Bail-in
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Regulatory Capital Anatomy™
The JC’s untutored thoughts on how bank capital works.
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bail-in
/beɪl/ /ɪn/ (n.)
A regulatory mechanism that applies to regulated financial institutions as they teeter on the edge of oblivion. It allows a prudential regulator to write down, cancel or convert into common equity any part of the institution’s indebtedness. This is designed to protect retail depositors and preserve essential systemic stability by sacrificing a small class of investors while saving everyone else.
This is quite a big deal, seeing as senior, unsecured indebtedness is meant to be senior in the hierarchy of investors and stakeholders in a company.
Some types of debt instruments — for example, alternative tier one capital — are explicitly designed to have this happen, and pay a whopping interest coupon to compensate for this contingency.
Art 55: Bail in language
For others, like senior unsecured bonds, loans and so on, it is less obvious. So much so that bank resolution legislation requires, on pain of — well it isn’t really clear on pain of what, exactly — legal departments to go around inserting approved contractual bail-in language into some contracts warning their participants that a bail-in event might happen.
Which contracts?
- Entered or amended after 1 January 2016;
- Governed by the law of a non-EEA jurisdiction (INCLUDING ENGLISH);
- Not an excluded liability (as to which see Art 44).
This we think runs against the general grain of how laws are meant to work: it is tough luck if you get bailed in: citizens are deemed to know the laws of the land they are in. It shouldn’t be incumbent on contractual counterparties to be advising each other of mandatory laws that apply irrespective of the terms of a contract. BRRD is clear: bail-in applies whether you know about it or not, and whether the language is present or not.
The collected wisdom of the legal crowd is that explicit language renders the exercise of “bail-in” powers less susceptible to challenge in a non-EEA court. In the meantime, we wish the judiciary of the Marshall Islands well should they challenge the German regulator’s bailing-in of a German bank.
Nonetheless assiduous legal eagles have gone around inserting bail-in language in all kinds of contracts for which it is not especially relevant. Like NDAs for example.
“Liabilities”
“Liability” is not defined under BRRD, but we feel it must impliedly mean liabilities “to pay a sum of money”. There are a range of liabilities one can incur — such as to maintain confidentiality — which cannot feasibly be bailed in. It seems quixotic to require financial institutions to hotly insist on bail-in language in their cross-border NDAs.
No doubt some pedant will meet with the rejoiner that a liability to pay damages under an NDA may be covered — but okay that’s the JC’s patience exhausted on this topic.