Enhancements To Resolution Regime Of Financial Institutions In Singapore - From A Capital Markets And Derivatives Perspective.
Legal News & Analysis - Asia Pacific - Singapore - Dispute Resolution
3 November, 2017
On 4th July 2017, the Monetary Authority of Singapore (Amendment) Bill 2017 (the “Bill”) was passed in Parliament to enhance the existing powers of the Monetary Authority of Singapore (“MAS”) to resolve non-viable financial institutions (“FIs”) in an orderly manner. This was followed by the release by MAS of a monograph in August 2017 which sets out MAS’ approach to resolution of FIs in Singapore (the “Monograph”). In the Monograph, MAS highlighted that its overarching objective is to achieve an orderly resolution when a FI is no longer viable, such that financial stability and the continuity of critical functions performed by FIs and financial market infrastructures (“FMI”s) are maintained.
The Bill is not yet in effect and will come into force when a commencement notice is published in the Gazette. Regulations to operationalise the provisions of the Bill (the “Regulations”) will be promulgated in due course.
This bulletin discusses the proposed enhanced regime and how this may impact certain capital markets and derivatives transactions. We will also look at whether the new regime will have an impact on transactions conducted through FMIs.
Part I: Singapore Resolution Regime - Overview
The resolution powers of MAS extend to a broad category of specified financial institutions. This includes a list of pertinent financial institutions (“Pertinent FIs”) as set out below:
A bank licensed under the Banking Act (Cap.19)
A finance company licensed under the Finance Companies Act (Cap. 108)
A merchant bank approved by MAS as a merchant bank under section 28 of the MAS Act (Cap. 186) (the “MAS Act”)
A financial holding company approved by the MAS as a financial holding company under s.28 of the MAS Act
An operator or a settlement institution of a designated payment system under the Payment Systems (Oversight) Act (Cap. 222A)
An approved exchange, a recognised market operator, a licensed trade repository, a licensed foreign trade repository, an approved clearing house, a recognised clearing house, an approved holding company, or a holder of a capital markets service license (not being a holder of a capital markets service license who carries on business in the regulated activity of providing credit rating services) under the Securities and Futures Act (Cap. 289) (the “SFA”)
A trustee for a collective investment scheme authorised under section 286 of the SFA, that is approved under that Act
A licensed trust company under the Trust Companies Act (Cap. 336)
Recovery & Resolution Planning
In the case of Pertinent FIs, the proposed enhanced powers of MAS include the requirement for institutions notified by MAS to prepare and submit a recovery plan. Resolution plans for Pertinent FIs are developed by MAS but MAS may issue a direction for institutions to provide any information or document that MAS reasonably requires for this purpose. MAS has highlighted that its intent is to apply recovery and resolution planning to FIs that are considered to be systematically important1.
MAS will have in place a wide range of resolution powers and tools to facilitate the resolution of non-viable FIs. Some of the existing and proposed tools are set out below and can be applied individually, in combination or sequentially:
- the power to direct a compulsory transfer of the business of a Pertinent FI (in whole or in part) (e.g. to a private sector acquirer, bridge entity or asset management company);
- the power to direct a compulsory transfer of the shares of a Pertinent FI (in whole or in part) (e.g. to a private sector acquirer);
- the power to direct a compulsory restructuring of the share capital of a Pertinent FI incorporated in Singapore; and
- the statutory power to bail-in eligible instruments.
While exercising any of these existing or proposed tools, MAS also has and will have moratorium powers such that no legal process may be commenced with respect to the relevant business or Pertinent FI and no steps may be taken to enforce any security with respect to the relevant business or Pertinent FI during the relevant period of time.
The ability of resolution authorities to carry out an orderly resolution may be compromised if counterparties of the failing FI have an unfettered right to trigger contractual early termination, acceleration or other close-out rights. Accordingly, the proposed enhanced regime seeks to introduce provisions which can affect termination rights in certain circumstances.
New Section 83 (MAS Act) (“s.83”)
A new s.83 which provides that a resolution measure (or any event directly linked to it) shall be disregarded in determining the applicability of a provision in a contract enabling a party to exercise its termination right against a failing Pertinent FI (or relevant group company) if the substantive obligations of the contract (including the payment, delivery and provision of collateral) continue to be performed by the parties.
New Section 84 (MAS Act) (“s.84”)
A new s.84 which gives MAS the power to temporarily suspend any termination right under a contract with a failing Pertinent FI (or the relevant group company). However, this stay is limited in time and must (in the case of a contract other than a reinsurance contract) expire no later than the same time on the second business day after it takes effect. The suspension also does not affect termination rights which become exercisable only for a breach of an obligation to pay, deliver or provide collateral.
In the case of s.84, this is commonly referred to as a temporary stay. The term “termination rights” is defined broadly and includes a right to terminate a contract and a right to accelerate, close-out, set-off or net an obligation under a contract that would result in a suspension, or modification or extinguishment of that obligation. s.83 and s.84, when implemented, will apply to both financial and non-financial contracts.
While the MAS will have in place a wide range of resolution powers to facilitate the resolution of non-viable FIs, the Singapore resolution regime incorporates and proposes to enhance safeguards to protect the interests of creditors in resolution. These include:
- a creditor compensation framework to provide creditors and shareholders the right to compensation if they receive less in resolution than what they would have received in liquidation of the non-viable FI (i.e. the “NCWOL” safeguard); and
- the ability for Regulations to be promulgated to exempt any arrangement, transaction, action or any matter from the application of the resolution toolkit, including any set-off, netting or other types of arrangements (the “Excluded Arrangements”).
These safeguards are intended to provide greater certainty and clarity to creditors on their outcome in resolution.
Cross Border Co-operation & Recognition
The Singapore resolution regime recognises the need for cross-border co-operation and recognition when a resolution is cross-border in nature. It gives MAS the ability to provide assistance to a resolution authority of a foreign country or territory to resolve a financial institution.
In addition, enhancements will also be made to give MAS the power to recognise a foreign resolution in whole or in part. To further enhance the effectiveness of cross-border resolutions, the Singapore regime proposes to allow Regulations to be prescribed for the contractual recognition of bail-in and stay of termination rights similar to those discussed above.
Part II: Considerations for Capital Markets and Derivatives Transactions
The proposed enhanced resolution regime in Singapore gives rise to various considerations for capital markets and derivatives transactions. In this Part II, we set out some of the key considerations.
Statutory Powers of Bail-in – What is in-scope?
The statutory power of MAS to bail-in is intended to help recapitalise failing FIs, and to reduce the risk to depositors and reliance on public funds to “bail out” failing FIs. The Bill provides that MAS is empowered to cancel or write down eligible instruments or liability (“Eligible Instruments”) of certain Pertinent FIs, as well as to convert or change the form of such Eligible Instruments, the scope of which will be prescribed by Regulations.
At present, these Regulations have not yet been prescribed but it is worth noting MAS’ intent, which is:
- to apply statutory bail-in to unsecured subordinated debt and unsecured subordinated loans of Singapore-incorporated banks and bank holding companies;
- that the proposed power will also cover any equity instrument that is not in the form of share capital, as well as contingent convertible instruments and contractual bail-in instruments whose terms have not been triggered prior to resolution; and
- that only Eligible Instruments which are issued or contracted after the commencement of the Bill will be within scope.
The above seems to suggest that the scope of Eligible Instruments which will initially be subject to statutory bail-in will be relatively narrow. Hence, subject to Regulations to be prescribed:
- unsubordinated liabilities towards clearing houses should effectively be excluded; and
- in the case of derivatives transactions documented under a master agreement (e.g. the ISDA Master Agreement), it is interesting to note that (unlike in certain other regimes) unsubordinated payment obligations owing under the derivatives transactions as well as at the master agreement level are likely to be excluded as well.
To the extent liabilities are subject to MAS’ statutory bail-in powers, disclosure requirements will need to be considered by the relevant Pertinent FIs.
Termination Rights – How will these be affected?
The new s.83 and s.84 of the MAS Act may, when implemented, have an impact on termination rights against a Pertinent Financial Institution or the relevant group company in both financial and non-financial contracts. In essence, s.83 has the effect of preventing parties from terminating a contract on the basis of the occurrence of a resolution measure or events which are directly linked to such resolution. On the other hand, s.84 seeks to introduce a temporary stay to the termination of a contract in certain circumstances. To the extent s.84 applies, while termination rights may be stayed, termination rights of a counterparty are preserved in the case of any default occurring before, during or after the period of stay that relates to a failure to make payment, deliver or provide collateral.
We set out below the key elements of s.83 and s.84 and some of the differences between them.
Please click on the table to enlarge.
In the case of both s.83 and s.84, Excluded Arrangements may be exempted but this is subject to issuance of Regulations (see also discussions below). In the case of s.84, termination rights with a prescribed person may also be excluded if prescribed by
Financial Arrangements – Will they be Protected?
MAS will have in place a wide range of resolution powers. Very often, these powers, together with the proposed s.83 and s.84, give rise to the question as to how netting, set-off and collateral arrangements (including in cleared derivatives) and secured liabilities vis-à-vis Pertinent FIs may be impacted, including in circumstances where a Pertinent Financial Institution is a participant of an FMI.
As we have noted above, the Singapore resolution regime incorporates a framework for Excluded Arrangements to be prescribed by Regulations such that certain arrangements, transactions, actions or any matter may be exempted from the provisions dealing with the resolutions of FIs. At present, these Regulations are not yet final and have not been issued. While these Regulations are being promulgated, it is worth noting the following:
- it is clear from parliamentary debates that Singapore regards itself as a good netting jurisdiction;
- MAS has expressed that in exercising its resolution powers, its intent is not to defeat or otherwise affect the preservation of set-off and bilateral netting arrangements (which includes (i) transactions cleared on an approved clearing house; and (ii) any related security interest or collateral arrangement);
- in a Consultation Paper in April 2016, MAS has sought to introduce certain safeguards for set-off and netting arrangements, particularly where there is a partial transfer of business of a non-viable FI during resolution3; and
- in the Monograph, MAS has again expressed that when it exercises its resolution powers, the integrity of protected financial arrangements will be preserved, in particular, where there is a partial transfer of business of a non-viable FI during resolution.
The industry awaits to see if some of the issues above will be further clarified when Regulations are prescribed.
Contractual Recognition of Bail-in and Stay Provisions – What will be Required?
Any requirement for the contractual recognition of bail-in and stay of termination rights provisions is subject to Regulations. At present, these Regulations have not yet been prescribed, but when they are, it is expected that:
- in the case of bail-in, Pertinent FIs whose obligations are subject to bail-in can be required to include contractual bail-in provisions in applicable instruments which are governed under foreign law; in addition, a legal opinion as to the enforceability of these provisions may also be required for specified jurisdictions; and
- in the case of termination rights, Pertinent FIs and their subsidiaries can be required to include contractual provisions in specified contracts to recognise s.83 and s.84 as described above.
FMIs – How will FMIs be Impacted?
FMIs such as an approved clearing house are subject to the Singapore resolution regime. Hence, as central counterparties (“CCPs”) in Singapore develop their default management and recovery process, the rule books of the relevant CCPs are likely to be required to be updated (including incorporating the various tools to allocate losses and rebalance a CCP’s books) and this will have an indirect impact on market participants. Where resolution of CCPs is necessary to maintain financial stability, MAS will have various powers to facilitate an orderly resolution of CCPs, including the ability to enforce outstanding contracts, return the CCP to a matched book in the case of a clearing member default and continue to temporarily operate the CCP.
In the case of an FMI participant, to the extent it should become a failing Pertinent FI, we note that it is MAS’ intent to have legal safeguards in place to ensure that the safe and efficient operations of FMIs in Singapore are not affected, including to preserve bilateral netting and collateral arrangements. See the discussion on “Financial Arrangements – Will they be Protected?” above.
Other Considerations – Product Structure
As the resolution regime in Singapore develops, there will be a need for market participants to consider its implication on transactions where trigger events may be linked to government intervention, debt restructuring and similar type events. In the case of credit derivatives, as an example, the application of the “Financial Reference Entity Terms” under the 2014 ISDA Credit Derivatives Definitions may need to be considered for reference entities that may be subject to the resolution powers of MAS.
Part III: Summary of Key Issues
In this Part III, we summarise the key issues for clients and trading counterparties of Pertinent FIs (or the relevant group company) to consider in capital markets and derivatives transactions under the proposed resolution regime in Singapore.
Please click on the table to enlarge.
For materials relating to the Hong Kong resolution regime, please see below:
- An Effective Resolution Regime for Financial Institutions in Hong Kong: Financial Institutions (Resolution) Ordinance (Cap. 628) Regulations on Protected Arrangements (click here)
- Financial Institutions (Resolution) Ordinance – the derivatives angle (click here)
For materials relating to the Bank Recovery and Resolution Directive (BRRD), please see below:
- Topical issues - Bail-in without borders (click here)
- Staying Power - ISDA 2015 Universal Resolution Stay Protocol (click here)
1 A list of banks which have been designated by MAS as domestic systemically important banks (i.e. D-SIBs) can be found on MAS’ website, see: http://www.mas.gov.sg/news-and-publications/media-releases/2015/mas-publishes-framework-for-domestic-systemically-important-banks-in-singapore.aspx
2 According to the Second Reading of the Bill in Parliament on 4 July 2017, we note that certain counterparties, such as central banks, payment systems, approved or recognised clearing houses, and depositories, will be excluded from the temporary stay requirements under s.84, see: http://www.mas.gov.sg/News-and-Publications/Speeches-and-Monetary-Policy- Statements/Speeches/2017/Monetary-Authority-of-Singapore-Amendment-Bill.aspx. However, this will be subject to Regulations in final form.
3 See paragraph 4.2 of the Consultation Paper on Proposed Legislative Amendments to Enhance the Resolution Regime for Financial Institutions in Singapore (P004-2016) published by MAS on 29 April 2016.
For further information, please contact:
Sonia Lim, Linklaters