«They say things are happening at the border, but nobody knows which border» (Mark Strand)
by Vincenzo Troiano
Abstract: the BRRD contributes to the establishment of the new EU regulatory framework on the measures to be adopted for the prevention and early intervention in the event of financial instability of credit institutions, which is a matter that stands at the crossroad between prudential supervision and resolution interventions. This article focuses on the analysis of substantive and procedural aspects relating to the drawing-up and approval of “recovery plans” in their role of preparation instruments established under BRRD as well as governance arrangements of banks under the meaning of the CRD 4. The analysis aims also at highlighting the distinction and similarities of “recovery plans” with the “resolution plans”, i.e. the other main preparation instrument provided for in the BRRD. Only time and practice will allow a detailed assessment of the relevance and effectiveness of the preparatory and preventative instruments provided for by the BRRD. However, at the moment it is already clear that “recovery plans” will play a key role in the improvement of corporate governance arrangements and will foster the development of a new culture of risk management in banks and financial companies.
Summary: 1. Preliminary remarks. – 2. Instruments for preparing for recovery and resolution: distinctions and continuity. – 3. Recovery plans as governance arrangements. – 4. Contents of recovery plans. – 5. Approval and assessment of the plan. – 6. Conclusions.
1. The area of recovery plans falls under the broader framework of prevention and early intervention in the event of situations of financial instability affecting credit institutions, which was subject to close attention in the wake of the 2008 financial crisis. This area, which serves as an interface, in light of its positioning within the system, between prudential supervision instruments and resolution instruments, is characterized by the latent ambiguities intrinsic in such framework: this applies with regard to both the link (that is established in this context) between competent and resolution authorities, as well as the identification of compatibility of injunctive measures which regulatory authorities may imposed during the plan assessment phase with principle of the freedom to conduct a business. I will first analyze recovery plans in the context of the preparation instruments established under directive 2014/59/EU, known as the BRRD, delineating distinctions and continuity with respect to resolution plans, another preparation instrument governed by the same EC legal base. Then I will analyze recovery plans as governance arrangements of banks, and later analyze more closely the substantive aspects of the above-mentioned plans and criteria for assessing and approving such plans. As for the method followed in this article, reference will be made exclusively to the BRRD, since it is quite clear, in consideration of the authorities involved, that all of the rules deriving from the application of the Single Supervisory Mechanism (and therefore of the role of the ECB with respect to intermediaries exceeding the relevant threshold and eventually also those below the threshold) and the Single Resolution Mechanism (with regard to the structure of the resolution authority) will apply. On the other end, the matters subject to analysis will be addressed individually, given that the relevant legal framework sets forth distinct provisions applicable to group plans, without such circumstance giving rise to any substantive implications with respect to the analysis.
2. The directive, drawing from the experience of the financial crisis, aims at establishing a credible recovery and resolution framework for credit institutions, in order to prevent to the extent possible the need to intervene with rescues of credit institutions using taxpayer funds; it aims at preventing insolvency and, in the event of insolvency, to reduce its adverse impacts. The improvement of the capital adequacy and prudential instruments provided by CDR IV should reduce – in the hopes of European lawmakers – the likelihood of future crises; however, the risk that credit institutions may face difficulties cannot be considered eliminated. With this risk in mind, there was a need to endow authorities with a set of instruments that allow for interventions that are sufficiently early and rapid for intermediaries facing financial crises or instability. The focus placed by the lawmakers upon the preparation and planning of interventions to be implemented in case of unfavorable circumstances is considerable. The early analysis of possible adverse scenarios and measures that may be taken if such adverse scenarios were to materialize, should serve as a safeguard to protect the functioning of the system as a whole (including various actors consisting of entities and competent and resolution authorities) to react quickly and early upon the emergence of situations of instability. While this, from a functional standpoint, constitutes the main feature of the “preparation phase”, it should be noted that such phase will have to be structured differently depending upon whether it is aimed at preparing the recovery of the entity in difficult or the resolution of the crisis faced by the entity. The directive indeed identifies two separate measures comprising the preparation phase, revolving around recovery plans and resolution plans: the former contain measures aimed at restoring the financial situation of an entity after a significant deterioration of the same; the latter include resolution actions that the competent authority may implement when the entity meets the conditions for resolution provided under the directive.
The two instruments differ in several respects: the most important distinctions regard (i) the entities responsible for the drawing up of the plans; (ii) the authorities involved in the drawing up and approval process; (iii) more generally, the systematic role of the two instruments.
On the drawing up. Recovery plans are drawn up by credit institutions (it is true that the directive envisages dialogue during the plan preparation and assessment phase, but the plan remains an instrument that is drawn up and approved by the lending institution); on the contrary, the resolution plans are drawn up by the competent resolution authority, the entity subjected to the plan does not play an active role (at least in principle), but rather is explicitly subjected to significant obligations to report to and cooperate with the authority in charge of preparing the resolution plan. This differences in structure with regard to the responsibility for drawing up the plans shows that, in the event of recovery, precedence was given to the autonomy of the concerned enterprise in assessing, in a forward-looking manner, the appropriate responses to deterioration in its financial condition; on the other hand, in the case of resolution, precedence is given to the public interest underlying the orderly management of crises, also considering the possible systemic impact of the same.
As for the authorities that take part in the plan adoption phase, the competent authorities of the individual entities that have prepared the recovery plan are the ones to carry out the assessment on the adequacy of the plan (in this regard, the role of the resolution authorities is limited to the possibility of formulating recommendations to the competent authority with regard to those actions envisaged under the plan that could have an adverse impact during a possible resolution phase); the resolution plan is – on the other hand – directly implemented by the entity’s resolution authority (and, in this case, the competent authority’s position is limited to cooperation with the resolution authority in gathering information necessary for the preparation of the plan).
It is clear from the foregoing considerations, with regard to the systematic role of the two instruments being compared, that recovery plans fall more clearly under the supervisory area, whereas resolution plans fall within the area of crisis management or resolution.
The recovery plans are positioned intrinsically within the ambit of ex-ante tools, as instruments through which a default may be prevented by imposing measures to be implemented in order to stabilize the financial situation of a bank; resolution plans are positioned conceptually within the ambit of ex-post tools, as corrective measures to be taken if a default becomes inevitable.
That said, it is worth noting that recovery plans, if they pertain to an entity that is not facing financial difficulties, nonetheless plan the measures to be implemented in order to overcome a hypothetical situation of deterioration; conceptually, they fall on the border between the areas of prudential supervision and crisis management. All of the foregoing occurs within and overarching context that does mark a clear line between the two areas and, in fact, tends to bring forward the assessments typical of a crisis situation to a much earlier moment, while from a different perspective, it creates authorities that have to remain separate, if not from a subjective standpoint, at least from a functional standpoint. The institutional and functional structure introduced by the directive (as supplemented by the Single Supervisory and Single Resolution mechanisms) must lead to the consolidation over time of roles and responsibilities, which to date has not been thoroughly defined.
A last remark, with regard to the system, concerns the significant role assigned to the EBA in this area. If we focus our attention solely on recovery plans, the EBA is called upon to prepare draft regulatory technical standards, for example, to define the criteria for the assessment of the systemic impact of the failure of an institution (which is relevant for purposes of eventually simplifying the obligations to prepare the plan), to specify the information to be included in the plans, to define the criteria for assessment of plans prepared by banks. It is also called upon to issue guidelines in order to define the range of stress scenarios to be considered in the preparation of plans. It results a varied and robust set of responsibilities aimed at achieving the objective of ensuring a uniform structure comprising the various authorities in charge of applying the new legal framework.
3. The directive indicates that recovery plans are to be considered a governance arrangement under art. 74 of CDR IV (directive 2013/36/EU). The provision of CRD IV just cited already envisaged the fact that the competent authorities ensured the drawing up by banks of recovery plans aimed at restoring their financial situation following a significant deterioration. The BRRD, moreover, expressly qualifies the plans in question as governance arrangements and, therefore, from a standpoint of prudential oversight, the drawing up of such plans, their implementation, monitoring periodic updating and so forth fall squarely under the legal framework of the CDR IV with regard to governance arrangements.
As known, governance arrangements consist of all those mechanisms, procedures, processes, technical means, organization of such factors, remuneration policies, aimed at collectively achieving and ensuring the governance and internal functioning of a bank. All of this is accomplished through an overarching structure that ensures the effective and prudent management of the bank and, in particular, the risks to which it is exposed. Considered from this perspective, namely as a governance arrangement, the recovery plan (rectius, its adoption) becomes a key instrument through which one of the main functions assigned by the EU to management body of credit institutions is exercised. The management body is assigned with general responsibility over the bank, approving and overseeing, inter alia, the implementation of its risk strategy (this has already led to the management body’s exposure to the adoption of banks’ Risk Appetite Framework). Within this context, the approval of the recovery plan, especially in consideration of the contents that such plan will have to have, constitutes an exercise in which the management body will have to demonstrate thorough awareness of the bank’s position and all of the circumstances that may jeopardize its stability. In performing such exercise, the management body may also decide to adopt measures immediately, aimed at reducing the identified sources of exposure to potential risk and underlying the scenarios envisaged under the plan. Construed in these terms, the approval and update of recovery plans may constitute an element of discipline in the performance of the duties of the management body regarding the bank’s policies on the control of the exposure to risks.
On another front, the particular depth of the analysis required during the assessment of recovery plans confirms the need, that has for some time been noted in the legal framework applicable to the sector, to enhance the qualitative composition of boards of directors: in this sense, the depth of knowledge and diversified areas of specialized expertise constitute, for the management body as a whole, a fundamental requisite in order to be in a position to effectively fulfill the management body’s duties of examining and approving the plans in question.
4. The directive sets forth, in an Annex thereof, the information to be included in the recovery plans. Such information constitute the minimum set of indications for the preparation of plans by entities of systemic importance (rectius: for entities subject to direct supervision on the part of the ECB or those that represent a significant part of the financial system of their home member state).
The national authorities may supplement this minimum set of information, and may also proceed, with regard to entities other than those of systemic important, to simplify the information to be included in plans and the timetables for updates and revisions to the same.
This is a particularly broad power which is dependent upon the satisfaction of a number of general criteria set by the directive: this is in order to ensure that the obligation to prepare recovery plans is applied appropriately and proportionately, minimizing the administrative costs related to the preparation of such plans.
In reality, the criteria identified by the directive are extremely broad in scope. In order to allow the simplification, competent authorities must assess the potential impact that the failure of the concerned entity could have on the financial markets, other entities and lending conditions as well as the economy in general. Such assessment, in turn, should be conducted taking into account, inter alia, the type of business pursued by the entity and the complexity of the same (including the performance or not of investment services), its shareholding structure, legal form, risk profile, size, legal status and interconnections between the entity and other entities or with the financial system in general, whether or not it belongs to an institutional protection system or other systems of mutual solidarity for cooperative credit institutions.
From a standpoint of contents, in addition to the disclosure set forth in the Annex to the directive, recovery plans (i) must not assume access to or receipt of extraordinary public financial support, (ii) must include any measures that the entity may adopt in the event that conditions are met for an early intervention within the meaning set forth in article 27 (and, in other words, the breach or risk of breach of one of the requisites established under the “CDR IV package”: directive 2013/36/EU and EU regulation no. 575/2013); (iii) must indicate the procedures to ensure the timeliness of the recovery actions planned.
In addition, recovery plans must indicate the measures that entities will be required to take to restore their financial situation following significant deterioration; they must be detailed and based upon realistic scenarios, applicable in a series of (valid and rigorous) situations of serious macroeconomic and financial stress pertaining to the specific situation of the entity (and including event of a systemic nature and specific stress event for individual legal entities and groups), and include the set of indicators, of a qualitative or quantitative nature, established by the entity and the circumstances in which the actions indicated in the plan may be implemented.
The breadth of simplification powers and the importance of detailed data needed in the definition of the required indicators and stress scenarios may theoretically lead to an effective risk of substantial fragmentation in the regime applicable to entities in different jurisdictions; this justifies the assignment to the EBA of the power to issue guidelines or draft regulatory technical standards, related to various aspects pertaining to the drawing up of the plans: this applies, for example, as regards the criteria to be used to assess the impact of the failure of one entity on the financial market, other entities, and lending conditions; or with regard to the scenarios to be used and the list of quantitative and qualitative indicators.
In cases in which the instrument to the used by the EBA consists of guidelines, the lack of binding value which is inherent in such instrument opens the door to the risk of an incomplete harmonization as regards the drawing up of the plans.
5. The recovery plan prepared by the competent bodies of bank, based upon its ordinary governance mechanisms, is subject to review and approval by the bank’s management body, before being submitted to the competent authority. The recurring reference to the fact that the management body must examine the draft plan for approval is an indication of the need of its full involvement in analyzing the contents of the plan.
The management body’s review is not merely procedural (i.e. for compliance with the internal process for the preparation of the plan), or aimed at assessing its completeness (i.e., to verify that the plan effectively contains the required information, the scenarios envisaged under the directive, the indicators, that will later be agreed at the time of its assessment), but rather also focuses on the matter of the various choices set forth in the document, with regard to both the establishment of the scenarios and the qualitative and quantitative indicators, and the measures that are planned to be activated upon the occurrence of the circumstances envisaged under the plan. From this latter standpoint, the measures may include instruments or initiatives (albeit merely planned) that also affect the bank’s strategic decisions, which must necessarily be submitted to the board of directors for approval. In these terms, the configuration of the recovery plan as a governance arrangement of the entity is plain to see.
Once approved, the plan is subjected to a “complete assessment” by the competent authority which has to verify its thoroughness and capacity to restore the solvency of the entity in a timely manner, including during periods of serious financial stress.
In particular, the assessment performed by the authority is aimed, on the one hand, at verifying that the contents of the plan meet the content-related requisites established by the directive; on the other, it is aimed at certifying the reasonable likelihood that the implementation of the provisions proposed in the plan preserves or restores the economic sustainability and the financial condition of the entity (taking into account the preparatory measures that the entity has taken or intends to take), and that the operating options contained therein work quickly and effectively in situations of financial stress (avoiding to the extent possible material adverse effects on the financial system, including in scenarios that would lead other entities to implement recovery plans in the same period).
In making such assessment, the competent authority has to take into consideration the capital adequacy and the funding structure of the entity compared to the level of complexity of the organizational structure and the risk profile of the same entity.
The assessment phase is an interactive process: if the authority finds that the plan presents material deficiencies or that its implementation is subject to material impediments, it formally notifies such assessment and asks the entity to present (within two months) an amended plan that indicates how it is remedying such deficiencies or impediments. If the amended plan is also found to be inadequate to remedy the deficiencies and impediments, the competent authority may direct the entity to make specific amendments, setting a deadline for remedying the deficiencies or impediments to the plan’s implementation.
In the absence of the foregoing, the competent authority may force the entity to take the measures considered necessary and proportionate, taking into account the seriousness of the deficiencies and impediments and the effect of the measures on the entity’s business operations. Taking into account the principle of proportionality, the measures in question may, inter alia, concern a reduction in the entity’s risk profile; the activation of recapitalization measures; the re-examination of the entity’s strategy and structure; and the modification of the governance structure.
The inclusion of an obligation for an entity to modify its plan with interventions that may concern the structure or governance of the entity may have a general impact upon the freedom to conduct a business guaranteed by article 16 of the EU Charter of Fundamental Rights; it should be recalled in this regard that at the time of drafting the recovery plan, the entity in question is not in a state of financial deterioration, but is rather preparing and planning actions and remedies for the possibility that certain adverse events may occur, which are credible but not necessarily probable. The directive, indicates that such limitation would be in line with the provisions of art. 52 of such Charter: this is due to the fact that the limitation in question would be necessary (in order to meet the objectives of financial stability and, in particular, to reinforce the entities’ business operations and prevent them from growing too quickly or assuming excessing risks without being in a position to address difficulties and losses and to restore a capital base) and proportionate (because it allows for preventative action of a nature and scope necessary to remedy the deficiencies) .
Obviously, such compatibility pertains to the introduction of provisions to the EU legal framework that enables the competent authorities to take measures of such type. The same criteria of strict necessity and proportionality must necessarily constitute the criteria for checking the lawfulness of the exercise by public authorities of the power to impose injunctions (as provided for in the directive), that in light of the compliance of such powers with the freedom to conduct a business guaranteed under art. 16 of the EU Charter of Fundamental Rights.
As for responsibility, it is fair to consider that the approval of supplementary and replacement measures required by the authority also rests with the management body, like the adoption of the plan.
One last remark has to be made on the role of the management body on this matter, drawing from the legal framework set forth in article 9 of the directive, related to the activation of the measures envisaged under the plan, upon the occurrence of circumstances covered by the qualitative and quantitative indicators included in the plan. In such regard, the directive expressly provides that the entity may take action in the context of its recovery plan also when the pertinent indicator has not been satisfied if the entity’s management body deems it advisable under the circumstances or, alternatively, may refrain from taking action when the entity’s management body does not consider such action advisable under the circumstances.
In the cases the management body’s decision is doubtlessly highly important, since it is in practice deviating from what provided in the plan. It goes without saying that a decision by the management body not to implement what provided in the plan, resulting in a worsening of the entity’s financial situation (eventually triggering even the adoption of early intervention measures), may end up exposing the management body to potential claims and criticisms from various sources (in addition to the authority, which could initiate supervisory actions even in the event of a decision not to proceed in accordance with the plan, shareholders and creditors may also have an interest in raising claims).
6. Concluding remarks regarding a legal framework that is still at such a preliminary stage must necessarily be limited to pointing out that only time and practice will enable an assessment of the relevance and effectiveness of the preparatory and preventative instruments in question; nonetheless it can certainly be concluded from the very outset that these are instruments that are destined to play a key role in the improvement of corporate governance arrangements and mechanisms for fostering a culture of risk awareness and control at the level of banking and financial companies.
 See Recital (11) BRRD, according to which “In order to ensure consistency with existing Union legislation in the area of financial services as well as the greatest possible level of financial stability across the spectrum of institutions, the resolution regime should apply to institutions subject to the prudential requirements laid down in Regulation (EU) No 575/2013 of the European Parliament and of the Council and Directive 2013/36/EU of the European Parliament and of the Council. The regime should also apply to financial holding companies, mixed financial holding companies provided for in Directive 2002/87/EC of the European Parliament and of the Council (3), mixed-activity holding companies and financial institutions, when the latter are subsidiaries of an institution or of a financial holding company, a mixed financial holding company or a mixed-activity holding company and are covered by the supervision of the parent undertaking on a consolidated basis. The crisis has demonstrated that the insolvency of an entity affiliated to a group can rapidly impact the solvency of the whole group and, thus, even have its own systemic implications. Authorities should therefore possess effective means of action with respect to those entities in order to prevent contagion and produce a consistent resolution scheme for the group as a whole, as the insolvency of an entity affiliated to a group could rapidly impact the solvency of the whole group.” See, inter alia, Babis, European Bank Recovery and Resolution Directive: Recovery Proceedings for Cross Border Banking Groups, University of Cambridge, Faculty of Law Research, Paper no. 49, 2013, p. 4 et seq.
 More in general, see Recital (5) BRRD: “a regime is therefore needed to provide authorities with a credible set of tools to intervene sufficiently early and quickly in an unsound or failing institution so as to ensure the continuity of the institution’s critical financial and economic functions, while minimising the impact of an institution’s failure on the economy and financial system. The regime should ensure that shareholders bear losses first and that creditors bear losses after shareholders, provided that no creditor incurs greater losses than it would have incurred if the institution had been wound up under normal insolvency proceedings in accordance with the no creditor worse off principle as specified in this Directive. New powers should enable authorities, for example, to maintain uninterrupted access to deposits and payment transactions, sell viable portions of the institution where appropriate, and apportion losses in a manner that is fair and predictable. Those objectives should help avoid destabilising financial markets and minimise the costs for taxpayers”.
 See Art. 5 BRRD.
 See, inter alia, Amorello – Huber, Recovery planning: a new valuable corporate governance framework for credit institutions, in Law and Economics Yearly Review, 2014, p. 314; John – Litov – Yeung, Corporate Governance and Risk Taking, in The Journal of Finance, Vol. 63, Issue 4, 2008, p. 1679 – 1728 et seq.; Laeven – Levine, Bank Governance, Regulation, and Risk Taking, in NBER Working Paper No. 14113, 2008; Stulz, Governance, Risk Management, and Risk-Taking in Banks, in ECGI Finance Working Paper No. 427/2014, 2014.
 In particular, according to Recital (14) BRRD: “Authorities should take into account the nature of an institution’s business, shareholding structure, legal form, risk profile, size, legal status and interconnectedness to other institutions or to the financial system in general, the scope and complexity of its activities, whether it is a member of an institutional protection scheme or other cooperative mutual solidarity systems, whether it exercises any investment services or activities and whether its failure and subsequent winding up under normal insolvency proceedings would be likely to have a significant negative effect on financial markets, on other institutions, on funding conditions, or on the wider economy in the context of recovery and resolution plans and when using the different powers and tools at their disposal, making sure that the regime is applied in an appropriate and proportionate way and that the administrative burden relating to the recovery and resolution plan preparation obligations is minimised. Whereas the contents and information specified in this Directive and in Annexes A, B and C establish a minimum standard for institutions with evident systemic relevance, authorities are permitted to apply different or significantly reduced recovery and resolution planning and information requirements on an institution-specific basis, and at a lower frequency for updates than one year. For a small institution of little interconnectedness and complexity, a recovery plan could be reduced to some basic information on its structure, triggers for recovery actions and recovery options. If an institution could be permitted to go insolvent, then the resolution plan could be reduced. Further, the regime should be applied so that the stability of financial markets is not jeopardised. In particular, in situations characterised by broader problems or even doubts about the resilience of many institutions, it is essential that authorities consider the risk of contagion from the actions taken in relation to any individual institution.”
 See Art. 7 – 8 BRRD.
 See Art. 9 BRDD.
 In particular, see the final report by EBA on “Guidelines on the minimum list of qualitative and quantitative recovery plan indicators” (6 May 2015), identifying the minimum qualitative and quantitative indicators that institutions should include in their recovery plans.
 See art. 6 et seq. BRRD.
 In particular, according to Recital (21) BRRD: “it is essential that institutions prepare and regularly update recovery plans that set out measures to be taken by those institutions for the restoration of their financial position following a significant deterioration. Such plans should be detailed and based on realistic assumptions applicable in a range of robust and severe scenarios. The requirement to prepare a recovery plan should, however, be applied proportionately, reflecting the systemic importance of the institution or the group and its interconnectedness, including through mutual guarantee schemes. Accordingly, the required content should take into account the nature of the institution’s sources of funding, including mutually guaranteed funding or liabilities, and the degree to which group support would be credibly available. Institutions should be required to submit their plans to competent authorities for a complete assessment, including whether the plans are comprehensive and could feasibly restore an institution’s viability, in a timely manner, even in periods of severe financial stress”.
 See Art. 16 of the Charter of fundamental rights of the European Union: “Freedom to conduct a business in accordance with Union law and national laws and practices is recognised”.
 See Recital (24) BRRD.
Vincenzo Troiano is Full professor of Financial Markets and Intermediaries regulation and Insurance Law in the Department of Economics of the State University of Perugia. He is a partner at Chiomenti Studio Legale since 2006, where is the Head of the Regulatory Department. He is Academic Member of the European Corporate Governance Institute. He is member of the Editorial Board of “Law and Economics Yearly Review” and of the Scientific Committee for the Evaluation of “Rivista Trimestrale di Diritto dell’Economia”. He is member of the Consultative Working Group of ESMA’s Investor Protection and Intermediaries Standing Committee. From 1989 to 2000 he has been working at the Bank of Italy, initially in the banking supervision department and lately as a lawyer in the Legal Service. He has been Visiting Scholar at Columbia University, School of Law (2011) and Honorary Research Fellow at University College London, Department of Laws (2001). He is the author of numerous publications (monographs, essays, articles, commentaries, research papers) on EU and Italian banking and financial regulation, securities regulation, company law, insurance law and the regulation on payment systems.