Last month, the Corp Fin Staff issued a no-action letter to the Bank of England that addressed the U.S. federal securities implications of a proposed approach for addressing bank failures. This Reuters article notes:

The Bank of England updated its guidance on handling bank failures on Monday, introducing an alternative bail-in mechanism that changes how bondholders are compensated during a rescue, after securing assurances from U.S. regulators.

The BoE said ‌it had received a no-action letter from U.S. regulators, assuring it that U.S. authorities would not pursue enforcement action over use of the new mechanism.

The new guidance was supported by lessons learned ​from the failures of Credit Suisse and Silicon Valley Bank, the BoE said.

Under ​the new approach, bondholders whose debt is wiped out or converted ⁠as part of a bank rescue will first receive temporary placeholder rights rather than ​shares in the rescued bank.

These rights, known as PROPPs, are a provisional entitlement that ​will later be converted into actual shares in the recapitalised bank once regulators have worked out exactly how much each creditor is owed.

“The key addition is the introduction of an alternate approach to ​bail-in where affected creditors receive non-transferable contingent beneficial interests,” the BoE said in a ​statement.

The Mayer Brown Free Writings + Perspectives blog describes the Bank of England’s request for no-action relief as follows:

The PROPPs Mechanism

In the scenario described in the Incoming Letter, as part of the Bail-In [a process used by a resolution authority to recapitalize a failing financial institution without using taxpayer funds], all ordinary shares of the failed Firm would be transferred to either the BoE or a third-party depositary bank, in each case with no consideration payable and without the consent of the holders of such ordinary shares. This process was distinct from Credit Suisse’s resolution, during which its Additional Tier 1 capital securities were written down despite the common stock remaining outstanding and even being entitled to receive proceeds from the sale of that bank. The voting rights pertaining to the ordinary shares of the failed Firm will be exercisable by either the “resolution administrator” of the failed Firm appointed pursuant to the “Bail-In Resolution Instrument,” or alternatively by the BoE. The BoE would then determine a structure for how the failed Firm’s liabilities that are subject to the Bail-In, including the Bail-In Securities, would be written-down. The BoE has established a structure whereby the holders of Bail-In Securities that have been or will be written-down would be granted contingent beneficial interests, created by virtue of the Bail-In Resolution Instrument, which would entitle such holders to the delivery of ordinary shares of the Firm after the resolution, or alternatively, if applicable, the receipt of the net cash proceeds derived from the sale of the ordinary shares. These interests are referred to as Potential Rights to Onward Property or Proceeds (“PROPPs”). Once the Bail-In process has been concluded and each class of PROPPs has been valued, some PROPPs may be converted into equity securities of the post-resolution Firm. The BoE’s question was whether the exchange or conversion process was exempt from registration under Section 3(a)(9) of the Securities Act.

Section 3(a)(9) Exemption

Section 3(a)(9) exempts from registration “any security exchanged by the issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly by or indirectly for soliciting such exchange.” The BoE was of the opinion that the exchange of ordinary shares in a failing Firm with the holders of Bail-In Securities would satisfy the requirements of Section 3(a)(9) in a case where the exchange is effectuated through the PROPPs mechanism. TheStaff concluded that it would not recommend enforcement action if a Firm, as part of the Bail-In process, (1) exchanges its Bail-In Securities for non-transferable PROPPs; and (2) subsequently exchanges those PROPPs for ordinary shares in the resolved Firm without registration under the Securities Act, in reliance on an opinion of counsel that the exemption provided in Section 3(a)(9) is available.

In its no-action letter, the Staff stated:

Based on the facts presented, the Division will not recommend enforcement action to the Commission if a Firm (1) exchanges its Bail-In Securities for non-transferable PROPPs and; (2) subsequently exchanges those PROPPs for ordinary shares in the resolved Firm without registration under the Securities Act, in reliance on your opinion of counsel that the exemption provided in Securities Act Section 3(a)(9) is available.

In a statement released on the same day that the no-action letter was published, SEC Chairman Paul Atkins directed the Staff to prepare a rulemaking for consideration by the Commission that would provide an exemption from registration under Section 5 of the Securities Act for bank bail-in frameworks beyond the Bank of England situation, stating:

I am pleased that the Division has issued the letter in response to the Bank of England’s request. However, there is a wide range of bank bail-in frameworks used globally. To account for these various frameworks and to provide for a more certain and authoritative solution, I have instructed the Division to prepare a rulemaking recommendation to the Commission regarding a potential exemption from the Securities Act’s registration requirements, for securities offered and sold in connection with a regulatory bail-in.

Until the Commission takes up any such rulemaking, I encourage other foreign regulators and regulated firms to contact the Division to discuss their particular bail-in processes or frameworks.

And with that directive there is yet one more rulemaking piled on Corp Fin’s already overflowing plate!

– Dave Lynn