While Spain's Banco Popular Español SA has been hailed as a textbook example of banking resolution, the ensuing legal turmoil shows that the process is by no means perfect, and future cases will need to address issues such as transparency and liquidity, according to legal experts, who said the system could also be challenged by the failure of a larger and more complex lender.
European authorities wound down Banco Popular in June 2017 after an acute liquidity crisis, arranging a €1 sale to Banco Santander SA in what was the first test for the EU's Single Resolution Mechanism. Although the authorities hailed it as a success, the decision is facing legal challenges in the European Court of Justice, Spain and New York after investors lost some €3 billion.
Given the likelihood of investor challenges, a resolution process needs to be "bulletproof from a legal perspective," said Fernando Minguez Hernandez, a lawyer specializing in financial regulation at Spanish law firm Cuatrecasas in Madrid.
"Resolution authorities must operate on the hypothesis that their decisions are going to be challenged and thoroughly reviewed," he said.
Plaintiffs in the suits contend that European regulators unduly influenced markets, ignored options to rescue Popular and failed to make transparent the process of dealing with the ailing lender. They have disputed the validity of a Deloitte report on the bank's value and say the agency in charge of failing EU banks, the Single Resolution Board, ignored the fact that the bank had been seeking a buyer or planning to raise capital.
"There is no problem with bank resolutions in principle, provided that they are initiated on the basis of a proper factual foundation and are conducted in accordance with the relevant legislation," said Richard East, a lawyer at Quinn Emanuel who is representing an ad hoc group of Popular bondholders, including Pacific Investment Management Co. LLC, Anchorage Capital Partners LP, and Algebris Investments (US) Inc. "However, in this case, unfortunately, the manner in which the SRB precipitated and then conducted the resolution and valuations clearly cannot be regarded as having a proper foundation or, indeed, to have complied with the legislation."
An SRB spokesman affirmed the agency's belief that it "handled the resolution case in accordance with the legislative framework and [has] been as open and transparent about it" as possible, pointing to the opportunity given to affected parties to use an ongoing 'right-to-be-heard' procedure. The SRB has received around 12,000 'right-to-be-heard' submissions.
Popular's struggles were primarily liquidity-related, and plaintiffs say these were exacerbated after Reuters reported that SRB Chair Elke König had delivered an "early warning" on Popular and said it risked being wound down if it failed to find a buyer. Panicked depositors withdrew €9 billion in the four days following the report, as the bank's share price plunged and its capital stock dwindled toward the trigger level at which its Additional Tier 1 bonds would be converted into equity.
Yet despite its struggles, Popular had not breached its minimum capital levels at the point when it was declared nonviable.
Minguez said EU bank failure rules do not sufficiently address liquidity crises as opposed to solvency issues and need fine-tuning, through a change either in the regime or in the roles played by the SRB and the European Central Bank.
The challenge lies in "creating a viable system that combines both the monetary policy element and the resolution element," said Jens-Hinrich Binder, a professor of corporate and commercial law at Tubingen University in Germany. "There is a role for central banks to act decisively as lenders of last resort in a pure liquidity crisis," he said, but in the eurozone, "the arrangements for that are piecemeal and are not realigned properly with the provision of resolution funding under the auspices of the SRB" and the Single Resolution Fund.
Rules need to be 'refined'
Much of the legal action over Popular hinges on a provisional sale-of-business valuation, conducted prior to the resolution by auditor Deloitte, which valued the bank at between €1.3 billion and negative €8.2 billion. In August 2018 the SRB published a long-awaited "no creditor worse off," or NCWO, valuation report, also by Deloitte, which concluded that bondholders and shareholders would not have received better treatment under normal insolvency proceedings, meaning that the SRB would likely not have to compensate investors.
However, some of Popular's bondholders have conducted their own valuation, which indicates that the bank would have generated €3.4 billion in cash following a seven-year insolvency, after repaying €2 billion lost by bondholders.
Binder said the wide range in valuations "is an indication that the bondholders might have a point ... but it is natural for a resolution authority to err on the safe side." Banking resolutions tend to happen very quickly, making valuations tricky, and the question is likely come up again, he said.
The SRB spokesman said it and the European Commission regularly review regulation for aspects that could be interpreted in different ways and for areas where rules may be "out of sync with each other."
Experts said it also remains questionable whether the current regime would be able to deal with the failure of a large, systemically important European bank.
"I still don't see how the massive difficulties in the respects of commercial, legal, cross-border issues, coordination of a vast number of authorities can be addressed in a meaningful and reliable way in the case of very large, complex internationally active institutions," Binder said.
Observing that Popular was not an international lender, Minguez added that the significance of its case "should not be overstated — not to criticize the rules but not to praise them too much — because we have not handled yet a really difficult case, so let's see how the framework operates when confronted with a case that really poses a challenge at the European scale."