Opinion of the European Central Bank of 19 May 2023 on the liquidation of credit institutions (CON/2023/12)

OPINION OF THE EUROPEAN CENTRAL BANK of 19 May 2023 on the liquidation of credit institutions (CON/2023/12) Introduction and legal basis

On 24 February 2023 the European Central Bank (ECB) received a request from the Cypriot Ministry of Finance for an opinion on a draft law on the liquidation of credit institutions (the ‘draft law’), together with draft laws amending a number of existing laws, including the Resolution of Credit Institutions and Investment Firms Laws, the Business of Credit Institutions Laws, and the Deposit Guarantee and Resolution of Credit and Other Institutions Scheme Laws and the Deposit Guarantee and Resolution of Credit and Other Institutions Scheme Regulations (such draft amendments together with the draft law are hereinafter collectively referred to as the ‘draft legislative framework’). 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 legislative framework relates to the Central Bank of Cyprus (CBC) and rules applicable to financial institutions in so far as they materially influence the stability of financial institutions and markets and the ECB’s tasks concerning the prudential supervision of credit institutions 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 legislative framework

1.1 As stated in the explanatory note accompanying the draft legislative framework, the main purpose of the draft law is to adopt an effective insolvency framework for credit institutions that ensures rapid intervention by the CBC in order to maintain financial stability and secure the continuity of depositors’ access to their deposits, through the appointment of a temporary liquidator. The primary duty of the temporary liquidator is the sale of assets and liabilities of the credit institution under liquidation to another credit institution. If the sale of assets and liabilities is not possible within a reasonable time, the temporary liquidator appointed by the CBC will assist in the compensation of covered depositors by the Deposit Guarantee Scheme (DGS) and the liquidation of the credit institution with the aim of reaching the best possible results for all creditors, in particular the maximisation of the liquidation value of the credit institution’s assets. The winding-up of the credit institution is completed by a court-appointed liquidator following the recommendation of the CBC.

1.2 As also noted in the explanatory memorandum, the draft legislative framework partially reharmonises some features of various Union directives on, inter alia, the recovery, resolution, reorganisation and winding-up of credit institutions and on deposit guarantee schemes . 1.3 As noted in the explanatory memorandum, the draft law is the core of the draft legislative framework. The draft law applies to all authorised credit institutions , except authorised credit institutions whose licences have been withdrawn by the ECB or the CBC and which do not maintain any deposits or other repayable funds from the public, in which case such credit institutions may 4 5 be liquidated under the Cypriot Companies Law without the involvement of the CBC . This exception does not apply in respect of the liquidation of a residual authorised credit institution (with no deposits or other repayable funds from the public) , in which case such residual authorised credit institution would be liquidated pursuant to the draft law. 1.4 The draft law provides for the jurisdiction of the Cypriot courts as regards the liquidation of authorised credit institutions . As noted in the explanatory memorandum, the framework governing the liquidation of authorised credit institutions will remain court-based, in the sense that a liquidation order and the appointment of a liquidator is under the absolute jurisdiction of the court and may take place only after the CBC submits an application to the court. In particular, the draft law provides that the court will issue a liquidation order and appoint a liquidator in respect of an authorised credit institution in two situations: (1) the credit institution’s licence has been withdrawn by the ECB or the CBC or (2) either the CBC as the national resolution authority or the Single Resolution Board has determined that all conditions for resolution under the applicable resolution legal framework are met except the public interest criterion . The liquidator is appointed by the court following a recommendation by the CBC and based on the CBC’s policy and criteria for taking up such a position . 1.5 Under the draft law the CBC is also granted the administrative power to appoint a temporary liquidator either (1) prior to the submission of the application to the court for the liquidation of an authorised credit institution, as soon as it determines that at least one of the conditions for

liquidation under the draft law is met, or (2) any time after the submission of the application but prior to the issuance of the court order. The temporary liquidator’s appointment will expire if the request for liquidation is not submitted by the CBC within 75 days or, in exceptional circumstances, two months from the temporary liquidator’s appointment. The temporary administrator will hold office until the appointment of a liquidator by the court or the winding-up petition by the CBC is dismissed by the court. The temporary liquidator’s powers and duties are subject to the CBC’s control and supervision . 1.6 Under the draft law the liquidation of an authorised credit institution will be deemed to have commenced on the day the application for liquidation is submitted to the court by the CBC or from the date the temporary liquidator is appointed by the CBC, whichever event takes place first, provided that, in the meantime, a liquidation order is issued by the court . 1.7 The draft law also lays down a framework governing the compensation, general powers and responsibilities, notifications to various parties, liquidators’ reports, accounting books and records of a temporary or court-appointed liquidator . The draft law further provides for the effects of the application for the court order for the liquidation of a credit institution on, inter alia, the credit institution’s property rights and contracts and the rights of third parties . 1.8 The draft law provides that once the court orders the liquidation of an authorised credit institution, the applicable hierarchy of claims is as follows: (1) debts or claims secured by a charge on the assets of the credit institution up to the amount resulting from the realisation of the collateral or the delivery of the guarantee to the beneficiary creditor; (2) all necessary and reasonable expenses incurred by the liquidator or the temporary liquidator, including professional expenses in the application of the winding-up provisions; (3) with the same priority ranking, all local, government taxes due from the liquidating credit institution, outstanding employees’ fees and any claim of the resolution authority and the (national) Resolution Fund; (4) the following with the same priority ranking: claims arising from financing or credit granted to the liquidating credit institution after the appointment of the liquidator or temporary liquidator and claims of the DGS for financing measures aiming to preserve depositors’ access to their deposits; (5) claims arising from credit granted by the CBC prior to the appointment of the liquidator or temporary liquidator; (6) with the same priority ranking: covered deposits, the DGS subrogating to the rights and obligations of covered depositors in insolvency, the DGS financing alternative measures under the Deposit Guarantee Scheme and Resolution of Credit and Other Institutions Law, (7) with the same priority ranking: the part of eligible deposits of natural persons and micro, small and medium sized enterprises exceeding the coverage level provided for by law and deposits of natural persons and micro, small and medium sized enterprises that would have been eligible had they not been made through non-Union branches of credit institutions established in the Union; (8) with the same priority ranking: remaining deposits, claims from commercial creditors or suppliers, claims secured with a floating charge over

the assets of the liquidating credit institution, common unsecured claims, including claims on derivatives, unsecured claims resulting from debt instruments that cumulatively meet the following conditions: (a) the original contractual maturity of the debt instruments is of at least one year, (b) the debt instruments contain no embedded derivatives and are not derivatives themselves, and (c) the relevant contractual documentation and, where applicable, the prospectus related to the issuance, explicitly refer to the lower ranking under unsecured claims from the foregoing debt instruments; and (9) debt or claims from subordinated debt instruments, except for claims on Tier 2 instruments, claims from additional Tier 1 instruments or Common Equity Tier 1 . 1.9 As noted in the explanatory memorandum, a number of safeguards and procedural requirements are introduced that aim to ensure that customers affected by a potential sale of business of the liquidating credit institution to another credit institution will continue to receive banking services until the acquiring credit institution integrates the acquired assets and liabilities within its systems’ processes and procedures. If there is a funding gap, this may be covered initially by the DGS, provided that the least-cost conditions under the applicable legal framework on DGS are met. Subsequently this may be covered by the State, provided that the applicable State aid rules are also met. 1.10 The CBC’s liability in the event of an action for damages relating to any act or omission in the exercise of its powers and responsibilities under the draft law is limited to an act or omission in bad faith or gross negligence .

2. General observations

The ECB welcomes the draft legislative framework, which seeks to establish an effective framework for the liquidation of credit institutions in line with the objectives of maintaining financial stability and securing depositors’ access to their deposits. Given that several stakeholders are involved in the liquidation of credit institutions, establishing a sound, effective and orderly liquidation of credit institutions is essential. Therefore, developing the Cypriot legal framework governing the liquidation of credit institutions is an important step towards increasing the protection of the value of the assets in liquidation and, ultimately, of creditors’ interests.

3. Specific observations on the draft legislative framework

3.1 Withdrawal of licences 3.1.1 The draft law stipulates , inter alia, that the liquidation of authorised credit institutions and the appointment of a liquidator will only be carried out by the court under the provisions of the draft law if the credit institution’s licence has been withdrawn by the ECB pursuant to Council Regulation (EU) No 1024/2013 (hereinafter the ‘SSM Regulation’) or by the CBC pursuant to the applicable

provisions of Cypriot law . Considering the ECB’s exclusive competence under the provisions of the SSM Regulation for granting and withdrawing authorisations to take up the business of credit institutions, the ECB suggests that it be clarified that the CBC’s competence is restricted to the withdrawal of licences in matters for which the ECB is not exclusively competent under the SSM Regulation, such as withdrawing the licences of third country branches. 3.1.2 Based on the provisions of the draft law amending the Business of Credit Institutions Laws , the CBC may withdraw the licence of a credit institution if liquidation proceedings have started pursuant to the draft law , while no resolution measures have been adopted or have failed. If the licence is withdrawn, the liquidator is not prohibited from providing specific banking services to the extent this is deemed necessary or appropriate for liquidation purposes, provided that such activities are carried out with the consent and under the control of the CBC. Under the draft law , the withdrawal of the licence of a credit institution still holding deposits falls under the cases in which the court might decide to put a credit institution into liquidation. The ECB understands that these provisions aim to empower the competent authority to withdraw the licence of a credit institution which is failing or likely to fail, but which has not been put into resolution. In this respect, the ECB would like to clarify that the withdrawal of the licence of a credit institution is a discretionary power granted to the competent authority. In particular, considering the ECB’s exclusive competences as concerns withdrawals of licences of credit institutions within the Single Supervisory Mechanism (SSM) under the SSM Regulation, the ECB would like to underline that its discretion in exercising these powers will remain unaffected. In this respect, the ECB also notes that, in accordance with Directive 2014/59/EU of the European Parliament and of the Council (hereinafter the ‘BRRD’) , an institution in relation to which the resolution authority considers that the conditions set out in points (a) and (b) of Article 32(1) of the BRRD are met, but in respect of which a resolution action would not be in the public interest, must be wound up in an orderly manner in accordance with the applicable national law. 3.2 Suspension of payments 3.2.1 The draft law stipulates that the CBC is empowered to suspend any payment or delivery obligations of a credit institution that are derived from a contract to which the credit institution is a party, at any time after the decision to put the credit institution into liquidation, or prior to the start of liquidation, for a period of 10 working days, provided that the CBC has determined that the credit institution is failing or likely to fail . The draft law further provides that if the suspension of some of the contractual obligations of that credit institution concerns covered deposits, these deposits will

not be considered as unavailable for the purposes of the Deposit Guarantee Scheme and the Resolution Scheme of Credit and Other Institutions Law. 3.2.2 The draft law amending the Business of Credit Institutions Laws seems to grant a similar power to the CBC, acting in this case in its capacity as competent authority for the prudential supervision of credit institutions . In particular, the CBC may suspend any payment or delivery obligations of the credit institution prior to the determination that the credit institution is failing or likely to fail , for a period of two working days, with the possibility of extending for a further two working days, provided that the exercise of this power is deemed necessary in order to avoid a further deterioration in the liquidity or general financial situation of the credit institution. If the suspension of some of the credit institution’s contractual obligations concerns covered deposits, these deposits are not to be considered as unavailable for the purposes of the Deposit Guarantee Scheme and the Resolution Scheme of Credit and Other Institutions Law . 3.2.3 While the ECB generally welcomes the introduction of the powers to impose the suspension of payments or delivery obligations, the ECB expects these far reaching powers to be exercised prior to the determination that a credit institution is failing or likely to fail only in extreme circumstances, if at all. Due to its exceptional nature and its disruptive impact on contracts, the moratorium tool should be decided in close coordination between all relevant authorities . 3.3 Commencement of liquidation proceedings 3.3.1 The draft law provides that a liquidation of a credit institution is to be decided by the court if the court is convinced that the conditions for liquidation are met - either that the CBC as national resolution authority or the Single Resolution Board has determined that all conditions for resolution under the applicable resolution legal framework are met except the public interest criterion or the credit institution’s licence has been withdrawn by the ECB or the CBC. This provision seems to go in the direction of correctly implementing the provisions of the BRRD introduced to address the ‘limbo risk’ for failed credit institutions for which the public interest assessment was negative, which require that those credit institutions are to be wound up in an orderly manner in accordance with the applicable national law . 3.3.2 The ECB understands that although the CBC has the power to apply to the court for the commencement of liquidation proceedings, the court might reject the CBC’s application if the conditions for issuing a liquidation order are not met. The ECB understands that although the conditions for issuing a liquidation order have been significantly narrowed down in scope compared to the legal framework currently in force , the possibility of not commencing liquidation still exists. Additionally, the draft provision concerning the automatic termination of the temporary liquidator’s

appointment in the theoretical scenario that the application for liquidation is not submitted to the court by the CBC within 75 days from the temporary liquidator’s appointment (or, in exceptional circumstances, a further two months) would also lead to the non-commencement of the liquidation procedure. In both these cases, the ECB understands that a liquidation procedure would not commence. Under these scenarios uncertainty could be created regarding the future of the credit institution, which is unwarranted. 3.4 Sale of assets and liabilities in liquidation proceedings 3.4.1 The draft law provides for a power of sale in respect of the liquidating credit institution’s business to another credit institution through transfer of its assets and liabilities (including secured deposits up to the secured amount pursuant to the Deposit Guarantee Scheme Regulations), following an independent valuation process and subject to the CBC’s prior approval. In particular, it is provided that the temporary liquidator or the liquidator appointed by the court may transfer any assets, rights and/or liabilities of the liquidating credit institution through the sale of business tool, in order to ensure that depositors have access to their deposits . 3.4.2 Any such transfer or sale of assets under the draft law must be considered to be valid and apply to third parties without the need to obtain the consent of the credit institution’s contributors, creditors or any other third party, other than the consent of the acquiring credit institution, and irrespective of the validity of any restriction imposed by law or contract terms or by any other means, including compliance with legal procedures that would otherwise apply . 3.4.3 The liquidator or the temporary liquidator must take any reasonable measure to ensure commercial terms as regards the sale of business that are consistent with the valuation carried out for this purpose . The valuation is to be carried out by an independent valuer with the aim of providing a prudent and realistic valuation of the assets, rights and liabilities of the credit institution . 3.4.4 The sale of business under the provisions of the draft law requires the prior approval of the CBC . 3.4.5 The ECB understands that the abovementioned sale of business tool may be used by the temporary liquidator appointed by the CBC or the liquidator to be appointed by the court after the commencement of liquidation proceedings with the primary aim of ensuring depositors’ access to their deposits. However, considering that the temporary administrator may be appointed by the CBC even prior to the submission of the application to the court for the liquidation of the credit institution and the commencement of the liquidation procedure issued by the court, the question arises as to whether the exercise of the sale of business tool under the draft law may affect any of the powers of the competent supervisory authority. 3.5 Use of the deposit guarantee fund to finance the liquidation of a credit institution 3.5.1 Pursuant to the draft law , the DGS’s available financial means may be used to cover any funding gap in respect of a sale of the business of the liquidating credit institution to another credit

institution; this is subject to a decision of the DGS Committee taken based on a recommendation of the CBC and subject to the consent of the Minister for Finance. In order to formulate its recommendation, the CBC must prepare and submit to the Deposit Guarantee Scheme Committee, inter alia, an assessment of whether the proposed sale of business meets its objective, the amount of the funding gap and the funding request from the DGS, together with an assessment of whether the requested funding meets the requirements under the relevant provisions of the law and whether State aid may also be necessary. In order to utilise the DGS to cover a funding gap, the CBC in cooperation with the Ministry of Finance, must ensure compliance with the Commission’s State aid rules, to the extent applicable. 3.5.2 The amending Deposit Guarantee Scheme Law provides for the use of the Deposit Guarantee Fund to finance (1) alternative measures to prevent the liquidation of credit institutions in accordance with the draft law, and (2) sales of businesses under the draft law . In particular, the draft law provides that the available financial means of the Deposit Guarantee Fund may also be used to finance measures aimed at ensuring depositors’ access to their covered deposits, including the transfer of assets and liabilities and the transfer of deposits in the liquidation of a credit institution pursuant to the draft law, provided that the direct or indirect costs borne by the Deposit Guarantee Scheme do not exceed the net amount of compensation paid in respect of covered deposits in that credit institution. 3.5.3 Alternative measures can help to preserve value for creditors, facilitate uninterrupted access to deposits and protect financial stability. At the same time, the least-cost test helps to limit costs for the DGS. The ECB therefore welcomes the option of using alternative measures to improve the management of bank failures in the Republic of Cyprus.

This opinion will be published on EUR-Lex.

Done at Frankfurt am Main, 19 May 2023.

[signed]

The President of the ECB

Christine LAGARDE