Introduction

Publication aims

In its capacity as the designated resolution authority in Portugal, the Banco de Portugal may apply a number of resolution tools and powers where a credit institution is failing or likely to fail (FOLTF) and where the public interest criteria laid down in the applicable law that justify preventing its liquidation are met.

These powers include the power to determine the write-down or conversion of capital instruments and eligible liabilities and to apply the bail-in tool.

In 2023 the European Banking Authority (EBA) adopted and published the Guidelines to resolution authorities on the publication of the write-down and conversion and bail-in exchange mechanic (Guidelines EBA/GL/2023/01– the “EBA Guidelines”).¹

These Guidelines provide the Resolution Authorities (RAs) with a framework for the disclosure of information on how the write-down and conversion of capital instruments and eligible liabilities will be applied, if needed, i.e. on the bail-in implementation mechanisms.

In particular, the EBA Guidelines establish that the RAs have a duty to publish a high-level description on their website of their approach to the execution of the write-down or conversion of bail-inable capital instruments and liabilities from the preliminary steps to the final execution of the exchange mechanic.

This publication therefore aims to describe the bail-in exchange mechanic in the context of the Portuguese banking system, in compliance with the EBA Guidelines.

The aim is to contribute to the predictability of the exchange mechanic, to promote transparency and greater clarification of the bail-in procedures in Portugal and to foster coordination and dialogue among the parties involved in implementing this tool.

The mechanic described in this publication and the procedures laid down herein are based on a set of assumptions underlying the application of the bail-in tool. Nevertheless, the Banco de Portugal is not limited to implementing this tool as described in this document and, in the event of resolution action, it will adapt and select the criteria, terms and methods of implementation most appropriate to a specific situation. This publication therefore does not bind the Banco de Portugal to implementing the mechanic described herein and, in a real situation, the effective implementation of the write-down and conversion procedures may differ from the mechanic set out in this publication.

The contents presented in this publication may also be updated, amended and revised to ensure that this document is adapted to possible legislative developments and the consolidation of practices concerning the exercise of the resolution function.

Division of tasks within the Single Resolution Mechanism

In the context of the Single Resolution Mechanism (SRM), the participating National Resolution Authorities (NRAs) share resolution tasks with the Single Resolution Board (SRB),² which is responsible for the effective and consistent functioning of the SRM.³

In this division of tasks, the SRB is responsible for the resolution functions⁴ relating to all significant institutions and to institutions designated as less significant⁵ where they are part of a cross-border group within the Banking Union.⁶ Moreover, the SRB is responsible for exercising resolution functions, even where the target institution is a less significant institution not part of a cross-border group, where the resolution tool to be applied requires use of the Single Resolution Fund (SRF).

In turn, the NRAs are responsible for the resolution tasks applicable to all institutions which the SRB is not directly responsible for, i.e. for less significant institutions that are not part of any cross-border group.⁷

Without prejudice to the powers conferred on the NRAs, the SRB, as guarantor of the effective and consistent functioning of the SRM as a whole, is also responsible for monitoring the tasks directly exercised by the NRAs in relation to the institutions within their remit and may at any time decide to directly exercise all of the powers laid down in the Regulation with regard to any institution.^8,9

According to the institutional design defined by the SRMR, the SRB’s decisions do not have characteristics of self-execution and do not have a direct effect on the institutions. Rather, the SRB’s decisions are addressed to the NRAs, which are responsible for implementing and enforcing them.

Thus, although the Banco de Portugal is not responsible for resolution decisions on Portuguese significant institutions, the descriptions herein are also applicable to them, given that the Banco de Portugal remains responsible for implementing and operationalising any resolution tool within Portuguese territory.

Finally, the SRB has created a webpage with references to the various national publications, accompanied by an umbrella document, in order to facilitate consultation and provide a more comprehensive overview of the processes in the various countries within the Banking Union.¹⁰

Bail-in

The legal framework for the resolution of credit institutions includes four resolution tools:¹¹

• partial or total sale of the institution’s business to an acquiring third party;¹²

• partial or total transfer of the institution’s business to bridge institutions;¹³

• separation and partial or total transfer of the business to asset management vehicles;¹⁴

• bail‐in.¹⁵

Included in the bail-in is the power for the RA to write down, in part or in full, the nominal value of the capital instruments and liabilities of the credit institution under resolution and convert, in part or in full, liabilities into instruments of ownership.

These powers are used to absorb the institution's losses and to restore compliance with own funds requirements.

Like the other resolution tools, bail-in is applied by an administrative act adopted by the Banco de Portugal.

To this end, the tool is applied by the Banco de Portugal using two distinct forms of action, with legal and accounting effects resulting from the application of the resolution tool:

• write-down of own funds or credit claims (liabilities) on the institution (emerging from different types of legal transactions and in accordance with their insolvency ranking), by the amount required to balance the liabilities and assets of the institution by having the liabilities absorb the losses recorded on the asset side until a net position of zero is reached;

• conversion of credit claims on the institution into capital instruments in order to restore the institution’s ability to comply with its own funds requirements. For accounting purposes, liabilities corresponding to these credit claims are written off (in full or in part), leading to the creation of reserves (since the conversion is already made from a neutral net position, after the write-down effects have been generated), with new shares (or other instruments of ownership) being issued against these reserves.

Stakeholders in the bail-in process

Banco de Portugal

In 2013¹⁶ the Banco de Portugal was appointed the RA in Portugal and, as such, its mission is to ensure that, in the event of severe financial imbalances occurring in banking groups or credit institutions, financial stability is preserved at the lowest possible cost to public funds.

The Banco de Portugal is part of the SRM and is represented in the SRB.

As stated above, according to the division of tasks established within the SRM, the SRB has the direct responsibility for making all resolution decisions for significant institutions established in Portugal, as well as for any institution – even if designated, under the relevant law, as a less significant institution – that is part of a cross-border group within the Banking Union or when its resolution includes the use of the SRF.

Nevertheless, in accordance with Articles 18 and 29 of the SRMR, the responsibility for implementing all resolution tools in Portugal, even if they concern an institution whose resolution is decided by the SRB, falls within the scope of the Banco de Portugal.

Single Resolution Board

The SRB is the central RA of the Banking Union within the SRM.

On 1 January 2016, the SRB became responsible for adopting resolution decisions in respect of the institutions covered by this mechanism and falling within its direct scope (section 1.2 above). These decisions are addressed to the NRAs for implementation in the institutions.

Comissão do Mercado de Valores Mobiliários (Portuguese Securities Market Commission)

The Portuguese Securities Market Commission (Comissão do Mercado de Valores Mobiliários – CMVM) is the regulatory and supervisory body for securities markets and the agents operating in these markets in Portugal. In the context of the implementation of the bail-in tool, the Banco de Portugal and the CMVM cooperate to ensure the effectiveness of this tool.

In resolution, the Banco de Portugal may request the CMVM to order market infrastructures to discontinue or suspend financial instruments from trading, as well as to admit or readmit instruments to trading, as necessary.¹⁷

The Banco de Portugal publishes the order by which resolution action is taken or a notice summarising the decision and its effects, or may request its disclosure by other means, including the CMVM’s information disclosure system,¹⁸ where the shares, other instruments of ownership or debt instruments of the credit institution under resolution are admitted to trading on a regulated market.

Institution under resolution

For the purposes of this publication, “institution under resolution” means a credit institution subject to a resolution tool (in the specific case of this publication, the bail-in tool).

The institution under resolution also has certain responsibilities and will also be responsible for carrying out certain steps in the implementation and operationalisation of the bail-in.

First, the institution under resolution is responsible for providing the RAs and the independent valuer¹⁹ with the information and data necessary to decision-making for resolution action.

In addition, it is responsible for ensuring that all the operations within the institution related to the implementation of the bail-in tool are carried out, which may include, in addition to a set of accounting movements, support to the valuer, information organisation and handling, permanent contact with the other stakeholders in the resolution, among others.

Euronext Securities Porto – Central Securities Depository and National Numbering Agency

Euronext Securities Porto is the commercial name of Interbolsa – Sociedade Gestora de Sistemas de Liquidação e de Sistemas Centralizados de Valores Mobiliários, S.A., a Central Securities Depository (CSD), as laid down in Regulation (EU) No 909/2014 of the European Parliament and of the Council of 23 July 2014).

In bank resolution, Euronext Securities Porto can act both as an issuer CSD or an investor CSD.

An issuer CSD is a CSD where securities are issued (or deposited). As an issuer CSD, Euronext Securities Porto plays a crucial role in changes to the records of the financial instruments affected by resolution action through their write-down, conversion or cancellation.

An investor CSD opens accounts in the issuer CSD to enable settlement of securities transactions between systems. Euronext Securities Porto may act as an investor CSD in relation to securities issued in other markets, following the instructions of the issuer CSD and spreading in its systems changes that result from the application of resolution action.

This version of the publication is based on a scenario in which Euronext Securities Porto is the issuer CSD where the relevant instruments are deposited, as this is the most common reality in Portugal.^20,21

In addition to its function as a CSD, Euronext Securities Porto acts as the National Numbering Agency in Portugal and is responsible for assigning International Securities Identification Number (ISIN) codes, unique international identifiers assigned to each security it deposits.

Paying agent

Paying agents are intermediaries between issuers and CSDs. Their role is to transmit the issuer’s instructions – in this case the institution under resolution – to the CSD on the transactions to be carried out in its financial instruments that are deposited in said CSD.

A number of Portuguese banking institutions fulfil the role of paying agent for their own issues, while others depend on the services of external paying agents.

Euronext Lisbon – Regulated Market Management Company

Euronext Lisbon – Sociedade Gestora de Mercados Regulamentados S. A. is a regulated market management company as defined in Law No 35/2018 of 20 July 2018.

Euronext Lisbon enables trading in financial instruments, including shares, bonds, funds and derivatives. Like Euronext Securities Porto, Euronext Lisbon is part of the Euronext Group. In a bail-in, Euronext Lisbon acts as a market operator and is responsible for reflecting in its systems any corporate events²² resulting from actions taken by the RAs.

For more information on the main stakeholders, the following addresses can be visited and used:

Characteristics of the bail-in tool

Should the Banco de Portugal need to apply the bail-in tool, its enforcement is expected to be based on the following characteristics:

• Due to the urgency of the circumstances, the Banco de Portugal’s decision is expected to be based on a provisional valuation, pursuant to the law;²³

• It is presumed that the institution under resolution is a public limited company with its head office in Portugal and that its shares are registered with a Portuguese CSD, in accordance with the regulations in force;

• The losses needing to be absorbed are expected to require writing down own funds until they are cancelled;

• Against this background, the Banco de Portugal would determine the issuance of interim resolution instruments (Instrumentos de Resolução Interinos – IRIS).

The resolution decision is based on a provisional valuation

The decision to place an institution under resolution and the choice of tool are preceded by two valuations of the assets, liabilities and off-balance sheet items of the institution under resolution.

These valuations include the following elements:²⁴

• “Valuation 1”, which essentially aims to inform the declaration that the credit institution is FOLTF, the first condition for resolution, focusing in particular on its solvency and liquidity situation under the regular accounting and regulatory framework in force;

• “Valuation 2”, carried out on the basis of the financial situation demonstrated in Valuation 1, is intended to support and substantiate the choice of resolution tool to be taken and to precisely determine the losses that need to be absorbed, taking into account the measures that need to be taken in light of the institution’s situation. Unlike Valuation 1, it focuses not just on the accounting but also the economic value of assets, liabilities and off-balance sheet items,²⁵ on the basis of which the institution’s statement of financial position will present a certain amount of losses to be reflected in the institution’s financial statements.

These valuations are carried out by an independent entity, appointed by the Banco de Portugal, at the expense of the institution under resolution and in accordance with the applicable regulation.²⁶

To characterise the procedure for implementing the bail-in tool and this publication, it is assumed, however, that, due to the urgency of the circumstances, unavailability of accounting information to date or the impossibility to designate an independent valuer under the applicable laws and regulations, one or both of the valuations cannot be carried out, before the resolution, under conditions which may qualify such valuations as definitive and independent – a situation which is expressly provided for by law.²⁷

In this case, the resolution decision is based on a provisional valuation, which may be carried out either by the independent valuer or by the Banco de Portugal.²⁸

Thus, the Banco de Portugal will make its decisions, at the time of resolution on the basis of the provisional valuation, including the decisions on the write-down of own funds and liabilities and their conversion.

If a provisional valuation is carried out when bail-in is applied, which is then the scenario assumed for the purposes of this publication, an independent and definitive valuation will be carried out after resolution. This will determine the definitive figures for the losses and recapitalisation needs of the institution, at the end and in accordance with the criteria laid down in the relevant legislation and regulations.

On the basis of this definitive valuation, the Banco de Portugal should then adjust, if necessary and appropriate, the write-down and conversion rates of the shareholders and creditors affected by the resolution, determined on the basis of the provisional valuation.

Holdings of shares of the credit institution’s shareholders are cancelled

The bail-in tool is applied to absorb the losses of the credit institution and strengthen its own funds²⁹ to the extent sufficient to restore its ability to comply with the conditions for authorisation and to continue to carry out its activities and to raise finance independently and under sustainable conditions from the financial markets, achieving the resolution objectives and restoring the credit institution’s financial soundness and long-term viability.³⁰

For this purpose and in the context of the powers to write down or convert capital instruments and eligible liabilities,³¹ necessarily applied before the bail-in tool,³² the Banco de Portugal reduces the share capital of the credit institution through amortisation or write down of the nominal value of its shares or instruments of ownership.³³

Valuation 2 losses determine which creditors are affected and to what extent by assuming, for the purposes of this publication and exposition, that the losses that need to be absorbed require all share capital to be written down.

In case of total write-down, which is then the scenario assumed for the purpose of this publication, the cancellation of the shares and their suspension from trading on a regulated market or other organised form of trading are expected to occur in accordance with the CSD’s internal procedures.³⁴

To ensure that the institution under resolution complies with the conditions for authorisation and to continue to carry out its activities and to raise finance independently and under sustainable conditions from the financial markets, liabilities will be converted into shares under the terms of the resolution decision in the amount necessary to comply with prudential requirements.

Given the legal requirement for a public limited company to have its capital divided into shares³⁵ and the need to ensure that the institution under resolution complies with its capital requirements, requiring its capital to be fully paid up, new shares will be issued, with each new share being issued against the capital reserves created upon conversion of the eligible liabilities.

Converted creditors receive interim resolution instruments

For the purposes of this publication, it is assumed that – for the reasons set out above – the resolution decision will be based on a provisional valuation and that the write-down and conversion rates of capital instruments and liabilities will only be definitively determined on the basis of an ex-post definitive valuation. Pending this definitive valuation, it is assumed that the Banco de Portugal determines the issuance of financial instruments specifically created under the bail-in tool, known as IRIS.

The IRIS will therefore be instruments issued by the institution under resolution and allocated at the time of resolution to creditors whose liabilities have been converted instead of the institution’s shares, which will only be allocated to these creditors following the final determination of the conversion rates on the basis of the definitive valuation. To this end, the IRIS will be securities representing a potential claim of their holder to receive instruments of ownership of the institution that has been subject to the bail-in tool, the number of which will initially be indeterminate and fixed with the final decision of the Banco de Portugal as regards the definitive write-down and conversion rates on the basis of definitive Valuation 2.

Use of the IRIS when applying bail-in is subject to a weighting to be carried out by the Banco de Portugal at the time of applying a resolution tool.

The IRIS have the potential to mitigate the difficulties arising when the tool is calibrated on the basis of a provisional Valuation 2 and subsequently supplemented by a definitive Valuation 2 where the final conversion rate is decided, which, as explained, is the assumption made in this publication.

In the absence of interim instruments, the converted creditors would receive the new shares issued by the institution under resolution, according to the conversion rates established under the provisional valuation, in which case any revision of the amount of losses to be absorbed and the capitalisation needs resulting from the definitive valuation, to be known at a later point in time, could lead to adjustments in the number or value of the shares already delivered.

There are two scenarios for which an adjustment may be necessary because there are differences between the write-down and conversion rates determined at the time of resolution and the final write-down and conversion rates, determined at a later point in time, after the definitive valuation has been finalised:

• In the event of excess conversion at the time of resolution,³⁶ the corresponding part of the converted liabilities may be repaid by being restored or by increasing the nominal value;³⁷

• In case the pre-determined level of loss absorption and subsequent recapitalisation prove insufficient³⁸ and an additional conversion is necessary, adjustments may have to be made to the shares already delivered, as new creditors would need to be converted and integrated into the shareholding structure.

Such adjustments could, however, cause instability to agents affected by the exchange mechanic, in addition to posing significant operational risks. These drawbacks could therefore be mitigated/surpassed by the use of interim instruments, which incorporate in their functioning the uncertainty inherent in the time gap between the provisional and definitive valuations and give their holders a prompt and tangible potential compensation for their converted liabilities.

Use of the IRIS may be considered, among other things, where there is a more heterogeneous and numerous universe of affected creditors or where there is greater uncertainty about the results of the valuations.

It should be noted that the use of the IRIS will have to be considered and decided by the Banco de Portugal in the light of the specific resolution scenario and that this publication does not bind the Banco de Portugal to any model of action; more specifically, it does not bind the Banco de Portugal to using the IRIS, maintaining the possibility for it to decide, in a specific case, on the direct conversion of liabilities into shares.

Implementation of the bail-in tool

In applying a resolution tool, and in particular the bail-in tool, four distinct phases are generally distinguished:

• the resolution planning phase;

• the implementation of the resolution decision;

• the period in which the exchange mechanic is implemented;

• the end of the resolution procedure.

Figure 1 illustrates the sequence of these four phases in a simplified way, signalling the key moments that occur in each of them.

Resolution timeline

The following sub-sections set out the actions expected to be implemented by the Banco de Portugal during the application of the bail-in tool and its different phases sequentially, always assuming satisfactory completion of the previous action and the foreseeable evolution of the crisis scenario.

As stated above, the Banco de Portugal is not limited to applying resolution tools as described above and, in the event of resolution action, it will adapt and select the criteria, terms and methods of implementation that are most appropriate to the specific situation.

Resolution planning phase

This sub-section focuses on the period from the detection of the first signs of difficulty in the credit institution and the actions that the RA takes in order to prepare for a possible resolution procedure. In this sense, the following main events or actions can be identified:

1. The RA identifies financial difficulties in a credit institution and increases the degree of monitoring of said institution. During this initial period, the Supervisory Authority may, among others:

• apply early intervention measures;³⁹

• require the institution concerned to prepare and deliver a restructuring plan.⁴⁰

2. The Supervisory Authority will be in regular contact with the RA;

3. Internal works begin to address the crisis situation;

4. The RA designates an independent entity to carry out Valuations 1 and 2 of the credit institution’s assets, liabilities and off-balance sheet items;⁴¹

5. The RA requests information from the institution to carry out Valuations 1 and 2 and may now request a proposal for the post-resolution Business Reorganisation Plan (BRP);⁴²

6. The RA updates the data on the credit institution and assesses the adequacy of its resolution plan;

7. The RA collects the results of Valuation 1 and, in cooperation with the Supervisory Authority, assesses whether the institution is FOLTF. If the institution is considered to be FOLTF, the following actions are taken;⁴³

8. The RA carries out the legally required notifications;⁴⁴

9. Due to the urgency of the circumstances, a provisional Valuation 2 is carried out on the institution under resolution, without prejudice to the definitive Valuation 2 being carried out by the independent valuer at a later time;⁴⁵

10. The RA collects the results of provisional Valuation 2 and decides on the various elements needed to define the resolution strategy to be implemented;

11. The RA verifies whether the conditions for applying resolution action are met.⁴⁶

Execution of the resolution decision

This subsection focuses on the moment where the Banco de Portugal determines the resolution tools to be applied to an institution, entering into effect with the publication of the resolution decision. Their content and the actions to be taken immediately after publication are detailed below.

12. The decision by the Banco de Portugal placing the credit institution under resolution should contain the following items:

• information on the institution under resolution;

• background that led to the institution being declared FOLTF;

• early intervention measures applied to the institution, if applicable;

• summary description of the results of Valuation 1 and FOLTF declaration;

• summary description of the results of the provisional Valuation 2;

• verification of compliance with the conditions necessary to the application of resolution tools;

• identification of the resolution powers to be exercised by the Banco de Portugal, together with the resolution tool;⁴⁷

• any possible decision on the suspension of payment or delivery obligations arising from a legal transaction in which the credit institution is a party;⁴⁸

• Any possible decision on the suspension of trading financial instruments and their operationalisation, including:⁴⁹

  • reasons for the decision;

  • scope;

  • reference date for identifying the instruments and applying the tool;

  • a possible decision on the suspension of the payment of unsettled transactions;

  • request to the CMVM to order:⁵⁰

    1. the trading venue to suspend trading of the instruments;⁵¹

    2. the CSD to suspend the settlement of the instruments;

    3. the CSD to record the write-down of the instruments’ nominal value;

    4. the CSD to cancel the registration of the instruments that have been fully written down.⁵²

  • terms of the bail-in tool, including:

    1. grounds for choosing the tool;

    2. the loss amount to be absorbed by the write-down of capital instruments, other capital instruments and eligible liabilities under provisional Valuation 2;

    3. the capital amount to be increased upon conversion of capital instruments and eligible liabilities under provisional Valuation 2;

    4. liabilities which are discretionarily excluded from bail-in and justification for their exclusion;⁵³

    5. the scope covered by the bail-in application, listing the liability classes affected by the tool;

    6. values to apply in the bail-in mechanic according to provisional Valuation 2, including:⁵⁴

       1. write-down rates applied to each liability class;

       2. conversion rates from liabilities to shares applied to each liability class;

       3. the nominal value of the shares to be issued;

       4. rates of exchange between converted liabilities and IRIS applied to each liability class according to their ranking in the insolvency hierarchy;

    7. items relating to the treatment of the financial instruments affected by the tool, including:

       1. treatment of accrued interest;

       2. payment of interest, dividends and unsettled transactions;

       3. indication of the paying agent of the institution under resolution, which will give instructions to the CSD.

    8. appointment of new members to the management body of the institution under resolution or justified decision on the retention of existing members;⁵⁵

    9. annexes, including the following:

       1. list of instruments written down or converted under the application of the tool;

       2. list of instruments affected by the trading suspension;

       3. list of instruments affected by the payment suspension;

       4. “Terms and Conditions” of the IRIS programme.

    10. Publication and entry into force of the decision.

13. The RA carries out the legally required notifications;⁵⁶

14. The RA launches the procedure for the designation of an independent entity to carry out the independent valuations.

1. The specific themes of unsettled transactions and fractional shares

Predictability in the functioning of markets is important during the application of a resolution tool. One way of ensuring that predictability, in the specific case of the bail-in tool, could be by minimising deviations from existing market practices. Indeed, for the CSD and for markets, bail-in implementation is the application of a similar set of actions to certain well-defined corporate events that are applied in other contexts on an equal or similar basis.

In this box we clarify two specific aspects of the CSD’s execution of the resolution decision by the Banco de Portugal.

In-flight transactions

In-flight transactions are those which have been initiated but whose transfer (or “settlement”) has not yet been completed.

In the case of the bail-in application, it should first be ensured that all in-flight transactions undertaken before the date on which the resolution decision takes effect are settled. After that settlement, the effects of the application of the resolution tool should be fully reflected on those instruments that were in the process of being settled/cleared.

It is generally acknowledged that the suspension of the settlement may occur in several contexts and in the implementation of certain corporate events and may facilitate this process. When suspending the settlement, the CSD avoids, for example, the completion of a transfer of ownership ordered before the resolution decision, but only completed thereafter. As suspending settlements is a common and known market procedure to support regular corporate events, it can also be considered.

Fractional shares

Fractional shares are fractions of a full share. When holders of converted debt instruments receive shares in exchange at the conversion rates determined in the resolution decision, a number of shares higher than the whole number may be allocated (e.g. 10.125 shares with a nominal value of €1). The fraction exceeding the whole number, which is 0.125 in this practical example, is then called a fractional share.

In accordance with Portuguese Company Law, in particular Article 276(3), the minimum nominal value of the shares or, in its absence, the issue value, may not be less than 1 cent. Establishing a written-down nominal value for each share, namely one cent, mitigates and sometimes eliminates the possibility of fractional shares being created. Nevertheless, as can be seen in the example given, even with shares with a nominal value of 1 cent, obtaining fractional shares may be inevitable.

However, in Portugal, it is only permitted to split the share capital of an entity into a whole number of shares (Article 276(6) of Portuguese Company Law). There are a number of mechanisms that can be used to deal with this situation, namely (i) rounding down, (ii) rounding up, (iii) standard rounding, i.e. if the fraction is greater or equal to 0.5, rounding up is used; if it is less than 0.5, rounding down is used, and (iv) compensation/repayment of the amount corresponding to the fractional share.

With a view to maximising the predictability of a possible resolution decision and minimising deviations from usual market practices where possible, when applying a resolution tool, the relevant decision may expressly refer to the way in which both situations described are dealt with, if relevant, and one of the hypotheses could be for CSDs to use the mechanisms already provided for in their own regulations and which are usual in the market.

Exchange mechanic implementation period

This subsection focuses on the period starting with the publication of the resolution decision and ending with the conclusion of Valuation 2 and subsequent allocation of shares to the IRIS holders, thus including the necessary steps to implement the tool. In this sense, the Banco de Portugal is expected to:

15. monitor the measures taken by the institution under resolution immediately after the resolution tool takes effect, namely:

• the issuance of new shares with the CSD against the reserves created in the write-down of liabilities and their transfer to the custodian’s securities account;

• the issuance of IRIS with the CSD and their transfer to the converted creditors’ securities accounts.

16. maintain an up-to-date register of IRIS holders while these are traded on over-the-counter (OTC) markets;

17. collect the results of the definitive Valuation 2 and determine the following in a reasoned decision subject to publication:

• the final conversion rate of the shares;

• the date to suspend the IRIS transactions;

• the start and end dates of the period to exchange IRIS for shares;

• the date to allocate voting rights to the new shareholders.

18. during the period to exchange IRIS for shares, consolidate and evaluate the electronic declarations received;

19. on the planned date, or when all the shares have been claimed, transfer these shares to the securities accounts of IRIS holders;

20. at the end of the exchange period, possibly sell the unclaimed shares, keeping the revenue for future compensation of IRIS holders who do not claim their shares within the deadline.

End of the resolution procedure

This subsection focuses on the measures that follow the application of the tool, ensuring the conclusion of the procedure. In this sense, the Banco de Portugal is expected to:

21. stabilise a final version of the BRP and monitor its implementation by the credit institution;

22. collect the results of Valuation 3 and decide on the compensations due under the NCWO mechanism.

Annex – IRIS characteristics and operationalisation

Should the Banco de Portugal consider it appropriate to use IRIS in the bail-in tool application, the use of these instruments is expected to comply with the following process:

• At the moment of resolution, the target institution issues two instruments: (i) new shares representing its share capital in number and value corresponding to the calibration of the conversion rates determined on the basis of the provisional valuation and (ii) IRIS, securities representing a potential claim of their holder to receive instruments of ownership of the institution that has been subject to the bail-in tool, the number of which will initially be indeterminate and which will be fixed with the final decision of the Banco de Portugal as regards the definitive write-down and conversion rates on the basis of definite Valuation 2;

• The new shares of the institution under resolution are given to the Banco de Portugal, as their custodian during the preparation of definitive Valuation 2, and are intended to be handed over to the new shareholders of the institution, i.e. to the converted creditors, at a later date. The issuance of shares, at this moment, by the institution under resolution, concomitant with the IRIS issuance, is justified by the need of the institution to have shares issued and fully paid at all times that are eligible to meet its capital requirements.

• In turn, IRIS are issued by the institution under resolution and allocated to the converted creditors, who receive them instead of shares;

• In a second phase, upon completion of definitive Valuation 2, the IRIS are extinguished and their holders receive the shares of the institution under resolution, which already follow the conversion rates determined on the basis of definitive Valuation 2.

In this context, and for the purposes of this publication, the following assumptions are made on the operation of IRIS:

• The IRIS are created by way of the Banco de Portugal’s administrative decision that applies the resolution tool, which provides for their use and operation, together with the conversion of liabilities into shares, issued by the institution under resolution together with the IRIS;

• The Banco de Portugal also approves the IRIS programme to be issued, containing the information necessary to inform the market of the instrument’s characteristics, adapted to the specific case;

• The IRIS are divided into classes corresponding to the classes of liabilities converted according to their ranking in case of insolvency, in order to differentiate the rates applicable to each class;

• Each IRIS unit has a nominal value of €1 and each creditor receives in IRIS the value of the converted part of the liability they held, regardless of its class;⁵⁷

• As IRIS are not capital instruments, they are not considered CET1 instruments of the institution under resolution, which continue to be the shares issued at the time of the liability’s conversion, in accordance with the rates set on the basis of the provisional valuation;

• The exchange rate of liabilities for IRIS is 1:1 in all classes. Subsequently, the exchange rate⁵⁸ of IRIS for shares differs by class, ensuring that ordinary creditors, if covered by conversion powers, have a higher rate and receive proportionately more shares than subordinated creditors;⁵⁹

• The CSD is asked to allocate an ISIN to the IRIS, with each IRIS class having a different ISIN,⁶⁰ in order to facilitate its identification and processing in settlement and clearing systems, including at the CSD level;

• As these instruments are issued in the context of resolution, it is assumed that the issuance of IRIS is exempt from the obligation to publish a prospectus;⁶¹

• The issuance of IRIS is accompanied by the IRIS’ “Terms and Conditions”, an informative document to be approved by the Banco de Portugal in the resolution tool application, detailing the various characteristics necessary to fulfil the resolution objectives in that particular case;⁶²

• IRIS of each class are represented by a master certificate, provided for in the “Terms and Conditions” of the instrument, which may be used to issue IRIS of that class at different points in the resolution process, if necessary;

• IRIS are issued by the institution under resolution, but are not visible in the statement of its financial position, as they are a potential right to shares, the latter already being accounted for as equity;

• IRIS are deposited in the CSD, as are shares. The introduction of interim instruments is not expected to impose substantial changes to the standard CSD procedure. This means that if the instruments to be written down and converted are deposited in other European CSDs, it is expected that the process is synchronised according to the procedures existing between the Portuguese CSD and the European CSD network and supported by communication between European market authorities;

• IRIS are automatically allocated to all creditors converted in the application of the resolution tool, no intervention being required of them to receive the IRIS in their respective securities accounts;

• During the period when the definitive valuation is being drawn up, IRIS are tradable on OTC markets, granting their holders the possibility to sell the instrument to obtain liquidity or avoid becoming a shareholder of the institution under resolution;⁶³

• IRIS are book-entry securities so as to simplify transmission, which can be done by transfer between registry accounts, and to make it easier to reconstruct holder succession;

• Transactions are traceable, so that IRIS holders can always be identified. A holder can be any agent able to purchase financial instruments on OTC markets, bearing in mind that the underlying right to this instrument is the acquisition of an uncertain number of shares;

• On completion of the definitive valuation, the Banco de Portugal determines the final conversion rate of the shares, as well as the date of conversion, and establishes the date to suspend the IRIS transaction to operationalise their exchange for shares. Upon expiry of the stipulated deadline, the transaction is suspended and the period to exchange IRIS for shares is opened for a duration set by the Banco de Portugal;

• The final creditors-to-shareholders conversion rate is applied by class and must respect its ranking in the insolvency hierarchy by ensuring that the conversion gives more shares to classes of common claims and less to classes of subordinated claims;⁶⁴

• The allocation of IRIS is without prejudice to the fact that, in the event of an initial excess conversion, the corresponding part of the converted liabilities is repaid by restoring them or increasing the nominal value, in their original terms and conditions, in the final decision;⁶⁵

• The allocation of shares may depend on the initiative of IRIS holders, who are responsible for claiming the shares to which they are entitled by means of an electronic declaration containing their identification, proof of ownership, evidence that the necessary regulatory approvals have been obtained and instructions for the effective delivery of the instruments;

• The allocation of shares implies the extinction of the IRIS and the transfer of the shares from the custodian to the holders’ securities account, indicated by the latter in the declaration;

• Unclaimed shares are sold and the proceeds are kept for an extended period of time in order to compensate IRIS holders who have not claimed their shares within the stipulated deadline and contact the Banco de Portugal at a later stage to request that amount;

• The shares, as well as their respective claims, may not be issued immediately after the declarations have been delivered and accepted, but rather as a whole, at a date to be determined by the Banco de Portugal after the end of the period for claiming shares, or during this period, when all existing shares have been claimed;

• The process is concluded at the end of the resolution period (decided by the Banco de Portugal as resolution authority), and with it the legal effects of suspension of the converted shareholders’ share capital rights, marking the institution’s return to business as usual.

Figure 2 illustrates how IRIS would operate throughout the procedure, starting from the liability structure of a hypothetical institution prior to resolution, its exchange for tradable IRIS classes and subsequent conversion into shares of the institution under resolution, where a conversion and partial write-down of the class of subordinated claims and a full conversion of the class of common claims would take place.

IRIS operating diagram