Against the background of the economic crisis, the National Bank of Romania (NBR) has put forward a proposal for a draft regulation dealing with the specific circumstances under which credit institutions may temporarily hold equity and therefore hold control over non-financial entities (entities which are not either: (i) credit institutions, financial institutions, insurance or re-insurance companies; or (ii) companies carrying out activities which are a direct extension of banking activities, such as leasing, factoring, management of investment funds, or which provide banking ancillary services).
Government Emergency Ordinance 99/2006 regarding credit institutions and capital adequacy provides that credit institutions are allowed to hold qualified participations, but not to hold control in non-financial entities provided that the following prudential ratios are complied with: (i) the value of each individual qualifying participation cannot exceed 15% of that credit institution's own funds; and (ii) the total value of all qualifying participations held by the relevant credit institution cannot exceed 50% of its own funds.
The Ordinance expressly stipulates, however, that the following participations are not considered qualifying participations: (i) shares held temporarily during a financial reconstruction or rescue operation or during the normal course of underwriting or in a credit institution's own name on behalf of others; and (ii) shares which are not financial fixed assets.
Based on this express provision, the NBR prepared the draft regulation elaborating on the conditions under which credit institutions may hold (through a debt-to-equity conversion mechanism) shares in non-financial entities. The Draft Regulation defines "temporary" as a period of 36 months as of the date the shares are acquired. In exceptional circumstances, such a period may be extended by the NBR up to a period of 48 months. The draft regulation clearly states that this timeline includes also the period necessary for the credit institution to exit. The draft regulation also re-states that the provision is applicable only for the holding of shares in a company that is under financial distress and the acquisition and the temporary holding of shares will be performed/carried out in accordance with the provisions of the Romanian companies' law.
In order to temporarily hold control in non-financial entities, the credit institution must comply with the following requirements: (i) have in place an overall strategy and policy regarding such type of operations; (ii) implement a concrete, viable and well-reasoned financial reconstruction or rescue plan for the undertaking concerned; (iii) come to a justified conclusion that there is no other manner more efficient to "satisfy the interests" of the credit institution in relation to the respective company; and (iv) hold an exposure towards the respective company exceeding 60% of the respective company's overall debt.
Furthermore, the draft regulation requires credit institutions to have in place policies or procedures for assuming, identifying, measuring, controlling and reporting all the risks entailed by such a transaction, including the concentration risk, in accordance with the specific provisions concerning governance arrangements of credit institutions and internal capital adequacy assessment process.
The overall strategy concerning such temporary holding of shares should specifically mention the maximum amount that the credit institution estimates that it will contribute to the rescue of the company and a ceiling amount of the participations acquired as a temporary holding of shares calculated by reference to the level of the own funds of the credit institution. The intention to acquire such shares must be notified to the NBR together with the documentation mentioned above.
Lastly, such participations must be reflected separately in the financial statements of the credit institutions and the entities in its group to which such participations have been transferred and will be deducted from the level of own funds of the respective credit institution.
The draft regulation is still in the consultation process and has stirred heavy debates due to its sometimes ambiguous wording, its implications and the risks entailed by the credit institutions that would choose such an option in order to recover their debts. On the one hand, there are regulatory and systemic issues that concern the risk exposure of a credit institution and the ability to deal with such participations and the ensuing responsibilities and ultimately the possibility to artificially "clean up" the balance sheet of such credit institutions.
On the other hand, there are other risks resulting from the debt to equity conversion as such, for example the change in the position of the credit institution from a third-party secured creditor into an unsecured creditor that may no longer enjoy the benefit of enforcing a security interest or voting a reorganisation plan in an insolvency procedure.
Even though the draft regulation gives rise to several legal aspects that have to be coordinated, the initiative of the NBR to provide further details on the conditions under which credit institutions may acquire control in non-financial entities is welcomed and meant to offer credit institutions another tool for debt recovery that may prove useful in some circumstances.