ECB: A human rights perspective on senior bondholders; pari passu not an absolute principle

There is a new ECB legal paper on bank resolution regimes.  In discussing the January 2011 European Commission working document,  the paper states :

Under the statutory or comprehensive approach, a statutory power would be conferred on the resolution authority ‘to write down by a discretionary amount or convert to an equity claim, all senior debt deemed necessary to ensure the credit institution is returned to solvency’.

… .

Key factors in determining the success of such a bail-in regime will include its compliance with the principles of human rights law governing peaceful enjoyment of property and the predictability of its outcome and, hence, its alignment with the expectations of market participants. However, it would appear that the Commission is considering the possibility to accord resolution authorities the power to discriminate.

Discrimination between equally ranked creditors is highly problematic both from the perspective of human rights and predictability. Discriminatory treatment defined as treating essentially identical cases differently or essentially different cases the same is per se not justified by objective differences and, therefore, unduly infringes property rights.

However, the situation could arise where a differentiated treatment of creditors of the same class may be necessary to achieve an optimal result during reorganisation. In such a scenario, the overall outcome in resolution is optimised by not respecting the pari passu principle within a class of creditors. In order to achieve the intended positive consequences of such differentiated treatment, it is important that it follows transparent principles and safeguards and that the differentiation is justified by objective criteria. In those circumstances, it will not be discriminatory. In other words, any exceptional deviation from the pari passu principle cannot be allowed to build on discriminatory treatment and, in any case, it must be ensured that the principle that creditors cannot be worse off than they would be in immediate liquidation is respected. This differentiated approach shows that the principle of no worse-off than in liquidation functions as a bottom line in the system of creditor safeguards and has to be respected in all cases, while the pari passu principle allows for exceptions, provided these are objectively justified and, therefore, non-discriminatory.

26 thoughts on “ECB: A human rights perspective on senior bondholders; pari passu not an absolute principle”

  1. From the January ECB legal paper above

    Discrimination between equally ranked creditors is highly problematic both from the perspective of human rights and predictability. Discriminatory treatment defined as treating essentially identical cases differently or essentially different cases the same is per se not justified by objective differences and, therefore, unduly infringes property rights.

    Incredible.

    This in a legal paper from the organization that forced people that were not even creditors of the banks to pick up the tab.

    I think Ireland should take the ECB to the European Court of Justice. The above document should be adduced as evidence in Ireland’s favour.

  2. The authors seem to be unaware of the existence of investor compensation schemes which are highly relevant when the financial institution potentially being liquidated only has state ownership as an alternative to liquidation.

    I wonder if they accidentally-on-purpose forgot about that?

  3. @joseph ryan

    I imagine that the ECB et al will deny that they

    “forced people that were not even creditors of the banks to pick up the tab”.

    I further imagine that they will say that those people decided through their representatives, which included those recently elevated to power, to “pick up the tab” as the alternative to allowing its so-called “pillar banks” to be put into liquidation.

    That was the choice. It was made in Dublin, not Frankfurt.

    Who can show them that this is incorrect ?

  4. @Fergus

    One hopes and certainly expects that there is documentation to support the Irish government position that it should not be forced to pay bondholders in completely bust banks. I would expect that there was more than:
    ‘ a nod is as good as a wink’.

    There is little point admonishing banks for not having proper loan documentation and then as government decide to give away 40% of GDP on the basis of ‘ a nod is as good as a wink’.
    Perhaps Kevin Cardiff should have been asked that question at the PAC hearings.

  5. @Joseph Ryan

    Who gets paid how much in a company – whether that is a banking company or otherwise – that has become insolvent was not a new question in 2008 (or even in 1908) for Irish legal arrangements.

    If normal insolvency procedures had been followed, bondholders would have suffered haircuts. The problem was that there was no rule permitting them to be *singled out* for haircuts.

    What has become The Standard Narrative (“TSN”) here and elsewhere relied on the assumption that the U.S. rules for bank bonds also applied here. (I am not clear – to put it mildly – why slavishly following U.S. law should be regarded as a virtue, but there we are.)

    Those U.S. rules were developed in the 1930s in response to specific U.S. circumstances which had no parallel here. Even in the U.S., they apply only to *bank* bonds – thousands of pensioners in several states have had entitlements slashed to keep muncipal bond-holders “whole”. (Not sure if Stephen Kinsella will be happy to be reminded of that, or not 🙂 ).

    Demands for adherence here to U.S. rules has been accompanied by a lot of nonsense – sometimes authored by those with Ph.Ds in Economics – to the effect that the bonds are risk investments of the same kind as equity share-holdings, no less. By way of illustration of how wrong-headed that is, any investor in the so-called Billion-Dollar Bond repaid in early-November who held it for the full five years received in return for their investment nothing but interest at the 3-month interbank rate plus 1/8 of a percentage point – hardly buccaneering capitalism.

    (I now realise that I have run out of time but may not have adequately addressed your question. I’ll return to it later, if I can.)

  6. @joseph

    If real evidence and documentation exists it is being kept secret. Can you blame foreigners for being just a tad suspicious that it is convenient for bad Irish decisions to be passed off for domestic consumption, as being decisions taken by foreigners and forced on Ireland.

    The Irish strategists may have been out of their depth, unused to market participation and manipulated into just doing what they could tell powerful parties would prefer. However a choice to suck-up is still a choice.

    What is the evidence?

  7. @ grumpy

    “The authors seem to be unaware of the existence of investor compensation schemes which are highly relevant when the financial institution potentially being liquidated only has state ownership as an alternative to liquidation.”

    I don’t follow – could you expand a bit if you have the chance?

    Overall I thought this a very readable, very thought provoking paper by Dr Attinger, willing to address uncomfortable issues, eg:

    “Another characteristic of the banking business is that it is almost entirely confidence-based. As is often emphasised, confidence is a bank’s most valuable asset. Bank runs, triggering a downwards spiral and the erosion of value, may be caused by rumours, anticipated problems or
    the contagious effect of other institutions’ difficulties.”

    The comparison between the UK and German banking acts is very good, concluding:

    “As regards the tools available, the UK legislation establishes a more comprehensive toolbox, contained in the clear structure of the Banking Act 2009. Although the German regime is more scattered, with provisions located in different laws, in substance, it provides for clear resolution powers. Both regimes offer the possibility to transfer assets and liabilities to a private sector purchaser or to a publicly owned bridge bank (transferee), whilst only the UK legislation provides explicitly for a temporary public ownership option. A considerable advantage of the German legislation is that it offers a solution to the financing of resolution measures, establishing a restructuring fund financed by ex ante levies on the private sector which may recapitalise the transferee or grant guarantees in its favour.”

    Which I take it is pushing the as yet unfinished EU model in the GB direction whilst encouraging a privately funded restructuring fund on German lines.

    A quote to emphasise the point:

    “An interesting feature of the German bank restructuring legislation is that it addresses potential funding needs in resolution by establishes a restructuring fund which is intended to stabilise financial markets by overcoming going concern and systemic risks. This fund may set up a
    bridge bank, to which assets and liabilities of an ailing credit institution may be transferred; it may acquire shares in this bridge bank; it may provide guarantees for claims against the transferee (private sector purchaser or bridge bank); and it may recapitalise the transferee, in
    order to pursue an important objective of the German State which cannot be attained otherwise in a better and more economical manner. The restructuring fund is financed via an ex ante levy from the financial sector, which may be complemented by special ex post contributions where
    necessary.”

    All this in the context of:

    “The [EU] Commission has defined the overriding objective of the EU resolution framework to be the notion that ‘ailing institutions of any type and size, and in particular systemically important institutions, can be allowed to fail without risk to financial stability whilst avoiding costs to taxpayers’”

    Very roughly in the case of Ireland, we can see that in the shocking, national and international, absence of such legislation, Ireland has unwillingly taken on board and paid off private banking creditors under pressure from the ECB, in order to maintain as far as possible the stability of the EU banking system (of course we have that in writing, er, don’t we?) to the severe detriment of its tax-payers. With the new system in place it should be possible to look again at the Irish position.

  8. Fergus Boy – all term loans to banks wether Bank bonds or otherwise are a risk or at least should be under the Euro system of low to zero fiscal defecits.

    But the Euro boys were pretty quiet about our fiscal debt production post 2008 because if we did not do that the bond holders would have found it impossible to escape.
    Now they are becoming fiscal conservatives again , funny that.
    The ECB has no interest in the real economy – they are only interested in the rate of extraction , its not even a sustainable rate of extraction.

  9. @ All

    As a layman, it seems to me that the issue is the legal one of avoiding discrimination and the definition quoted of what constitutes such discrimination is one of commonsense and found in many ECJ judgements.

    The legal opinion is a shot across the bows of the Commission (and the Member States that might support its approach) in developing (a EZ-wide?)bank resolution scheme.

  10. I think it is very innocent of people to believe that the Irish governments primary objective at the time of the guarantee was protecting the interests of the citizens. It may have been an aspiration but powerful interest groups also had the ears and pockets of those involved. It is their interests that are at the forefront of the minds of politicians from the ECB and Ireland in times of crisis. Ivan Yeats column in the examiner this morning is an example of this type of cronyism.
    Joseph I am afraid I do not share your optimism that
    “One hopes and certainly expects that there is documentation to support the Irish government position that it should not be forced to pay bondholders in completely bust banks. I would expect that there was more than:
    ‘ a nod is as good as a wink’.”
    We famously heard about the Geithner nod that cost us 20billion. It wouldnt surprise me at all if other important decisions at times of crises are made in ad-hoc ways.

  11. @gavin

    The basic principle is non-discrimination – and the idea that no creditor should receive less than he or she would in a liquidation is unarguably sensible.

    Where it gets murky is when the state becomes involved in effectively subsidising a non-liquidation. At this point, to continue to argue that discrimination is a really really big deal is slightly contrived. Once the state’s involvement starts to provide a benefit to creditors, the fact that the state would be free to compensate some creditors (eg depositors) from resources not derived from a liquidation after such a liquidation, makes discrimination academic.

  12. This just arrived in a reply to me from “Commission Sources”:

    “Thank you for your e-mail. The adoption of the proposal for a EU framework on Bank Recovery and Resolution has been postponed. It should be adopted in the first quarter of 2012. This is due to further ongoing analysis and internal consultation.”

    Boo. As of November it was meant to be out by the end of the year.

  13. @Fergus

    Are you aware that the USA Depositor Preference rule was introduced in 1993 as a result of the late 80’s S&L crisis? The S&L crisis was a classic case of unsound real estate lending, and so is directly relevant to the current situation in Ireland. Introducing a Depositor Preference rule would be a sensible policy response, since government subsidies to senior bond holders should be viewed in the same way as government subsidies for milk or wheat – an anachronism. There are better ways to spend taxpayer money than propping up sheltered industries or compensating financial industry investors for poor investment decisions.

  14. @Joseph Ryan

    1. I should say that I do not entirely accept or entirely reject the proposition that I have put into the mouth of the ECB in my first comment above.

    2. Nor do I believe that the pari-passu point means that no haircut (above that suffered by depositors) could be applied in any circumstances to any bond-holder. I was slightly over-reacting to the rhetoric which would suggest that the pari-passu point was irrelevant.

    3. I agree with you on the documentation point.

    4. I disagree with you regarding interrogation of Kevin Cardiff at that PAC meeting. By the way, I watched that hearing in its entirety, and disagree with the media view that Mr Cardiff acquitted himself badly. (That does not mean that I am a fan of his – I do not have a view yet on his record as a whole).

    5. The PAC hearing was supposed to be, and in fairness to all involved, was focussed on one important point. It became a shambles at times despite this focus. To have introduced another issue would not have been a good use of the time, to put it mildly.

    6. Mr Cardiff and other officials cannot entirely avoid scrutiny on the banking resolution issues, and maybe PAC is the right forum for that. I am not sure that it is.

    7. More generally, I am sure that KC and the others will say that while they proposed, the politicians disposed. I agree that that is an over-simplification and a “cop-out” to some extent at least. However, I would be keen to have the proprieties observed, and to have the Minister either solely or (probably better) accompanied by the officials explain the decisions taken by himself and his predecessor (as to the latter of which the records will, sadly, have to serve as testimony but supplemented by Cowen and Calleary and some others from the previous administration).

    8. Perhaps the PAC’s investigation of the Banking Crisis will feature such testimony. The Terms of Reference for that enquiry are eagerly awaited .

  15. @Bryan G

    1. To take your last point first, it’s accurate in some contexts to describe bonds as “investments”, but the use to which you put that meaning illustrates the limits.

    2. A bond is a loan, not an equity-type investment.

    3. As The Dork of Cork correctly observes, all loans are risky (which is why it is nonsense to describe banking as “essentially a simple business of getting money in and lending it out again”).

    4. A bank deposit is also a loan and an investment. Depositor Preference (“DP”) changes that. It may be sensible, but it does represent an interference with “Nature” and one which has consequences.

    5. I will not dispute with you on the history of DP in U.S. federal law, but I agree that my earlier presentation over-simplified the position.

    6. DP a la 1993, though, is mainly relevant AIUI to deposits uninsured by the FDIC which has been there since 1933.

    7. Your point is valuable, nonetheless, for two reasons:

    a) FDIC coverage is not as comprehensive as many (myself included) suggested

    b) even FDIC “seizures” of banks did not always (pre-1993) preserve uninsured depositors “whole”

    8. The beneficiaries of the Depositor Preference rule are thus, predominantly, larger depositors in less mainstream “banking” institutions. Cue Milton Friedman and his non-relative Jeffrey … 🙂

  16. The key point here is that human rights are being mentioned by a European institution – for the first time that I can think of – in the discussion.

    Whether it was the ECB or, more likely, our own govt that imposed the guarantee on Irish residents and taxpayers it’s still a vital discussion on human and property rights. Did they have the right to pass a commercial debt on to unrelated individuals? So far, legally, they did.

    Could a human rights challenge succeed?

  17. @Hugh
    ‘Could a human rights challenge succeed?’

    Probably not. The EU has not acceded to any UN human rights treaties or agreements and has only acceded to the European Convention of Human Rights and Fundamental Freedoms (CoE http://www.echr.coe.int/ECHR/EN/Header/Basic+Texts/The+Convention+and+additional+protocols/The+European+Convention+on+Human+Rights/). It is one of the anomalies in EU law that the EU requires candidate states to accede to UN and CoE human rights documents in order to join the Union, when the EU is not itself a signatory. Another anomaly is that although the EU has only had observer status (enhanced observers since 2011) at the UN for many years, EU member states usually coordinate their activities in different UN bodies, in many cases under the leadership of the country holding the Presidency of the EU.

  18. @Fergus O’Rourke

    I imagine that the ECB et al will deny that they
    “forced people that were not even creditors of the banks to pick up the tab”.
    I further imagine that they will say that those people decided through their representatives, which included those recently elevated to power, to “pick up the tab” as the alternative to allowing its so-called “pillar banks” to be put into liquidation.
    That was the choice. It was made in Dublin, not Frankfurt.
    Who can show them that this is incorrect ?

    I should preface my response by pointing to the very astute observation made by the Dork above

    But the Euro boys were pretty quiet about our fiscal debt production post 2008 because if we did not do that the bond holders would have found it impossible to escape.
    Now they are becoming fiscal conservatives again , funny that.

    Despite the appalling mess that Ireland made of its economy and its disastrous decision to guarantee bondholders lets pause for a few minutes and take it from there.
    1. The bank guarantee was not a forever guarantee until secula-seculorum. It was a guarantee renewable at six or 12 month intervals.
    2. On each occasion of renewal in the Dail, we have been informed that the ECB is vehemently against senior haircuts and will not ‘allow’ them.
    3. We were lectured on the ECB position by the Lorenzo Bini Smaghi and others, who reminded us that the ECB could (presumably at its discretion) refuse to accept the collateral of all Irish banks and therefore implode the Irish banking system. Some would call this a position statement. I, on the other hand without legal knowledge of the term, would call it blackmail.

    4. The ECB has made no distinction between Pillar banks’ and bust banks for the purposes of its threats. This makes the ECB position on Irish banking indefensible. Irish Pillar banks were not their concern. The ECB position was the naked insistence that bank seniors be paid by the State regardless. The position was unashamed in favour of a particular class of creditor in banks. The ECB insisted that a particular class of creditors be made whole not from bank resources but outside of bank resources. Not only outside of bank resources but by selected country taxpayers outside of bank resources.

    5. Now the ECB has now reduced its collateral requirement for all Euro banks. This is a really interesting matter as (based on my understanding of a Karl Whelan post) funds now being loaned to banks by the ECB under REPO operations will be covered by the ECB in the event of bank failure.
    So we see that when the big European banks need cover the good old ECB steps up to the plate. An interesting development that has not received the attention it merits.

    6. We are of course back to the issue of documentation of the ECB position and evidence of their insistence and threats to the Irish governments. This is a point raised by @Grumpy on several occasions. Perhaps he is doubtful of the existence of written evidence.

    7. I am not doubtful of the existence of evidence as the matter has been commented on the IMF reports in sufficient detail (IMHO) to put the matter beyond doubt. And in sufficient detail to take a case against the ECB as an institution.
    8. What a pity our ‘Gang of Eight’ have not seen fit to concern themselves with the constitutionality of the ECB position both in Irish and European law. The same ‘Gang of eight’ leapt stealth-like from the ditch to intervene in the last constitutional issue that raised it head. But the reputation of some gang members might have been subject to scrutiny if that particular amendment has passed. The ECB insistence that Irish people pay private banks debts in dead banks is clearly causing our ‘Gang of Eight’ no loss of sleep.

    9. I am slightly familiar with creditor seniority ranking in wind-ups and am somewhat aware of the FDIC deposit protection. But again as @Grumpy points out, the fact that a bank is kept afloat by a sugar daddy State, should in common law at least make the case different.

    10. What the State should have done was as follows.
    A. Put Anglo and Nationwide into administration in Sept 2008 and guaranteed the rest for a period of six month.
    B. Put AIB, EBS and PTSB (subsidiary) into administration in 2009 starting a new bank with a 100% refund of depositors funds lost in AIB, EBS, PTSB. As the refund would be outside of the legal entities in administration, the bondholders would have no call on the funds.

    11. In short we should have done an Iceland.

    12. Now generations of Irish will pay these reparations, because that is what they are.
    The ECB, German and French position was not unlike that of Clemenceau at Versailles
    ‘When the goose is on the table, you don’t ask her how she would like to be plucked’.

    13. I do hope that somebody will take a case to the European Court of Justice. Colm McCarthy has argued at length that sovereign bondholders have been seriously affected at ECB insistence. Further, depositors (right throughout the EZ) have been downranked by the ECB policy. Perhaps some pension fund that has lost money on Ireland will take a case. I hope they do.

    In summary the ECB position is that because we as householders left the house doors open, we should allow all who entered the house to make off with the contents and we should not be allowed stop the looting because of our own negligence in not securing the house doors in the first place.

    It would make an interesting case at the European Court of Justice.
    Even though European Justice has become a 21st century oxymoron, just as it was in previous centuries.

  19. @Joseph Ryan et al.

    I think Philip L. was just having some festive fun with this posting, by giving the impression that there was an ECB paper that used human rights principles to support the ECB’s position. In fact the paper is quite taxpayer friendly, and argues that parri passu should not necessarily apply, provided that there are objective criteria used to discriminate, and that it is in the public interest to do so. It would be good if the paper were in fact an ECB paper per se, but it just represents the views of the author.

    As pointed out by Gavin K. above, the paper argues for combining the better parts of the UK and German special resolution regimes and extending them to include the still untackled areas of complex legal group structures and cross-border bank resolution. The EU Commission appears to be a weak point here, with delay after delay, and it is still only at the “framework” stage. I suspect the real ECB decision makers oppose the principles described in this paper, and are, with other vested interests, trying to ensure that any EU-level resolution regime is watered down and far more bank-friendly.

  20. @Fergus

    It is accurate to describe senior bonds as investments in all contexts. This is what the banks themselves describe them as. For example for Anglo senior bonds:

    Anglo currently believes that the factors described below represent the principal risks inherent in investing in Notes, but this Base Prospectus does not describe all the risks of an investment in Notes….

    and then goes on to list the following

    – Anglo’s results may be adversely affected by general economic conditions and other business conditions
    – Liquidity risk may impair Anglo’s ability to fund its business and make timely payments on the Notes
    – Anglo’s credit ratings may not reflect all the risks of an investment in the Notes
    – Anglo’s hedging strategies may not prevent losses
    – Anglo’s derivative counterparties may not honour their contracts
    – Competition may adversely affect Anglo’s income and business
    – Systemic risk could adversely affect Anglo’s business
    – etc. etc.

    Senior bondholders cannot say they were not warned. By applying to purchase the bonds they explicitly agreed that they understood the risks. Perhaps the ECB would prefer a revised Prospectus with all this stuff replaced by

    – You’ll get back all your money in full and on time, no matter what sort of mad or bad things Anglo may do with your money. The ECB guarantee to make it so.

  21. @joseph ryan

    1. My point in this discussion is not to defend everything that the ECB has done or is doing, but to question the implication that Irish decisions have played no part and/or were sub-optimal because the ECB was putting our decision-makers in an impossible position.

    2. The ECB and the defective Eurozone architecture is not something that was imposed on us unwillingly. Au contraire, we were to the fore in the project (a.k.a. The Project) and the line being taken by many suggests that we would repeat the same mistakes again in that respect.

    3. Which “case against the ECB as an institution” do you see ?

    4. I cannot make sense of all your ‘Gang of Eight’ remarks without your answer to the latter question. However, your point about scrutiny makes no sense: what is inhibiting scrutiny of the individuals in question ? And I would be very surprised if some of the gang, as you call them, do not regularly lose sleep as a consequence of consideration of their roles over the last number of years. Why ever do you think otherwise ?

    5. I don’t understand your point about the “sugar daddy State”. What the common law has to do with it I cannot imagine.

    6. At your point 10, you say “what the State should have done”. Indeed, but it did not. That is partly my point.

    7. I do not agree that “we should have done an Iceland”, or that what you suggest would ahve been the same. By the way, it is often neglected that Iceland has agreed to pay something to its bank creditors. Strange, that

    8. “Now generations of Irish will pay these reparations”, you say. I predict that we will not.

    9. You say “In summary the ECB position is that because we as householders left the house doors open, we should allow all who entered the house to make off with the contents and we should not be allowed stop the looting because of our own negligence in not securing the house doors in the first place.” I say: We can *still* put our banks into liquidation. Maybe we shouldn’t, but be that as it may, it seems that we won’t. *We* won’t.

    10. “European Justice has become a 21st century oxymoron, just as it was in previous centuries.” Whereas perfect justice has been more nearly achieved… um , where ?

  22. @FergusORourke 201112230851
    You say a deposit is also a loan, but in Ireland, under 18’s are allowed make deposits but not allowed enter into loan agreements, contradicting this statement.

  23. @Carawaystick

    1. I am unclear as to the legal basis for your assertion that “under 18’s are…not allowed [to] enter into loan agreements”. My understanding is that it is less straightforward.

    2. I make the point at 1 solely so that people are not misled into thinking that a 17-year-old who lends his younger brother €100 is somehow technically committing a criminal offence.

    3. It is probably accurate to say that, in Irish law, a deposit is not a loan, at least for the purpose of laws and regulations which govern lending. A deposit, nevertheless, is IMHO clearly a loan in at least some senses of that word, and you can take it that I was using the word in one of those senses ! 🙂

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