Novo Banco bail-in may breach BRRD transfer rules

Louise Bowman
Published on:

Bank of Portugal tells Euromoney that Novo Banco bail in has satisfied BRRD conditions for the exercise of retransfer power but insolvency experts believe that important criteria have not been met

The market had long been preparing for the implementation of the BRRD’s bail-in regulation on January 1. However, the Bank of Portugal’s decision to bail in a small number of senior bondholders in Novo Banco, the 'good’ bank created after the collapse of Banco Espirito Santo (BES) in 2014, just before this implementation took place ensured that the ushering in of bail-in legislation when it finally came was overshadowed by confusion and controversy.

Many senior bond investors relaxing over their year-end break were rudely interrupted by the press release from the Bank of Portugal on December 29.

It stated that, based on the deteriorating situation at Novo Banco, "Banco de Portugal decided to confer again on BES the responsibility for certain issues of non-subordinated bonds issued by the latter and intended for institutional investors". (The affected bonds had been transferred from BES to Novo Banco when the latter was set up in August 2014).

It then identified five tranches of fixed rate senior bonds maturing between July 2016 and June 2024 with a face value of €1.985 billion that would be retransferred to BES and, in effect, wiped out.

The fact the bail-in took place on December 29 is widely seen as an attempt to complete the process before the bail-in regulations under BRRD came into force on January 1 this year. However, as this was a transfer of bonds to a third party rather than a conversion to equity or write-off, the applicable regulation under BRRD was already in place when the retransfer took place.

When Euromoney asked the Bank of Portugal about the authority under which the bonds were transferred, it confirmed that it was the right granted under the BES rescue in 2014. 

"The retransfer was made pursuant to a power provided for under the Portuguese Banking Act which was included in the original resolution decision for BES,"  Bruno Proenca,  head of communication directorate at Bank of Portugal, tells Euromoney. 

Proenca maintains that the BRRD conditions for the retransfer were, nevertheless, met. "A similar power is provided for under BRRD and the conditions for the exercise of that power are similar," he states. "The conditions for the exercise of the retransfer power in the manner it was exercised were satisfied."  He does not, however, elaborate on the basis upon which this conclusion has been reached. On Wednesday January 13 the ECB issued a statement declaring that:  "The decision by Banco de Portugal to bail in some senior bond holders in Novo Banco was taken exclusively by BdP under its national resolution powers. The ECB neither requested nor approved a bail-in of senior bond holders in this case." Not exactly an unequivocal endorsement.

sonya van de graaff-160x186
Sonya Van de Graaff,
Morrison & Foerster

"One of the relevant provisions of the BRRD in this case is the transfer/retransfer of a liability to a third party (since this power was in effect on the date of the purported retransfer to BES)," explains Sonya Van de Graaff, partner in the business restructuring and insolvency group at law firm Morrison & Foerster. 

"Whilst this precise factual scenario has not previously been adjudicated on and there have been admittedly few cases testing the BRRD in court, it would be surprising if a retransfer of a liability was not, in itself, properly to be characterized as an exercise of a resolution power."  

She adds: "If this is correct, it means that the Portuguese authorities needed duly to consider whether the conditions imposed by the BRRD  on the date of the retransfer were satisfied and duly invoked, and the authorities could not rely on the factual matrix or legal characterization as at the date of the original transfer in 2014."

In other words, it is not sufficient to simply grant yourself the power of retransfer - as the Bank of Portugal did in August 2014 - and issue a press release.

Certain provisos have to have been met for the transfer of liabilities under BRRD. The institution has to be about to fail, not just have breached its tier-one capital ratios. The prospect of a consensual deal with private investors has to have been explored and it has to have been considered whether the transfer is in the public interest. 

"Although the BRRD is untested in this respect, it would be surprising if a failure to satisfy a tier 1 ratio  of itself satisfied invoking the powers granted to authorities in the BRRD," says Van de Graaff.  

"The backdrop to the extraordinary powers given to authorities in the BRRD is the existence of extraordinary circumstances, and so we find that the first condition to invoking the BRRD’s powers requires the institution in question to be at risk of failure."  

She continues: "BRRD was written into law to create a level playing field and is arguably a sensible solution to these problems.

"However, if it is invoked in an arbitrary fashion and if institutions try to hang their hat on anything other than clearly enunciated authority for their actions, then investor confidence in Europe will be shaken."