Opinion of the European Central Bank of 28 May 2019 on judicial relief granted to former holders of qualified bank credit (CON/2019/20)

OPINION OF THE EUROPEAN CENTRAL BANK of 28 May 2019 on judicial relief granted to former holders of qualified bank credit (CON/2019/20) Introduction and legal basis

On 12 April 2019 the European Central Bank (ECB) received a request from the Vice-President of the Slovenian National Assembly for an opinion on a draft law on judicial relief granted to former holders of qualified bank credit (hereinafter the ‘draft law’) prepared by the National Council of the Republic of Slovenia. The ECB’s competence to deliver an opinion is based on Articles 127(4) and 282(5) of the Treaty on the Functioning of the European Union and the third and sixth indents of Article 2(1) of Council Decision 98/415/EC as the draft law relates to Banka Slovenije, rules applicable to financial institutions insofar as they materially influence the stability of financial institutions and markets and the tasks conferred upon the ECB pursuant to Article 127(6) of the Treaty. 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 main objective of the draft law is to remedy the unconstitutionality, as declared by the Constitutional Court of the Republic of Slovenia (hereinafter the ‘Constitutional Court’) in Decision No U-I-295/13-260 of 19 October 2016 (hereinafter the ‘Constitutional Court’s Decision’) , of certain provisions of the Law on banking (hereinafter the ‘ZBan-1’) governing Banka Slovenije’s liability for damages with respect to extraordinary measures imposed by Banka Slovenije. The provisions assessed by the Constitutional Court authorised Banka Slovenije to adopt extraordinary measures to write-down or convert qualified liabilities during the reorganisation of a bank that failed or was likely to fail, to meet minimum requirements for capital and liquidity, to an extent that could result in the withdrawal of their banking authorisation.

1.2 While the Constitutional Court confirmed that the legal basis for the extraordinary measures imposed in 2013 and 2014 by Banka Slovenije in respect of the write-down of subordinated instruments was in line with the Constitution of the Republic of Slovenia , it held that the provisions of Article 350.a of the ZBan-1 providing for judicial relief to be unconstitutional. This conclusion was based on the Constitutional Court’s finding that exercising judicial relief under Article 350.a of the ZBan-1 did not afford effective judicial protection to former holders of qualified bank credit affected by Banka Slovenije’s extraordinary measures. The Constitutional Court decided that the legislator must remedy the unconstitutionality within six months of the publication of the Constitutional Court’s decision and provided the legislator with further guidance on how best to ensure more effective judicial protection. 1.3 The main purpose of the draft law is to remedy the unconstitutionality of the judicial relief afforded to former holders of qualified bank credit affected by Banka Slovenije’s extraordinary measures, as declared by the Constitutional Court. 1.4 The draft law codifies special procedural rules of judicial redress for the former holders of qualified bank credit, which deviate from the general rules and, inter alia, enable legal proceedings against a particular decision on extraordinary measures to be reviewed in a “sample procedure”, meaning that the court reviews one claim, while other procedures are put on hold and a decision is then applied to other claims. Any action for compensation may be filed at the latest within twelve months from the entry into force of the draft law. 1.5 The draft law regulates those proceedings in which the former holders of qualified bank credit are seeking judicial protection under civil law on the basis of Article 350.a of the ZBan-1. 1.6 Article 350.a of the ZBan-1 stipulates that shareholders, creditors, and other persons whose rights are affected due to the effects of an order by Banka Slovenije on an extraordinary measure may claim damages from Banka Slovenije in accordance with Article 223.a of the ZBan-1, if they prove that the loss that has arisen due to the effects of the extraordinary measure is higher than it would have been had the extraordinary measure not been adopted. Article 223.a of the ZBan-1 stated that Banka Slovenije and all of the persons acting on its behalf should be acting with the diligence of a good expert when exercising their supervisory functions. As confirmed by the Constitutional Court, the liability of Banka Slovenije under Article 350.a of the ZBan-1 is a sui generis liability (specially determined liability) . 1.7 The draft law refers to the provisions of the ZBan-1 for the criteria by which the court establishes whether a claimant has a right to compensation. It provides guidelines for the court on how to establish a right to compensation. When determining whether a claimant has a right to compensation, the court should primarily establish whether extraordinary measures relating to qualified liabilities were adopted by the Banka Slovenije in accordance with, and subject to the fulfillment of, the conditions laid down in the ZBan-1 . The court should, verify whether (a) the

assessment of the fulfillment of the conditions for adoption of extraordinary measures was incorrect, (b) the obligations were not treated in line with the provisions of the ZBan-1, and (c) the assessment was not in line with the International Financial Reporting Standards (hereinafter the ‘IFRS’) and the relevant legislation applicable at that time. 1.8 To determine whether the conditions laid down in the ZBan-1 were accurately assessed , the main aspects that the court should verify, are whether: (a) the method and the premise underlying the method used in the assessment were in breach of the relevant provisions of the ZBan-1 applicable 10 11 at that time, Law on companies or Law on measures to strengthen the stability of banks ; (b) the methods and premise underlying the methods used in the assessment were in breach of the IFRS or other legislation applicable at that time; (c) the method of obtaining the data used in the preparation of the assessment gives rise to a reasonable doubt as to whether correct source data were used and whether this affected the assessment; (d) the data used in the assessment was used incorrectly and whether this affected the assessment, and (e) there is reasonable doubt concerning the professionalism of the person who performed the valuation of the assets of the bank that was used for the assessment to such an extent that it would be an unsuitable basis for a decision . 1.9 To determine whether the valuation of liabilities was performed in line with the provisions of the ZBan-1 applicable at that time , the main aspects that the court should verify are whether: (a) the method and the premise underlying the method used in the assessment , to an extent that impacted the assessment, were in breach of the provisions of the ZBan-1 applicable at that time, Law on Companies, Law on measures to strengthen the stability of banks, the IFRS and other relevant legislation applicable at that time; (b) the methods and premise underlying the methods used in the assessment were used wrongly or in breach of the relevant legislation applicable at that time; (c) the method of obtaining the data used in the preparation of the assessment gives rise to a reasonable doubt as to whether original source data were used and whether this affected the assessment; (d) the data used in the assessment was used incorrectly and whether this affected the assessment, and (e) the assessment of the premise and capital requirements, which were the basis for the preparation of the assessment, were in breach of the IFRS or the relevant legislation, as applicable at that time .

1.10 If the court establishes that the conditions for the imposition of extraordinary measures were not fulfilled or that qualified liabilities were not treated correctly, the court would have to establish what would have been the most likely treatment of qualified liabilities had they been treated correctly or had no extraordinary measures been imposed, and the difference in value of qualified liabilities in such a case in comparison with their actual treatment. 1.11 Thereby, the damages are set as the difference between the actual and most likely treatment of the qualified liabilities . The basis for damages to be calculated by the court will include the amount of unpaid principal in qualified liabilities that had a due date, or the book value of qualified liabilities without a due date, and the prescribed interest rate . 1.12 The draft law regulates claims for damages filed against Banka Slovenije pursuant to the relevant provisions of the ZBan-1 by the former holders of qualified liabilities, who were worse off due to the adoption of the extraordinary measures. According to the explanatory memorandum , any compensation will be paid solely by Banka Slovenije. The draft law also provides for the Republic of Slovenia, in its role as a former holder of qualified liabilities, to make a claim against Banka Slovenije through the State Attorney’s office. 1.13 The draft law also lays down rules for the disclosure of documents and information in relation to any decision on extraordinary measures adopted by Banka Slovenije. Banka Slovenije must establish a virtual data room for each bank in respect of which an extraordinary measure was adopted and disclose to the former holders of qualified liabilities and their advisers in full, in the original language as well as in Slovene, documents which were considered by Banka Slovenije in the adoption of the extraordinary measures. In particular, the following documentation must be disclosed: (a) the decision on extraordinary measures with all appendices and documents referenced in the decision, (b) the assessment of the relevant bank’s assets, (c) all asset quality review (AQR) and stress tests, (d) the contract between the evaluator and Banka Slovenije and/or the relevant bank, (e) all documentation dealing with the Slovene economy prepared by Roland Berger and Oliver Wyman for the period between September 2013 and June 2014 which are in the possession of Banka Slovenije, (f) all minutes of the steering committee and operating committee, (g) loan files with an explanation how they were used in the valuation, (h) samples of real estate valuations and (i) other documents used in the assessment . Access to such documents will be subject to confidentiality requirements. 1.14 The draft law provides that the costs of legal proceedings will be paid by the State.

2. Observations

2.1 Prohibition of monetary financing 2.1.1 The ECB has already delivered opinions on three earlier versions of the draft law prepared by the

Government of the Republic of Slovenia . Under the first version of the draft law, compensation for damages incurred as a result of the extraordinary measures was required to be paid either by Banka Slovenije or the State, and if no liability could be attributed to Banka Slovenije, compensation was required to be paid by the State . Under the second version of the draft law, even though Banka Slovenije would be liable for damages, provision was also made for Banka Slovenije to file an action against the State in order to prove in a separate court procedure that Banka Slovenije was not liable for the damages resulting from the imposition of the extraordinary measures . The third version of the draft law did not make any reference to the liability of the State . Similarly to the latter, the current version of the draft law does not make any reference to the liability of the State. It however stipulates that the costs of legal proceedings will be paid by the State. 2.1.2 Against this background, the ECB reiterates the observations made in its previous opinion on this 23 24 matter . As noted therein , a requirement that Banka Slovenije must pay compensation for damages, to the extent that it results in Banka Slovenije assuming the liability of the Republic of Slovenia, would not be in line with the monetary financing prohibition laid down in Article 123 of the Treaty . As repeatedly noted by the ECB, while resolution tasks may be considered to be central banking tasks, provided that they do not undermine the independence of a national central bank (NCB) in accordance with Article 130 of the Treaty, the discharge of these tasks by NCBs may not extend to the financing of resolution funds or other financial arrangements related to resolution proceedings as these are governmental tasks . In this respect, it is noted that Directive 2014/59/EU of the European Parliament and of the Council provides that the resolution financing arrangements may be used to pay compensation to shareholders and creditors if the valuation carried out for the purposes of assessing whether shareholders and creditors would have received better treatment if the institution under resolution had entered into normal insolvency proceedings determines that any shareholder or creditor has incurred greater losses than they would have incurred under normal insolvency proceedings . It is also noted that Regulation (EU) No 806/2014 of the European Parliament and of the Council envisages that, on the one hand, the resolution

fund may be used to pay compensation to shareholders or creditors if, following a valuation, they have incurred greater losses than they would have incurred under normal insolvency proceedings while on the other hand, in the case of non-contractual liability, the Single Resolution Board would compensate for any damage caused by it or by its staff in the performance of their duties . The draft law should establish liability arrangements which clarify that Banka Slovenije is not liable to pay compensation for damages in circumstances that mirror the compensation provided for under Directive 2014/59/EU and Regulation (EU) No 806/2014 to be paid from resolution financing arrangements to shareholders or creditors when a second independent valuation (carried out after resolution actions have been effected) determines that shareholders or creditors have incurred greater losses than they would have incurred under normal insolvency proceedings, as otherwise, Banka Slovenije would de facto finance extraordinary measures akin to resolution proceedings. Banka Slovenije may not finance a government task. 2.1.3 In addition, the ECB notes that Article 258 of the Treaty empowers the European Commission to bring a case before the Court of Justice of the European Union where a Member State has failed to fulfil an obligation under the Treaties, e.g. by way of enacting national legislation incompatible with the Treaties. Such action for infringement of Union law by a Member State covers also infringement proceedings in connection with the prohibition on monetary financing laid down in Article 123 of the Treaty. In addition, under Article 271(d) of the Treaty the Governing Council of the ECB has in respect of NCBs the same powers as those conferred upon the Commission in respect of Member States by Article 258 of the Treaty. Consequently, if the ECB considers that an NCB has infringed an obligation under the Treaties, including where the monetary financing prohibition is concerned , the ECB may bring an action for failure to fulfil obligations against that NCB before the Court . 2.2 Financial independence of Banka Slovenije As the ECB has repeatedly stated , Member States may not put their central banks in a position where they have insufficient financial resources and inadequate net equity to carry out their ESCB or Eurosystem-related tasks, as well as their national tasks. Consequently, the impact of the draft law on the financial resources of Banka Slovenije and its financial independence should be carefully considered should there be a possibility that Banka Slovenije could lose a significant amount of its reserves due to compensation for damages to be paid under the draft law. 2.3 Professional secrecy 2.3.1 As noted by the ECB in its opinions on earlier versions of the draft law, national legislation should be compatible with obligations to maintain professional secrecy imposed by Union law, in particular

by Article 53 of Directive 2013/36/EU of the European Parliament and of the Council . In this respect, the ECB considers that except for the outcome of stress tests, the publication of which is explicitly permitted under Article 53(3) of Directive 2013/36/EU, the stress test reports, AQR and asset valuations relating to individual supervised banks are to be regarded as confidential information. Disclosure of such confidential information can generally only be permitted in cases specified in Article 53(1) of Directive 2013/36/EU, which does not include disclosure to all the claimants envisaged under the draft law as disclosure is only permitted in cases of civil proceedings in connection with cases where a credit institution has been declared bankrupt or is being compulsorily wound up . 2.3.2 In order to ensure the adequate protection of confidential supervisory information, the disclosure of stress test reports and minutes of the steering and operating committees to the shareholders or creditors who were directly affected by the extraordinary measures taken by Banka Slovenije and therefore have a legitimate legal interest as defined by the Constitutional Court should be done without confidential information being disclosed. 2.4 Miscellaneous 2.4.1 Finally, as previously noted by the ECB , pursuant to Article 33 of Council Regulation (EU) No 1024/2013 , from 3 November 2013 onwards, in view of the imminent assumption of its prudential supervisory tasks under Regulation (EU) No 1024/2013, the ECB was authorised to require the national competent authorities, including Banka Slovenije, together with credit institutions, financial holding companies, mixed financial holding companies and mixed-activity holding companies of euro area Member States, as well as persons belonging to these entities and third parties to whom these entities had outsourced functions or activities, to provide all relevant information for the ECB to carry out a comprehensive assessment, including a balance-sheet assessment, of credit institutions in euro area Member States. The comprehensive assessment conducted by the ECB in this context comprised two components, including an AQR, which was a point-in-time assessment of the accuracy of the carrying value of banks’ assets as on 31 December 2013. The AQR was undertaken by the ECB and the national competent authorities, including Banka Slovenije, and was based on a uniform methodology and harmonised definitions. The comprehensive assessment was based on Regulation (EU) No 575/2013 of the European Parliament and of the Council and

Directive 2013/36/EU . The ECB notes that the judicial review of the comprehensive assessment, including the underlying uniform methodology, conducted by the ECB in this respect falls outside the competence of the national courts, and falls exclusively within the competence of the Court of Justice of the European Union. It would be useful, to avoid any possible doubt on this issue, to introduce a provision into the draft law to clarify this particular point, so that any possible discrepancies between the draft law and Union law in this respect can be avoided.

This opinion will be published on the ECB’s website.

Done at Frankfurt am Main, 28 May 2019.

[signed]

The President of the ECB

Mario DRAGHI