Daniel Willam works in Treasury Regulation at Deutsche Bank and looks after all resolution related matters, including MREL / TLAC, valuations, bail-in operationalization, and rating methodologies as well as the analysis and implementation of other structural reform projects.
Bail-in is one of the key bank resolution tools provided for in the European legal framework in case of a bank failure. This happens not via a rescue from a government via a capital injection (“bail-out”) but by converting outstanding debt into equity, therewith forcing holders of the bank’s debt to bear the burden (“bail-in”).
Bail-in operationalization is the term for preparing the processes, data and mechanisms to make the execution of bail-in possible. While the legal framework has been established and regulators have been in discussions with banks to set up resolution plans based on bail-in, the actual bail-in process has not been tested in its entirety. The particular challenges of bail-in operationalization are:
- Very condensed execution timeframe: it is expected that the process for the recapitalization of a bank happens over a very short period of time, ideally over the so called “resolution weekend”
- Precise preparation: since bail-in must work already in its first application for any given bank (which should hopefully actually never happen), all process steps needs to be prepared and documented upfront, with little to no room for ad-hoc solutions
- Lack of precedents and standards: as a full-fledged bail-in has not been tested yet, there is little practical experience and hence still a need to develop actual concepts and market standards for banks and other involved parties
- Wide range of topics: the entire preparation spans diverse topics such as data availability and IT solutions, financial information and valuation approaches, internal systems for booking debt and equity, or settlement systems for shares and bonds; each requiring experts in the respective field
- Involvement of many parties: apart from the bank and the resolution authority itself, several external counterparties need to be involved, including an independent valuer for the valuation process, and financial market infrastructure providers for the write-down of bonds and the creation and delivery of shares (e.g. paying agents and central securities depositories (CSDs))
- Number of affected instruments: for a large bank with market based funding, there can easily be hundreds of affected instruments, including hybrid capital, subordinated debt and senior unsecured bonds, both in large benchmark format or private placements
Deutsche Bank has come up with a holistic approach to bail-in operationalization. This breaks down the preparation into the steps required for the actual execution of a bail-in. Each process step then represents a separate workstream and project on its own. The identified workstreams are:
- Reporting: creating a dedicated IT tool for reporting and calculations of liability data at resolution
- Financial valuation: setting up a framework and systems needed to determine the balance sheet and loss at the resolution date within 24 hours
- Economic valuations: defining the value to be allocated to the liability holders, the number of shares and the share price
- Internal execution: writing down debt instruments in internal systems, recognizing balance sheet capital and re-hedging internal swaps
- External execution: using financial market infrastructure to write down bonds in investors’ securities accounts, creating new shares and allocating them to investors
- End-to-end planning: documenting each process step and ideally automating all or parts of them via IT solutions
Most of these workstreams have sub-streams and topics which are only linked because they all play into the bail-in processes. The internal bank project involves experts from front to middle and back office functions, and needs to be run in alignment with the respective resolution authority. Such programme can take up 1-2 years even with a full fledged project infrastructure.
Given these tremendous challenges, it is questionable how smoothly a bail-in could be executed for any given bank within the coming years. The establishment of certain standards and potentially some actual experiences of applying a bail-in should hopefully facilitate the operationalization of bail-in going forward.
Daniel joined the RiskMinds Regulation Digital Week to discuss how to find right set up of data, processes and external counter parties for bail-in operationalisation. Watch the webinar here.