well-founded conclusions drawn that resolution is a better economic outcome for stakeholders than liquidation.

FBME was resolved without any such study. FBME was solvent, liquid and non-systemic. CBC resolved it from one day to the next on the pretext of allegations made against FBME for alleged failings in Anti-Money Laundering processes and controls.

AML failings – let alone unproven allegations of them – are not a resolution-triggering event under the Directive, and nor were they under the pre-existing local legislation.

In another case of the large Spanish bank Banco Popular Espanol (“BPE”), the authorities noted an outflow of funds in mid-2017 and intervened to force BPE’s sale to Santander for €1, with Santander taking over all the assets and senior liabilities of BPE. BPE was a bank that was Basel III-compliant and had passed all its stress tests as dictated by the European Banking Authority.

In the case of BPE there was no time to carry out a study, neither for the authorities nor for Banco Santander. This contrasts with the Monti dei Paschi di Siena case where the bank has been studied ad infinitum, there are clear grounds for resolution, but the authorities have exercised a forbearance that should not be within their gift.

The determination of the fulfilment of the preconditions for the Directive to be brought to bear are thus at the whim of the authorities.

The third issue is what should happen in case the preconditions for resolution are met. The resolution should be based on two main operations:

• the holders of share capital, subordinated and mezzanine debt (also known as holders of Tier 1 and Tier 2 capital) have their investments expunged;
• depositors with over €100,000 in their accounts are bailed-in, with the excess amount converted into capital instruments. These depositors become the new owners, replacing the ones who had their investments expunged.

The first operation has occurred in all the cases where resolution has been implemented

The second one only occurred towards Bank of Cyprus and Laiki Bank.Instead, in the cases of BPE, Veneto Banca and Banca Popolare di Vicenza, a “white knight” was induced to step in, and in the case of FBME the Central Bank of Cyprus attempted but failed to bring in Bank of Cyprus as a “white knight” and ended up taking over FBME’s assets and liabilities itself.

The Directive itself is oppressive If it gives the authorities such flexibility over which parts to implement in any one case. If it doesn’t, the authorities have acted ultra vires. There is no mention of a “white knight” being the first option to be attempted, or of state support. Indeed, the target institution – by passing stress tests and being Basel III-compliant – should be proven to have the resources to tide it through the resolution process without either state support or a “white knight”.

In practice all of this has gone out of the window.

Lastly, regarding rights of redress for the target institution, these do not exist in practice because the actions of the authorities put the target institution out of business as an independent organisation. The authorities bring about a fait accompli, and the losers cannot cause a return to the status quo ante. They may be able to obtain financial compensation through an extensive legal process, which is what the losers out of Banco Popular Espanol and FBME are attempting now, but this is not the same as enjoying protection in law from unjust actions of authorities.

The authorities have variously acted against a bank that was not systemically-important (FBME) and decided not to act against one that was (Monti dei Paschi di Siena), and also, when convenient, to carve out institutions from the definition (Veneto Banca and Banca Popolare di Vicenza).

The authorities have acted against banks that do not meet the preconditions (FBME), against banks that may or may not meet them (BPE), and not against banks that do (Monti dei Paschi di Siena).

Then the authorities operate the bail-in in one scenario (Bank of Cyprus and Laiki), and mostly not (BPE, Veneto Banca, Banca Popolare di Vicenza), but expunge in all cases the investments of holders of Tier 1 and Tier 2 equity.

The EU Bank Recovery and Resolution Directive has proven unusable in whole, for political reasons, even though all elements are clear: who it should be applied to, when what preconditions are met, and what should be done as a result.

Instead the authorities make up their own mind behind closed doors as to which banks to apply it to and when, and which remedies to apply to a given situation. That is then not a proper law within a proper legal system, but an oppressive one giving the authority extra-judicial powers and denying the subject adequate forewarning, protection and right of redress.