Do credit institutions always have to obtain a reasoned written legal opinion in order to be able to rely on their credit protection techniques within the meaning of Article 194(1) of the CRR? If so, (a) Should such an opinion be obtained from outside counsel? (b) Should the notice be specific to the relevant transactions and techniques for which the institution wishes to rely on the notice, or can lending institutions rely on general notices for certain types of transactions? In the latter case, how often should general notices be updated? The expectations of the ARP are not entirely clear in this regard. For example, it is not clear whether, in the ARP`s view, the phrase „may well include other jurisdictions” leaves the issue of jurisdiction to the discretion of the firm wishing to rely on credit risk mitigation; or what factors should be considered in assessing whether legal advice should be obtained from other jurisdictions. It is up to the institutions concerned that wish to reduce the risk capital requirements for credit assets to ensure that they have the necessary legal advice and, if not, to consider which advice needs to be obtained. Where opinions are needed, it should be determined whether they can be adapted to repeat transactions – with or without supplements – or whether they can rely on generic and/or internal opinions. To the extent that national banking supervisors should also require specific local legal advice, local businesses can rely on the general legal opinion from a local perspective, thus significantly limiting costs and likely delays. This issue goes beyond the issues of consistent and effective application of the legal framework. A Commission Directorate-General (Directorate-General for Internal Market and Services) prepared the response, although only the Court of Justice of the European Union can give final interpretations of EU legislation. This is an unofficial opinion of this Directorate-General, which the European Banking Authority publishes on its behalf. The answers are not binding on the European Commission as an institution.
They should be aware that the European Commission might adopt a different position from that expressed in those questions and answers, for example in the context of an infringement procedure or after a thorough examination of a particular case or on the basis of new legal or factual elements that might have been brought to its attention. Below are four standard opinions regarding English guarantees and counter-guarantees under the URDG, reserve letters of credit under UCP or ISP and bank-to-bank repayments under URR approved by the management of the Banking Commission on the recommendation of its Legal Affairs Committee. As regards the interpretation of the requirement for legal advice, EBA1 stated: „Article 194(1) requires that credit protection be legally effective and enforceable in all relevant jurisdictions. This condition must be met before credit protection can be considered an appropriate credit risk mitigation technique. The only way for an institution to determine whether this condition is met is to seek legal advice. The EBA goes on to say that such an opinion does not need to be obtained from an external lawyer, but that as long as it is „independent, written and reasoned”, it can also be provided by an in-house lawyer. Through the implementation of Basel 3 through CRD IV, the European Union adopted the Capital Requirements Regulation, which entered into force on 1 January 2014 (CRR). Article 194 of the CRR requires financial institutions that apply credit reduction agreements to ensure that they are legally effective and enforceable in all relevant jurisdictions.
To that end, those institutions shall be required, at the request of their regulatory authorities, to provide the latest version of the independent, written and reasoned legal opinion or opinions they have used for that purpose. In addition, the requirement for legal review under the CRR also extends to the issue of the enforceability of collateral arrangements in all relevant jurisdictions (Article 207(3) as regards financial guarantees and gold and Article 209(2)(c) of the CRR as regards claims) and the enforceability of guarantees and credit derivatives (Article 213, paragraph 3 of the CRR), which supplement all obligations under Article 194. The PRA states that it expects companies to review the terms of the warranty itself, the remedies available under applicable law, and whether there are scenarios in which the guarantor might successfully attempt in practice to reduce or be relieved of its liability under the warranty. Again, this goes beyond mere „legal leeway” to reduce liability or be relieved of liability (i.e. by provisions of the guarantee itself or by law enforcement) and takes into account practical factors. However, the ARP does not provide examples of what such a „practical scope” could extend to. The CRR applies directly to EU financial institutions and is in force on 1. Entered into force in January 2014. The purpose of this note is to recall the types of credit risk mitigation envisaged under the CRR and the specific legal advice requirements introduced by the CRR. In accordance with Article 194(1) of Regulation (EU) No 575/2013, credit protection is legally effective and enforceable in all relevant jurisdictions. This condition must be met before credit protection can be considered an appropriate credit risk mitigation technique.
The only way for an institution to determine whether this condition is met is to seek legal advice. CRM is important for many banking institutions because it reduces credit risk-weighted assets and therefore the amount of credit venture capital required. Leverage ratio requirements have undermined this factor to some extent, as the calculation of the exposure measure in the leverage ratio ignores any CRM associated with a particular credit asset. More recently, the European Central Bank, in its new form as supervisory authority for significant banking institutions under the Single Supervisory Mechanism, has carried out audits of banks` balance sheets in its supervisory area, including the review of documents and legal opinions relating to the use of the CRM. This process encourages many of these institutions to make documentary and procedural changes to ensure that their use of CRM is robust and subject to legal due diligence. In this context, we believe that one of the key aspects of this consultation paper is the following sentence: „The PRA would expect companies to review existing agreements to ensure that they do not contain such clauses or clauses that could be interpreted in this way.” Such an expectation could result in costs for businesses in the context of the review of relevant safeguards and previously issued legal advice. The CRR`s credit risk mitigation requirements are prescriptive and often require a complete interpretation. To be considered an eligible credit risk mitigation, the relevant technique must be supported by independent, written and reasoned legal advice to determine that the agreements are legally valid and enforceable in all relevant jurisdictions. An undertaking must be able to make it available to its respective competent authority on request. Whether a notice should be specific to the undertaking covered and the technique used by the institution, or whether it may be a general opinion, depends mainly on the nature of both. Where an institution carries out the same type of transaction with counterparties located in the same jurisdiction and applies the same credit risk mitigation technique, it may rely on the same opinion.
For example, if an institution uses a framework netting agreement for which a general opinion is available, it may use that opinion provided that it clearly states that the agreement is legally effective and enforceable in all jurisdictions relevant to the transactions covered by that agreement. A good example of the nature of the framework clearing agreement under consideration is the International Deposit Clearing Agreement sponsored by BBA, for which legal opinions on applicability have been sought in several jurisdictions. In contrast, closing clearing notices ordered by ISDA may not be successful because they generally address the effectiveness of closing clearing provisions for several types of derivatives transactions – they do not certify the applicability of tailor-made credit default swap transactions used as CRMs for individual liabilities. In other words, additional advice may be required2. Similarly, expert opinions for repeated transactions may also require additional assistance from in-house, if not external, legal counsel. The main change introduced by the CRR with regard to the CRM, whether funded or not, is set out in Article 194(1) of the CRR. It states that `the lending institution shall provide, at the request of the competent authority, the latest version of the independent, written and reasoned legal opinion or opinions establishing whether its credit guarantee agreements fulfil the condition [that such contracts be effective and enforceable in all the jurisdictions concerned]`. This represents a significant departure from the pre-CRR position, where financial institutions may not have taken legal advice regarding CRM for granted – rather, it relies on in-house legal reviews, analogous opinions, individual experience and market practices.