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10th July 2020
Banking & Finance

Op-Ed: “First ECB penalties partly annulled: prudent banks and reasoned administration” by Christy Ann Petit

Crédit Agricole v ECB (T-576/18), Crédit Agricole Corporate and Investment Bank v ECB (T-577/18), and CA Consumer Finance v ECB (T-578/18)

In the first judgments concerning administrative pecuniary penalties imposed by the ECB in its supervisory arm since the inception of the Single Supervisory Mechanism (SSM), the General Court partly annulled the ECB’s decisions for inadequate reasoning, while confirming a breach of EU Law (as already reported on EU Law Live). Generally, these judgments bring to the fore the enforcement and sanctioning powers existing in banking supervision that ensure the application of prudential regulation, overhauled after the last economic and financial crisis. These legal acts are addressed to credit institutions which have, in the ECB’s view, breached EU Law (see the list of sanctions publicly available). If the SSM legal framework clearly provides for administrative penalties (Article 18, SSM Regulation 1024/2013), the word ‘sanction’ is also used as a generic term hereinafter.

In these cases, the ECB considered the credit institutions classified capital instruments as Common Equity Tier (CET) 1 without obtaining prior permission from it as competent authority, in breach of prudential regulations. Put simply, the CET1 requirements regulate the quality and quantity of capital constituted at banks’ level, to keep them safe and sound, so that they are able to absorb losses, but also in a systematic way, to guarantee the stability of the financial system (all objectives set for banking supervision in Article 1 SSM Regulation). This said, the ECB decided on 16 July 2018 to impose administrative penalties for continued breach of the requirements provided for in Article 26(3) of the Capital Requirements Regulation CRR, 575/2013 (in force at that time). The penalties amounted to 4,300,000 euros for Crédit Agricole S.A. (published version), 300,000 euros for Crédit Agricole Corporate and Investment Bank (published version), and 200,000 for CA Consumer Finance (published version), (hereinafter ‘the applicants’, except where stated otherwise). They challenged the ECB’s decisions imposing administrative penalties before the General Court.

Three requests sought the annulment of the penalties imposed on these credit institutions-part of the Crédit Agricole Group, which is under the direct supervision of the ECB (for the Group’s governance and structure, see here). Crédit Agricole S.A. is indeed classified as a significant institution according to its size, total assets being more than 1,000 billion euros (see the ECB’s published list of supervised entities as of July 2018, and the list applicable today). The ‘significance’ is not disputed, even though the size will be an element invoked late, in the hearing. Concretely, the applicants have issued ordinary shares in different amounts, in 2015 and 2016. As a result of those issuances, they have classified capital instruments in their CET1 instruments in quarterly reporting on own funds and public disclosures without prior permission from the ECB.

The applicants relied on two pleas in law, which are in essence identical in the three cases.

First, the applicants considered the three contested decisions to be ultra vires because the ECB erred in law in its interpretation of Article 26(3) CRR. They considered the provision does not require a prior authorisation from the ECB to classify ordinary shares as CET1 capital, that they did not commit an intentional or negligent breach in applying that provision, and claimed the contested decisions are contrary to the principle of proportionality considering the lack of seriousness of the alleged breach and their cooperation. The second plea concerned the applicants’ procedural fundamental rights as far as the contested decisions were based on complaints against which they could not present their objections.

It is a halftone outcome for all parties: it is confirmed the credit institutions have breached prudential requirements, but the ECB failed in stating the reasons to justify the amounts of the pecuniary penalties. In other words, the application and interpretation of the rule had been correct and justified the adoption of these sanctions, but the means to reach such outcome contradicted essential procedural requirements in administrative legal acts. The legal issues, as examined by the General Court, concern the alleged breach of EU law and the ECB’s pecuniary penalties imposed on the applicants, both examined in turn.

I. A clear breach of EU Law

In substance, the provision of EU law is a core part of the Single Rulebook adopted after the last crisis. Credit institutions’ own funds must be held following prudential requirements that concern the quantity and quality of capital. Shortly, own funds appear on the liabilities side of the credit institutions’ balance sheet in order to absorb losses and cover risks. They consist of tier 1 and tier 2 capital, with different degrees of quality depending on the capital instruments. Tier 1 capital includes CET1 and Additional Tier 1 capital. CET1 is considered the ‘highest quality’. The amounts of issuances that qualify as CET1 items/instruments have an obvious implication on the CET1 ratio applicable to all credit institutions (a CET1 capital ratio of 4.5 %, as per Article 92(1) CRR, which is expressed as a percentage of the total risk exposure amount).

At the time of the dispute, Article 26(3) CRR provided ‘institutions shall classify capital instruments as CET1 instruments only after permission is granted by the competent authorities, which may consult EBA’. The applicants discussed the application and interpretation of such permission, and relied on the inclusion of their issued capital instruments within CET1 in compliance with an EBA list that could be considered, in the applicants’ views, as the competent authorities’ permission. The list of all the forms of capital instruments that can qualify as CET1 instruments is indeed published by the EBA (as per the third paragraph of Article 26(3) CRR, see EBA’s list of CET1 instruments).

The General Court interpreted the provision in length and referred to its new wording after the CRD/CRR Review. The sequencing is crystal clear: permission must be obtained before classifying the capital instruments as CET1 instruments. The issue relates to the boundaries in the distinction between prior authorisation and the granting of the permission (which are respectively translated from autorisation préalable and accord in the French original version, but this distinction does not exist in all linguistic versions, as the General Court underlined). If the EBA may be consulted, the inclusion of capital instruments as CET1 on the EBA’s list is not sufficient to consider the CET1 instruments classification lawful. Prior to any classification, the competent authorities, and here, the ECB, grant the permission to the credit institutions.

Before turning to the legal issues in determining the pecuniary penalties, it should be noted that the provision that was breached has been revised in the CRR2, 575/2013, as amended, by Regulation 2019/876, recital 23 of which indicates the necessity ‘to provide for a clear and transparent approval process’ of the classification of CET1 instruments. If this change has no consequence for the interpretation and application of the law in the cases at hand, this shows the legislators’ willingness to clarify the process, and potentially avoid some burdens on both the supervisors’ and supervised entities’ sides. In particular, the ‘recurring’ and subsequent issuances of capital instruments potentially classified as CET1 may benefit from some derogation with a prior notification to the competent authorities, instead of a prior permission. Then, the credit institutions can classify subsequent issuances as CET1 instruments when they have the form of CET1 instruments for which they already received such permission. The provisions governing those subsequent issuances must be substantially the same as the provisions that governed the previous permission to classify issuances as CET1 instruments, provided the notification intervenes sufficiently in advance (see Article 26(3), second subparagraph, and recital 23 CRR2).

II. Administrative pecuniary penalties

ECB’s wide margin of appreciation and statement of reasons

In its supervisory tasks, the ECB may impose administrative pecuniary penalties in the event credit institutions intentionally or negligently breach a requirement stemming from prudential regulation (Article 18(1) SSM Regulation). Such penalties can be: (i) up to twice the amount of the profits gained or losses avoided because of the breach where those can be determined, or (ii) up to 10% of the total annual turnover of a legal person in the preceding business year or such other pecuniary penalties as may be provided for in relevant EU law.

The General Court considered the ECB holds a significant margin of appreciation to determine the amount of the pecuniary penalty under this provision. Therefore, safeguarding procedural rights in such administrative procedures is all the more important so that the Courts are able to review and assess the facts and law underpinning the exercise of ECB’s wide discretion in setting administrative penalties. Both such discretion and the high amount of the penalty (stated in all three cases despite a numerical difference) give the statement of reasons a particular importance. In this regard, the General Court examined the statement of reasons of the contested decisions as a plea raised by the judge of its own motion and at any time of the procedure (see for instance Krupp Thyssen Stainless GmbH T‑45/98 et T‑47/98, paragraph 125). As a constitutional requirement stemming from the Treaties (Article 296 TFEU), the obligation to state the reasoning is, furthermore, part of the right to be heard and adversarial principle. The lack of clear methodology to determine the amounts of the penalties is the central missing point in the statement of reasons.

A disclosed methodology to determine the amounts of the administrative penalties?

The ECB’s decisions that have been published are short and concise and cite ‘among other circumstances’ the duration of the breach (for example in number of quarterly reporting periods) and the degree of responsibility of Crédit Agricole Corporate and Investment Group and CA Consumer Finance within the group. This impression given from the ‘abstract’ of such penalties is not clarified by the three judgments. There are only a few additional indicative elements from the ECB’s reasoning exposed in the cases, such as the proportion represented by these capital instruments in the CET1 ratios of the applicants, and their persistence to classify the issuances of ordinary shares as CET1 instruments after being warned by the ECB of the obligation to obtain prior authorisation.

Notwithstanding an effort to explain its methodology to determine the amount of the penalties under two steps, the elements provided by the ECB did not convince the General Court. The ECB argued that, firstly, the basic amount of the penalties is based on the gravity of the infringement and the total amount of the assets managed by the credit institution (which was not included in the contested decisions). Secondly, the basic amount is adjusted upon attenuating or aggravating circumstances. In the ECB’s view, the lack of explanation of the methodology in the contested decisions themselves are supposed to ensure the dissuasive character of the sanction, otherwise anticipated by the credit institutions.

All cases benefited from attenuating circumstances because the late requests resulted in the ECB granting permission to classify the ordinary shares as CET1 instruments. Nevertheless, there is no indication as to how such circumstances were weighed in determining the amounts. Moreover, the size element was wrongly used in the contested decisions (as to the Crédit Agricole group and not the concerned applicants) and presented as part of the ECB’s methodology only at the stage of the hearing. The General Court rightly underlined the necessity to integrate the size, even though it is an ‘objective element’ in the ECB’s views, in the decisions to explain how and to what extent this element plays a role in determining the amount of the penalties imposed on the applicants.

The line of reasoning in the legal acts and defended in these cases cannot really stand. In reference to another field where setting the fines methodologically triggered litigation, namely competition law, the General Court reiterated the necessity for the Commission to state the reasons regarding the amounts and method of calculation of the fines (see for instance Jungbunzlauer AG T‑43/02, paragraph 91). As the General Court affirmed in the cases analysed here, the statement of reasons must disclose in a clear and unequivocal fashion the ECB’s reasoning in such a way as to enable the addressees to ascertain the reasons for the measure and to enable the competent court to exercise its power of review. The inadequate statement of reasons also precluded the General Court from assessing the effective, proportionate and dissuasive character of the penalties (as per Article 18(3) of the SSM Regulation). Therefore, the General Court assessed the few considerations given on the gravity of the infringement, the duration, and attenuating circumstances, and finally observed the lack of precise methodology in the contested decisions.

III. Squaring the circle: prudential regulation, supervision, and prudent banks

The halftone impression results from different angles. On the one hand, credit institutions cannot ignore the supervisory dialogue they must carry on with the relevant Joint Supervisory Teams and the ECB. All cases mentioned that, following information about the unfulfilled obligation from the said Joint Supervisory Teams, some requests for permission to classify some issuances as CET1 instruments intervened both ex post and for future issuances. The applicants were granted the permission for such classifications by the ECB after such requests. The effective application and enforcement of the prudential regime also critically relies upon the good cooperation and dialogue of the supervisors with the supervised entities, in reciprocal directions.

Overall, prudential regulation has undoubtedly instilled a more prudent approach of the supervisors in ongoing banking supervision, reinforced with common supervisory methods and culture. But the prudent approach is also incumbent upon the credit institutions ‘object’ of supervision. In examining the negligence of the applicants, the General Court emphasised the responsibility lying on them when applying the CRR requirements with ‘grande prudence’, that is with all care for the scope of their obligations. In spite of acknowledged difficulties encountered by other ‘operators’ and supervised entities as regards the interpretation of Article 26(3) CRR, the General Court reiterated the prudence and diligence of a credit institution that should have ensured an ‘attentive reading’ of the provision, alleviating any doubts as to the scope of its obligations. Beyond compliance considerations stricto sensu, this is a matter of banking governance, behaviour, and culture on the part of the credit institutions.

On the other hand, an effort of explanation and justification lies on the ECB as supervisory competent authority to comply with the requirement to adopt administrative penalties that are ‘effective, proportionate and dissuasive’. Eventually, in adopting a methodology for setting penalties in line with the obligation to state the reasons, the ECB would also have to deal with the complex interplay between the provisions established in Council Regulation 2532/98 as amended (present only in case CA Consumer Finance v BCE (T-578/18)) and the relevant provisions in the SSM Framework Regulation 468/2014 (Articles 120 to 137). The cases published remain silent on some elements of the procedure to determine the penalty (for example the involvement of a special investigating unit and referral reports that have been probably produced to report the breaches). It must be noted that on the same day, the General Court did not annul another ECB pecuniary penalty, one that was imposed on Banco Sabadell S.A., which disputed the alleged breach, the proportionality of the penalty as well as the publicity of the decision (read more on EU Law Live). In all cases, the parties may appeal the judgment before the Court of Justice.

A potential avenue for setting a methodology determining the amount of penalties may be inferred from the General Court’s judgments. Indeed, decisions may be reasoned in a ‘summary manner’ when they refer to previous administrative practices. The publication of a methodology applied in its power to adopt and determine pecuniary penalties would alleviate the ECB’s obligation to reason extensively in individual decisions. Without mentioning it explicitly, the Guidelines existing in competition law are an obvious reference point (see Guidelines on the method of setting fines imposed pursuant to Article 23(2)(a) of Regulation 1/2003). The release of the ‘standard’ methodology could ensure the effectiveness of the judicial review and give sufficient information to the addressees of the decisions as to whether the legal act may be vitiated and its validity, administratively and judicially challenged.

 

Christy Ann Petit is a Research Associate at the Florence School of Banking and Finance at the European University Institute (EUI) and recently defended her Ph.D. thesis ‘An integrated system for banking supervision in the Banking Union’ at the EUI Law Department. She is author of ‘The SSM and the ECB decision-making governance’, in G. lo Schiavo (ed.) The European Banking Union and the role of law (Cheltenham, Edward Elgar : 2019).

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