## cr17259 ## Source details **Canonical URL:** [cr17259](https://www.imf.org/-/media/files/publications/cr/2017/cr17259.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17259.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17259.pdf.json) --- ### Executive summary — introduction and scope - Technical Note analyzes bank failure mitigation and resolution regime, and arrangements for managing a financial crisis, in Luxembourg. - Findings summarize the FSAP mission undertaken during the period November 29–December 14, 2016. - Focus areas: supervision of recovery planning by banks; early intervention powers; resolution planning; institutional and legal framework for bank resolution and financial safety nets; preparedness for a potential system-wide crisis. ### Banking industry landscape — key aggregates and functions - Investment fund and money market industry: €3.8 trillion in assets under management or 72.2 times GDP. - Banking industry: €747 billion in assets or 14.3 times GDP. - Insurance industry: €205 billion or 3.9 times GDP. - Banking sector functions: - Domestic retail and commercial banking (small number of banks; dominate local mortgage market). - Investor services to Luxembourg-domiciled international investment funds (safekeeping/custody, fund accounting, transfer agent services). - Private wealth management. - Intragroup liquidity management and treasury services. - Ownership and structure: - 144 banks domiciled in Luxembourg. - Five are domestically owned (accounting for 7 percent of industry assets), including two wholly state-owned banks. - One bank is a financial market infrastructure (FMI) that clears and settles international payments and securities transactions and offers related securities depository services globally. ### Institutional arrangements and governance - Luxembourg is part of the euro area “Banking Union”: - ECB has exclusive competence to directly supervise significant institutions (SIs). - CSSF, under the oversight of the ECB, directly supervises less significant institutions (LSIs). - Bank resolution competences are shared between the Single Resolution Board (SRB) and the CSSF. - Legal and structural changes: - BRRD and DGSD were transposed in late 2015 via the Law of 18 December 2015 (the 2015 Law), introducing a new resolution framework and a public deposit insurance scheme. - A Resolution Board and the Depositor Protection Council were established within the CSSF to carry out resolution and administer the deposit insurance scheme respectively. - Staffing and conflicts of interest: - The Resolution Department had 10 staff at the end of 2016; expected to increase to 13 by the end of 2017. - CSSF conducts operational tasks related to resolution via its Resolution Department and has increased staffing, but additional increases are recommended given workload. - Supervision and resolution functions are structurally separated within CSSF; supervision and deposit insurance functions are not fully separated: the Director responsible for the Banking Supervision Department is also Director responsible for the Depositor and Investor Protection Department (PDI) and chairs the CPDI. - Recommendation: develop structural arrangements to address potential conflicts of interest between supervisory and deposit insurance functions; continue staffing Resolution Department. ### Recovery planning and early intervention — status and findings - Recovery planning: - CSSF began implementing recovery planning requirements in 2013. - All banks have submitted at least initial recovery plans; CSSF (for LSIs) or ECB (for SIs) have formally provided feedback and recommendations for improvements. - Most more significant banks have submitted revised plans. - Timeline and submissions: - By year-end (2013), four banks had submitted initial recovery plans. - Two other banks submitted initial plans by February 2015. - By July 2015, nine additional LSIs had submitted initial plans. - An additional 27 LSIs submitted initial plans by the end of 2015. - Five LSIs had not passed the initial quick completeness check when submitting their first recovery plan and were requested to re-submit within the 2-month extendable period. - Assessment quality: - Thus far, no "material deficiencies" have been identified in the plans. - Early intervention: - Triggers and powers are adequate. - Intrusiveness of measures increases gradually from requiring additional capital and liquidity to intervention in management by appointing a temporary administrator. - Early intervention measures available include requiring additional capital and liquidity, implementing recovery plan measures, drawing up an action plan, negotiating debt restructuring, changing business strategy and legal or operational structure, removing management, appointing a temporary administrator, and write down and conversion of capital instruments (common equity Tier 1, additional Tier 1 or Tier 2). ### Resolution regime and planning — tools, gaps, and cross-border issues - Resolution planning status: - Planning is at an early stage with many challenges ahead. - Resolution plans for the largest banks are being developed by the SRB and the CSSF Resolution Department; CSSF is preparing plans for the most important LSIs. - Resolution planning began in 2015; initial plans have been reviewed by the SRB where appropriate. - Under SRB leadership, revised plans for most large banks have been finalized recently or will be prepared in 2017. - Principal resolution tools transposed into Luxembourg law (2015 Law): - Bail-in tool. - Sale of business tool. - Bridge institution tool. - Asset separation tool. - Supporting powers such as appointment of a special manager and imposing stays on rights to terminate contracts or execute collateral. - Preferred tools and gaps: - Current plans for banks likely to meet the “public interest test” focus on using bail-in to absorb losses and recapitalize a bank in resolution. - Means to use other resolution tools (sale of business tool, bridge bank tool) have yet to be well addressed. - Means to ensure adequate liquidity funding in resolution have not been well addressed. - Concern: bail-in alone may not be sufficient to resolve a bank; work on alternative tools and liquidity arrangements should be accelerated. - MREL and operationalization: - MREL components: (i) loss absorption component; (ii) recapitalization component; (iii) market confidence component. - 2016 SRB approach: standardized approach yielding an "informative" external MREL target based on risk-weighted assets. - 2017 vision: factor resolution strategy into external MREL target, specify "quality" of MREL, define internal MREL distribution. - Requirements for MREL must ensure it can (i) absorb losses identified in the level one valuation; (ii) recapitalize the bank to supervisory standards; (iii) provide an additional recapitalization amount to help instill market confidence; (iv) provide a confidence margin for unidentifed losses and post-bail-in restructuring losses. - Intragroup exposures and internal MREL concerns: - Many Luxembourg subsidiaries have significant intragroup claims on their foreign parent and affiliates; these claims are in principle subject to bail-in if the parent or affiliate is in resolution. - In an unanticipated parent failure, write-off losses on these claims may dwarf the subsidiary's regulatory capital and internal MREL, potentially rendering the subsidiary insolvent. - The CSSF and SRB should provide clarity for banks to meet their MREL requirements as soon as possible; one option being considered is to require intragroup claims be collateralized. - Legal constraints, NCWO and pari passu: - No Creditor Worse Off (NCWO) safeguard applies; departures from pari passu treatment may give rise to compensation claims. - Certain senior claims (e.g., uncovered UCITS deposits) may rank pari passu with unsecured deposits and senior unsecured bonds, complicating bail-in scope and NCWO implications. - SRB policy precluding consideration of SRF access in plans constrains credible planning. - Recommendation: reconsider SRB policy on SRF preclusion so plans can address SRF access requirements. - Practical constraints: - Transfer of custodian functions is time-consuming: most market transactions require at least three months and potentially up to nine. - Limited market for sale of retail business lines given small number of retail banks. - Authorities should factor these constraints into resolution planning and develop policies to tackle them. - Bridge bank tool considerations: - Bridge bank is available in law; emphasis in plans has been on bail-in and not on operationalizing bridge bank. - Recommendation: CSSF and SRB should consider how to use and operate a bridge bank, including ownership, governance and funding arrangements; SRB should clarify expectations regarding terms and conditions for bridge bank use. ### Financial safety nets and funding in resolution — SRF, FGDL, ELA - Single Resolution Fund (SRF): - SRF target: currently estimated to be at least €55 billion (at least 1 percent of covered deposits of all banks within the member states participating in the SRM). - SRF composition and Luxembourg-specific funding as of end-2016: - Total roughly € 5.5 billion - Funded amount of the Luxembourg compartment: €105 million - €4.3 billion from the mutualized compartments - €1.1 billion bridge financing arrangement in the form of a Loan Facility Agreement (LFA) from the Luxembourg state for the unfunded portion of the Luxembourg compartment - If Luxembourg compartment and mutualized compartment are insufficient: - SRB can first seek ex post contributions from Luxembourg banks (up to an annual limit currently of around €0.2 billion) - SRB can secondly seek to borrow from the market - If market financing is not available on reasonable terms and/or in sufficient amount, SRB can access the Luxembourg LFA - Current level of funding available for Luxembourg compares to the € 3.5 billion in fiscal cost incurred during the 2008/09 crisis. - No permanent, common public back-stop exists for the SRF currently; BU states committed to negotiate a common backstop by full mutualization in 2024. - Recommendation: continue advocating BU-wide backstop for the SRF and a common BU-wide DGS; develop contingency plans where SRF is insufficient. - Fonds de garantie des dépôts Luxembourg (FGDL): - DGSD harmonized EU coverage at €100,000 and introduced ex ante funding requirements. - Covered deposits as of December 31, 2015: €28.7 billion (roughly 6 percent of the roughly €490 billion in total deposits). - FGDL targets an eventual balance of 1.6 percent of covered deposits (twice the EU DGSD target of 0.8 percent): - First compartment to be fully funded at around €230 million by the end of 2018 - Second compartment to be fully funded by 2026 - As of September 30, 2016, the balance of the first compartment was €76 million, representing one-third its target level. - FGDL is subject to a requirement to payout deposits within seven days; operational capacity for medium-sized and larger banks is still being implemented. - FGDL financing: ex-ante contributions; CPDI can require extraordinary contributions of up to 0.5 percent of covered deposits each year. - FGDL liability in resolution: - FGDL is liable for amounts by which covered deposits would have been written down to absorb losses in a bail-in if covered deposits had been included and written down to same extent as creditors with same priority. - FGDL's liability cannot exceed losses that would result under normal insolvency proceedings. - Recommendation: clarify interpretation of Article 109 BRRD and FGDL’s liability in resolution; CPDI should pursue backstop funding arrangements; as a last resort, public funding in compliance with state aid rules could be necessary. - Emergency Liquidity Assistance (ELA) — Banque centrale du Luxembourg (BCL): - BCL has a contingent framework for provision of ELA. - BCL has not provided ELA to a Luxembourg bank since the last FSAP in 2011. - General terms and conditions of a possible state guarantee for extension of ELA have not yet been laid out by the BCL and the Ministry of Finance (MoF). - BCL has limited capacity to provide ELA in FX; has access to FX from market sources and the BIS but has no bilateral FX swap arrangements in place with relevant central banks. - Recommendation: MoF and BCL to discuss terms and conditions of state guarantee for ELA; BCL should continue to pursue additional contingent FX funding arrangements and consider communicating its ELA policies and procedures to resolution authorities. ### Cross-border cooperation, colleges, and third-country arrangements - As of June 30, 2016, 61 of 143 banks in Luxembourg were under the direct supervision of the ECB. - Four of the six D-SIBs are subsidiaries of FSB-designated G-SIBs; four other FSB-designated G-SIBs operate significant subsidiaries in Luxembourg. - Resolution Colleges and cooperation: - Article 88 Resolution Colleges required by BRRD; SRB or CSSF serves as the Group Level Resolution Authority (GLRA) depending on headquarters. - European Resolution Colleges (ERCs) and G-SIB Crisis Management Groups (CMGs) participate; non-EU third-country authorities may be granted observer status subject to confidentiality equivalence. - Cooperation with third-country authorities: - Information exchange allowed only if third-country authorities are under a confidentiality regime equivalent to that applying to the Resolution Board. - No cooperation arrangements have yet been concluded for resolution purposes by the Resolution Board; SRB has negotiated arrangements with the US and Swiss authorities but no MoU concluded. - Recommendation: Resolution Board should establish cooperation arrangements with third country authorities; SRB should continue efforts in 2017. ### Legal and insolvency framework issues — transfers, creditor hierarchy, and courts - Transfer powers during winding-up: - Powers to transfer assets and liabilities of a bank during winding-up should be made explicitly available for orderly liquidation and to maximize value for creditors and reduce costs for FGDL. - Current Article 181(3) refers to use of FGDL's funds to transfer assets and liabilities including deposit book transfer, but no explicit power is granted to the liquidator or the CSSF to conduct such a transfer. - A winding-up order triggers a deposit payout in 7 days, creating urgency for explicit transfer powers without creditor consent. - Creditor hierarchy: - Determined by different laws (Civil Code, securities law, financial collateral law, 2015 Law), making interpretation difficult. - MoF has initiated a project to assess clarity of creditor hierarchy. - Recommendation: consider the European Commission proposal on harmonization of creditor hierarchy as an opportunity to enhance clarity of creditor hierarchy rules. - Judicial review and SRM interaction: - SRB decisions are subject to ex post judicial review by the European Court of Justice (ECJ); ECJ reviews legality but not substance and may declare SRB decisions void or order suspension. - Where courts find national resolution decisions illegal, remedy is compensation for loss suffered; acquisitions under resolution are protected. - Recommendation: clarify scope and triggers for the BCL’s lien right and ranking of SRB's preferential claims. ### Systemic crisis management — preparedness and contingency planning - Current status: - Arrangements for management of a system-wide financial crisis in Luxembourg have yet to be fully developed. - BU institutional architecture largely oriented to individual bank/group resolution; simultaneous failures across BU states may require a more comprehensive strategy. - Recommendations: - MoF should lead to ensure domestic authorities, in coordination with BU authorities, have a clear understanding of respective roles in a system-wide crisis. - MOF should pursue adoption of a formal coordination framework among relevant parties, perhaps first domestically and then with the ECB and the SRB. - Domestic authorities, with eventual involvement of the ECB and the SRB, should develop Luxembourg-specific contingency plans and periodically test them via simulation exercises. - Contingency plans might contemplate extraordinary financial support from the state as a last resort, address state aid rules, and ensure recovery of state resources. ### Selected key recommendations (topic-categorized and timing where provided) - Institutional Arrangements: - Develop structural arrangements to safeguard the autonomous conduct of different functions (CSSF; Continuous). - Continue staffing Resolution Department (CSSF; Continuous). - Recovery and Resolution Planning: - Provide more guidance for recovery and resolution planning (e.g., on defining critical functions, including custodian functions, and addressing large intragroup claims) (ECB, SRB; Immediate). - Streamline SRB decision-making to ensure timely resolution action and clarify the ECB’s role in triggering resolution for LSIs under the direct remit of the SRB (EU*/ECB and SRB; Immediate). - Advocate integration of host countries into cooperation mechanisms for recovery and resolution planning where they host branches providing critical functions (ECB, SRB and CSSF; Near term). - Develop cooperation arrangements with third-country authorities (ECB, SRB and CSSF; Near term). - Accelerate resolution planning in most significant banks (CSSF, SRB; Immediate). - Give consideration to fallback resolution strategies if preferred strategy cannot be implemented (CSSF, SRB; Near term). - Reconsider blanket preclusion of the use of the SRF in resolution plans (SRB; Near term). - Provide guidance and clarity on liquidity funding in resolution, core business lines and material entities, and terms and conditions for bridge bank (SRB; Near term). - Develop policies and procedures to address challenges in implementing sale of business tool and bridge bank tool (CSSF, SRB; Near term). - Clarify that departure from pari passu treatment of creditors is allowed with respect to all resolution tools (EU*/SRB; Immediate). - Allow the transfer of assets and liabilities during liquidation (MoF; Immediate). - Ensure clarity and transparency of creditor hierarchy, including BCL’s lien right and ranking of SRB’s preferential claims (MoF; Near term). - Financial Safety Net and Funding: - Continue advocating BU-wide backstop for the SRF and a common BU-wide DGS (MoF; Continuous). - Arrange for backstop funding for FGDL (CSSF; Medium term). - Discuss terms and conditions of state guarantee for ELA (MoF, BCL; Near term). - BCL should continue to pursue additional contingent FX funding arrangements (BCL; Medium term). - Systemic Crisis Management: - MoF should seek clarity and agreement on roles and responsibilities of domestic authorities, and eventually the ECB and the SRB, in a system-wide crisis (MoF; Medium term). - Contingency plans should be tested and enhanced via simulation exercises (MoF, CSSF, BCL, CAA; Near term). _Excerpts from IMF staff report (FSAP mission, November 29–December 14, 2016)._ ### EXECUTIVE SUMMARY ___________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### Introduction and Scope - This Technical Note analyzes the bank failure mitigation and resolution regime, and arrangements for managing a financial crisis, in Luxembourg. - Findings summarize the FSAP mission undertaken during the period November 29–December 14, 2016. - Focus areas: supervision of recovery planning by banks; early intervention powers; resolution planning; institutional and legal framework for bank resolution and financial safety nets; preparedness for a potential system-wide crisis. *Source: IMF staff report (FSAP mission, November 29–December 14, 2016).* ### Banking Industry Landscape - Luxembourg’s financial sector is large relative to its economy and global in scope. - Key aggregates: - Investment fund and money market industry: €3.8 trillion in assets under management or 72.2 times GDP. - Banking industry: €747 billion in assets or 14.3 times GDP. - Insurance industry: €205 billion or 3.9 times GDP. - Banking sector functions: - Domestic retail and commercial banking (small number of banks; dominate local mortgage market). - Investor services to Luxembourg-domiciled international investment funds (safekeeping/custody, fund accounting, transfer agent services). - Private wealth management. - Intragroup liquidity management and treasury services. - Ownership and structure: - 144 banks domiciled in Luxembourg. - Five are domestically owned (accounting for 7 percent of industry assets), including two wholly state-owned banks. - One bank is a financial market infrastructure (FMI) that clears and settles international payments and securities transactions and offers related securities depository services globally. ### Institutional Arrangements and Governance - Luxembourg is part of the euro area “Banking Union” (BU): - ECB has exclusive competence to directly supervise significant institutions (SIs). - CSSF, under the oversight of the ECB, directly supervises less significant institutions (LSIs). - Bank resolution competences are shared between the Single Resolution Board (SRB) and the CSSF. - Legal and structural changes: - BRRD and DGSD were transposed in late 2015, introducing a new resolution framework and a public deposit insurance scheme. - A Resolution Board and the Depositor Protection Council were established within the CSSF to carry out resolution and administer the deposit insurance scheme respectively. - Staffing and conflicts of interest: - CSSF conducts operational tasks related to resolution via its Resolution Department and has increased staffing, but additional increases are recommended given workload. - Supervision and resolution functions are structurally separated within CSSF; supervision and deposit insurance functions are not fully separated: the Director responsible for the Banking Supervision Department is also Director responsible for the Depositor and Investor Protection Department (PDI) and chairs the Conseil de Protection des Déposants et des Investisseurs (CPDI). - Recommendation: develop structural arrangements to address potential conflicts of interest between supervisory and deposit insurance functions; continue staffing Resolution Department. ### Recovery Planning and Early Intervention - Recovery planning: - CSSF began implementing recovery planning requirements in 2013. - All banks have submitted at least initial recovery plans; CSSF (for LSIs) or ECB (for SIs) have formally provided feedback and recommendations for improvements. - Most more significant banks have submitted revised plans. - Early intervention: - Triggers and powers are adequate. - Intrusiveness of measures increases gradually from requiring additional capital and liquidity to intervention in management by appointing a temporary administrator. ### Resolution Regime and Planning - Resolution planning status: - Planning is at an early stage with many challenges ahead. - Resolution plans for the largest banks are being developed by the SRB and the CSSF Resolution Department; CSSF is preparing plans for the most important LSIs. - Resolution planning began in 2015; initial plans have been reviewed by the SRB where appropriate. - Under SRB leadership, revised plans for most large banks have been finalized recently or will be prepared in 2017. - Preferred tools and gaps: - Current plans for banks likely to meet the “public interest test” focus on using bail-in to absorb losses and recapitalize a bank in resolution. - Means to use other resolution tools (sale of business tool, bridge bank tool) have yet to be well addressed. - Means to ensure adequate liquidity funding in resolution have not been well addressed. - Concern: bail-in alone may not be sufficient to resolve a bank; work on alternative tools and liquidity arrangements should be accelerated. - SRF policy constraint: - Under SRB policy, resolution planners cannot contemplate the use of the Single Resolution Fund (SRF) in their plans; thus plans do not address how SRF access requirements would be met. - Recommendation: reconsider this policy so plans can address SRF access requirements to enable credible and feasible resolution plans for the most important Luxembourg banks as soon as possible. - Cross-border and branch issues: - Certain characteristics of the Luxembourg financial system present special challenges: - Importance of investment fund industry: authorities retain discretion to exclude deposits held by investment funds with resolved banks to avoid systemic consequences of bail-in; excluding such deposits could give rise to significant claims under the “No Creditor Worse Off” safeguard if other creditors in the same class are bailable. - Large intragroup claims of Luxembourg subsidiaries on foreign parents/affiliates could be bailed-in at parent/affiliate resolution, potentially affecting subsidiaries’ viability. - Cross-border cooperation improvements needed: - Designation of a branch as “significant branch” under CRD IV allows host Member State participation in cooperation mechanisms (supervisory colleges, resolution colleges, Joint Supervisory Teams, Internal Resolution Teams) to review recovery and resolution plans. - Recent conversion of several Luxembourg subsidiaries into branches indicates host Member States hosting branches that are not “significant branches” but that provide “critical functions” also have interest in reviewing recovery and resolution plans; their access to cooperation mechanisms is constrained. - Recommendation: consider EU-level initiatives addressing branchification to integrate host countries into cooperation mechanisms where branches provide critical functions. - Need for SRB to continue, and CSSF to seek, cooperation and coordination arrangements with third-country authorities. - Legal and insolvency framework issues: - Transfer powers during winding-up: powers to transfer assets and liabilities of a bank during winding-up procedure should be made explicitly available for orderly liquidation and to maximize value for creditors and reduce costs for the Fonds de garantie des dépôts Luxembourg (FGDL). - Creditor hierarchy: - Plays a vital role for loss allocation and the No Creditor Worse Off safeguard. - Creditor hierarchy in Luxembourg is determined by different laws and is difficult to interpret with clarity. - Recommendation: consider the European Commission proposal on harmonization of creditor hierarchy as an opportunity to enhance clarity of creditor hierarchy rules. ### Financial Safety Nets and Funding in Resolution - Deposit insurance: - A new public deposit insurance scheme was introduced in late 2015. - The new deposit insurance scheme targets a fund balance twice that required in relevant EU legislation, and the timetable for being able to make rapid payouts is well advanced. - At present, there are no backstop funding arrangements in place; recommendation: pursue back-up funding arrangements for FGDL. As a last resort, public funding in compliance with state aid rules could be necessary. - Emergency Liquidity Assistance (ELA): - Banque centrale du Luxembourg (BCL) has a contingent framework in place for the provision of ELA. - These arrangements have not been communicated to the resolution authorities, which may impede adequate resolution planning. - General terms and conditions of a possible state guarantee for extension of ELA have not yet been laid out by the BCL and the Ministry of Finance (MoF)—progress on this front is needed. - Recommendation: MoF and BCL to discuss terms and conditions of state guarantee for ELA; BCL should continue to pursue additional contingent FX funding arrangements. - Single Resolution Fund (SRF) and backstops: - In principle, the SRF is available to support resolution funding, subject to conditions. - Backup funding arrangements for the unfunded portion of the national compartment are in place, but a common BU-wide backstop for the SRF is not. - Recommendation: continue advocating BU-wide backstop for the SRF and a common BU-wide DGS; develop contingency plans for situations where the SRF is insufficient. ### Systemic Crisis Management - Current status: - Arrangements for management of a system-wide financial crisis in Luxembourg have yet to be fully developed. - Recommendation: the MoF should lead to ensure domestic authorities, in coordination with BU authorities, have a clear understanding of respective roles in a system-wide crisis. - Contingency plans should be developed and tested via crisis simulation exercises. ### Key Recommendations (selected and categorized by topic and timing) - Institutional Arrangements: - Develop structural arrangements to safeguard the autonomous conduct of different functions (CSSF; Continuous). - Continue staffing Resolution Department (CSSF; Continuous). - Recovery and Resolution Planning: - Provide more guidance for recovery and resolution planning (e.g., on defining critical functions, including custodian functions, and addressing large intragroup claims) (ECB, SRB; Immediate). - Streamline SRB decision-making to ensure timely resolution action and clarify the ECB’s role in triggering resolution for LSIs under the direct remit of the SRB (EU*/ECB and SRB; Immediate). - Advocate integration of host countries into cooperation mechanisms for recovery and resolution planning where they host branches providing critical functions (ECB, SRB and CSSF; Near term). - Develop cooperation arrangements with third-country authorities (ECB, SRB and CSSF; Near term). - Accelerate resolution planning in most significant banks (CSSF, SRB; Immediate). - Give consideration to fallback resolution strategies if preferred strategy cannot be implemented (CSSF, SRB; Near term). - Reconsider blanket preclusion of the use of the SRF in resolution plans (SRB; Near term). - Provide guidance and clarity on liquidity funding in resolution, core business lines and material entities, and terms and conditions for bridge bank (SRB; Near term). - Develop policies and procedures to address challenges in implementing sale of business tool and bridge bank tool (CSSF, SRB; Near term). - Clarify that departure from pari passu treatment of creditors is allowed with respect to all resolution tools (EU*/SRB; Immediate). - Allow the transfer of assets and liabilities during liquidation (MoF; Immediate). - Ensure clarity and transparency of creditor hierarchy, including BCL’s lien right and ranking of SRB’s preferential claims (MoF; Near term). - Financial Safety Net and Funding: - Continue advocating BU-wide backstop for the SRF and a common BU-wide DGS (MoF; Continuous). - Arrange for backstop funding for FGDL (CSSF; Medium term). - Discuss terms and conditions of state guarantee for ELA (MoF, BCL; Near term). - BCL should continue to pursue additional contingent FX funding arrangements (BCL; Medium term). - Systemic Crisis Management: - MoF should seek clarity and agreement on roles and responsibilities of domestic authorities, and eventually the ECB and SRB, in a system-wide crisis (MoF; Medium term). - Contingency plans should be tested and enhanced via simulation exercises (MoF, CSSF, BCL, CAA; Near term). *NT = near term: 1 to 3 years; MT = medium term: 3–5 years; I = immediate: within 1 year; C = continuous.* *Source: IMF staff report (FSAP mission, November 29–December 14, 2016).* ### 3. A number of banks in Luxembourg are systemically important or significant. Four ### 3. A number of banks in Luxembourg are systemically important or significant. ### Systemic importance and supervisory coverage - Four banks of the six banks designated by the CSSF to be domestically systemically important (D-SIBs) in Luxembourg are subsidiaries of banking groups deemed globally systemically important (G-SIBs) by the Financial Stability Board (FSB) in Basel. - Four other FSB-designated G-SIBs operate significant subsidiaries in Luxembourg. - As of the start of 2016, six banks were designated as "Significant Institutions" (SIs) by the ECB, but by early 2017 this number will have been reduced to three, in two cases by virtue of a change in legal status from subsidiary to branch. - Many Luxembourg-based entities are branches or subsidiaries of SIs in other Banking Union member states. - In total, 61 of 143 banks in Luxembourg were under the direct supervision of the ECB as of June 30, 2016. ### Intragroup liquidity and large exposures - The internationally-oriented banks are often providers of liquidity to their parents or affiliated group entities outside Luxembourg. - Many banks have large exposures to their foreign parents or affiliated group entities. - The main source of this funding is deposits placed with the Luxembourg banks associated with the provision of investor services. - The Luxembourg authorities have availed themselves of provisions in the CRR that provide for a waiver of the large exposures limit in the context of intragroup exposures. ### Legal framework developments - Luxembourg is part of the “Banking Union,” which conferred certain powers to the ECB and SRB in accordance with the Single Supervisory Mechanism (SSM) Regulation and Single Resolution Mechanism (SRM) Regulation respectively. - The authorities transposed the BRRD and DGSD by “the Law of 18 December 2015 on the Resolution, Reorganization and Winding up Measures of Credit Institutions and Certain Investment Firms” (the 2015 Law). - The 2015 Law: - established a new resolution framework and a public deposit insurance scheme; - amended the Law on Financial Sector (LFS) to introduce recovery planning and new early intervention measures; - amended the CSSF’s organic law to establish new internal bodies and departments to carry out duties related to resolution and deposit insurance. ### Institutional arrangements — European institutions - Under the Banking Union, the ECB and SRB play significant roles in bank supervision and resolution in Luxembourg: - (i) exercise of direct supervision powers by the ECB, and resolution planning and resolution decision-making powers by the SRB over institutions under their remits; - (ii) oversight of NCAs by the ECB and NRAs by the SRB in the discharge of their competences; - (iii) exercise of respective powers where necessary to ensure consistent application of supervisory and resolution standards for institutions under NCAs and NRAs. ### Institutional arrangements — domestic institutions and roles - Domestic authorities contribute to ECB and SRB work via participation in Joint Supervisory Teams (JSTs) and Internal Resolution Teams (IRTs) and through information exchange; they remain responsible for banks not under ECB/SRB remit. - Relevant domestic authorities: CSSF, FGDL, BCL and the Ministry of Finance (MoF). - CSSF governance: - public institution under direct authority of the MoF; - non-executive board and three decision-making boards: Executive Board (supervision), Resolution Board (resolution), and Depositors and Investors Protection Council (CPDI) (depositor protection). - the non-executive board adopts the CSSF budget and sets general policy but has no power regarding supervisory decisions or involvement with resolution or deposit insurance functions. - CSSF responsibilities and boards: - CSSF is the "national competent authority" (NCA) responsible for early intervention and supervision of recovery planning for all "less significant institutions" (LSIs); decisions taken by the Executive Board composed of five Directors appointed to renewable five-year terms by the Grand Duke on a proposal from the Government. - CSSF is the "national resolution authority" (NRA) for banks not under SRB remit and implements resolution actions in all banks; resolution decisions are taken by the Resolution Board composed of five members, including the Resolution Director (Chairman), the Director of the Treasury, the Director General of the BCL, the CSSF Director in charge of banking supervision, and a magistrate appointed by the Grand Duke. - The Resolution Director heads the Resolution Department, which has its own budget consolidated under the CSSF's budget; staff are recruited and dismissed by the Resolution Director and directly report to the Resolution Director. - Members of the Resolution Board and Resolution Department staff enjoy legal protection in discharge of duties unless acting with gross negligence and are indemnified for legal expenses when defending themselves. - The Resolution Board has adopted "Internal Rules" regarding information sharing and cooperation with the Executive Board and the CPDI. ### Staffing and operational capacity for resolution - The Resolution Department had 10 staff at the end of 2016. - This is expected to be increased to 13 by the end of 2017. - Due to current scarcity of staffing, the Resolution Department actively engages in 10 of the 40 Internal Resolution Teams (IRT) established within the SRB to coordinate work related to SIs relevant to Luxembourg. - Staffing increases are lauded but existing and planned levels are not sufficient; further staffing is needed to enable meaningful contributions to SRB policy development and to accelerate resolution planning. ### Deposit guarantee arrangements and potential conflicts of interest - The Fonds de garantie des dépôts Luxembourg (FGDL), the deposit guarantee fund, was established in 2015 as a "pay box" operated by the CSSF. - To minimize operational costs, the CSSF executes the FGDL's operational tasks via the CPDI; a Management Committee was established within the FGDL with same members as the CPDI. - CPDI responsibilities: determine contributions to the FGDL and amounts to be reimbursed to depositors in case of payout. - FGDL also responsible for contributing to resolution upon a request by the Resolution Board if the latter considers resolution necessary to ensure depositors' access to funds. - Management Committee responsibilities: collecting contributions, paying out insured depositors at the request of the CPDI, and determining investment policy for the fund. - CPDI and Management Committee are operationally assisted by the CSSF's Depositor and Investor Protection Department (PDI). - Members of these boards and PDI staff receive legal protection analogous to Resolution Board members and Resolution Department staff. - Potential conflict of interest: - supervision and resolution functions are structurally separated, but supervision and deposit insurance functions are not fully separated; - the Director responsible for the Banking Supervision Department may also be Director responsible for the PDI and chairs the CPDI; - supervisory function can trigger deposit payouts for LSIs, creating potential for conflicts (e.g., forbearance). - Recommendation: structural arrangements should be put in place to ensure operational autonomy of supervisory and deposit insurance functions and review reporting lines accordingly. ### Central bank role and liquidity surveillance - The BCL may provide emergency liquidity assistance (ELA) outside normal Eurosystem monetary policy operations conducted by the ECB and is responsible for supervising general market liquidity and evaluating market operators. - BCL involvement: participates in Joint Supervisory Teams (JSTs) within the SSM for SIs. - Division of liquidity surveillance: BCL carries out liquidity surveillance of 25 large LSIs while the CSSF carries out liquidity surveillance for the remainder; this division does not affect respective legal responsibilities and the CSSF retains ultimate overall responsibility for LSIs. - If enforcement action is required for a bank under BCL surveillance, the CSSF will take the action. ### Ministry of Finance role - The Finance Minister is required by the 2015 Law to approve draft decisions of the Resolution Board which may lead to a call for public support or have systemic consequences. - The Director of Treasury is a member of the Resolution Board, providing a communication channel to the Finance Minister. - The MoF participates in resolution colleges as a member but does not vote for joint decisions in these colleges. ### Recommendations (summary) - Continue to increase the Resolution Department's staff. - Develop structural arrangements to safeguard the autonomous conduct of supervision and deposit guarantee functions. ### Recovery planning and early intervention (SSM context) - The SSM placed prudential supervision, early intervention, and recovery planning for SIs in the euro area under the exclusive competence of the ECB as of end-2014. - Under the SSM Regulation, supervision of LSIs is primarily the responsibility of the NCAs; however, the ECB may decide to directly supervise an LSI if necessary to ensure consistent application of high supervisory standards. - The ECB designates SIs on the basis of consolidated accounts and, following designation, can exercise powers with regard to the banking subsidiaries and branches of that group established in Member States participating in the SSM. - As of June 30, 2016, 61 of 143 banks in Luxembourg were under direct supervision of the ECB. - The ECB carries out supplementary supervision of financial conglomerates and is involved in supervisory colleges as home or host supervisor; while conducting direct supervision, the ECB has the powers conferred on NCAs by EU law. - The ECB is also responsible for indirect supervision of LSIs to ensure effective and consistent functioning of the SSM and may issue regulations, guidelines and general instructions to NCAs. NCAs must notify the ECB of material supervisory procedures, draft decisions and institution-specific information (e.g., rapid or significant deterioration of an LSI). - Operationally, supervision of SIs is undertaken by Joint Supervisory Teams (JSTs) led by ECB coordinators including home NCA staff and staff from other NCAs; JSTs are supported by horizontal specialized expertise of the ECB and NCAs for functions such as recovery planning. - Recovery plans: - All banks in the EU are subject to recovery planning requirements. - Recovery plans are prepared by banks at the highest level of consolidation and are assessed by JSTs for SIs or by the home NCA for LSIs. - LSIs may be allowed to prepare recovery plans under simplified procedures. - For banks with operations in the EU outside the Banking Union, plans are shared with and assessed by relevant supervisory colleges. - Plans are shared with the relevant EU resolution authority (SRB or NRA), which may identify actions in the recovery plan that could adversely affect resolvability and make recommendations to the supervisory authority. _This Background Note was prepared by David Scott, External Expert for the Monetary and Capital Markets Department, and Ender Emre (Counsel), IMF Legal Department._ ### 20. The CSSF began to implement recovery planning requirements in 2013. Initial recovery ### 20. The CSSF began to implement recovery planning requirements in 2013. Initial recovery ### Recovery planning implementation and submissions - Initial recovery plan preparation guidance was issued by the European Banking Authority (EBA) in 2013. - The CSSF prioritized banks and requested certain of them to submit plans, referring them to the EBA publications for guidance. - By year-end, four banks had submitted initial recovery plans. - Two other banks submitted initial plans by February 2015. - By July 2015, nine additional LSIs had submitted initial plans. - An additional 27 LSIs submitted initial plans by the end of 2015. - Among these, three banks for which the CSSF is the group level consolidated supervisor had provided group recovery plans. ### ECB responsibility for SIs and feedback process - The ECB became responsible for recovery planning by SIs in 2015. - Respective JSTs rely largely on the home NCA and ECB specialists to assess the plans. - The JST provides feedback letters to the banks identifying areas for improvements. - Two domestically oriented Luxembourg SIs had plans requested by CSSF in 2013; these were reviewed by ECB and feedback letters were provided in 2015; revised plans have been submitted. - A bank designated an SI in 2016 had a plan first submitted in 2015; a feedback letter was sent by CSSF and a revised plan has been submitted. - The plan for a fourth SI was first submitted in January of 2015, a feedback letter was sent by ECB, and a revised plan was submitted. - Four other Luxembourg D-SIBs are covered by group recovery plans of BU-based G-SIBs; the CSSF is a member of these groups' JSTs and is requesting more explicit and comprehensive coverage of the Luxembourg subsidiaries in the plans in some cases. ### CSSF responsibility for LSIs and scope of plans - The CSSF remains responsible for supervising recovery plans of LSIs. - All LSIs have been notified as to whether they are to submit full scope plans or plans prepared under simplified obligations. - In general, the top ten banks ranked per each of the mandatory indicators prescribed by the EBA were required to submit full scope plans. - LSIs designated as "high priority" (HP LSI) by the ECB are required to submit full scope plans. - All subsidiaries where the parent is based in a third country (i.e. outside the EU) are required to submit recovery plans independent of the existence of a group recovery plan. - The CSSF required some LSIs to submit full scope plans due to their business model, including the largest custodian banks. - All LSIs have now submitted at least their initial plans and feedback letters have been sent. - Five LSIs, including one college bank, had not passed the initial quick completeness check when submitting their first (group) recovery plan; they were requested to re-submit the recovery plan within the 2-month extendable period. ### Assessment quality and material deficiencies - Thus far, no "material deficiencies" have been identified in the plans, though it cannot be precluded that material deficiencies will be identified in future as supervisors' standards are clarified and possibly coordinated with resolution authorities. - The main general findings have been documented and are being addressed. ### Host authority role and assessment of group plans - As a host authority, the CSSF participates in the assessment of group recovery plans of EU banking groups based in non-BU jurisdictions. - The CSSF assesses these recovery plans from the perspective of the Luxembourg subsidiaries (e.g., U.K. and Sweden based) and contributes to a joint decision on the assessment of the group recovery plan. - The assessment is largely focused on whether the groups' Luxembourg operations are appropriately identified as material legal entities, core business lines and/or critical functions in the group plan. - The recent conversion of some important subsidiaries to branches restricts the involvement of the CSSF in assessing relevant recovery plans. ### Need for additional EU-level guidance - Main findings by the ECB and CSSF indicate a need to further assess critical functions of the banks. - There have been cases where the CSSF did not agree with the banks' criticality assessment in relation to their custodian functions. - An SRB task force, in which the ECB participates, is developing an assessment template which will be shared with the industry in February 2017; one goal is to clarify what functions are deemed critical and thus require specific attention in both recovery and resolution plans. - The report states: "This work should be brought to conclusion so that adequate guidance is provided for the assessment of the criticality of custodian functions." - Many Luxembourg subsidiaries have large intragroup claims on their foreign parents and/or affiliated entities that can give rise to highly significant liquidity and capital consequences in times of stress. - Recommendation: The ECB and CSSF should define for banks specifically how such claims are to be addressed in recovery planning. - Such guidance could complement improvements in the supervisory framework and practices regarding intragroup exposures (referenced further in the Technical Note on Banking Supervision). ### Early intervention framework (overview) - The 2015 Law strengthened the early intervention framework in Luxembourg and transposed BRRD early intervention measures into Luxembourg law. - The ECB and CSSF are responsible for application of early intervention measures to SIs and LSIs respectively; the ECB has the power to decide to exercise direct supervision of an LSI. - The use of intervention powers by the CSSF must be communicated promptly to the ECB. - Triggers for early intervention are based on failure to comply with existing regulations and likely failure to comply with (risk-based) regulations due to deteriorating financial condition (including deteriorating liquidity, increased leverage, non-performing loans or concentration of exposures). - The CSSF is in the final stages of transposing the EBA May 2015 guidelines on early intervention triggers, which are largely but not exclusively based on the Supervisory Review and Evaluation Process (SREP) for each bank. - Early intervention measures available include requiring additional capital and liquidity, implementing recovery plan measures, drawing up an action plan, negotiating debt restructuring, changing business strategy and legal or operational structure, removing management, appointing a temporary administrator, and write down and conversion of capital instruments (common equity Tier 1, additional Tier 1 or Tier 2). - The CSSF has used its powers under the CRD IV on several occasions to impose business restrictions. ### Summary recommendation (from the source) - The ECB, in cooperation with resolution authorities, should provide more guidance on defining critical functions and the treatment of large intragroup claims by subsidiaries on foreign group entities in recovery plans. *Source: IMF country report excerpt (cr17259), Luxembourg — Recovery planning, early intervention, and related recommendations* ### 36. Cooperation and coordination with third-country authorities is allowed, albeit under ### Cooperation and coordination with third-country authorities is allowed, albeit under certain conditions. ### Conditions for cooperation and information exchange - Information exchange is allowed only if the third-country authorities are under a confidentiality regime equivalent to that applying to the Resolution Board. - The handling and transmission of personal data should be compliant with EU and Luxembourg data protection laws. - Information exchange and coordination can also take place in RCs or ERCs. - Participation in these colleges is subject to the request of the third-country authority and an affirmative decision of the Resolution Board or the SRB, as GLRA. - When its request is accepted, the third-country authority can only be granted an "observer" status. ### Current status of cooperation arrangements and negotiations - No cooperation arrangements have yet been concluded for resolution purposes by the Resolution Board. - There is no cooperation arrangement concluded by the Resolution Board as a newly established resolution authority. - The EBA shared its draft non-binding framework cooperation arrangements (FCA) with selected third country authorities in 2015. - The negotiations with the US on the draft FCA have been finalized but the conclusion of the FCA awaits the completion of internal processes on both sides. - The EBA's draft FCAs are high-level arrangements and therefore do not eliminate the need for the SRB and the Resolution Board to have arrangements to operationalize such cooperation provided that such arrangements are in line with the EBA's FCAs. - The SRB has negotiated cooperation arrangements with the US and Swiss authorities, but no MoU has yet been concluded. ### Policy recommendations and priorities - The Resolution Board should establish cooperation arrangements with third country authorities and the SRB should continue its efforts in this area. - Enhancing cooperation and coordination with third countries is a priority for the SRB in 2017. - One challenge is the need of the Resolution Board to assess the equivalence of the confidentiality regime of third-country resolution authorities. - While EBA provides guidance on the equivalence of confidentiality regimes of third-country supervisory authorities, no similar guidance exists regarding third-country resolution authorities. - The SRB should provide guidance on how resolution plans should address liquidity funding in resolution, and on criteria for determining critical functions, core business lines and material entities, ensuring access to FMIs in resolution, and on undertaking the various valuations involved in resolution. ### Recognition and enforcement of third-country resolution proceedings - Recognition and enforcement of third country resolution proceedings in Luxembourg is permitted by the SRM regulation and the 2015 Law. - Following a recommendation by the SRB for the banks or groups under its competence, the Resolution Board will implement this recommendation. - Where the bank or group is subject to its own competence (e.g., third country proceeding implicating solely a Luxembourg LSI), the Resolution Board will decide on recognition and enforcement of such proceedings. - The Resolution Board may decide not to recognize or enforce third-country proceedings on several grounds, including the adverse effect of such action on financial stability in Luxembourg or another EU Member State. ### Configuration of Resolution Colleges (Box 1) — key points - Article 88 Resolution Colleges (Art. 88 RCs): BRRD Article 88 requires that “resolution colleges” be established by Group Level Resolution Authorities (GLRAs) as a framework for cross-border coordination of all resolution activities. - Non-EU (third) country resolution authorities, at their request, may be invited to participate as observers, but have no voting rights. - In Luxembourg, there are two classes of Art. 88 RCs. For banks/groups headquartered within the BU, either the SRB or the CSSF serves as the GLRA. SRB serves as the GLRA for 29 groups and the CSSF for three. - For banks/groups headquartered within the EU but outside the BU, the relevant NRA serves as GLRA, and SRB and/or CSSF may participate as members. The CSSF typically will send three staff, representing the resolution, supervision and deposit insurance functions. - EU European Resolution Colleges (ERCs): BRRD Article 89 requires establishment of “European resolution colleges” (ERCs) where a third country bank operates in more than one EU Member State. At present no ERCs have been set up though the EBA is completing a mapping, focused first on G-SIBs. - G-SIB Crisis Management Groups (CMGs): For G-SIBs headquartered in the BU, the ECB and SRB function as co-leads. In Luxembourg, the SRB is co-lead of the CMGs for Société Générale, BNP Paribas and Credit Agricole (FR), Deutsche Bank (DE), ING Bank (NL) and UniCredit (IT). The SRB is a member of the CMG for UBS (CH) and will soon be a member of the CMGs for JP Morgan Chase. The CSSF is member of the CMG State Street (US). - Third Country Resolution Colleges: Example — the Canada Deposit Insurance Corporation established a college for Royal Bank of Canada where SRB participates as a member and the CSSF as an observer. *Source: IMF country report content unit cr17259.* ### 50. Resolution can be initiated if a resolution action is necessary in the public interest, but ### cr17259 - 50. Resolution can be initiated if a resolution action is necessary in the public interest, but ### Cross-border "public interest" test and challenges - Resolution can be initiated if a resolution action is necessary in the public interest; applying this test in a cross-border context may be complex. - The SRM Regulation requires the SRB to take into account the extent to which liquidation could achieve resolution objectives when assessing the public interest test. - Bank liquidation procedures within Member States are not harmonized, so the ability of liquidation to achieve resolution objectives may differ by jurisdiction. - It may therefore prove difficult for the SRB to apply the "public interest" test with respect to a group established in two or more Member States. ### Principal resolution tools transposed into Luxembourg law (2015 Law) - The 2015 Law introduced four principal resolution tools: - Bail-in tool: allows write down of certain liabilities and/or conversion into equity; can recapitalize and restructure the bank; may generate capital for a bridge bank acquiring good assets and critical operations (e.g., deposit book). - Sale of business tool: allows sale of shares or assets, rights and liabilities of the failing bank to a private sector purchaser without requiring consent of shareholders or third parties. - Bridge institution tool: similar to sale of business tool but acquirer is a government-sponsored and possibly government-owned temporary bridge institution. - Asset separation tool: allows transfer of assets, rights and liabilities to a separate asset management vehicle directed by the resolution authority to manage or liquidate assets to maximize value; may only be used in combination with other tools to minimize State aid implications. - The 2015 Law also: - Allows the Resolution Board to write down and convert capital instruments outside of resolution (ensuring losses are first borne by shareholders then holders of capital instruments before use of resolution tools). - Introduced supporting powers such as appointment of a special manager and imposing stays on rights to terminate contracts or execute collateral. ### SRB and CSSF strategy and planning needs - The SRB and the CSSF need to further develop preferred strategies for managing failing banks. - CSSF envisions that normal insolvency proceedings with a payout of covered depositors would be employed for most LSIs under the CSSF’s remit, as they likely would not meet the public interest test for use of resolution tools. - For banks engaged in critical functions, bail-in may be preferred, with losses in subsidiaries passed up to the parent and restructuring potentially requiring other resolution tools. - For some groups with multiple subsidiaries in Luxembourg, a combination of normal insolvency proceedings and resolution tools may be appropriate. - The CSSF is not prioritizing the use of a bridge bank at present. ### Bail-in, MREL and operationalization - Current resolution planning focuses on operationalizing the bail-in tool and setting MREL requirements. - Bail-in effectiveness depends on banks having sufficient bail-inable liabilities; establishing MREL requirements at BU and Luxembourg levels is an ongoing goal. - MREL components comprise: - (i) a loss absorption component (to bring capital to zero); - (ii) a recapitalization component (to meet the regulatory capital requirement); - (iii) a market confidence component (to restore access to market funding). - In 2016 the SRB applied a standardized approach in calculating the amount of each component applicable to all BU parent banks based on each bank's risk-weighted assets irrespective of tentative resolution strategy, yielding an "informative" external MREL target. - In 2017 it is envisioned that: - elements of the resolution strategy may be factored into setting the external MREL target; - the "quality" of MREL (the nature of subordination and proportion of the instruments that comprise MREL) will be further specified; - the distribution of MREL instruments within group entities (internal MREL) will be defined. - Given many Luxembourg banks are subsidiaries of foreign banks headquartered in the BU, specification of the nature and amount of internal MREL is critical to establish subsidiaries' capacity to upstream losses and potentially recapitalize. - The SRB, in consultation with the ECB, is transitioning the MREL specification in 2017 from a standardized approach to one tailored to each bank/group and is working to operationalize bail-in. - Incorporating institution-specific factors into MREL requires ensuring MREL is sufficient to: - (i) absorb losses identified in the level one valuation; - (ii) recapitalize the bank to supervisory standards; - (iii) provide an additional recapitalization amount to help instill market confidence; - (iv) provide a confidence margin to absorb losses not identified in the level one valuation and losses inherent in post-bail-in restructuring. - The SRB and the CSSF should ensure that MREL determinations in individual banks and groups address each of these components. ### Intragroup exposures and internal MREL concerns - Significant intragroup claims of many Luxembourg subsidiaries on their foreign parent and affiliates must be considered in setting internal MREL targets in those subsidiaries. - These intragroup claims are, in principle, subject to bail-in if the parent or affiliate is subject to resolution. - In an unanticipated parent failure, write-off losses on these claims may dwarf the subsidiary's regulatory capital and internal MREL issued to the parent, potentially rendering the subsidiary insolvent. - It is unclear how the SRB and the CSSF will agree to address this risk. - The CSSF and SRB should provide clarity for banks to meet their MREL requirements as soon as possible. - One option being considered by the CSSF is to require that intragroup claims be collateralized. ### Legal constraints: pari passu, NCWO, and cross-border recognition - Departing from pari passu treatment of creditors is permitted by the BRRD and Luxembourg law for bail-in under certain circumstances, but departures may give rise to compensation claims. - Under Luxembourg creditor hierarchy, some senior claims that might be excluded from bail-in, such as uncovered UCITS deposits, rank pari passu with other unsecured deposits and senior unsecured bonds. - The 2015 Law provides the No-Creditor-Worse-Off (NCWO) safeguard: no creditor shall be left worse off in a resolution action than under normal insolvency proceedings. - Excluding claims such as uncovered UCITS deposits from bail-in could give rise to significant NCWO claims (for example, where a bank engaged in custodian functions holds UCITS deposits and wealth management clients’ deposits are bailed-in). - NCWO claims must be paid by the SRF and SRF access criteria give rise to additional challenges. - The lack of express authority to depart from pari passu under the sale of business and bridge bank tools may constrain effective implementation; flexibility to depart from pari passu for sale of business and bridge bank tools is recommended by international good practices. - To minimize the risk that a transfer involving departure from pari passu would not be automatically recognized/enforced in other Member States, changes at the BRRD level should be considered. ### Practical constraints on executing sales and transfers - Four major business lines in Luxembourg banking: domestic retail and commercial banking, investor services, private wealth management, intragroup treasury services. - Domestic retail banking may be deemed a critical function; custodian functions may be a critical function for the largest banks engaged in investor services. - There is a limited number of banks engaged in retail functions in Luxembourg, thus a limited market for sale of retail business lines. - Transfer of custodian functions is time-consuming: most market transactions require at least three months and potentially up to nine. - Sale of custodian functions also gives rise to potentially significant NCWO claims. - Authorities should factor these issues into resolution planning and develop policies to tackle them. ### Bridge bank tool considerations - Bridge bank can be an effective fallback where a private sector acquirer cannot be found within required timeframes or on acceptable terms. - Existing law provides a clear basis to establish a bridge bank; the bridge bank is to be controlled by the Resolution Board, with a range of ownership options. - Emphasis in resolution plans is currently on bail-in; no consideration is being given to operationalizing the bridge bank tool. - As a contingency, the CSSF should consider how to use and operate a bridge bank, including ownership, governance and funding arrangements. - The SRB should provide clarity on expectations regarding terms and conditions under which the bridge bank tool can be employed. ### Resolution funding constraints and implications - The SRF (Single Resolution Fund) is the main funding mechanism to support resolution; it can provide new capital to facilitate loss absorption and recapitalization, and liquidity support; it is also to be used to pay successful NCWO claims arising from departures from pari passu. - Prerequisite for access to the SRF: shareholders and creditors must have collectively first absorbed losses of at least 8 percent of total liabilities and own funds of the bank. - This 8 percent rule may impede implementation of resolution tools requiring SRF where there are insufficient bail-inable liabilities due to statutory or discretionary exclusions from bail-in (for example, exclusion of UCITS deposits). - A second constraint: the amount provided by the SRF is limited to the lesser of five percent of the bank’s total liabilities and own funds or the means available to the SRF plus any amounts that could be raised through ex post contributions in the following three years. - This limitation may be a resolution impediment particularly during the transitional period to meeting MREL requirements. - In a systemic crisis involving multiple LSI failures, reliance on normal insolvency proceedings (preferred for most LSIs) could leave little or no MREL buffer above regulatory capital, precluding access to the SRF for any resolution funding purpose. - The potential inability to access the SRF in such circumstances highlights the importance of putting in place explicit asset and liability transfer powers under liquidation (normal insolvency proceedings). - Ensuring adequate post-resolution liquidity funding is a significant challenge, particularly in the context of bail-in: bail-in may trigger significant funding withdrawals and there is little experience in calibrating the additional capital required to restore market confidence. - If post-resolution liquidity plans are insufficient, additional resolution actions may be needed; SRB and CSSF need fallback plans. See Section on Financial Safety Nets and Funding in Resolution (in source). ### Role of courts - (Section header in source; content beyond this point not included in the supplied excerpt.) *Excerpt from IMF staff report (cr17259).* ### 65. While the judicial review regime in Luxembourg strikes a balance between the rights ### cr17259 - 65. While the judicial review regime in Luxembourg strikes a balance between the rights ### Judicial review and EU SRM interaction - The SRM centralizes decision making but relies for implementation on the NRAs; judicial review may take place both at the national and EU levels. - In Luxembourg: - Where courts find the resolution decisions of the Resolution Board illegal, acquisitions by third parties of the shares, assets, rights or liabilities of the bank under resolution are protected. - The remedy in such national cases is limited to compensation for the loss suffered as a result of the wrongful decision or act. - SRB (Single Resolution Board) decisions are subject to ex post judicial review by the European Court of Justice (ECJ). - The ECJ will only review the legality of the decision taken (and not the substance of the decision). - The ECJ may declare SRB decisions void, order the suspension of the implementation of the SRB decision, or reverse the resolution action. - If an SRB decision/instruction to the CSSF were declared void, there would be no legal authority for the CSSF to act unless the ECJ's decision provides otherwise. ### Insolvency regime applying to banks - The SRM Regulation and the BRRD do not replace the insolvency laws applying to credit institutions. - The BRRD contemplates that existing insolvency procedures for banks remain applicable as an alternative to resolution when the criteria for entry into resolution have not been met and/or alongside resolution where residual parts will be wound down. - Insolvency regimes remain relevant in resolution implementation (e.g., hierarchy of claims). - The 2015 Law introduced new resolution tools and powers in accordance with the BRRD while maintaining existing court-based insolvency proceedings (suspension of payments and winding-up). Key observations on procedures - Suspension of payments under the 2015 Law: - Can be ordered by the court upon application by the CSSF or the bank concerned to impose a general moratorium where the bank faces liquidity problems. - Can be imposed as an interim measure after license withdrawal where that decision is not final. - Requires creditor consent for reorganization, triggers insured deposit payouts within 7 days, and allows counterparties to exercise termination or modification rights — features that may destabilize the bank and make the procedure inconvenient for reorganization. - Recommendation: if retained as a reorganization instrument, assess how it could be modified to ensure orderly restructuring. - Winding-up of banks: - Can be initiated by courts upon the CSSF's or the State Prosecutor's application where suspension of payments does not rectify the situation, the bank cannot comply with commitments, or the license withdrawal has become final. - Grounds for withdrawal of license include failure to meet prudential requirements on capital, liquidity or large exposures. - Asset and liability transfer powers under winding-up: - The 2015 Law gives significant discretion to the court in determining winding-up method; general bankruptcy provisions applied in BCCI and Landsbanki did not allow transferring assets and liabilities to a third party. - Article 181(3) of the 2015 Law refers to use of FGDL's funds to transfer assets and liabilities including deposit book transfer, but no explicit power is granted to the liquidator or the CSSF to conduct such a transfer. - A winding-up order triggers a deposit payout in 7 days, creating urgency for explicit transfer powers without creditor consent to enable orderly wind down and preserve franchise value. - Such powers could increase capacity to handle multiple bank failures through winding-up but would require revisiting CSSF and FGDL roles and responsibilities during insolvency. - Creditor hierarchy: - Plays a vital role in resolution for allocating losses and determining compensation under the NCWO principle. - The creditor hierarchy in Luxembourg winding-up is determined by various laws (Civil Code, securities law, financial collateral law, 2015 Law), giving rise to interpretation difficulties and lack of precedential clarity. - The MoF has initiated a project to assess clarity of creditor hierarchy. - The recent EC proposal on subordination of senior unsecured bonds presents an opportunity to clarify creditor hierarchy rules in Luxembourg. ### Summary of recommendations (as presented) - SRB and CSSF should accelerate resolution planning in the most significant banks - SRB should reconsider its policy of a blanket preclusion of the use of the SRF in resolution plans - CSSF and the SRB should continue to work to ensure adequate consideration of significant Luxembourg subsidiaries in group resolution plans in other BU jurisdictions and in third countries - The SRB should provide policy guidance on how resolution plans should address liquidity funding in resolution, criteria for determining critical functions, core business lines and material entities, and on the various valuations involved in resolution - SRB (and CSSF) should develop any required policy guidance on the treatment of intragroup exposures in setting internal MREL requirements - Streamline SRB decision-making to ensure timely resolution and clarify the ECB's role in initiating resolution for banks/groups not supervised by the ECB - The CSSF and SRB need to address NCWO and operational challenges in implementing the sale of business tool (e.g., in the case of critical retail and custodian functions) - Clarify that the ability to depart from pari passu treatment of creditors in a class are available under all resolution tools - Contemplate fallback strategies, including the potential use of the bridge bank tool - The SRB should provide clarity on its expectations regarding the terms and conditions under which the bridge bank tool can be employed and funded - The SRB should continue and the CSSF should seek establishing cooperation arrangements with third country authorities - The ECB and CSSF should advocate at EU level the integration of host Member States into cooperation mechanisms for recovery and resolution planning insofar as these plans relate to the branches providing critical functions to the host country - Explicitly allow the transfer of assets and liabilities during the winding-up process - Ensure the clarity of creditor hierarchy, including the BCL's lien right and the ranking of SRB's preferential claims ### Financial safety nets and funding in resolution — Single Resolution Fund (SRF) - SRF features: - Owned and administered by the SRB and funded by regular ex ante and potentially extraordinary ex post contributions by banks. - Built up over eight years to a target amount currently estimated to be at least €55 billion (at least 1 percent of covered deposits of all banks within the member states participating in the SRM). - Consists of national compartments progressively mutualized over eight years; mutualized parts available to fund resolution measures in any SRM jurisdiction after a certain percentage of the jurisdiction's national compartment is used. - Permitted uses of the SRF include funding losses, recapitalization costs, liquidity needs and other expenses only to the extent necessary to ensure effective application of resolution tools, specifically: - To guarantee the assets or the liabilities of, or make loans to, an institution under resolution, a bridge institution, or asset management vehicle - To purchase assets of the institution under resolution - To make capital contributions to a bridge institution and an asset management vehicle - To make loans to the institution under resolution, a bridge institution or an asset management vehicle - To pay compensation to shareholders or creditors who suffered greater losses than they would have if the bank had been wound up under normal insolvency proceedings (NCWO claims) - To make contributions to the institution under resolution in lieu of the write-down or conversion of certain liabilities and/or creditors under exceptional circumstances and subject to certain conditions - Luxembourg-specific SRF funding as of end-2016: - Total roughly € 5.5 billion - Funded amount of the Luxembourg compartment: €105 million - €4.3 billion from the mutualized compartments - €1.1 billion bridge financing arrangement in the form of a Loan Facility Agreement (LFA) from the Luxembourg state for the unfunded portion of the Luxembourg compartment - If the Luxembourg compartment and mutualized compartment are insufficient: - SRB can first seek ex post contributions from Luxembourg banks (up to an annual limit currently of around €0.2 billion) - Secondly can seek to borrow from the market - If timely market financing is not available on reasonable terms and/or in sufficient amount, SRB can access the Luxembourg LFA - The current level of funding available for Luxembourg compares to the € 3.5 billion in fiscal cost incurred during the 2008/09 crisis - No permanent, common public back-stop exists for the SRF currently - BU participating states committed to negotiate arrangements for a common backstop at least by the time the SRF is fully mutualized in 2024 - A common backstop could take the form of a credit line from the European Stability Mechanism; MOF's preferred approach - Any borrowings against the credit line would be reimbursed from extraordinary ex post levies on banks in the medium term ### Deposit insurance — FGDL (Fonds de garantie des dépôts Luxembourg) - DGSD harmonized EU coverage: - Introduced coverage of deposits at €100,000, a requirement for faster payout, and ex ante funding arrangements - DGSD requires premiums be risk-based and that by July 3, 2024, each scheme shall reach a target level of at least 0.8 percent of covered deposits - FGDL specifics: - Established in late 2015 with the transposition of the DGSD - Covers eligible deposits made in banks in Luxembourg and their branches in the EU; does not cover deposits in Luxembourg bank branches outside the EU, deposits of other banks or investment firms, deposits by undertakings for collective investment, nor most deposits by pension and retirement funds - Covered deposits as of December 31, 2015: €28.7 billion (roughly 6 percent of the roughly €490 billion in total deposits) - Low proportion of covered deposits reflects sizeable deposits of investment funds and wealth management clients in Luxembourg banks - Funds are kept in a BCL account - The CSSF is empowered to determine when the FGDL is triggered - FGDL is subject to a requirement to payout deposits within seven days; operational capacity for medium-sized and larger banks is still being implemented - FGDL financing and targets: - Financed through ex-ante contributions imposed on banks; targets an eventual balance of 1.6 percent of covered deposits - Risk-based premiums determined by CPDI; first contributions were made in Q2 2016 - Relative to the EU DGSD target of 0.8 percent of covered deposits by 2024, FGDL target level is twice that, comprised of two fund compartments with target levels of 0.8 percent each - First compartment to be fully funded at around €230 million by the end of 2018 - Second compartment to be fully funded by 2026 - CPDI can require extraordinary contributions of up to 0.5 percent of covered deposits each year if FGDL resources are insufficient - CPDI may enter into agreements with third parties to obtain financing; exploring a line of credit with a consortium of banks - Recommendation: CPDI should pursue backstop funding arrangements; as a last resort, public funding in compliance with state aid rules could be necessary - Operational implementation note: FGDL will test all banks’ capacity to deliver required information to FGDL in the second half of 2017 *INTERNATIONAL MONETARY FUND* ### 77. The authorities have transposed the BRRD requirements regarding the ranking of ### cr17259 - 77. The authorities have transposed the BRRD requirements regarding the ranking of ### BRRD transposition, FGDL ranking, and FGDL liability in resolution - Covered deposits are senior to uncovered FGDL-eligible deposits of natural persons and SMEs, which in turn are senior to other deposits and ordinary unsecured non-preferred creditors. - In the case of a covered deposit payout, FGDL assumes the rights and obligations of the depositor in liquidation. - FGDL can fund resolution actions in certain cases in addition to paying out covered deposits in normal insolvency proceedings. - In the context of bail-in, FGDL is liable for the amount by which covered deposits would have been written down to absorb the losses in the bank, had covered deposits been included within the scope of a bail-in and been written down to the same extent as creditors with the same level of priority. - FGDL is not required to make any contribution for recapitalizing the bank or a bridge bank into which its operations are transferred. - If resolution tools other than bail-in are employed, FGDL is liable for the amount of losses that covered depositors would have suffered in proportion to the losses suffered by creditors with the same level of priority. - FGDL's liability cannot exceed losses that would result under normal insolvency proceedings. - The interpretation of Article 109 of the BRRD regarding deposit guarantee liability remains to be clarified: "in all cases the liability of the deposit guarantee shall not be greater than the amount of losses that it would have had to bear had the institution been wound up under normal insolvency proceedings." - A narrow interpretation could mean FGDL may not provide gross, upfront support greater than its estimated cost (net of recoveries in liquidation) without taking recoveries from resolution into account. - Example from the text: if a failed bank liquidation with insured deposits payout yields FGDL estimated net cost of €10, an alternative transfer of insured deposits of €60 along with €40 of the failed bank’s assets and €20 in cash from FGDL to an acquirer could result in FGDL recovering €15 of the €20 via its claim on the bankruptcy estate, resulting in a net cost of €5. Interpreting FGDL’s liability as its net cost in liquidation (€10) would prevent it from pursuing the least cost alternative. - Given the super preference given to covered deposits, FGDL's ability to support resolution powers (e.g., by injecting cash to back a deposit transfer under a sale of business resolution) may be constrained. If constrained, reconsideration is suggested to allow FGDL to disburse greater funds upfront in resolution if its estimated final cost, net of recoveries, would be lower. - Operational data point: As of September 30, 2016, the balance of the first compartment was €76 million, representing one-third its target level. - The FGDL generally ranks only below the costs of the bankruptcy administration and tax authority and certain employee claims. ### Emergency Liquidity Assistance (ELA) - Provision of ELA in the BU is the responsibility of the national central banks, subject to potential objection by the ECB. - Luxembourg banks have access to the Eurosystem's single monetary policy credit operations; collateral requirements are established under the Eurosystem framework. - Eligibility for single monetary policy credit is decided by the ECB's Governing Council according to criteria that include the financial soundness of the bank, generally requiring compliance with minimum regulatory capital requirements, as assessed in the first instance by the CSSF with input from the ECB where relevant. - Provision of ELA to Luxembourg banks is a discretionary decision for the BCL, which bears the risk of any loss. - In practice BCL ELA would involve: - Lending to a solvent bank whose eligibility requirements for accessing monetary policy are not fulfilled, and/or - Lending against collateral falling outside the established Eurosystem framework. - BCL organic law allows, in exceptional circumstances, to "grant short-term loans to its counterparts while respecting its independence and the provisions prohibiting monetary financing. It shall grant loans on the basis of adequate collateral which may consist of a State guarantee under the conditions previously agreed between the State and the Central Bank." - The ECB's Governing Council can object to BCL provision of ELA if it conflicts with ESCB objectives or constitutes monetary financing; procedures exist for ex post and ex ante notification and regular review of outstanding ELA. - Operational history and status: - No ELA has been provided to a Luxembourg bank since the last FSAP in 2011. - A communication between BCL and the MOF regarding a possible state guarantee as provided for in BCL's organic law was initiated but no decisions have been taken. The report states: "This matter should be brought to conclusion." - BCL policy developments and recommendations: - BCL has policies to guide ELA decisions and will make its own solvency determination based on input from supervisors (CSSF, ECB) and use discretion. - BCL is taking steps to value, set haircuts for, and perfect liens on acceptable collateral. - BCL may wish to formulate a policy on circumstances and conditions under which it might provide ELA in line with the Eurosystem ELA framework to a bank being resolved under a resolution strategy and plan; such a policy could address situations where present solvency is unclear but prospective solvency is reasonably assured. - FX capacity and contingency arrangements: - BCL has limited capacity to provide ELA in FX. While it has access to FX from market sources and the BIS, it has no bilateral FX swap arrangements in place with relevant central banks. - Recommendation: continue to pursue additional contingent FX funding arrangements, possibly by collaborating with the ECB (for example, exploring whether it could avail itself of swap lines entered into by the ECB). - Communication and coordination: - BCL's policies and procedural requirements have not been communicated to banks or to the resolution authorities (Resolution Board and SBR). Not providing relevant information to resolution authorities may impede comprehensiveness and effectiveness of resolution planning. - Recommendation: BCL should consider means to communicate to resolution planners information about its ELA policies and procedures. - Lien right: - BCL has a special lien right over all the assets of a credit institution for claims arising from monetary and exchange policies, as well from ELA. - The 2011 FSAP recommendation to clarify the scope and triggers for this lien right remains relevant. - Given significant changes in the resolution framework, interaction of this lien right with implementation of resolution tools and powers needs to be explored. ### Additional resolution funding support - The BRRD's government financial stabilization tools (temporary public ownership and public equity support) are not included in the SRM Regulation and were therefore not transposed in the 2015 Law, but this does not preclude state involvement as a last resort. - Should SRF and ELA funding not be available or prove insufficient, the Luxembourg state may be able to bring financial resources to support an effective resolution, subject to state aid rules. - EC approval required under the state aid rule is subject to 8 percent loss absorption rule. - Any state arrangement should address recovery of the resources committed to the full extent possible; contingency planning should address this objective. ### Systemic crisis management: preparedness and contingency planning - Current BU institutional architecture is largely oriented to individual bank/group supervision and resolution; simultaneous failures of multiple banks across BU states may require a more comprehensive strategy. - Ambiguity can exist on which authorities are responsible for design, implementation, and public communication of a system-wide strategy and how coordination would occur. - Recommendations to MOF and domestic authorities: - MOF should ensure preparedness to manage a system-wide financial crisis in Luxembourg and seek clarity and agreement on respective roles and responsibilities of the ECB and the SRB in planning for and managing such a crisis relative to domestic authorities. - MOF should pursue adoption of a formal coordination framework among all relevant parties, perhaps first domestically and then with the ECB and the SRB. - Domestic authorities, with eventual involvement of the ECB and the SRB, should develop Luxembourg-specific contingency plans for management of a system-wide crisis. - Contingency plans might contemplate as a last resort extraordinary financial support from the state, address adherence to state aid rules, and ensure recovery of state resources to the full extent possible. - Contingency plans should be periodically tested and enhanced, perhaps initially domestically and later together with the SRB and ECB. ### Implementation status and key metrics from prior FSAP recommendations - Deposit insurance scheme: - National transposition of the DGSD transformed the private ex post financed deposit guarantee scheme into a public ex ante financed scheme. - Luxembourg DGS has a final target level of 1.6 percent of covered deposits, twice the level required in the DGSD. - The first 0.8 percent are to be collected by end 2018, ahead of the 2024 DGSD deadline. - Luxembourg already requires a covered deposit payout within 7 working days, which is the 2024 DGSD target payout period. - Bank resolution framework: - Provisions of the BRRD involving a new range of resolution tools were transposed into domestic law. Requirements for recovery planning provide additional mechanisms for intervention in problem banks. - Cross-border resolution cooperation: - SRM regulation and the 2015 Law provide for strong cooperation mechanisms with EU authorities and other Member States. Resolution actions in a Member State are given automatic recognition; third-country resolution proceedings can be recognized and enforced by the Resolution Board. - Currently there is no cooperation arrangement signed by the CSSF’s Resolution Board with third countries. - Crisis preparedness and management: - The 2015 Law provides roles and responsibilities of authorities for individual bank failures, but no formal and structured mechanisms exist for interagency cooperation and communication for crisis preparedness and management. - A Systemic Risk Board was established in April 2015. Its composition ensures close cooperation between its members (the Government, the BCL, the CSSF, and the CAA). Its aim is to help safeguard stability of the Luxembourg financial system by strengthening resilience and decreasing the build-up of systemic risks. ### Summary of recommendations (selected, verbatim where provided) - The MOF should continue to contribute to deliberations on adoption of a BU-wide backstop funding arrangements for the SRF and a common BU-wide deposit insurance scheme - The CSSF should arrange for backstop funding for FGDL - Clarify the interpretation of the FGDL's liability in resolution, and its potential to fund an insured deposit and asset transfer as a less expensive and disruptive alternative to payout - A potential state guarantee of BCL ELA should be discussed between the BCL and the MOF - The BCL should continue to pursue additional contingent FX funding arrangements - The BCL may wish to consider formulating a policy on the circumstances and conditions under which it would provide ELA in line with the established ELA framework to a bank being resolved under a resolution strategy and plan - The BCL should consider to communicate to resolution authorities information regarding its ELA policies and procedures to enable better resolution planning - Clarify the scope and triggers for the BCL's lien right as well as its impact on resolution tools - MOF should seek to achieve clarity and agreement on the roles and responsibilities of the domestic authorities, and eventually the ECB and the SRB, in dealing with a system-wide crisis - The domestic authorities initially, and with ECB and SRB involvement eventually, should develop Luxembourg-specific contingency plans for the management of a system-wide crisis - Contingency plans should be tested and enhanced via simulation exercises *IMF staff report content as provided in the source text* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17259.pdf_