"Restructuring ELA Liabilities: Lessons From Ireland"

by Skadden, Arps, Slate, Meagher & Flom LLP
Contact

The Irish banking crisis has provided some insights into the use by EU member states of emergency liquidity assistance (ELA), which supports financial institutions or markets that are experiencing an exceptional and temporary crisis of liquidity. As other EU member states’ banking systems continue to struggle with their debt in 2014, the approach used to restructure the ELA liabilities of the Irish Bank Resolution Corporation (IBRC) merits consideration.

How ELA Works

In many states, the discretionary use of ELA is one of the core functions of the national central bank, which acts as a “lender of last resort.” Typically, the national central bank will create money and lend it to a troubled financial institution with the intention that, upon repayment, the money will be destroyed; the aim is to provide support to meet the demands of a crisis without making a long-term impact on a country’s monetary policy.

In EU member states that use the euro as their currency, the national central banks have remained in existence, retaining their former powers and functions subject to the restrictions on monetary sovereignty imposed by several legislative instruments.1 The banks are entitled to engage in ELA programs unless expressly prevented by a two-thirds majority vote of the European Central Bank’s (ECB) Governing Council. However, any proposed use of ELA still must be communicated to the ECB in advance in accordance with published procedures,2 giving the ECB a central role in governing the use of ELA within the eurozone. Despite the ECB’s role, the national central banks remain responsible for providing the emergency liquidity, and their member states assume the costs and risks,3 which makes ELA an exception to the eurozone’s single monetary policy. The ECB’s involvement in the process has led to some erroneous commentary suggesting that the ECB has lent money to eurozone banks through ELA.

Study of ELA activity is complicated by the veil of secrecy (deployed in the interests of systemic stability) that shrouds not only the negotiation of ELA proposals between the ECB and national central banks, but also the provision of ELA to particular institutions. In many cases, the existence of an ELA program is discernible only through a close reading of national central banks’ published balance sheets, while the identities of ELA recipients will not be publicized. However, during the global financial crisis, this veil was lifted to some extent, as the ELA liabilities of certain eurozone banks to their respective national central banks became public knowledge in the context of the “bail-outs” of troubled eurozone states. Very significant and potentially destabilizing ELA liabilities in certain states were important factors in the negotiation of assistance programs. IBRC was one of the more remarkable known instances of a financial institution with very significant ELA liabilities, and the restructuring of these liabilities may be an instructive example going forward for other member states with troubled financial sectors.

The IBRC Restructuring

The July 2011 court-mandated merger of Anglo Irish Bank and Irish Nationwide Building Society, which had been taken into public ownership by the Irish government during the crisis, created IBRC.

Both banks had suffered heavy losses largely as a result of over-exposure to the Irish property lending market. Anglo Irish, the larger of the two, experienced a dramatic loss of access to funds in the years before the merger; between 2007 and 2010, its funding from deposits and debt securities declined from €82 billion to €19 billion. The Central Bank of Ireland (CBI) started providing ELA4 financing to Anglo Irish in 2009. The scale of support given to the bank was vast: At the end of June 2011, Anglo Irish had ELA liabilities of around €40 billion. Irish Nationwide experienced similar problems and also was supported with much smaller amounts in ELA. As a result of the merger, the publicly held IBRC owed approximately €42 billion in ELA debt to the CBI, guaranteed by the Irish government.5

To support IBRC’s ELA liabilities repayment, the Irish government first issued promissory notes to IBRC, which provided for payments to IBRC of €3.1 billion per year for the period of about 10 years that it would take IBRC to repay the CBI. However, many commentators on the deal expressed concerns that this approach was not satisfactory, as it allowed a large, long-term burden to remain on the Irish public finances (the annual payments of €3.1 billion would represent about 2 percent of Irish GDP), which would prevent a return to fiscal health. The arrangement also may have contravened the EU’s prohibition on monetary financing,6 although no legal action was taken.

As a result, a more radical restructuring was enacted. An agreement was reached whereby the promissory notes held by IBRC were retired, in return for which the government provided long-dated bonds worth €25 billion. The new bonds have a maturity range from 27 to 40 years and an interest rate of six-month Euribor plus 263 basis points. Next, in a February 2013 parliamentary session, emergency legislation was passed to wind up IBRC, with the result that the bonds ended up in the hands of the CBI.

The key element of the restructuring is that the CBI undertook to sell the bonds to the private sector in accordance with a schedule that imposes a gradually increasing minimum annual sales level until all the bonds are sold in the early 2030s (although, financial stability permitting, the government has stated it may dispose of the bonds as early as possible). Because the CBI’s profits are returned to government funds, the plan means that initially the coupon on the bonds will mostly return to the government, but gradually over time, the amount paid out to private investors will increase as the bonds are sold on.

The result is that IBRC has been liquidated, and its huge and destabilizing ELA liabilities have been replaced by a program of gradually increased borrowing by the government from investors over a 40-year period, with the primary burden falling at a time when inflation, economic growth and a return to fiscal health may be expected to have reduced its impact. There may be some dispute as to the compliance of the plan with the EU’s legislative guidelines — although the bonds were not directly provided to the CBI under the restructuring, the mechanism by which IBRC was forced into liquidation was part of a prearranged scheme. The ECB has indicated that it will not seek to challenge the restructuring, illustrating further the pragmatic approach to interpretation of EU law that it has routinely employed during the crisis when financial stability is otherwise endangered.

Despite the restructuring’s success, the Financial Times reported in September 2013 that Elliott Management, once of IBRC’s creditors, was seeking to investigate the circumstances surrounding the liquidation. What, if anything, might come of aggressive investor action in this case remains unclear. Regardless, the IBRC approach to restructuring ELA liabilities may provide a useful example in 2014, as other EU member states, such as Cyprus and Malta, attempt to come to terms with similar problems in their own banking systems.
__________________

1 These include the Treaty on the Functioning of the European Union (TFEU) and the Statute of the European System of Central Banks and of the European Central Bank (ESCB Statute), which set out the powers and functions of the European Central Bank. Note that the ESCB Statute is drafted to apply to all national central banks within the EU, but that its application to national central banks outside the eurozone is limited by Article 139 of the TFEU and Article 42 of the ESCB Statute.

2 European Central Bank Eurosystem, ELA Procedures, (Oct. 17, 2013), available at http://www.ecb.europa.eu/pub/pdf/other/elaprocedures.en.pdf.

3 “Responsibility for the provision of ELA lies with the NCB(s) concerned. This means that any costs of, and the risks arising from, the provision of ELA are incurred by the relevant NCB.” Id.

4 Known in Ireland as “Exceptional Liquidity Assistance.”

5 Karl Whelan, ELA, Promissory Notes and All That: The Fiscal Costs of Anglo Irish Bank (September 2012), available at http://www.karlwhelan.com/IrishEconomy/Whelan-PNotes-September2012.pdf.

6 Article 123 TFEU: “Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States … in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.”

* This article appeared in the firm's sixth annual edition of Insights on January 16, 2014.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP
Contact
more
less

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!