Under the EU’s Bank Recovery and Resolution Directive (“BRRD”), one of the key powers given to national resolution authorities is the ability to impose losses on, or “bail-in”, certain financial liabilities of the failing bank in a resolution action, either by writing down the principal amount of the liability or converting it into equity. One of the main aims of a bail-in is to ensure that creditors and/or shareholders can be made to bear an appropriate proportion of the failing institution’s losses, in order to minimise the need for the application of public funds (a “bail-out”).

The BRRD provides that all liabilities of the bank in resolution can be bailed-in, unless they are contained on an express list of excluded liabilities, or are excluded from bail-in pursuant to the discretion of the relevant resolution authority, which can be exercised in exceptional circumstances. As a result, derivatives liabilities are eligible for bail-in, except to the extent that they meet the criteria for one of the express exclusions. In order to facilitate such a bail-in of a derivative liability, however, such transactions firstly need to be terminated and closed-out and valued for the purpose of Article 36 of the BRRD. This process raises significant issues for market participants, who will no doubt be keen to ensure that, in the event that their derivatives transactions are mandatorily terminated earlier than intended, their net exposure is valued in a way that is consistent with expectations resulting from their contractually negotiated trading documentation.