STSM041510 - Exemptions and reliefs: exemptions: Financial institutions in resolution - resolution stabilisation options

The special resolution regime in the Banking Act 2009 (‘the Act’) provides the Bank of England (BoE) with various stabilisation powers and stabilisation options to restore liquidity to a failed institution to allow it to continue its business operations.

The stabilisation options allow for a resolution instrument, share transfer instrument/order or property transfer instrument to be executed. That instrument effectively transfers shares and other securities, or land, away from the failing institution either to a temporary holding bank appointed by the BoE or to a private sector purchaser.

These stabilisation powers also include the right to make supplemental, onward and reverse instruments and orders, transferring shares and land in addition to any already executed resolution instrument. The choice of whether one or more stabilisation options is used is dependent on how the failed institution is to be stabilised, and the type of failed institution.

When placing a firm in resolution it is, however, a requirement under section 6B of the Act that existing shareholders of the failed institution bear the first loss by transferring their shares away from them and cancelling (i.e. ‘writing-down’) all debt instruments issued by the failed firm.

In this respect, where a failed firm reaches the ‘Point Of Non-Viability’ (PONV) and is placed into resolution, the main resolution stabilisation options under the Act that can be used are:

Mandatory Reduction Instrument

A mandatory reduction instrument is made under section 6B of the Act. Here all subordinated debt issued by the failed institution (i.e. subordinated loans which rank lower than other issued loan capital with regard to claims on assets etc.) is cancelled, and issued share capital of the failed institution is transferred by way of:

• A direct transfer of shares from the shareholders of the failed institution to the former holders of the subordinated loans; or
• A transfer of shares from the shareholders of the failed institution to a temporary holding depositary bank (appointed by the BoE) to be held on trust for the benefit of the former holders of subordinated loans.

While this instrument could itself be sufficient to resolve a failed institution, it is likely this will be used with another stabilisation option, such as bail-in, where the type of issued debt to be cancelled includes both subordinated and higher ranking loan capital.

Bail-In (section 12A of the Act)

Under the terms of a resolution instrument, existing issued debt instruments (i.e. subordinated and other unsecured loan capital, bonds etc.), of the failed institution are cancelled and/or their value reduced and converted into shares to the extent needed to restore the failed firm’s capital to the level necessary for it to continue operating.

In practical terms, once all debt instruments are cancelled the resolution instrument may also effectively transfer the issued share capital of the failed institution to a temporary holding depositary bank to hold on trust for unspecified creditors (i.e. former loan note and bond holders). A separate resolution administrator is appointed who will control the voting rights of all shares in the failed firm during the bail-in period.

After the resolution announcement and during the period of revaluation of the failed institution each creditor of each class of debt instrument is issued with a ‘Certificate of Entitlement’ (CE). A CE represents a right to potential compensation once revaluation of the failed institution is finalised.

Once details of the failed firm’s revaluation is finalised and the form of (any) compensation is known and announced, a holder of a CE sends it to the temporary holding depositary bank in exchange for the known form of compensation. This is likely to be a transfer of a proportion of the shares held by the temporary depositary bank.

Once a sufficient majority of shares has been returned to CE holders, voting rights are transferred from the resolution administrator to the new shareholders and the failed institution at that point exits resolution and is returned to private sector control.

After a specified time, any unclaimed compensation shares are sold in the stock market and the proceeds are given to those CE holders who have not returned their CE to the temporary holding depositary bank.

Private sector purchaser

Under section 11 of the Act a share or property transfer instrument can be executed transferring all or part of the failed institution’s business direct to a private sector purchaser. There is no requirement for the failed institution’s consent.

Bridge Bank

Under section 12(2) of the Act a share or property transfer instrument can be executed transferring of all or part of the failed institution’s business, which can include securities and/or land held by the failed institution, as an investment to a temporary holding bridge bank controlled by the BoE. This is to maintain continuity of the failed institution’s critical functions. Once revaluation of the failed firm is complete, there is an onward sale and transfer of the failed institution’s business from the temporary holding bridge bank to a private sector purchaser.

Asset Management Vehicle (AMV)

Under section 12ZA(3) of the Act a property transfer instrument can be executed which onward transfers all or part of the failed institution’s business (which includes its investments in the form of securities and/or land) that was previously transferred to a bridge bank to a separate AMV wholly or partially owned by the BoE or HM Treasury.

Similar to the bridge bank option, once revaluation of the failed firm is complete, there is a further onward sale and transfer of the failed institution’s business from the AMV to a private sector purchaser.

Temporary Public Ownership

Under sections 13(2) and 85 of the Act, a share transfer order or share transfer instrument can be executed transferring all or part of the business of the failed institution into temporary public ownership.

Once revaluation of the failed institution is finalised, there is an onward sale and transfer of the failed institution’s business from temporary public ownership to a private sector purchaser.