What is a Bail-in Clause?
A bail-in clause provides that debt obligations of a distressed institution can, if necessary, be reduced or converted into equity by a Member State “resolution authority.” Bail-in clauses are not required for agreements governed by the law of a Member State because in that scenario the write-down and conversion powers.
In addition to covering off liabilities owed to EEA counterparties (under EEA law-governed contracts), Article 55 of the BRRD also required EU member states to implement legislation which obliges banks (and certain other financial institutions) which are incorporated in the relevant jurisdiction to include “bail-in” clauses in contracts which are governed by the laws of a “third” (i.e. non-EEA member state) country.
The bail-in clauses require the relevant contract counterparty to agree to the contractual recognition of bail-in, thereby acknowledging that any liabilities owed by the financial institution to it may be written down or converted into equity.
Currently, financial institutions in EEA member states are only obliged to include bail-in clauses in these third country contracts. Whilst part of the EU and during the Brexit implementation period, the UK is not a third country.
Bail-In Clause – History
During the 2008 Global Financial Crisis, the U.S. Government issued bailouts for a number of failing, bankrupt financial institutions due to the substantial impact of their failure on the economy, and the expectation that the collapse of the companies would result in an overall economic disaster.
The total cost of the bailout was estimated to be around $700 billion. It was largely funded by U.S. taxpayers, which caused political turmoil among taxpayers since their money was being used for purposes other than improvements in infrastructure and healthcare services. To avoid the issue, the concept of bail-ins was introduced, which protects depositors and taxpayers at the expense of the creditors’ debt claims.