The European Union’s top court backed EU guidelines designed to prevent taxpayers from footing the bill for bailing out stricken lenders, strengthening the hand of Brussels regulators as Italy fights to shield some bondholders caught up in the nation’s banking crisis.
Tuesday’s decision is a show of support for the European Commission, which updated its crisis rules for banks in 2013 as part of a shift from taxpayer-funded bailouts to bail-in, the practice of imposing losses on investors before public money can flow.
“Burden-sharing by shareholders and subordinated creditors as a prerequisite for the authorization, by the commission, of state aid to a bank with a shortfall is not contrary to EU law,” according to the EU Court of Justice. The Luxembourg-based court’s decision is binding and can’t be appealed.
The “banking communication” sets out rules for when burden-sharing should be applied to shareholders and subordinated creditors, and when it can be avoided. The court said that “burden-sharing measures can be understood as being designed to prevent recourse to state aid merely as a tool to overcome the financial difficulties of the banks concerned.”
Bail-in has been much discussed in recent weeks as the Italian government tries to find a way to recapitalize some of the country’s banks, including Banca Monte dei Paschi di Siena SpA. It’s a thorny issue for Prime Minister Matteo Renzi because many subordinated bondholders are ordinary families who bought the securities looking for a better rate of return. With a referendum to overhaul the political system expected in October, Renzi is looking for a solution that saves banks and spares voters.
Italian banks dropped after the ruling with Banca Monte dei Paschi declining as much as 7.1 percent. UniCredit SpA slipped 3.2 percent at 11:30 a.m. in Milan, while Intesa Sanpaolo SpA decreased 2.5 percent.
Monte Paschi’s 379 million euros ($419.5 million) of 5.6 percent subordinated bonds fell 3 cents to 71 cents on Tuesday, according to data compiled by Bloomberg. They are down about 20 cents this month as attempts to recapitalize the country’s frail lenders raise the prospect that junior creditors could face losses.
The European Commission, which checks whether state aid violates EU rules, said the ruling “confirms the commission’s current case practice and application of EU state aid rules to the banking sector.”
“Burden-sharing and bail-in rules protect the taxpayers and public budgets and maintain the level playing field in the EU,” said Ricardo Cardoso, a commission spokesman. “It makes sure that those who also stood to benefit from their investments, i.e. the bank’s owners and creditors, bear the losses if they materialize — public support comes as a last resort.”
Jacopo Ceccatelli, the head of Milan broker-dealer Marzotto SIM SpA, said the ruling might not be a serious obstacle in Italy’s attempts to get a green light from the EU for a bank-rescue plan.
“The EU Court ruling is a bit of this and a bit of that, it’s just quoting the bail-in regime clause which admits burden sharing in some extreme cases,” Ceccatelli said in an interview. “Obviously the question is when is there an extreme case. That depends on the situation so it cuts both ways.”
The markets should pay attention to the ruling, which “could have a read-across for others such as the Italian and Portuguese banking systems,” Morgan Stanley currency strategists said in a report to clients.
Tuesday’s case was triggered by a group of junior debt holders who want to recoup their losses from Slovenia’s move in December 2013 to recapitalize its mostly state-owned banks with 3.2 billion euros of taxpayers’ money to avoid the fate of Greece and Ireland in seeking an international bailout.
At the same time, some 600 million euros worth of subordinated debt was also wiped-out from these banks. The government of then Prime Minister Alenka Bratusek and the central bank governor Bostjan Jazbec said at the time they acted in line with EU state aid rules.
In 2014, a Slovenian court sought the EU tribunal’s guidance on whether the commission’s banking communication is valid and whether the regulator can require burden-sharing as a condition for state aid to be granted in times of crisis.
In a non-binding opinion in February, Nils Wahl, an advocate general at the EU court, backed the commission, saying it “enjoys broad discretion in assessing” the validity of state aid.”
He said the EU executive “is entitled to consider that, in situations such as those governed by the banking communication, burden-sharing by investors may normally be regarded as necessary” for aid to be considered to be compatible under EU state-aid rules.
The banking communication makes clear that while burden sharing is normal practice in bank state-aid cases, it’s not mandatory. The rules also provide an exception when imposing bail-in “would endanger financial stability or lead to disproportionate results.”
The EU state-aid rules give Italy strictly limited room to provide state aid to banks without imposing losses on creditors, EU Competition Commissioner Margrethe Vestager told reporters on July 14.
“The rules are so that, if there is risk of financial instability, then there are exceptions for burden-sharing and bail-in — that is very, very clear,” she said.