Banking and Financial Markets Law

Seminar Questions #2

Question 1

Contingent convertible capital instruments (CoCos) are hybrid capital securities issued by banks that absorb
losses when the capital of the issuing bank falls below a certain level. Then, debt is reduced and bank
capitalisation gets a boost. From a bank perspective, CoCos have the capacity to absorb losses, and in turn
the potential to satisfy regulatory capital requirements and, eventually, maintain financial stability.
On the other hand, from a retail investor perspective, figuring out when a CoCo bond is at risk of being
converted to equity — effectively eradicating the value of the bond — can be tricky.
Dr. Müller, a customer of the retail bank LP Morgan located in Munich, Germany, has been offered a tranche
of CoCos bond, with fixed coupons of 6 per cent. Lured by the high returns Dr. Muller decided to buy LP
Morgan’s CoCos. One year later, LP Morgan ran into troubles finding itself in need of capital to keep the
banking license, thus activating the mechanism as to convert CoCo bonds into capital. Dr. Muller incurred a
great loss and he had a reasonable suspicion that he was not properly informed of the risky nature of
subscribing CoCos. In his opinion, the management of the bank has not taken appropriate measures and
procedures to properly inform customer of financial services being offered (as provided for by the EU
Directive MiFID II), and decides to come to you for some advice. Note that LP Morgan is to be considered a
significant institution as it amounts to one of the biggest banks and the total value of its assets exceeds €30
billion.

a) Which authority is responsible for the oversight of the CoCos issued by LP Morgan Bank?
- Start with defining if we are inside or outside European union, and eurozone(currency) then
either ECB or NCA.
- If we are looking for the cocos to strengthen the bank, the authority will be:
- 69 67 MiFID II

b) Now, assume that Müller’s brother has been lured into CoCos, too. He also wants to hire you as
consultant. He lives in Denmark and he has been offered CoCos by a Danish insurance broker
distributing financial services. Would this make any difference?

o Danish competent Authorities would have the supervision of the insurance broker. Goal
is protecting customers.

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 c) Do you expect the Danish and German investor protection regimes to be different from each other?
Discuss whether and to what extent the EBA (European Banking Authority)(ESMA) is entitled to
play a role in converging and harmonising the rules contained in MiFID II.
o Even If we don’t know the national implementation, because it is a directive, so there
could be some differences between the two member states.
o talk a bit about how EBA and/or ESMA could fill in the gaps about developing the
technical standards. There are a possibility to harmonize technical standards protocol,
forms etc. (standardizing practices)
- On one hand, legislation 2 is based on legislation 1. If a difference in level 1 consists it will
forward it to level 2 as well.

EBA is doing a great deal of work, in many aspects. Seems to be on the side, but is very relevant.

Question 2

Question 1 Danish banks

On the 2nd of January 2017 the Danish Financial Services and Banking Authority, Finanstilsynet,
has made an unfavorable decision addressed to Fyn Bank relating to its corporate governance. In
particular, the National Competent Authority fined Fyn Bank 5.224.350 Danish Kronas (700.000
Euro) since the bank had not established a “nomination committee”, according to article 37 of the
Danish Financial Business Act (FBA). FBA implements Directive 2013/36/EU (the CRD IV) into
national legislation. In particular, art. 37 FBA reads as follow “institutions which are significant in
terms of their size, internal organisation and the nature, scope and complexity of their activities
must establish a nomination committee composed of members of the management body who do not
perform any executive function in the institution concerned”. Fyn bank is astonished. It is a very
small bank. It carries out traditional retail banking only (loan-deposit activities). Art. 37 FBA
repeats exactly what art. 88, par. 2, CRD IV says... hence, there seems to be a problem of
interpretation and enforcement of EU law by the competent authority.

A. You are asked to give Fyn bank an advisory opinion on how to manage this situation.
a. Check EBA art. 17.
i. EBA art. 17, 18, 19 is very important
Check from both sides

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In the same country, another bank is facing severe problems relating to liquidity. This bank is
Danske bank, the biggest bank in Denmark. The liquidity issues stemmed from reckless investment
strategies and a shortage of available liquidity due to a dried up interbank lending market. Liquidity
was needed as Danske Bank used financial products with a shorter maturity period than the one of
the investments that were refinanced by them. Danske Bank erred in the quality of the securities
underlying these financial products that lost during their maturity period practically their entire
value. After the expiry of the maturity of these financial products, Danske Bank was hence in an
immediate need for liquidity in order to meet its refinancing obligations. The loss in value of the
securities underlying the financial products required a downward correction of the balance sheet,
which made Danske Bank “cross the line”, as liabilities became greater than assets. On top of that,
its demand for liquidity could not be accommodated by private markets since most of the banks in
Europe and in the world that still had liquid assets used them for stabilizing their liquidity reserve
instead of lending them out to other banks.

B. You are hired as consultant by the Danish Ministry of Finance to find out “what could
be done and by whom” in this situation. Is the bank to be helped? By whom and how?
i. Main job is to talk about resolution confer BRRD Art. 32
ii. What kind of tools should we use? Depends on the situation and the bank
(discuss) Second pillar of the BU: resolution tools.
iii. If a big bank: SRB is to apply resolution tools.

Til eksamen: der vil nok komme noget omkring resolution plans brrd art. 5, 6 etc.