Research

ABSTRACT

The sudden banking defaults in spring 2023 proved current prudential norms insufficient to prevent bank distress. Capital and liquidity norms will need to be adjusted (Admati et al., 2023). The experience also shows how a lack of credible supervisory tools led to forbearance and finally chaotic public bailouts. An intervention gap arises when viable but undercapitalized banks become at the mercy of runs. Once outflows start to escalate, all is left is to prepare for resolution and assign losses. We call for new stabilizing measures under Pillar II, as contingent capital and liquidity tools.

A timely recapitalization option requires stronger supervisory powers to activate a timely going concern recapitalization, such as by equity conversion of AT1 CoCo debt. A contingent liquidity measure would be redemption charges (fees) activated automatically upon large outflows of uninsured deposits, related to new SEC norms for institutional MMFs. The goal is to interrupt any self-fulfilling expectation of further outflows. The measure mirrors new SEC norms created for institutional MMFs, the natural benchmark for uninsured corporate deposits. The combination creates a framework for credible early intervention and a chance to steer solvent banks towards recovery rather than resolution and bailouts.

Keywords: bank resolution, bank recovery, contingent capital, redemption charges

JEL Classification: G21, G33, K20

ABSTRACT

The relationship between private and public money has shaped the economic and legal debate over money for centuries. Private money can either compete with or complement public money and this depends on the applicable law and the relative powers of the State and private parties. The rise of disruptive digital and cryptographic technologies applied to money creation has the potential to innovate this century-long debate.

This article proposes a framework to analyse the role of the law in relation to the risks and benefits of having circulating private money competing with public money. Accordingly, the article highlights the unprecedented threat to monetary sovereignty, the risks to systemic stability and, ultimately, to democratic decision-making prompted by digital private money.

To counter these risks while seizing potential efficiency gains generated by novel forms of private money, the article proposes to regulate convertibility and fragment by regulation such a potentially global market.

Keywords: Monetary sovereignty, monetary competition, private money, stablecoins, optimal digital currency area

JEL Classification: E42; E44; G24

ABSTRACT

Il rapporto tra denaro pubblico e privato ha caratterizzato il dibattito economico e giuridico sul denaro per secoli. Il denaro privato può competere o integrare il denaro pubblico e ciò dipende dal diritto applicabile e dai poteri relativi dello Stato e delle parti private. L'ascesa di nuove tecnologie digitali e crittografiche applicate alla creazione di denaro ha il potenziale di innovare questo dibattito secolare. 
Questo articolo propone un quadro analitico per analizzare il ruolo della legge in relazione ai rischi e ai benefici della circolazione di denaro privato in competizione con il denaro pubblico. Di conseguenza, l'articolo evidenzia la minaccia senza precedenti alla sovranità monetaria, i rischi per la stabilità finanziaria e, in ultima analisi, per il processo decisionale democratico, provocati dal denaro privato digitale.
Per contrastare questi rischi e cogliere al contempo i potenziali guadagni in termini di efficienza generati da nuove forme di denaro privato, l'articolo propone di regolamentare la convertibilità e di frammentare per via normativa un mercato potenzialmente globale.

ABSTRACT

The risk retention rule was introduced in the US and the EU as a mechanism to curb the originate-to-distribute model, associated with securitizations and the financial crisis of 2008. This paper argues that besides its original financial stability rationale, the rule has positive spillovers on debt governance and specifically on the incentives to monitor, the design of covenants and the lender’s stance during renegotiation and bankruptcy (the ‘empty creditor’ problem). Risk retention in true sale securitizations makes the strongest case for debt governance, although the existence of various options of retention appears to be associated with varying incentives. The mechanism and effects of risk retention on synthetic securitizations remain ambivalent, given the perverse incentives associated with over-insurance (negative economic ownership). However, the upcoming restriction of double hedging for synthetic STS transactions is a positive development.

Keywords: Law & Finance, Financial Regulation, Debt Governance, Securitization, Risk Retention

JEL Classification: G21, G38, K22

ABSTRACT

Shareholders are the residual claimants on the assets of a corporation. Creditors are fixed claimants whose interest lies in the solvency of the borrower. Consequently, shareholders are usually thought to have optimal incentives to maximise the value of the corporation. The article challenges this common wisdom and proposes to reform bank governance granting (some) ex-ante governance rights to bank creditors. This aims at fine-tuning bank governance and incumbent substantive regulation, in particular the resolution framework for distressed banks, and enhances the quality of bank decision-making in terms of risk-taking. At the same time, the proposed reform should increase the ex-ante credibility of resolution. The second part of the article operationalises this construct focusing on the specific case of the European Banking Union and discusses the design of the governance status of bail-inable creditors. The analysis demonstrates how bail-inable creditors can correct for shareholders’ perverse incentives and make debt governance work in banking. The policy proposal advanced in the paper would complement substantive regulation and prudential oversight. The governance role of creditors has the potential to be particularly helpful in preventing disproportionate risk-taking decisions in good times, when regulatory and supervisory standards are lax and systemic risk piles-up.

Keywords: Financial Stability, Bank Governance, Debt Governance, Voting Rights, Appointment Rights, Governance Arrangements

JEL Classification: G21, G38, K22

ABSTRACT

Bank Resolution is considered a cornerstone of the post-crisis financial regulation; however, it is also widely considered ineffective and inefficient in handling bank failures. This article analyses the preventive potential of the resolution framework, specifically focusing on the minimum requirement for own funds and eligible liabilities (MREL).

We argue that MREL has a double nature. On the one hand, it should ensure the feasibility of resolution in case of a bank failure. On the other hand, it aims at restricting the funding model of banks, similarly to the other (preventive) capital requirements.

By analysing the 2019 reform of the EU banking regulation, we contend that MREL represents an important complement to the rest of the preventive regulatory framework and that the latest reform unleashes such potential. We demonstrate that the new rules on MREL determination and enforcement allows the resolution authority to look after the build-up of systemic risk. The analysis reveals that MREL can serve both micro- and macro-prudential purposes. Finally, we argue that the current institutional architecture represents the main impeding factor for the new regulation to efficiently work, curbing the positive preventive potential of MREL.

Keywords: law & finance, financial regulation, BRRDII, bank resolution; MREL, preventive regulation, macro-prudential regulation.

JEL Classification: G21; G28; K23

ABSTRACT

The core insight of the new EU framework for bank resolution is to allocate losses to bank's insiders (bail-inable creditors). This affects both financial stability and the corporate governance of banks. 

The current academic debate on bank resolution overlooks the relevance of identifying the investors in bail-inable securities (ie who is going to bear losses) and the role of counterparty risk. This article identifies the investors that are better suited to hold those instruments and highlights the trade-offs between the corporate governance role and the threat to financial stability posed by different investors. 

The article demonstrates that the composition of bail-inable debtholders matters and shows – empirically and theoretically – a transition towards a desirable composition of holders; although a considerable room for improvement remains. This exercise deepens the understanding of the impact of the resolution framework and the importance of counterparties for its credibility and future applications.

Keywords: Bail-in, Corporate Governance, Financial Stability, Counterparties, Institutional Investors.

ABSTRACT

The revision of the Shareholders Rights Directive (“SRDII”) entered into force in 2017. The SRDII represents the landing point of a long process started in 2012 with the “Action Plan: European company law and corporate governance” drafted by the EU Commission.

Already in the Action plan, the two key objectives pursued by the European Legislator were clearly displayed: enhancing companies’ transparency and enhancing shareholders’ engagement. These objectives are, in turn, instrumental in attracting stock market funding, alleviating the dependence of European companies on bank funding.

This article discusses the implementation of the SRDII into the Italian legal system. The analysis discusses the main choices of the Italian legislation in implementing the SRDII rules and the coordination between these new rules and the Italian legal system, with specific reference to the general corporate law and the existing provisions on listed companies.

We analyse four main features of the SRDII:

1) Rules on shareholder identification. These may create more problems than they solve. In particular, these rules may slightly curb the incentives of activists to engage target companies, fearing the free-ride of other investors. The coordination with the existing Italian law may worsen the situation.

2) Rules on shareholder engagement. The Italian legislator provides Consob with interesting enforcement powers, close to a duty to demonstrate engagement. The Italian approach to the supervision of proxy advisors is also interesting, but likely ineffective because of the limited extraterritorial effect of the provisions.

3) Say-on-pay legislation. The biggest novelty is the binding vote on the Remuneration Policy. Moreover, the coordination may prove problematic between the implementation of SRD II and the existing Italian law on variable remuneration awarded through financial instruments.

4) Related-Party Transaction. The Italian legal system was ahead of its time in this regard. This can be explained by the peculiarities of Italian capitalism. The SRD II brought very few amendments to the existing regime. Notably, the definition of Related-Party has been widened and now directly refers to the international accounting principles (IAS 24).

Keywords: Company Law, Shareholders Right Directive, Say on Pay, Related Party Transaction, Shareholders Engagement, Italian Law, CONSOB

JEL Classification: G34, G38, K22

ABSTRACT

Market Discipline of creditors on risk taking behaviours of borrowing banks represents a long-lasting debate. Such a debate gained new attention after the post-crisis stream of reforms concerning resolution policy: creditors should be incentivized to take optimal effort in monitoring their borrowers and, at the same time, their interests have been aligned with the social ones. Many commentators criticized such an expectation especially in the European context, arguing that the lack of credibility and excessive complexity of the resolution mechanism impair the ability and willingness of creditors to exert disciplining role.

This paper aims at taking a step forward in this scientific debate, investigating whether the ability to exert disciplining activity is inherently impaired by the design of the Directive. In other words, this research wants to assess if, assuming an ideal environment, creditors would have optimal incentives to monitor bank’s behaviours and react accordingly. To do so, the paper reviews the literature on Market Discipline, then carries out a legal analysis of the Bank Recovery and Resolution Directive (BRRD), focusing on those norms shaping the market for bail-inable securities. Eventually, the incentives stemming from those norms are discussed, assuming an ideal environment where bail-in is certain and credible and the market for bail-inable securities works smoothly.

The analysis highlight that the incentives of creditors toward market discipline are inherently diluted by the BRRD legal design because of competing policy objectives pursued by the Directive. The direct normative consequence of such a finding is that enhancing information and predictability, though desirable in principle, will never lead to optimal monitoring effort, leaving the floor to alternative rule-based strategies.

Keywords: Law & Finance, Bank resolution, Bail-inable creditors, Market Discipline, No-Creditors-Worse-Off.

ABSTRACT

Remuneration of bankers represents a highly contentious matter that has attracted the attention of academics and policy makers and the rage of the media and public in the aftermath of the financial crisis. This chapter proposes a radical change in the current remuneration practices, including bail-inable debt within the variable component of remuneration packages. 

In fact, the current regulatory framework and resulting practices in the EU are to be considered heavily unsatisfactory since they decreased the link between pay and performance. Moreover, it does not consider the specificities of bank corporate governance; consequently, the negative externalities it generates are still not accounted for. 

In supporting the, apparently naïve, claim of remunerating bankers through debt, the chapter set the economic rationale for remuneration, highlighting the special case of the banking industry and explaining why debt can be particularly useful in such framework. Against the theoretical framework resulting from such analysis, the incumbent EU regulation on the structure of remuneration packages is critically assessed. This highlights how the policy goal of optimising risk-taking incentives of bankers is far from being reached and, more importantly, that it cannot be reached without a radical change in the regulatory paradigm. 

The chapter shows why such shift necessarily implies to include bail-inable debt in remuneration packages. The chapter shows how it would tighten the link between pay and performance, it would address the specificities of bank governance and, as an additional positive spillovers, it would enhance the resolvability of the institution. The second part of the research develop a detailed policy proposal that focuses both on the content of the regulation and on the possible implementation strategies. 

Keywords: Remuneration, Capital Requirement Directive, Resolvability, Managerial Incentives; Material Risk-Takers.

ABSTRACT

The post-crisis stream of reforms, especially the new recovery and resolution framework, has been often welcomed for its aim to increase market discipline in the banking sector, allocating the losses to shareholders and creditors of failing banks and not anymore on the general public though state bail-out. Nonetheless, the concrete mechanisms according to which such turnaround shall happen and the corporate governance consequences of financial reforms have been severely understudied.

The paper tackles the trade-off between market discipline and financial stability in the post-crisis EU regulatory environment through the lenses of financial contracting. Building on the debt as a mechanism to contingently allocate control, the paper approaches the regulatory framework as a set of restrictions to contractual freedom, exploring the room for investors to discipline risk-taking of banks through specific contractual arrangements.

Traditional contractual devices are scrutinized against the qualitative requirements for regulatory capital and bail-inable securities and turned out to be largely unavailable because of regulatory constraints, so that the ability of investors to limit risk-taking appetite of managers is limited. Therefore, the attention moves to the peculiar case of contingent convertible instruments (Cocos), discussing some design features that might allow investors to successfully reduce risk-taking incentives both before and after the distress of the bank, enhancing market discipline after all.

Keywords: Incomplete contracts, Corporate governance, Banking regulation, Bail-in, Contingent convertible

JEL Classification: G21; G33; K29

ABSTRACT

This paper aims to address the role of subordinated liabilities within the new resolution framework resulting from the post-crisis reforms.

In particular, this study starts from the resolution intervention of four Italian banks in November 2015. The legal analysis of that resolution is complemented by an empirical analysis of the determinants of subordinated debt issuances for Italian banks.

From this set of evidence is possible to infer the desirability of a well-functioning and dynamic market for subordinated debt. On the other hand, what clearly emerges is the incompatibility between such a market and the new regulatory framework as it is.

Therefore, the paper, given the compelling arguments showing the inefficiency of a pure mandatory bail-in mechanism for subordinated debt, proposes to complement it with a contractual clause to bail-in subordinated creditors, tailored on coco bonds model, in order to enhance certainty amongst the contractual parties.

Keywords: Law and Economics, Law and Finance, European Banking Union, Resolution, Subordinated Bonds.; Decreto Salva Banche

JEL Classification: G21, G28, K22

ABSTRACT

Financial markets play a significant role in channelling funds from surplus spending units (fund givers) to deficit spending units (fund takers). Whether financial intermediation is carried out by banks or capital markets, market failures are ubiquitous and call for financial regulation. This chapter studies how different jurisdictions cope with market failures in banking and capital markets with a focus on how such market failures are addressed in different jurisdictions. We identify significant divergences in financial regulation despite the similarity of market failures. The drivers of such divergences are the private law underpinnings of financial markets, diverging policy objectives and regulatory goals, and the varying structure of financial markets. However, in the past few decades, there has been significant harmonization and convergence of financial regulation at the global level. We identify two main drivers of convergence: convergence with the aim to reduce transaction costs for cross-border transactions, mainly driven by pressure from industry associations; and convergence in financial regulations to address risk spillovers and prevent potential race-to-the-bottom from regulatory arbitrage. Discussing the drivers of divergence and convergence in financial regulation, this chapter provides an analytical framework for the comparative analysis of financial regulation.

Keywords: Comparative Law & Economics, Financial Regulation, Banking, Capital Markets, Regulatory Convergence, Regulatory Competition

JEL Classification: G20; K22; P51

ABSTRACT

The financial applications of the blockchain technology are gaining increasing attention in the regulatory sphere both for their growing relevance and for the several scandals and failures of the past months. The regulatory landscape is quickly and non-linearly evolving, resulting in the impossibility to capture a nitid snapshot of the international regulatory regime from a comparative perspective. Therefore, this chapter takes a functional approach, investigating the sources and dynamics of regulatory convergence and divergence in the area of cryptocurrencies and stablecoins. The chapter focuses mostly, but not exclusively, on the regulatory regime of the EU, UK and US. This chapter adds to the literature on the regulation of crypto finance as it provides a functional framework to approach an area whose regulation is quickly evolving. Moreover, it also adds to the comparative law literature, looking at the sources and dynamics of divergence in the regulation of innovative technologies.

Keywords: cryptocurrencies, stablecoins, comparative law, Market in Crypto Asset Regulation, Financial Services and Markets Bill

JEL Classification: G23, K22, K23

ABSTRACT 

As FinTech promises to increase competition for both banks and investment firms, we consider the market failures that emerge from its existence, particularly as they relate to issues of financial stability and investor protection. This chapter discusses the wave of technology-enabled disintermediation of financial services, asking how regulation should cope with the risks associated with disintermediating finance.

While regulation of financial intermediaries has been embraced because the industry is particularly prone to market failures, disintermediation has the potential to make current frameworks obsolete. The law & economics problem is twofold: 1) potential market failures, and 2) the issue of enforcement. This chapter discusses the foundations of financial intermediation and the traditional regulatory approaches to both banks and other providers of financial services. Our analysis establishes a distinction between FinTechs working outside and inside the blockchain. For the former, the crucial regulatory trade-off is between efficiency gains from innovation and regulatory arbitrage. For the latter, our analysis suggests that regulating the convertibility of cryptocurrencies into fiat money is a promising strategy not only to safeguard financial stability, but also to attract financial services to the regulatory perimeter, whenever it is efficient to do so.

Keywords: Law & economics, Disintermediation, Fintech, Financial Stability, Asymmetric Information.

JEL Classification: G21; G23; K22

ABSTRACT 

Sommario: 1. La risposta europea alla crisi pandemica: regole e supervisione alla prova dei fatti (inquadramento generale). – 2. Le misure di vigilanza adottate dalla BCE nel contesto della crisi da Covid-19. – 3. Il trattamento prudenziale delle esposizioni soggette a misure di moratoria, rifinanziamenti e garanzie pubbliche nella crisi da Covid-19. – 4. Prospettive per la supervisione e la risoluzione bancaria nel medio periodo: tra sostegno alla ripresa e rischio sistemico. – 5. Riflessioni conclusive. 

ABSTRACT 

We analyse the tension surrounding the EU trade policy, with a particular focus on Free Trade Agreements (FTAs) that have recently gained considerable attention. The paper highlights different key trade policy objectives, including economic interests and moral values, and the expansive nature of the EU regarding the allocation of competences vis-à-vis Member States. Based on an a corporate versus FTA-law study regarding the right to establishment, our argument is that Member States may feel pressured by their competitors to change their national laws to implement the signed FTAs. This holds true, even if these changes are not strictly required according to the text of the FTA. The state of affairs can be explained through application of Hill’s capability-expectation gap theory. This framework suggests that the current limited EU competences can scarcely serve the EU’s international behaviour, thus causing a lack of coherence between the internal (protecting Member States’ interests) and external action (promoting trade). In this sense, FTAs have bitten off more than they can chew. Such a situation could negatively affect the EU’s reputation with Member States and citizens as well as its bargaining power with third countries. However, Hill’s framework also indicates how the capability-expectation gap could be reduced. In the short term, this requires a sincere dialogue with EU citizens, clearly signalling what the EU can, and what it cannot do. In the long term, European decision-makers ought to be particularly careful in drawing a clear line between the specific competences of the EU and those of the Member States. One viable option would be to grant the EU additional powers for concluding FTAs, as to prevent competition between Member States to arise.

Keywords: EU FTAs; M&A; corporate law; capability-expectation gap; multilevel governance

JEL Classification: F10; K29