In the process of implementation of the Bank Recovery and Resolution Directive (BRRD) in Spain, the draft bill is proposing a change in the ranking of claims which will enable Spanish banks to issue the so-called senior subordinated notes or Tier 3. This e-alert explains the current framework, the change and the implications for the current and new T2 and subordinated notes programme.

Key features of the proposal

BRRD implementation is currently under discussion in the Spanish Parliament by means of the bill of law on recovery and resolution of credit institutions and investment firms (proyecto de ley de recuperación y resolución de entidades de crédito y empresas de servicios de inversión) (the BRRD Bill of Law). The BRRD Bill of Law has already been approved by the Congress and it is under discussion in the Senate.

In the BRRD Bill of Law, the Congress has included an Additional Provision 14 which changes Article 92 of the Insolvency Law. By virtue of this amendment, ranking of subordinated notes will be the same within an insolvency or a restructuring resolution of a bank. This will enable Spanish credit institutions to issue T3 or Subordinated Notes ranking ahead of T2 notes.

Current insolvency and resolution framework

The current insolvency and resolution framework did not set out any difference in ranking of subordinated notes depending on its classification as T2 or subordinated notes which do not qualify as T2 or AT1.

Pursuant to the current ranking of debts in Law 22/2003, of 9 July, on Insolvency Law (Ley 22/2003, de 9 de julio, Concursal) (Law 22/2003), the payment of subordinated claims will only be made after the secured and unsubordinated claims have been satisfied. Pursuant to Article 92 of the Insolvency Law, subordinated claims rank as follows:

• late or incorrect claims. The following claims shall not be subordinated for this cause and shall be classified as follows: (a) those credits arising from article 86.3 of the Insolvency Law, (b) those credits whose existence arises from the documentation of the Issuer, (c) those arising from an executive title, (d) those guaranteed by an in rem guarantee registered with a public registry, (e) those that are in any way recorded in the insolvency proceedings or in any other judicial proceedings, or (f) those that require inspection action by the Public Administrations to be determined;
• contractually subordinated debts (including the subordinated notes);
• interest (including accrued and unpaid interest due);
• fines;
• claims of creditors that are especially related to the Issuer as provided for under the Spanish Insolvency Law. Creditors that have converted into equity directly or indirectly all or part of their credits pursuant to a refinancing agreement adopted in accordance with article 71 bis or the fourth additional disposition of the Insolvency Law will not be regarded as persons especially related (personas especialmente relacionadas) to the Issuer, for the purpose of qualifying the credits held against the debtor as a result of the refinancing granted by virtue of such agreement;
• detrimental claims against the Issuer where a Spanish Court has determined that the relevant creditor has acted in bad faith (rescisión concursal); and
  claims arising from contracts with reciprocal obligations as referred to in articles 61, 62, 68 and 69 of the Insolvency Law, wherever, prior to the administrators’ report of insolvency (administración concursal), the court rules that the creditor repeatedly impedes the fulfilment of the contract against the interest of the insolvency.

Under Spanish law, the contractual subordination agreed between the parties will not be enforced within the insolvency proceeding. In an insolvency procedure the Spanish judge will apply the ranking of claims set out in Article 92 of the Insolvency Law. As per this article, all the subordinated contractual obligations will rank pari passu among themselves. Therefore, all contractual clauses which modify the subordination ranking will not be enforced within an insolvency proceeding and all contractually subordinated creditors will rank pari passu among themselves and be paid pro rata between them regardless of any terms and conditions.

Quite recently some banks have begun to insert clauses which contemplate the possibility of issuing senior subordinated notes at some time in the future. In those programmes of T2 instruments, by subscribing them, the holders of such T2 subordinated notes accepted to be subordinated to any senior subordinated notes of the issuer, meaning any subordinated notes that by their contractual terms rank ahead of T2 instruments. However, as set out above, this ranking distinction among subordinated notes had not been legally established between subordinated notes, senior subordinated and other contractual subordinated obligations of the issuer. Therefore, this “voluntary” subordination would only be contractually possible but not enforceable within the insolvency procedure.

Regulation under the BRRD bill of law

With the approval and implementation of the BRRD Bill of Law, upon the insolvency of the entities subject to the BRRD Bill of Law (as set out in Article 1, credit institutions and certain investment firms), subordinated notes, will rank in the following order: (i) any contractually subordinated obligations not qualifying as Additional Tier 1 instruments or Tier 2 instruments, (ii) subordinated notes qualifying as Tier 2 instruments and any other contractually subordinated obligations of the relevant issuer qualifying as Tier 2 instruments, and (iii) any contractually subordinated obligations of the relevant issuer qualifying as Additional Tier 1 instruments.

As a result, upon BRRD implementation, the ranking of subordinated notes under a bail-in procedure and within an insolvency scenario will be the same.

Impact on practical existing and future debt issuances

Once the BRRD Bill of Law has entered into force and the modification becomes effective, the banks will be entitled to issue debt instruments with different ranking levels. Therefore, the credit entities will have several alternatives for obtain financing by means of AT1, T2 or T3 notes at different interest rates depending on the actual rankings. This is important taking into account the requirements of MREL in accordance with BRRD and TLAC for the Global Systemically Important Financial Institutions (GSIFI) according to the FSB proposal.

The change in the ranking of claims proposed by the BRRD Bill of Law would have an impact on the ranking of the debt instruments in the existing debt programmes since ranking will not depend on contractual subordination terms, but rather on the qualification of subordinated notes according to CRR.

This option is very interesting for Spanish banks as a way of diversifying both their sources and costs of funding, but it will also need certain analysis on the existing programmes. The existing debt programmes will need to be revisited to confirm to what extent they allow the issuance of senior subordinated notes without being inconsistent with the existing T2 subordinated notes terms and conditions.