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Abstract
Since the beginning of the financial crisis, the financial burdens associated with the restructuring or the resolution of distressed financial institutions were primarily borne by the states and, ultimately, by the taxpayers. This paradigm, however, is about to change. Both on a global and on a European level, the creditor bail-in is currently replacing the former taxpayer bail-out. Henceforward, private creditor rather than public taxpayer funds will be used to stabilise and restructure distressed financial institutions. With the entering into force of the European Bank Recovery and Resolution Directive (BRRD) in July of 2014, the creditor bail-in has also become the tool of choice within the European Union. This paradigm change entails considerable economic risks for creditors and depositors of financial institutions and may, as the events in Cyprus in 2013 demonstrate, also give rise to legal challenges by aggrieved parties. This article gives an overview on the legal questions surrounding a mandatory participation of creditors and depositors and suggests that the legality and thus the success of the bail-in tool in Cyprus and beyond will ultimately be for judges and arbitrators to decide.
Notes
1 The BRRD (Official Journal of the European Union L 173 of 12 June 2014 at 190-348) is effective in all 28 EU Member States. The Single Resolution Mechanism (SRM) as a central component of the future European Banking Union incorporates the BRRD resolution regime into the Eurozone. Within the SRM, the BRRD resolution regime is being further “europeanised” with the establishment of a European Resolution Fund and a central European Supervisory Authority.
2 See also the European Commission Memorandum, “EU Bank Recovery and Resolution Directive (BRRD): Frequently Asked Questions”, 15 April 2014, at 1, http://www.europa.eu/rapid/press-release_MEMO-14-297_fr.htm, accessed on 1 October 2014.
3 See Recital 82 of the BRRD. Some Member States, including the Federal Republic of Germany, have already implemented the bail-in tool by 1 January 2015.
4 Financial Stability Board, Key Attributes of Effective Resolution Regimes (October 2011), Art 3.5, http://www.financialstabilityboard.org/publications/r_111104cc.pdf, accessed on 1 October 2014. The International Monetary Fund (IMF) also supported the introduction of a bail-in tool early on; see IMF Staff Discussion Note SDN/12/03 of 24 April 2012, https://www.imf.org/external/pubs/ft/Sdn/2012/sdn1203.pdf, accessed on 1 October 2014. For details on national and international developments regarding the restructuring and resolution of financial institutions since the financial crisis see also M Haentjens, “Bank Recovery and Resolution: An Overview of International Initiatives” (2014) 3 International Insolvency Law Review 255.
5 The legal basis consists of the revised Banking Act of 1 September 2011, the Bank Insolvency Ordinance of 1 November 2012 and the Capital Adequacy Ordinance of 1 January 2013, see also the overview by M Lanz and O Favre, “Loss Absorption and Bail-in for Swiss Banks”, February 2013, http://www.swlegal.ch/Publications/Newsletter/2013-02-Loss-Absorption-and-Bail-in-for-Swiss-Bank.aspx, accessed on 1 October 2014.
6 The legal basis is Title II (ss 201–217) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub L No 111–203, 124 Stat 1376 (2010). For details see TH Jackson and DA Skeel, “Dynamic Resolution of Large Financial Institutions” (2012) 2 Harvard Business Law Review 435, 451–455.
7 See also the draft of the Canadian Budget legislation for the year 2013 (Economic Action Plan 2013), at 144–145, http://www.budget.gc.ca/2013/doc/plan/budget2013-eng.pdf, accessed on 1 October 2014.
8 The legal basis is the Law on the Amendment of the Deposit Insurance Act of 12 June 2013. For details see K Kodachi, “Orderly Resolution Regime for Financial Firms: A New Scheme Provided for Under the Revised DIA” (2013) 5(2) Nomura Journal of Capital Markets 1.
9 See the announcement of the Brazilian Central Bank of 6 May 2013, http://www.bloomberg.com/news/2013-05-15/euro-style-bail-in-plan-means-bondholder-wipe-out-brazil-credit.html, accessed on 1 October 2014.
10 See the announcement by the Australian Prudential Regulation Authority (APRA) in the Portfolio Budget Statement 2013–14, at 133–144, http://www.treasury.gov.au/~/media/Treasury/Publications%20and%20Media/Publications/2013/PBS%202013-14/Downloads/PDF/05_APRA.ashx, accessed on 1 October 2014.
11 See the plans of the Government of New Zealand to introduce an Open Bank Resolution (OBR) policy, http://www.rbnz.govt.nz/regulation_and_supervision/banks/policy/4368385.html, accessed on 1 October 2014.
12 The legal basis is the Financial Services (Banking Reform) Act 2013, http://www.legislation.gov.uk/ukpga/2013/33/contents/enacted, accessed on 1 October 2014.
13 In 2010, the balance sheet total of all Cypriot Banks reached approximately 896% and was thus more than nine times higher than the annual GNP of the Republic of Cyprus, see C Stephanou, “The Banking System in Cyprus: Time to Rethink the Business Model?” (2011) 5 Cyprus Economic Policy Review 123.
14 Between 2009 and 2012, the Cypriot economy shrank by an average of 1.6% per year. Source: Eurostat, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00115&plugin=1, accessed on 1 October 2014.
15 Source: Eurostat, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=teina225&plugin=1, accessed on 1 October 2014. These figures did not include the considerable debts of the Cypriot banks. Considering these debts, the total gross debt would have been even higher.
16 “Cyprus Faces Triple Wave of Trouble”, Financial Times, 27 July 2011, ft.com, http://www.ft.com/cms/s/0/856fb806-b86b-11e0-b62b-00144feabdc0.html, accessed on 1 October 2014. The World Bank had already pointed to the systemic risks emanating from the Cypriot banking sector in 2011, see C Stephanou, “The Banking System in Cyprus: Time to Rethink the Business Model?” (2011) 5 Cyprus Economic Policy Review 123.
17 According to a due diligence conducted by PIMCO on behalf of the Troika in February 2013, the average tier 1 core capital ratio of the Cypriot banks amounted to a mere 4.9%; see http://www.centralbank.gov.cy/media/pdf/CyprusIndependentDueDiligenceReport_18April.pdf, accessed on 1 October 2014. Laiki Bank alone would have required an additional EUR 1.97 billion to fulfil the EBA capital requirements, the Bank of Cyprus would have required another EUR 1.56 billion.
18 The interest on Cypriot ten-year bonds increased from 4% in January 2011 to 11.5% in August 2011; see “Cyprus Applies for EU Aid”, FAZ Online, 25 June 2012, http://www.faz.net/aktuell/wirtschaft/eurokrise/schuldenkrise-zypern-stellt-antrag-auf-eu-hilfen-11799229.html, accessed on 1 October 2014.
19 “Cypriot Junk Cycle”, FAZ Online, 5 June 2012, http://www.faz.net/aktuell/politik/europaeische-union/eu-hilfen-fuer-zypern-zyprischer-ramsch-kreislauf-11775578.html, accessed on 1 October 2014.
20 “Buying Frenzy Ruined Bank of Cyprus”, FAZ Online, 8 April 2013, http://www.faz.net/aktuell/wirtschaft/eurokrise/zypern/brisanter-untersuchungsbericht-kaufrausch-stuerzte-bank-of-cyprus-in-den-ruin-12141530.html, accessed on 1 October 2014.
21 Press release of the Central Bank of Cyprus of 30 March 2013, “Rescue Programme for Laiki Bank”, http://www.centralbank.gov.cy/nqcontent.cfm?a_id=12634.
22 “Billions for Cypriot Banks”, Handelsblatt Online, 14 January 2013, http://www.handelsblatt.com/politik/international/heimliche-hilfe-milliarden-fuer-zyperns-banken-/7624234.html, accessed on 1 October 2014.
23 “Cyprus Debt Swells to 23 bn, and Scrambles for Extra 6 bn”, rt.com (Russia Today), 11 April 2013, http://www.rt.com/business/the-bailout-billion-cyprus-693/, accessed on 1 October 2014.
24 “EU Law Makers Divided on Compulsory Bail-Ins for Savers”, euobserver.com, 27 March 2013, https://euobserver.com/news/119591, accessed on 1 October 2014.
25 Of this total sum, EUR 2.5 billion were intended for further recapitalisation of Cypriot banks, EUR 4.1 billion for the redemption of loans and EUR 3.4 billion for public expenditure, see “Big Depositors in Cypriot Banks to lose 8.3 Billion Euros”, reuters.com, 15 April 2013, http://www.reuters.com/article/2013/04/15/us-cyprus-banks-depositors-idUSBRE93E0K920130415, accessed on 1 October 2014.
26 “Schäuble: Cyprus Has to Change Its Business Model”, FAZ Online, 20 March 2013, http://www.faz.net/aktuell/wirtschaft/eurokrise/zypern/zyprisches-parlament-lehnt-rettungspaket-ab-schaeuble-zypern-muss-sein-geschaeftsmodell-aendern-12121133.html, accessed on 1 October 2014.
27 “Your Cyprus Question, Answered (Updated)”, Wall Street Journal Online, 18 March 2013, http://blogs.wsj.com/brussels/2013/03/18/your-cyprus-questions-answered/, accessed on 1 October 2014; “A New Deal Regarding Aid for Cyprus”, nzz online, 25 March 2013, http://www.nzz.ch/ein-neuer-deal-zur-zypern-hilfe-1.18052953, accessed on 1 October 2014.
28 “Cyprus MPs Reject EU-IMF Bailout Tax on Bank Depositors”, BBC News Europe Online, 19 March 2013, http://www.bbc.com/news/world-europe-21842966, accessed on 1 October 2014.
29 Press release of the European Central Bank of 21 March 2013, http://www.ecb.europa.eu/press/pr/date/2013/html/pr130321.en.html, accessed on 1 October 2014.
30 “Cypriot Central Bank Has Carte Blanche”, FAZ Online, 24 March 2013, http://www.faz.net/aktuell/politik/europaeische-union/laiki-chefvolkswirt-tirkides-zyprische-zentralbank-hat-freie-hand-12126998.html, accessed on 1 October 2014; “A New Deal Regarding Aid for Cyprus”, nzz online, 25 March 2013, http://www.nzz.ch/ein-neuer-deal-zur-zypern-hilfe-1.18052953, accessed on 1 October 2014. For a summary of the decrees enacted by the Central Bank of Cyprus to date see http://www.centralbank.gov.cy/nqcontent.cfm?a_id=12636&lang=en.
31 “Small Investors Remain Untroubled, High Losses for Major Customers”, FAZ Online, 25 March 2013, http://www.faz.net/aktuell/wirtschaft/eurokrise/zypern/rettungspaket-fuer-zypern-kleinanleger-bleiben-verschont-hohe-verluste-fuer-grosskunden-12127268.html, accessed on 1 October 2014.
32 Available at http://www.mof.gov.cy/mof/mof.nsf/MoU_Final_approved_13913.pdf, accessed on 1 October 2014. On 18 April 2013, the Cypriot Parliament approved the bill in a close vote (29–27), see “Parliament in Cyprus Passes International Bailout Deal”, BBC News Europe, 30 April 2013, http://www.bbc.com/news/world-europe-22357240, accessed on 1 October 2014; “Cyprus Bailout Scrapes through Island's Parliament”, reuters.com, 30 April 2013, http://www.reuters.com/article/2013/04/30/us-cyprus-parliament-bailout-idUSBRE93S12M20130430, accessed on 1 October 2014.
33 Press release of the Central Bank of Cyprus of 3 April 2013, “Unfreezing 10% of Uninsured Deposits at the Bank of Cyprus Public Company Ltd.”, http://www.centralbank.gov.cy/nqcontent.cfm?a_id=12678.
34 Decree of the Cypriot Central Bank of 29 March 2013 (Bailing-In of Bank of Cyprus Public Company Limited Decree).
35 Press release of the Central Bank of Cyprus of 30 July 2013, “Significant Progress at Bank of Cyprus with the Completion of the Recapitalisation and the Exit from Resolution”, http://www.centralbank.gov.cy/nqcontent.cfm?a_id=12896.
36 “Bank of Cyprus Restructured”, Handelsblatt Online, 30 July 2013, http://www.handelsblatt.com/unternehmen/banken-versicherungen/bankenrettung-bank-of-cyprus-saniert/8570328.html, accessed on 1 October 2014.
37 “Rejection of Haircut Appeals by the Supreme Court of Cyprus”, http://www.cypruslawfirm.com/rejection-of-haircut-appeals-by-the-Supreme-court-of-cyprus/, accessed on 1 October 2014.
38 “Cypriots Challenge ‘Bail-In' to fight for Lost Savings”, reuters.com, 6 August 2013, http://www.reuters.com/article/2013/08/06/cyprus-bank-depositors-idUSL6N0G232Y20130806, accessed on 1 October 2014.
39 Effective 1 June 2013, the Republic of Cyprus has concluded a total of 27 BITs, 20 of which have so far entered into force. Cyprus acceded to the ICSID Convention effective 25 December 1966.
40 “Cyprus Threatened with Bail-Out Claim”, Global Arbitration Review, 14 July 2014, http://globalarbitrationreview.com/news/article/32810/, accessed on 1 October 2014.
41 The same standards apply in intra-EU arbitration. The Frankfurt Higher Regional Court (decision of 10 May 2012, file no 26 SchH 11/10; see Zeitschrift für Schiedsverfahren (SchiedsVZ) 2013, 119; see also C Tietje “Investment Arbitration within the EU Single European Market” (2013) Praxis des Internationalen Privat- und Verfahrensrechts (IPrax) 64) recently confirmed that there are no additional prerequisites with regard to admissibility in intra-EU cases.
42 A common definition (in this case from the Cyprus–Czech Republic BIT) would be:
“The term ‘investment' shall comprise every kind of asset invested in connection with economic activities by an investor of one Contracting Party in the territory of the other Contracting Party in accordance with the laws and regulations of the latter and shall include, in particular, though not exclusively:
movable and immovable property as well as any other property rights, such as mortgages, liens or pledges;
shares, stocks and debentures of companies or any other form of participation in a company;
claims to money or to any performance under contract having a financial value associated with an investment;
intellectual property rights, such as trademarks, patents, industrial designs, technical processes, know-how, trade secrets, trade names and goodwill associated with an investment;
any right conferred by laws or under contract and any licenses and permits pursuant to laws, including the concessions to search for, extract, cultivate or exploit natural resources.
43 Ambiente Ufficio SpA and others v The Argentine Republic, ICSID Case No ARB/08/9, Decision on Jurisdiction of 8 February 2013, paras 415–495; Abaclat and others v The Argentine Republic, ICSID Case No ARB/07/5, Decision on Jurisdiction of 4 August 2011, paras 352–367. All cited decisions available online at www.italaw.com.
44 The terms “expropriation” and “measures with equivalent effect” are not defined in the BITs concluded by Cyprus. Notwithstanding the above, over the last few years several criteria regarding the existence of an expropriation have emerged from arbitral practice (see the references at C McLachlan, L Shore and M Weiniger International Investment Arbitration (Oxford University Press, 2007), margin no 8.01 et seq). Arbitral tribunals have highlighted on various occasions that the existence of an expropriation is not limited to property infringements, but is also conceivable in the case of a frustration of contractual obligations. Accordingly, deposits can, in principle, be qualified as investments insofar as they constitute claims of the depositors against the account-managing bank regarding the repayment of their deposit up to the amount of the existing balance.
45 The BITs concluded by the Republic of Cyprus contain mostly identical provisions with regard to the issue of compensation in case of expropriation or measures with equivalent effect conducted by the state. Accordingly, an expropriation of investors is permitted only if and to the extent such expropriation (i) is conducted in the public interest, (ii) is conducted in lawful proceedings, (iii) is non-discriminatory and (iv) offers a prompt and freely convertible monetary compensation that considers the value of the investment at the time the investment was made and interest. The rationale of the latter requirement is to grant the investor adequate compensation in return for the expropriation and, in addition, permit him to independently decide on the reinvestment of the compensation. In this regard, an arbitral tribunal would have to examine whether the compulsory conversion of deposits into shares of the “new” Bank of Cyprus meets these requirements. In particular, it may be questionable whether a mandatory capital participation such as a deposit-to-equity swap constitutes adequate compensation and provides the investor with sufficient discretion regarding reinvestment.
46 With regard to the question of causality one could argue that without the bail-in, Laiki Bank and the Bank of Cyprus would very likely have collapsed so that depositors would have suffered a total loss. The bail-in could be construed to at least have saved part of the uninsured deposits. Considering such a hypothetical course of events, it seems doubtful whether the bail-in measures indeed entailed financial damages on the part of the depositors.
47 Effective 30 July 2014, a total of 17 lawsuits by more than 60 claimants have been filed in the period between 24 May 2013 and 5 March 2014 before the Court of the European Union. In detail, these concern the following proceedings: file no T-289/13–T-294/13; T-327/13–T-332/13 (Official Journal of the European Union C-226 of 3 August 2013, at 13–21 and C-252 of 31 August 2013, at 32–36); file no T-680/13 (Official Journal of the European Union C-194 of 24 June 2014, at 25–26); file no T-149/14–T-152/14 (Official Journal of the European Union C-159 of 26 May 2014, at 31–32).
48 “Cypriot Law Firm Launches Legal Action against EU over ‘Bail-In’”, 23 July 2014, http://www.parikiaki.com/2014/07/cypriot-firm-launches-legal-action-against-eu-over-bail-in/, accessed on 1 October 2014; “EU Court to Examine 12 Applications for Annulment of Eurogroup's Decision on Cyprus”, 18 October 2013, voiceofrussia.com, http://sputniknews.com/voiceofrussia/news/2013_10_18/EU-Court-to-examine-12-applications-for-annulment-of-Eurogroup-s-decision-on-Cyprus-9541/, accessed on 1 October 2014.
49 A Union legal act, whose lawfulness is determined by European Union law, specifically by CFR, Art 17, could only exist if the Eurogroup were an organ or an institution of the European Union pursuant to TFEU, Art 263. The Court of the European Union would need to review whether this is the case. In this context, the Court could take into account that the Eurogroup – irrespective of its political influence – is, with a view to TFEU, Art 137 and Protocol No 14 to the TFEU, an informal grouping without proper competences. In contrast to the Council, the Eurogroup does not pass legally binding resolutions, but rather prepares the resolutions of the Council (U Palm, in E Grabitz, M Hilf and M Nettesheim, The Law of the European Union (50th edn, 2013), TFEU, Art 137, margin no 4 et seq). Furthermore the Court might also consider whether the participation of the Commission and the European Central Bank – in the latter case on a voluntary basis – in the meetings of the Eurogroup exerts any influence on the legal nature of the resolutions taken and, in particular, makes them resolutions of the Commission or the European Central Bank. Should the Court reject the organ quality of the Eurogroup, the Eurogroup resolution of 25 March 2013 may not be challenged with an action for annulment pursuant to TFEU, Art 263.
50 The Memorandum of Understanding of 26 April 2013, too, could only be assessed by the standards of Union law, specifically by CFR, Art 17 if it could be considered a Union legal act. First, the Court of the European Union would have to examine whether the Commission and the European Central Bank signed the Memorandum of Understanding in their respective functions as organs of the European Union. In this context the Court would need to consider that, in the context of the ESM, the Commission and the European Central Bank have no proper decision-making power, but rather carry out support functions such as assessing requests for stability support and their urgency, negotiating Memorandums of Understanding detailing the conditionality attached to the financial assistance granted and monitoring compliance with the conditionality attached to the financial assistance. Furthermore the Court would need to consider that the European Court of Justice only recently held that the Commission and the European Central Bank, as far as they act on behalf of the ESM, do not act in their function as organs of the European Union (European Court of Justice, judgment of 27 November 2012, http://curia.europa.eu/juris/celex.jsf?celex=62012CJ0370&lang1=en&type=TXT&ancre=, Case C-370/12 Pringle v Ireland, margin no 155–169). The ESM Treaty forms part of “plain” public international law and does not pertain to primary or secondary European Union law (German Federal Constitutional Court, judgment of 12 September 2012, file no 2 BvR 1390/12, margin no 235–237). For the above reasons, it may be doubted whether a Memorandum of Understanding signed on the basis of the ESM constitutes a legal act of the European Union. However, since the adoption of the BRRD, one may come to a different conclusion. Should resolution authorities henceforth apply the instruments provided for in the BRRD or in the respective national legislation, this could be construed as an implementation of Union law pursuant to CFR, Art 51. Hence, affected creditors and depositors might be able to claim compensation under CFR, Art 17 for losses incurred as a result of a bail-in.
51 The declaration of nullity is effective ex tunc and erga omnes, see H-J Cremer, in C Calliess and M Ruffert, EU/TFEU (4th edn, 2011), TFEU, Art 264 margin no 2.
52 O Dörr, in E Grabitz, M Hilf and M Nettesheim, The Law of the European Union (52nd edn, 2014), TFEU, Art 263 margin no 198.
Additional information
Christian Duve, Freshfields Bruckhaus Deringer.
Philip Wimalasena, Freshfields Bruckhaus Deringer. [email protected]