Banking regulation Q&A: recovery, resolution and liquidation
The banking regulation Q&A series provides a comprehensive overview of the rules governing the banking sector in Luxembourg. Today's chapter focuses on recovery, resolution and liquidation.
What options are available where banks are failing in your jurisdiction?
The failure of banks is governed by the Law of 5 April 1993 on the financial sector, as amended ('Banking Act') and the Law of 18 December 2015 on the resolution, reorganisation and winding up measures of credit institutions and certain investment firms and on deposit guarantee and investor compensation schemes ('BRR Law'). The Banking Act contains prudential rules and obligations in relation to recovery planning, intra-group financial support and early intervention; the BRR Law covers the resolution of banks.
Recovery: Credit institutions must draw up and maintain a recovery plan that provides for measures to be taken by the credit institution to restore its financial position following a significant deterioration of its financial situation, which must be updated at least once a year and is subject to an assessment by the Commission de Surveillance du Secteur Financier (CSSF). The recovery plan must include a number of elements, including:
- a communication and disclosure plan outlining how the bank intends to manage any potentially negative market reactions;
- a range of capital and liquidity actions required to maintain or restore the viability and financial position of the bank;
- a detailed description of how recovery planning is integrated into the corporate governance structure of the bank;
- arrangements and measures to conserve or restore the own funds of the bank;
- arrangements and measures to ensure the bank has adequate access to contingency funding sources; and
- arrangements and measures to restructure liabilities or business lines.
The Banking Act includes specific provisions for group recovery plans. Recovery plans must be kept confidential and may be shared only with third parties which have participated in their drafting and transposition. The failure to draw up, maintain and update recovery plans is subject to specific administrative penalties, which include fines of up to 10% of the total annual net turnover of the bank in the preceding business year, or up to €5 million for individuals.
The Banking Act also includes provisions regulating the entry into group financial support agreements, which may be entered into only subject to specific conditions and with the authorisation of the relevant competent authorities.
Where a bank infringes or is likely in the near future to infringe the requirements of Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms, as amended (CRR), the Banking Act, their implementing measures or certain provisions of Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments, the CSSF may take a number of early intervention measures. The CSSF may:
- require the management body of the bank to:
- update the recovery plan;
- implement one or more of the arrangements or measures of the recovery plan;
- prepare an action plan to address the situation and a timetable for its implementation;
- convene a meeting of the bank's shareholders; or
- draw up a plan for the negotiation on restructuring of debt;
- require the bank to remove or replace one or more members of the management body or authorised management, change its business strategy or change its legal or operational structures; and
- acquire, including through on-site inspections, all information necessary to update the resolution plan and prepare for the possible resolution of the bank.
Where there is a significant deterioration in the financial situation of a bank, or where there are serious infringements of applicable laws or regulations or of the statutes of the bank, or serious administrative irregularities, and the taking of early intervention measures is not sufficient to reverse that deterioration, the CSSF may also require the removal of the authorised management or management body.
Finally, where the replacement of the authorised management or management body is deemed to be insufficient, the CSSF may appoint a temporary administrator to temporarily replace the management body or temporarily work with the management body. The powers, role and duties of the temporary administrator are determined by the CSSF.
Resolution: The BRR Law contains extensive provisions on the resolution of credit institutions. Any reference in this Q&A to the 'Resolution Board' is a reference to the CSSF acting in its capacity as resolution authority in Luxembourg. The Resolution Board carries out its resolution functions independently from the CSSF's supervisory functions.
Prior to any resolution, the Resolution Board must prepare a resolution plan and perform a resolvability assessment for each credit institution. Specific provisions apply for groups. The resolution plan provides for the resolution actions that the Resolution Board may take where the relevant credit institution meets the conditions for resolution. Its content is detailed in the BRR Law.
The Resolution Board shall take a resolution action where all the following conditions are met:
- The credit institution is failing or likely to fail;
- There is no reasonable prospect that any alternative private sector measures or supervisory action would prevent the failure of the institution within a reasonable timeframe; and
- A resolution action is necessary in the public interest.
The Resolution Board has a number of resolution tools, resolution powers and other powers at its disposal. These include:
- the power to appoint a special manager to replace the management body of the institution under resolution, which shall have all the powers of the shareholders and of the management body;
- the power to transfer to a purchaser shares or other instruments of ownership issued by, and/or all of any assets, rights or liabilities of, the bank under resolution (the 'sale of business' tool);
- the power to transfer to a bridge institution, which shall be a legal person that is wholly or partially owned by one or more public authorities and controlled by the Resolution Board, shares or other instruments of ownership issued by, and/or all of any assets, rights or liabilities of, the bank under resolution (the 'bridge institution' tool);
- the power to transfer assets, rights or liabilities of the bank under resolution or of a bridge institution to one or more asset management vehicles (the 'asset separation' tool);
- write-down and conversion powers in relation to liabilities of the bank under resolution (the 'bail-in' tool);
- the power to write down or convert relevant capital instruments;
- a number of general and ancillary powers, including:
- the power to take control of an institution;
- the power to transfer rights, assets or liabilities of an institution;
- the power to reduce the principal amount of eligible liabilities;
- the power to convert eligible liabilities into ordinary shares or other instruments of ownership;
- the power to cancel debt instruments;
- the power to amend or alter the maturity of debt instruments; and
- the power to close out or terminate financial or derivatives contracts;
- the power to require an institution or any of its group entities to provide any services or facilities;
- powers in respect of assets, rights, liabilities, shares and other instruments located in a third country;
- the power to suspend any payment or delivery obligations pursuant to any contract;
- the power to restrict the enforcement of security interests;
- the power to temporarily suspend termination rights of any party to a contract with an institution under resolution;
- the power to require an institution to contact potential purchasers in view of the resolution of the institution; and
- information-gathering and investigatory powers.
The objectives of resolution (which must be taken into account by the Resolution Board when applying the resolution tools and exercising its resolution powers) are:
- the continuity of critical functions;
- the avoidance of significant adverse effect on the financial system;
- the protection of public funds;
- the protection of depositors; and
- the protection of client funds and client assets.
The Resolution Board must also take into account certain general principles set out in the BRR Law. For instance, the shareholders of the institution under resolution shall bear first losses, creditors in the same class shall be treated in an equitable manner and covered deposits shall be fully protected.
The Resolution Board may impose administrative penalties on banks, members of their management body and other natural persons responsible in case of specific infringements with respect to resolution as set out in the BRR Law. These penalties include:
- public statements;
- orders requiring the cessation of a specific conduct;
- temporary or permanent bans from exercising certain functions;
- temporary bans from carrying out certain activities;
- suspension of voting rights; and
- fines (which can reach up to 10% of the total annual net turnover of the bank in the preceding business year or, for individuals, up to €5 million).
The BRR Law established the Luxembourg Resolution Fund (Fonds de Résolution Luxembourg (FRL)), the purpose of which is to collect contributions due under the BRR Law, manage the financial means so collected and participate in the financing of the resolution of failing institutions. The FRL must have adequate financial means, which must reach 1% of the amount of covered deposits of all the institutions authorised under the Banking Act by 31 December 2024. In order to collect these financial means, the FRL collects annual ex ante contributions from banks, among others. Where the FRL's financial means are not sufficient to cover the losses, costs or other expenses incurred, the FRL may raise extraordinary contributions ex post. The FRL may also borrow money.
The resolution of Luxembourg banks is further subject to Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund.
What insolvency and liquidation regime applies to banks in your jurisdiction?
In addition to resolution, the BRR Law covers the reorganisation and winding up of credit institutions. In terms of specific procedures, the BRR Law covers suspension of payments, voluntary liquidation and judicial winding-up proceedings. The BRR Law further specifies that the following do not apply to credit institutions:
- Book III of the Luxembourg Commercial Code (which covers bankruptcy and suspension of payments, among other things);
- the provisions of the Law of 4 April 1886 on court-approved compositions and arrangements with creditors aimed at preventing bankruptcy; and
- the provision of the Grand-ducal Decree of 24 May 1935 supplementing the legislation relating to suspension of payments, compositions and arrangements with creditors aimed at preventing bankruptcy and bankruptcy following on from the setting-up of a controlled management scheme.
Suspension of payments: Suspension of payments proceedings may be started where:
- the bank has lost its creditworthiness or has reached an impasse regarding liquidity, whether it is in a state of cessation of payments or not;
- the execution of the bank's commitments is compromised; or
- the authorisation of the bank has been withdrawn and the decision in this respect is not yet final.
Only the CSSF or the bank concerned may apply for suspension of payments proceedings. The application is lodged with the Tribunal d'Arrondissement (district court) of Luxembourg sitting in commercial matters. Where the application is made by the bank, the bank shall, under penalty of inadmissibility of the application, inform the CSSF prior to bringing the matter before the court. The lodging of the application results in the suspension of all payments by the bank and a prohibition of all acts other than precautionary measures pending a final decision. The BRR Law details the procedure. The judgment determines, for a period not exceeding six months, the conditions and arrangements for the suspension of payments and appoints one or more administrators, who shall be in charge of the management of the bank's assets. The written authorisation by the administrator(s) is required for all acts and decisions of the bank. The suspension of payments has universal effect and applies to branches and assets of the institution located abroad.
Voluntary liquidation: A bank may start voluntary liquidation proceedings only after notifying the CSSF of its intention to do so; the notification must be made at least one month prior to convening the general meeting which shall decide on the voluntary liquidation. Specific publication requirements apply to the notice convening the meeting. A report on the completion of the voluntary liquidation and the arrangements of such voluntary liquidation must be transmitted to the CSSF.
Judicial winding-up: The dissolution and winding-up of a bank may take place where:
- it is apparent that the suspension of payments set out above cannot rectify the situation that caused it;
- the financial situation of the bank is affected to such an extent that the bank will no longer be able to comply with the commitments with respect to the rights of holders of claims or participations; and
- the authorisation of the bank has been withdrawn and the decision in this respect became final.
Only the CSSF or the state prosecutor may apply to the Tribunal d'Arrondissement of Luxembourg sitting in commercial matters to order the dissolution and winding-up of a bank. When ordering the winding-up, the Tribunal d'Arrondissement appoints an official receiver and one or more liquidators, determines the winding-up method and may make applicable the general rules governing bankruptcy. The liquidators inform the known creditors located abroad of the winding-up. Any creditor has the right and obligation to deposit its claim with the registry of the Tribunal d'Arrondissement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
First published in Mondaq
Michael SchweigerLocal Partner Attorney at law / Avocat à la Cour / Solicitor
Michael Schweiger, local partner, is a member of the Banking & Finance practice group in our Luxembourg office. He leads the Luxembourg financial regulatory team and regularly advises banks, e-money and payment institutions, insurers, and other clients regarding financial regulation.T: +352 466 230 520 E: [email protected]
Adrien PierreSenior Associate Attorney at law / Avocat à la Cour
Adrien Pierre, senior associate, is a member of the Banking & Finance Practice Group in our Luxembourg office. He advises banks, asset managers, fintechs, payment institutions, insurance companies and other financial institutions on regulatory matters.T: +352 466 230 523 E: [email protected]