4.8.2.1 Exercise of resolution powers

The PONV conversion power and the bail-in tool are exercised/applied by the resolution authorities through the following resolution powers:

In order to restore the NAV, existing shares or other instruments of ownership issued by a bank in resolution may either be cancelled2 or transferred to bailed-in creditors. When the NAV is zero or negative, resolution authorities should cancel or transfer in full all shares or other instruments of ownership. When the NAV is positive, the extent of cancellation or transfer should be partial and ensure that shareholders retain at least the NAV.3 In that case, cancellation or transfer is combined with dilution.

In order to restore the CET 1 capital ratio of a bank, shares or other types of capital instruments may be diluted as a result of the conversion of capital instruments and eligible liabilities into shares or other types of capital instruments at an ‘appropriate rate of conversion’.4 Restoring the CET 1 capital ratio through dilution is only possible, when the bank in resolution has a positive NAV.

In order to ensure an ‘appropriate rate of conversion’ the conversion has to be conducted at a rate of conversion that severely dilutes existing holdings of shares or other instruments of ownership.5 This entails that both the shareholders’ percentage of ownership of the bank and the value of the instruments of ownership must be reduced, unless this would breach the safeguards set out in section 4.8.2.4 (more specifically, the NCWO-principle).6 The conversion rate has to represent appropriate compensation to the affected creditors for any loss incurred by virtue of the exercise of the PONV conversion power and/or the application of the bail-in tool. A different conversion rate may be applied to different classes of capital instruments and liabilities, as long as the conversion rate represents the appropriate compensation and the conversion rate applicable to liabilities that are considered to be senior under applicable insolvency law is higher than the conversion rate applicable to subordinated liabilities.7

In certain circumstances, it may not be sufficient to cancel or transfer shares or other instruments of ownership in order to restore the NAV of a bank in resolution. In such a case, eligible liabilities must be written down.8 In that case, it will be necessary to write down, at least partially, creditors more senior in insolvency to shares or other instruments of ownership. Writing down other creditors while shareholders retain some value would be inconsistent with both the required sequence of write-down and the respect for the creditor hierarchy in insolvency.9

A reduction of the principal amount of eligible liabilities is permanent.10 No compensation is paid.11 Only, where the level of the reduction is found to exceed requirements when assessed against the ex post valuation,12 a write-up mechanism may be applied to reimburse creditors to the extent necessary.13

Where a resolution authority reduces to zero the principal amount of, or outstanding amount payable in respect of, an eligible liability, that liability and any obligations or claims arising in relation to it not accrued at the time when the power is exercised shall be treated as discharged for all purposes, and shall not be provable in any subsequent proceedings in relation to the bank in resolution or any successor entity in any subsequent winding up.14 Where a resolution authority reduces in part, but not in full, the principal amount of, or outstanding amount payable in respect of, an eligible liability, the liability shall be discharged to the extent of the amount reduced, and the relevant instrument or agreement that created the original liability shall continue to apply in relation to the residual principal amount of, or outstanding amount payable in respect of the liability, subject to any modification of the amount of interest payable to reflect the reduction of the principal amount, and any further modification of the terms that the resolution authority might make.15