Opinion of the European Central Bank of 9 March 2009 at the request of the Polish Minister for Finance on a draft law on recapitalisation of certain financial institutions (CON/2009/19)

OPINION OF THE EUROPEAN CENTRAL BANK of 9 March 2009 at the request of the Polish Minister for Finance on a draft law on recapitalisation of certain financial institutions (CON/2009/19) Introduction and legal basis

On 19 February 2009 the European Central Bank (ECB) received a request from the Polish Minister for Finance for an opinion on a draft law on the recapitalisation of certain financial institutions (hereinafter the ‘draft law’). The ECB’s competence to deliver an opinion is based on Article 105(4) of the Treaty establishing the European Community and the sixth indent of Article 2(1) of Council Decision 98/415/EC of 29 June 1998 on the consultation of the European Central Bank by national authorities regarding draft legislative provisions , as the draft law contains rules applicable to financial institutions insofar as they materially influence the stability of financial institutions and markets. In accordance with the first sentence of Article 17.5 of the Rules of Procedure of the European Central Bank, the Governing Council has adopted this opinion.

1. Purpose of the draft law

1.1 The draft law provides for public intervention instruments to address potential liquidity or solvency difficulties that may arise in the financial market by way of enabling public authorities to: (i) provide a State guarantee to market-initiated recapitalisation operations (hereinafter a ‘State recapitalisation guarantee’); and (ii) initiate compulsory State takeovers of a distressed financial institution (hereinafter a ‘compulsory State takeover’) . The measures provided for in the draft law may be adopted until 31 December 2010 in relation to two categories of financial institutions 4 5 established in Poland: domestic banks and domestic insurance companies , excluding mutual

insurance associations. They will complement other measures, which will be introduced on the basis of the Law on State Treasury support to financial institutions (hereinafter the ‘Law on State support’). 1.2 Specifically, the draft law will enable the Minister for Finance to provide State Treasury guarantees facilitating recapitalisation by market entities of distressed financial institutions in relation to which rehabilitation proceedings have been initiated . Such State recapitalisation guarantees will result in the State Treasury acquiring shares, bonds or other debt instruments issued by the recapitalised financial institution in cases where such instruments are not acquired by market entities (existing shareholders or third persons) . The Minister for Finance will issue State recapitalisation guarantees under the following cumulative conditions: (a) on application by the financial institution and by way of an agreement with the institution concluded after consultation with the Financial Supervision Commission (FSC) and the President of Narodowy Bank Polski (NBP); (b) on approval by the FSC of the relevant rehabilitation plan ; and (c) subject to certain statutory limitations as to the scope and amount of the guarantees . The provision of a guarantee will be remunerated by way of commission charged to the recapitalised financial institution, the amount of which will be determined in accordance with the rules specified in the draft law and the implementing provisions to be adopted by the Minister for Finance . 1.3 According to conditions linked to the provision of State recapitalisation guarantees, the guarantee agreement will also determine, inter alia, the power of the Minister for Finance to appoint members of the recapitalised financial institution’s bodies and the Minister’s influence on the financial policy of such institution, as well as limitations on the remuneration that the institution may offer to its management . Where a State recapitalisation guarantee is exercised, i.e. if the State Treasury acquires financial instruments issued by the recapitalised financial institution, the FSC may, acting on a request of the Minister for Finance, appoint a guardian to oversee the realisation of the rehabilitation plan . Furthermore, in the event of a breach of the conditions of a State recapitalisation guarantee, the State Treasury may demand the redemption of its holdings of financial instruments issued by the recapitalised financial institution and/or apply to the FSC to

place the institution under compulsory administration, or carry out a compulsory State takeover of the institution . 1.4 Finally, the draft law permits a compulsory takeover of a distressed financial institution by the State Treasury if there is a threat to the solvency of a financial institution and such takeover is justified on the grounds of financial system stability . A compulsory State takeover requires the adoption of a decision by the Council of Ministers following consultation with the FSC and the President of the NBP . The State Treasury has to dispose of the shares it has acquired as a result of a takeover once financial stability is restored, and in any event no later than within three years of their acquisition with up to two additional extensions of one year each being possible .

2. General observations

2.1 The ECB notes that the draft law is the second Polish law providing for State intervention in the financial sector to mitigate the current financial turmoil alongside the Law on State support , and therefore reminds the consulting authority of the statements expressed in ECB Opinion CON/2008/80 on the Law on State support and in its other recent opinions on draft national laws in other Member States relating to emergency measures . The ECB also notes that the common principles to guide State actions have been highlighted in the conclusions adopted at the Ecofin meeting on 7 October 2008 . On 12 October 2008 the Heads of State of the euro area issued a ‘Declaration on a concerted European action plan of the euro area countries’ (hereinafter the ‘Declaration’), in which they agreed on common principles to be followed by the EU and euro area governments, central banks and supervisors to avoid national measures adversely affecting the functioning of the single market and other Member States. This coordinated approach includes initiatives aimed at ensuring appropriate liquidity, facilitating the funding of banks by various means, providing additional capital resources to financial institutions and recapitalising distressed banks. The European Council endorsed these principles for all Member States on

16 October 2008 . The ECB notes that coordination of national measures is already taking place at

European and international level .

2.2 Concerning the issue of the application of State aid rules to measures taken by the Member States

in connection with financial institutions in the context of the ongoing financial crisis, the ECB also

draws the consulting authority’s attention to the importance of ensuring that the proposed

arrangements comply with the relevant Community law provisions, in particular that they avoid

undue distortions of competition, and with the criteria recently laid down by the Commission in its

guidance on compliance by financial sector support schemes with EU State aid rules , as well as

the subsequent Commission’s guidance specifically targeting recapitalisation measures .

2.3 The ECB notes that under the draft law the Ministry of Finance proposes to consult the President of

NBP prior to deciding to support a domestic financial institution. While appreciating the draft law’s

recognition of NBP’s expertise in this field, the ECB also expects that NBP’s involvement in the

procedure provided for in the draft law should not extend beyond the provision of advice and that it

of the Treaty, read in conjunction with Council Regulation (EC) No 3603/93 of 13 December 1993

specifying definitions for the application of the prohibitions referred to in Articles 104 and 104b(1)

of the Treaty . In addition, it is also expected that NBP will perform these advisory tasks in

connection with State support measures in a manner fully compatible with its institutional and

financial independence, thereby safeguarding the proper performance of its tasks under the Treaty

and the Statute of the European System of Central Banks and of the European Central Bank .

3. Specific observations

3.1 Eligibility for support and takeover measures

The ECB understands that subsidiaries of foreign financial institutions are included in the scope of

from the measures provided for by the draft law. This is in line with the Commission’s guidance on

compliance by the financial sector support schemes with State aid rules . The ECB welcomes the

above provision, as it avoids distortion of the level playing-field for domestic financial institutions

and subsidiaries of foreign institutions.

3.2 The draft law and coordination of the policy of the Member States

In line with the Declaration, Member States have to act in a coordinated manner to avoid the risk of

significant differences in national implementation creating distortions in global banking markets.

The euro area Heads of State also acknowledged the need to work in cooperation with the ECB so

as to ensure consistency with the management of liquidity by the Eurosystem and compatibility

with the operational framework of the Eurosystem. In this respect, the ECB emphasises that

uncoordinated decisions among Member States should be avoided as they may lead to significant

differences in the treatment of financial institutions between Member States. This remark also

applies to measures relating to state capital investments.

3.3 Conditions for State capital investments

The ECB takes the opportunity to reiterate the points made in its previous opinions regarding

recapitalisations , as also subsequently published in a separate document . In this respect the ECB

notes that the recapitalisation measures considered in Member States should be aimed at

strengthening the capital position of fundamentally sound financial institutions in order to improve

the functioning and stability of the banking system and to ensure the proper financing of the

economy. In particular, a consistent approach should be adopted in defining the conditions for recapitalisations and the pricing of the instruments intended to provide Tier 1 capital to financial institutions. The ECB underlines the importance of appropriate pricing for recapitalisations in terms of the goals of enhancing the stability of the financial system, facilitating a return to normal market conditions and ensuring the proper financing of the economy. The ECB also highlights that the pricing conditions for capital support should be risk-based and market-oriented, determined by taking into consideration the specific risk of both the specific instrument chosen for injecting capital and the institution concerned. Specific features of the instruments for capital injections, such as preference shares, should be appropriately chosen so that, while encouraging an early end to the State’s capital support of banks, they should not result in an excessive increase in the cost of capital. 3.4 Against this background, the ECB has the following remarks. First, the ECB notes that pursuant to the draft law the State may issue guarantees in order to facilitate recapitalisation by market entities of distressed financial institutions in relation to which rehabilitation proceedings have been initiated. The ECB therefore understands that these guarantees, if activated, would lead to capital injections by the State into distressed financial institutions. In this respect, the ECB underlines that, according to the Recommendations and in line with paragraph 9 of the Declaration, the recapitalisation measures considered by Member States should be aimed at strengthening the capital position of distressed but fundamentally sound financial institutions. 3.5 Second, as regards the pricing of State recapitalisation guarantees, the ECB reminds the consulting authority that it is crucial to ensure a level playing-field for the harmonisation of the price determination of such guarantees within the euro area and the EU; moreover, that the price of a State recapitalisation guarantee is risk-based and market-oriented and determined on the basis of the costs of a corresponding guarantee in the market. In this context, the ECB welcomes Articles 11 and 12 of the draft law and the implementing provisions to be adopted by the Minister for Finance, which make the applicable commission dependent, inter alia, on the beneficiary’s risk rating. 3.6 Third, the ECB also reminds the Polish authorities that beneficiary financial institutions may not profit from undue use of their guaranteed status to engage in a heightened level of activities that distort the market. In this regard, the ECB reiterates the importance of establishing appropriate safeguards such as limits on the marketing of financial products or on the expansion of activities on the basis of State guarantees. 3.7 Fourth, in line with the Declaration, the ECB also emphasises that harmonisation regarding the expiry of national financial support schemes across the EU is crucial, as application of such schemes is aimed at restoring normal market conditions. In this context, reiterating its position taken in previous opinions , the ECB welcomes the fact that the draft law expressly provides that

the State’s participation in financial institutions resulting from a compulsory State takeover is temporary and that the State’s role as a shareholder is limited both on the basis of a period of time and the development of market conditions . The ECB also welcomes the introduction of a precise deadline, 31 December 2010, for the issuance of State recapitalisation guarantees and carrying out compulsory State takeovers . In this context, the ECB suggests introducing a more precise reference to issuance of State recapitalisation guarantees in Article 25 of the draft law by extending the reference to Article 3(1) in conjunction with Article 4(1). In contrast, it appears from the draft law that once State recapitalisation guarantees are exercised, the related capital injection by the State into the financial institutions is not intended to be a temporary measure that would only remain in force for the duration of the present crisis or until a given point in time in the future. In this respect, the ECB suggests introducing limitations on State ownership of shares acquired as a result of exercising the recapitalisation guarantee pursuant to Article 5(1) of the draft law, which are similar to those applicable to shares acquired by the State in result of a compulsory State takeover pursuant to Article 14 of the draft law. In this context, the ECB notes that the step-up clause in Article 7(3) of the draft law regarding dividends paid on preferred shares of the State Treasury provides an incentive for the issuer to redeem the shares acquired by the State Treasury as soon as possible . However, for such a step-up clause to be fully effective, a specific provision in the articles of association of the financial institution in question would be necessary to enable it to redeem such shares at its own discretion if the capital injection provided by the State Treasury is no longer needed . The ECB notes that in this regard, by establishing such an open-ended scheme, the draft law is not fully in line with the Declaration, which clearly draws attention to the need for any domestic support schemes and for the legal framework that provides for them to be temporary in nature, even if these can be extended or renewed . 3.8 Technical remarks The ECB points to a possible omission in Article 15(2) of the draft law, which applies some effects of placing the financial institution under compulsory administration only to bodies of a bank. It seems that insurance companies are also intended to be covered by this provision. For reasons of

clarity the ECB therefore suggests replacing the references to ‘bank’ in Article 15(2) by references to ‘financial institution’. This opinion will be published on the ECB’s website. Done at Frankfurt am Main, 9 March 2009. [signed]

The President of the ECB

Jean-Claude TRICHET