Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.7.1.1:3.7.1.1 The restructuring plan

Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.7.1.1

3.7.1.1 The restructuring plan

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A restructuring plan should include:

1.

Information on the bank, including in particular its organisational structure, funding (demonstrating viability of the short and long term funding structure), corporate governance (demonstrating prevention of conflicts of interest as well as necessary management changes), risk management (including disclosure of impaired assets and prudent provisioning for expected non-performing assets), and asset-liability management, cash-flow generation (which should reach sufficient levels without State support), off-balance sheet commitments (demonstrating their sustainability and consolidation when the bank bears a significant exposure), leveraging, current and prospective capital adequacy in line with applicable supervisory regulation (based on prudent valuation and adequate provisioning), and the remuneration incentive structure (demonstrating how it promotes the beneficiary's long-term profitability);

2.

A market description and calculations of market shares;

3.

An analysis of the reasons why the bank ran into difficulty;

4.

A comparison with alternative options, including a break-up or absorption by another bank, in order to allow the Commission to assess whether more market oriented, less costly or less distortive solutions are available consistent with maintaining financial stability.1

5.

A description of the State intervention (that is, information on whether the bank or its subsidiaries have already received rescue or restructuring aid in the past, information on the form and amount of the State support) and assessment of the State aid;

6.

A presentation of the measures that will be taken to restore the long-term viability of the bank, including a presentation of the different market assumptions and a description of the repayment plan of the State aid;

7.

A presentation of the measures that will limit the distortion of competition; and

8.

Monitoring arrangements.2

Ad 6: Measures to restore the long-term viability of the bank

The restructuring plan needs to include measures to restore the long-term viability of the bank, because zombie banks artificially kept alive distort competition and market prices, do not provide for financial stability and cannot lend to the real economy.3 The restructured bank should be able to compete in the marketplace for capital on its own merits in compliance with relevant regulatory requirements.4

In a speech of 28 June 2017, Ms Vestager, in her role as DG Competition Commissioner, stated that the overwhelming majority of banks that had restructured under the State aid rules were returning to viability. On average, three years after the start of that restructuring, they perform just as well as banks that didn't need aid.5

The expected results of the planned restructuring need to be demonstrated in the restructuring plan under a base case scenario as well as under ‘stress’ scenarios. For this, restructuring plans need to take account, inter alia, of the current state and future prospects of the financial markets, reflecting base-case and worst-case assumptions.6 On the basis of the outcome of this ‘stress testing’, certain measures should be proposed in the restructuring plan to restore the long-term viability of the bank. These measures should be mainly internal measures, such as a withdrawal from activities which would remain structurally loss making in the medium term.7 The solutions can however range from limited restructuring with no divestments to winding up the bank in an orderly manner. An adjustment in the bank’s business model can also be necessary, inter alia, to reduce systemic risks.8 This can consist of an investment restriction in the form of an acquisition ban (if the bank has insufficient capital buffers), constraints in respect of the investment portfolio, price leadership bans and restrictions on profitability (when aggressive pricing and commercial practices have contributed to the structural difficulties of the beneficiary).9 In addition to divestments and business constraints measures, corporate governance measures have been central for promoting the return to viability. These can include changes in the management of the bank or reinforcement of the role of the risk control committee.10

In the case of the restructuring of the German bank WestLB, the Commission had demanded a change in the ownership structure, because it was the finding of the Commission that the problems of WestLB were caused by the pursuit of the wrong business model which it needed to change in order to achieve long-term viability. The shares of WestLB were hold by the German State and other State-controlled entities. A shareholder in WestLB brought an action for annulment of the decision from the Commission before the GC, inter alia, because it did not agree on the requirement set by the Commission. The GC considered that the Commission is not required to explain the need for each measure provided for by the restructuring plan or to seek to impose only the least restrictive measures, unless the Member State has not committed itself to the restructuring plan or committed itself only to a restructuring plan because the Commission had definitively informed it that the aid would not be authorised in the absence of those measures.11 The shareholder in WestLB had not submitted a plea for annulment of the contested decision alleging that the Commission used coercion or placed undue pressure on Germany so that it would commit itself to the final restructuring plan.12 In addition, in principle, the fact that authorisation of restructuring aid is made subject to compliance with the measures provided for by the restructuring plan to which the Member State concerned has committed itself cannot result in an infringement of the principle of equal treatment .13

Ad 7: Measures to limit the distortion of competition

Whilst State aid can support financial stability in times of systemic crisis, with wider positive spillovers, it can nevertheless create distortions of competition in various ways. State aid prolongs past distortions of competition created by excessive risk-taking and unsustainable business models by artificially supporting the market power of beneficiaries. In this way it may create a moral hazard for the beneficiaries, while weakening the incentives for non-beneficiaries to compete, invest and innovate. Finally, State aid may undermine the single market by shifting an unfair share of the burden of structural adjustment and the attendant social and economic problems to other Member States, whilst at the same time creating entry barriers and undermining incentives for cross-border activities.14

The restructuring plan should therefore also include measures to limit the distortion of competition as a result of the State aid award. These should not compromise the prospects of the bank's return to viability.15

Despite the fact that the distinction between measures limiting distortions and measures to restore the long-term viability of the bank can be useful to better understand the restructuring process, some measures can address two objectives at the same time – for instance, a divestment could be instrumental in restoring the viability of the beneficiary and in mitigating distortions of competition.16 In practice, the distinction could therefore be less clear than presented here.

The Commission takes as a starting point for its assessment of the need for measures limiting distortions of competition the size, scale and scope of the activities that the bank in question would have upon implementation of a credible restructuring plan. Depending on the nature of the distortion of competition, it may be addressed through measures in respect of liabilities and/or in respect of assets. The nature and form of these measures depend on two criteria:

1.

The amount of the aid and the conditions and circumstances under which it was granted; and

2.

The characteristics of the market or markets on which the beneficiary bank will operate.17

As regards the first criterion, measures limiting distortions will vary significantly according to the amount of the aid as well as the degree of burden-sharing and the level of pricing. Generally speaking, where there is greater burden-sharing and the own contribution is higher, there are fewer negative consequences resulting from moral hazard. Therefore, the need for further measures is reduced.18

As regards the second criterion, the Commission analyses the likely effects of the aid on the markets where the beneficiary bank operates after the restructuring. Firstly, the size and the relative importance of the bank on its market or markets, once it is made viable, are examined. If the restructured bank has limited remaining market presence, additional constraints, in the form of divestments or behavioural commitments, are less likely to be needed.19 In addition, the Commission pays attention to the risk that restructuring measures may undermine the internal market and positively views measures that help to ensure that national markets remain open and contestable.20

The measures to limit the distortion of competition can be divided in structural measures, corporate governance measures and behavioural measures.21

Structural measures

The structural measures that can be included in the restructuring plan to limit the distortion of competition may differ. Their purpose is to incentivise the entry of competitors as well as cross-border activity.22 Examples thereof are:

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The sale of the entire bank to another bank via a transparent, objective, unconditional and non-discriminatory competitive sale process to offer equal opportunities to all potential bidders.23

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Divestment of subsidiaries or branches, portfolios of customers or business units.24

–

The creation of an autonomous ‘bad bank’. The ‘bad’ assets and liabilities of a bank in difficulty are in this solution transferred to another entity or put in run-off.25

–

The creation of an autonomous ‘good bank’. This solution entails that the ‘good’ assets and liabilities are transferred to another entity.26

–

The obligation to provide access to infrastructure by the beneficiary to its competitors.27

–

Commitments to pre-announced paths that alter the bank balance sheet (that is, the improvement of indicators, such as short-term funding compared as a percentage of total funding, the average maturity of long term funding, and the proportion of ‘stable funding’).28

Where the imposition of structural measures is not appropriate, the Commission may accept the imposition by the Member State of a claw-back mechanism, for example in the form of a levy on the aid recipients.29

Corporate governance measures

In addition to the structural measures set out above, banks can also be required to take certain internal governance measures. If recourse to State aid could have reasonably been averted through appropriate and timely management action, any entity relying on State aid for its restructuring or winding up in an orderly manner should normally replace the CEO, as well as other board members, if appropriate.30 Some Member States imposed the appointment of new board members or their direct participation in the board, sometimes with veto power on key decisions (such as acquisition, compensation or dividend payments).31

In addition, entities in need of recapitalisation or asset relief measures should apply strict executive remuneration policies. This requires a cap on remuneration of executive pay combined with incentives ensuring that the bank is implementing its restructuring plan towards sustainable, long-term company objectives. Thus, any bank in receipt of State aid in the form of recapitalisation or asset relief measures should restrict the total remuneration to staff, including board members and senior management, to an appropriate level. The total remuneration of any such individual may not exceed 15 times the national average salary in the Member State where the beneficiary is incorporated or 10 times the average salary of employees in the beneficiary bank. Restrictions on remuneration must apply until the end of the restructuring period or until the bank has repaid the State aid, whichever occurs earlier.32

Lastly, any bank in receipt of State aid in the form of recapitalisation or asset relief measures should not in principle make severance payments in excess of what is required by law or contract.33

Behavioural measures

State aid should not be used to the detriment of competitors which do not enjoy similar public support. It can therefore be necessary to include certain behavioural measures in the restructuring plan. The 2013 Banking Communication, in combination with the relevant Crisis Communications, remains open as to the specificities of these commitments. Member States consequently adopted a wide set of measures to foster appropriate behaviour from beneficiaries:

–

A ban on using State aid for the acquisition of competing businesses. In exceptional circumstances and on notification, acquisitions may be authorised by the Commission where they are part of a consolidation process necessary to restore financial stability or to ensure effective competition.34

–

A ban on dividend or limitations on the payment of dividends for the duration of the State aid.

–

A ban on advertising the State support when marketing financial offers.

–

A ban on aggressive commercial strategy.

–

A ban on price leadership. State aid should not be used to offer terms (for example as regards rates or collateral) which cannot be matched by competitors which are not in receipt of State aid.

–

Formal commitments by the beneficiary to ensure lending to SMEs and households with sometimes quantified targets for those subcategories.35

The behavioural measures should remain in place, depending on the scope, size and duration of the aid, for a period ranging between three years and the entire duration of the restructuring period (normally, five years). They would then also serve as a clear incentive to repay the State as soon as possible.36

According to Shamsi, Solomon and Robins there is a general scepticism among commentators about whether compensatory measures introduced during the financial crisis were effective at achieving their stated objectives. Commentators noted that instead of aiming to remedy distortions to competition, many of the structural measures appear to have been imposed so as to restructure the market and to sanction excessive risk taking and mismanagement.37 According to some, structural measures may even have reduced competition, undermined the competitive process and damaged the economy by reducing lending.38 According to Heimler and Jenny, the introduction of broad and discretionary behavioural remedies cannot eliminate moral hazard. This should be left to the ‘one time last time principle’.39 It is however this principle that had been let go by the Commission in the State aid regime for the banking sector. Heimler and Jenny suggest that, instead of approving the aid in almost all circumstances, while imposing all sort of behavioural remedies on the aided company, the Commission should only approve the aid when it does not restrict competition, and should otherwise prohibit it.40 In the author’s view, this approach would not work in the financial sector due to the overriding goal of financial stability.

Government measures

For exceptional cases involving closed off vulnerable banking markets, the Restructuring Communication also foresaw the possibility of going beyond structural and behavioural measures and directly requiring Member States ‘to promote more sound and competitive markets’.41

In the restructuring of Bank of Ireland, Ireland for example committed to enact reforms to ease customer switching and increase consumer protection, to lift restrictions on online banking and to improve corporate governance in the financial sector.42

Ad 8: The monitoring arrangements

The restructuring plan should also describe the monitoring arrangements. The Commission requires appropriate monitoring to be in place to ensure that aid beneficiaries comply with either general conditions of schemes or the more specific conditions included in individual restructuring plans.43

In relation to individual restructuring plans, the Commission requires the appointment of a monitoring trustee. The monitoring trustee is normally appointed after the approval of the restructuring plan. The beneficiary bank normally provides the Commission with the name of one or more persons whom it proposes to appoint as trustee. Such a person must be independent of the bank, possess the necessary qualifications to carry out the mandate (e.g. as an investment bank, consultant or auditor) and should not be exposed to a conflict of interest.44 The monitoring trustee must also be agreed by the Member State. It may be that a divestiture trustee is appointed in addition to the monitoring trustee. This can be the case if the beneficiary bank fails to comply with certain divesture requirements. The divestiture trustee may be the same person as the monitoring trustee.45

According to the Commission, the monitoring trustee has proved a useful tool in the implementation of the complicated restructuring decisions. Although trust has to be built between the trustee and both the Commission and the aid recipient, that structure allows for original commitments to include fall-back options and claw-back mechanisms, which eventually help the decisions to be adapted to the actual circumstances of each bank and better reach their objectives.46

In relation to aid schemes and ad hoc rescue aid measures the Commission is usually satisfied with monitoring by, and regular reports from, the Member State granting the aid.47

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