Article 49 of the Bank Recovery and Resolution Directive (BRRD) sets out the conditions that resolution authorities must comply with when bailing in derivative liabilities. In particular resolution authorities will exercise the bail-in power only upon or after closing-out derivatives. Resolution authorities are empowered by the BRRD to close-out and terminate derivatives for this purpose.

Resolution authorities need to determine the value of derivative liabilities as part of the general valuation of assets and liabilities carried out pursuant to article 36 of the BRRD and in accordance with methodologies and principles which will be specified in regulatory technical standards (RTS) which will be developed by the European Banking Authority (EBA). These methodologies and principles will target three sets of issues:

  • determining the value of classes of derivatives, including transactions that are subject to netting agreements;
  • establishing the relevant point in time at which the value of a derivative position should be established; and
  • comparing the destruction in value that would arise from the close-out and bail-in of derivatives with the amount of losses that would be borne by derivative liabilities in a bail-in.

The EBA has now published a consultation paper containing draft RTS on the valuation of derivatives pursuant to article 49 of the BRRD. The deadline for comments on the consultation paper is 13 August 2015.

The draft RTS provide for an approach that applies a statutory valuation methodology based on the costs or gains that would be incurred by the counterparty in replacing the contract. Derivative counterparties will be given the opportunity to provide evidence of commercially reasonable replacement trades and to determine the close-out amount within a certain deadline; if no feedback is received, resolution authorities can apply their valuation based on mid-market prices and bid-offer spreads. The draft standards also specify that resolution authorities should establish the value of derivative liabilities at the date of close-out or when a price is available in the market for the contract or the underlying assets, which allows for a final valuation within a matter of days with maximum accuracy. The draft RTS further specify the circumstances in which resolution authorities might exempt contracts from close-out and bail-in where the application of the bail-in tool is likely to bring destruction in value exceeding the bail-in potential of the corresponding liabilities. The draft standards also take into account the framework applicable to centrally cleared derivatives, for which EMIR as introduced rules and procedures for valuing derivatives in resolution.

View EBA consults on the valuation of derivatives in resolution, 13 May 2015