Special bank resolution and shareholders' rights: balancing competing interests
| Published date | 24 July 2009 |
| Date | 24 July 2009 |
| DOI | https://doi.org/10.1108/13581980910972232 |
| Pages | 277-301 |
| Author | Eva Hüpkes |
| Subject Matter | Accounting & finance |
Special bank resolution and
shareholders’ rights: balancing
competing interests
Eva Hu
¨pkes
Swiss Financial Market Authority, Bern, Switzerland
Abstract
Purpose – An effective bank resolution regime requires taking action while the bank still has
positive net worth and shareholder claims still have economic value. Such actions raise a number of
legal issues with respect to the rights of shareholders. This paper aims to consider how to strike a
balance between the need to protect the legitimate rights of shareholders and the need for a prompt
and rapid action and a failure resolution mechanism that minimizes disruptions to the financial system
and preserves market discipline.
Design/methodology/approach – The paper examines the nature of the shareholders’ rights and
the legal protection afforded to them. In the European context, the relevant sources of law are the
European Convention on Human Rights and the applicable community legislation. It considers
different options for resolution within this framework ranging from a pre-packaged resolution decided
by the shareholders ex ante to the outright divestiture of the shareholders once certain regulatory
thresholds are breached while the bank still has positive net worth.
Findings – The curtailment of shareholder rights should seek to generate appropriate incentives for
shareholders and other stakeholder and achieve broad objectives of enhancing predictability and
maintaining public goods, while at the same time providing for due process, proportionality and
adequate compensation.
Practical implications – The paper presents options on how to reform existing frameworks in
order to facilitate bank restructurings in a crisis.
Originality/value – The paper discusses key elements that policy makers need to consider in the
design of a regulatory framework for early intervention and resolution.
Keywords Legislation,United States of America, EuropeanUnion, Banks, Insolvency, Shareholders
Paper type Research paper
1. Introduction: why have a special resolution regime for banks?
A bank facing the prospect of failure may be a source of significant public concern
given the potential costs to its depositors and, more importantly, to the rest of the
economy (Bank of England, HM Treasury, Financial Services Authority, 2008a, b, c).
Ordinary insolvency procedures provide highly developed mechanisms to deal with
the interests of different classes of stakeholders in circumstances where a shortfall of
financial resources prevents an economic agent from meeting all of its financial
obligations on time and in full (Goode, 1997). However, they do so at a cost. General
corporate insolvency law deals only with institutions that are already drained of
economic value. For a bank this is too late because its capacity to perform its essential
functions will have been compromised by then (Hu
¨pkes, 2005b). Some elements of the
The current issue and full text archive of this journal is available at
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This paper is based on a presentation given at the Cass Business School workshop on the
proposed new UK regime for resolution of banking problems held on 7 April 2008. The views
expressed here are those of the author alone.
Special bank
resolution
277
Journal of Financial Regulation and
Compliance
Vol. 17 No. 3, 2009
pp. 277-301
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/13581980910972232
general bankruptcy procedure, such as freezing balance sheets, may in some cases be
very damaging (Hu
¨pkes, 2005a). A stay on payments would make operations
impossible for an institution relying on wholesale funding and using the full array of
modern instruments to manage its risks. It could also have serious advers e
consequences for the country’s payment system. Since general corporate insolven cy
law is not well-suited to dealing with distress in financial institutions, a number of
countries, including the USA, Canada, Italy, Switzerland and most recently the UK,
have adopted special resolution regimes for banks. One feature common to all special
bank resolution frameworks is that they provide for pre-insolvency intervention and
the curtailment of shareholder rights. Authorities need to intervene early, when there is
loss of market confidence and counterparties begin to entertain doubts about whether
the bank will be able to honour its commitments (Bliss and Kaufman, 2007; Benston
and Kaufman, 1998). The taking of such action when the bank still has positive net
worth raises a number of legal issues with respect to shareholders rights. For instance,
the appointment of an administrator to take control of the bank’s business operations
compromises the shareholders’ rights of corporate control and a decision to bring in
outside capital, transfer part of the bank’s business to another financial institution or to
merge the bank with another institution affects their pecuniary interests (equity
dilution). To understand the nature of shareholder rights and the legal protection
afforded to them it is useful to examine the relevant sources of law. In the European
context, these are the European Convention on Human Rights (ECHR) and the
applicable community legislation.
Where market solutions fail, a public sector solution may need to be considered. The
recent financial crisis highlighted the relevance of an adequate crisis management and
resolution frameworks. The size of the institutions under stress and the fact that they
provided functions that were critical for the domestic financial systems led authorities
to resort to extraordinary measures which included extensive liquidity support and the
injection of public funds. However, contrary to action taken in the past, as for instance
in the Scandinavian crisis, which resulted in completely wiping out shareholders
(Moe et al., 2004), the initial actions left shareholders largely in place though they suffer
significant dilution and loss of dividends. More recently, more intrusive form of
recapitalization with state funds and de facto bank nationalization gained grounds in a
number of jurisdiction hit by the financial crisis. Shareholder rights’ issues were at the
centre of many rescue operations leading to significant delays and legal uncertainty.
A number of jurisdictions adopted laws that curtailed shareholder rights or resulted in
an outright divestiture of shareholder rights. The objective was to facilitate a quick
resolution.
2. What are shareholders’ rights?
2.1 A definition
The European Court of Human Rights defines the right of a shareholder as the:
[...] right to a share in the company’s assets in the event of its being wound up, and other
unconditioned rights, especially voting rights and the right to influence the company’s
conduct[1].
The court distinguishes between pecuniary rights – the right to receive any remaining
value in a company when it is wound up – and governance rights, i.e. the right to
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