EUROPEAN COMMISSION Brussels, 14.3.2018 SWD(2018) 72 final COMMISSION STAFF WORKING DOCUMENT AMC Blueprint Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL AND THE EUROPEAN CENTRAL BANK Second Progress Report on the Reduction of Non-Performing Loans in Europe



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Table of Contents Summary I. Introduction II. Preconditions for centralised AMCs 2.1.Maximising the benefits and efficiency of AMCs 2.2.Commitment to comprehensive macro and structural reforms, as well as banking sector reforms 2.3.Considerations of financial stability and public funds at risk III. Conditions for asset transfer to AMCs 3.1.Consistency with EU legal framework (bank resolution and State aid) 3.2.Needed diagnostics and critical mass of impaired assets IV. Design and set-up of an AMC 4.1.Legislation, mandate and powers 4.2.Ownership and governance, institutional independence 4.3.Asset perimeter and size of the AMC 4.4.Asset valuation principles and processes 4.5.Accounting aspects 4.5.1. Accounting standards 4.5.2. Specific aspects of accounting 4.5.3. Accounting related disclosures

4.6.Data 4.6.1. Need for harmonisation of data 4.6.2. Data needs 4.6.3. Data quality 4.6.4. Data sharing and transparency 4.7.Conditions for bank participation 4.8.Funding 4.9.Impact on public finances and national accounts 4.9.1. Main considerations for sector classification of AMC units 4.9.2. Impact of losses related to impaired assets on government deficit and debt 4.9.3. Valuation of assets 4.9.4. Capital injections into banks and apportioned losses 4.10.Safeguard mechanisms and supervision 4.10.1. Safeguard mechanisms introduction 4.10.2. Time-limit safeguards 4.10.3. Financial safeguards 4.10.4. Risk management safeguards 4.10.5. Other safeguard mechanisms 4.10.6. Supervision V. Effective operations of an AMC

5.1.Organisation and staffing, internal controls and transparency 5.2.Strategic planning, asset and financial management 5.2.1. Strategic planning 5.2.2. Asset and financial management 5.3.Interaction with transferring banks 5.4.Options regarding loan servicing 5.5.Closing the AMC Annex: Overview of aid-free impaired asset relief measures alternative to centralised AMCs NPL securitisation enabled by a market-conform State guarantee Aid-free transfer of NPLs to a bank-specific AMC Summary Policy context The Council's "Action Plan To Tackle Non-Performing Loans In Europe" of 11 July 2017 recognises the complementarity of necessary actions by banks, Member States and the EU. The Action Plan invites the Commission and other actors to take steps on several fronts to tackle both the legacy stock of non-performing loans (NPLs) and the risk of build-up in the future. In order to achieve this, the Action Plan identifies four main areas where further action is needed to tackle NPLs: ·supervisory policies; ·structural reforms (enforcement and insolvency); ·the development of secondary markets for NPLs; ·aiding the restructuring of banking systems. The Action Plan also invited the Commission to develop a Blueprint for national Asset Management Companies (AMCs) by in close cooperation with other European institutions (i.e. the ECB, EBA and SRB). This Blueprint, drafted by Commission services, is to be seen in the context of the comprehensive package that the Commission services is putting forward in order to address the four areas identified in the Action Plan and thereby fostering financial stability in the EU. The purpose of the Blueprint is to set out how an AMC can be set up on the basis of these principles; however other ways of designing and operating an AMC may be possible.

This package will enable banks and Member States to better address existing NPLs and avoid excessive build-up of NPLs in the future. The package is an essential part of the Council's Action Plan. In combining several necessary initiatives, it creates the appropriate environment for dealing with NPLs on banks' balance sheets and reducing the risk of future NPL accumulation. Their impact is expected to be different across Member States and affected institutions. Some will have a stronger impact on banks' ex-ante risk assessment at loan origination, some will foster swift recognition and better management of NPLs, and others will enhance the market value of such NPLs. These initiatives mutually reinforce each other and would not be as effective if implemented in isolation. Historically, AMCs have under the right pre-conditions been an important part of solutions to foster banks' stability. General lessons on how AMCs can be set up and how their operations can be run in an effective and efficient manner can be learned from historical examples, while keeping in mind that the legal framework has changed due the introduction of the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRMR). The main aim of AMCs has been to remove troubled assets from banks' balance sheets and thereby reduce the high uncertainty about the quality of banks' assets, which made access to finance very difficult. AMCs thereby accelerated the restructuring of banks with high levels of distressed assets, stabilised the national banking sectors at large and eliminated a significant impediment to the flow of new credit to the economy. The possible use of AMCs is also closely linked to several other key elements of the Action Plan, in particular: -Further developing secondary markets for NPLs is important in order to enable banks to better manage their NPLs. In addition, AMCs might significantly benefit from better functioning secondary markets as one way by which an AMC maximises the recovery value on its portfolio of NPLs is loan sales to third-party investors. Both the AMC and many potential end-investors would also be dependent on the availability of independent companies to service and manage the loans on their behalf. -In its review of the Single Supervisory Mechanism (SSM), the Commission further clarified the powers of supervisors, i.e. that they have the power to make prudential adjustments to banks' provisions towards losses on NPLs on a case by case basis. Without such clear supervisory powers, weaker banks could set aside too few funds (i.e. under-provision) to cover the expected losses on their NPLs, and pretend that real losses have not materialised. -Many banks also have to enhance the management of their NPLs. They have to collect more accurate, undated and standardised data on their NPL holdings, for their own management purposes and provide these to supervisors. As regards data on NPLs, the Commission is working with the EBA towards standardised data templates. The EBA NPL Templates aim to fostering transparency, comparability and proper valuation of NPLs. This should help banks to manage their NPLs better and facilitate the transactions of NPLs between banks and investors, including AMCs. Moreover, banks that have adequately written down the value of their NPLs will be more inclined to sell them as they would not realise an accounting loss at the time of sale. Scope of the Blueprint The objective of this document is to provide practical guidance and recommendations for Member States when considering the design and set-up of centralised AMCs at the national level, building, where applicable, upon best practices from past experiences. The Blueprint therefore puts forward a number of non-binding principles, such as the relevant asset perimeter, the participation perimeter, considerations regarding the asset-size threshold, asset valuation rules, the appropriate capital structure, and the governance and operations of the AMC. AMCs can be private or (partly) publicly funded without State aid, if the State can be considered to act as any other economic agent. Setting up an AMC with State aid should not be seen as the default option and will, in all cases, be subject to all applicable rules including State aid rules, the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation SRMR. The Blueprint clarifies the permissible design for AMCs supported with a State aid element that can be used as an exceptional solution. Such AMCs will remain fully consistent with the EU legal framework, particularly the BRRD), SRMR and State aid rules. A Member State's most effective measure to handle impaired assets depends on its specific situation, including the size of the problem, the concerned asset classes and banks' own capacity to manage and work out NPLs. A centralised AMC, as described in this Blueprint, is an effective measure under specific circumstances, namely when impaired assets affect a large part of the domestic banking system and mainly cover loans secured by commercial real estate and large corporate exposures (c.f. section 4.3). For these asset classes, centralised AMCs may enjoy a comparative advantage in working out impaired loans. Under different circumstances, alternative measures may be more suitable, for instance when the impaired assets constitute a very large share of the total assets of the banking system and are heterogeneous in nature. Several Member States have implemented such alternative measures with success in recent years. Notably, the share of banks with high NPL ratios, the composition of NPLs in a Member State’s banking system, and the capacity of the Member State to set up and, in the case of a publicly supported AMC, to operate and (at least partially) fund it, will determine an AMC's capacity to achieve economies of scale. Such considerations will influence the AMCs ability to restructure distressed debt, and allow borrowers a path back to viability and therefore determine whether a centralised AMC will be set up and how wide its mandate will be. Other key choices concern the transfer price of assets and the AMC's funding and ownership structure, which play a critical role in its future success. Alternative impaired asset measures (IAMs) may include, among others, bank-driven initiatives, securitisation-based approaches, guarantees or asset protection schemes, as well as ad-hoc AMCs common to one or a limited number of banks. Preconditions for centralised AMCs The design of a centralised AMC should follow the identified best practices, as set out in the Blueprint. Otherwise, the AMC may not realise its potential benefits of maximising recovery values and foster financial stability and may even have a negative impact on financial stability and public finances. In the worst case, a loss-making AMC may have to be liquidated under the relevant corporate law, which could trigger the type of fire sale of assets that the AMC is intended to avoid. Similarly, the size of any asset removal scheme, including an AMC, and its riskiness will need to be limited for several reasons. In general, a number of conditions must be met to achieve sufficient benefits and efficiency the AMC. To mitigate risks related to conflicts of interest and political pressure, sound governance standards are necessary. Managers and administrators must fulfil strictly defined fit-and-proper requirements. Conflicts of interest should be closely monitored and independence from political bodies must be ensured. Moreover, transferring assets is costly. Good documentation of loans and collaterals and active cooperation of the transferring bank can greatly facilitate the transfer of impaired assets and reduce costs. Therefore, the transactions should be structured in such a way that the incentives of the transferring bank are aligned with maximising recovery values. A prerequisite for the success of an AMC is its embedding in relevant structural reforms of the economy, the banking sector and relevant legal frameworks, in particular the ability of the legal systems to enforce contracts and laws. European AMCs have in several cases been created within comprehensive macro-financial recovery programmes that included a set of structural reforms addressing weaknesses that were brought to the surface during the crisis. In this regard, insolvency, bankruptcy and foreclosure laws need to be or become robust in order to ensure that the AMC and prospective asset buyers can access the collateral of insolvent debtors under fair terms and within a reasonable timeframe. In order to make full use of an AMC, a Member State's banking sector may have to adjust in various ways. Hence, reforms of the banking sector should be initiated, including: ·address the emergence of new NPLs, most notably by sound underwriting practices; ·address the piling up of already existing NPLs, most notably by sound NPL management frameworks, as addressed by the ECB’s NPL guidance, and timely provisioning/ write-off practices;

·ensure a high degree of transparency and data availability on NPLs, based on the EBA data templates, to support other NPL workout measures, and to enhance market confidence more generally. Conditions for asset transfer to an AMC Consistency with EU legal framework The AMC needs to be set up and operate in full compliance with the existing EU legal framework. Practically this entails that, in case the AMC receives public support, compliance with State-aid rules, the BRRD and the SRMR has to be ensured. Under the EU's bank resolution framework, a bank requiring extraordinary public financial support – for instance to address a regulatory capital shortfall – may be declared "failing or likely to fail" (FOLF) by the competent or resolution authority. This triggers either the bank's resolution (if considered in the public interest by the resolution authority) or, alternatively, its liquidation under national ordinary insolvency law. Where impaired asset aid granted in the context of a transfer of NPLs from a bank to a publicly-supported AMC constitutes extraordinary public financial support, a bank benefitting from such an IAM should thus in principle be resolved or liquidated. However, the bank resolution framework provides for an exception to this general principle that is relevant in context of NPL transfers to a publicly supported AMC, namely when extraordinary public financial support is needed inter alia "to remedy a serious disturbance in the economy of a Member State and to preserve financial stability". In case a "precautionary recapitalisation" is granted, a bank will not be considered FOLF. Neither resolution nor liquidation under national ordinary insolvency proceedings will thus be triggered. In the case of a publicly supported AMC, compliance with the applicable legal framework (i.e. State-aid rules, BRRD and SRMR) has to be ensured regardless whether resolution, insolvency proceedings under national law or, in exceptional cases, precautionary recapitalisation is employed. If the AMC buys assets at a price exceeding the estimated market value (EMV), the transaction involves State aid, in the amount of the difference between the actual transfer price (TP) and the EMV. The transaction has then to be approved by Commission before it can be implemented. A first condition for authorising such aid is that the assets' TP cannot exceed their real economic value (REV). Losses resulting from the write-down of NPLs from their net book value to the transfer price cannot be covered by the impaired asset aid. The valuation of impaired assets should be conducted by independent experts and validated by the competent authority based on the valuation provisions in the Communication. Any impaired asset aid to a going-concern bank must comply with the general requirements applicable to restructuring aid. In particular, the following general requirements must be met before the aid is granted: ·restoring the bank's long-term viability; ·limiting State aid to the minimum necessary through burden-sharing and own contribution; ·limiting distortions of competition. Irrespective of whether extraordinary public financial support is granted to a bank in a context of precautionary recapitalisation, resolution or liquidation under national insolvency proceedings, these general principles of the EU's State aid framework continue to be fully applicable, alongside the applicable bank resolution framework provisions. Considering these general principles of the EU's State aid and the bank resolution framework, there are several scenarios of transfers of NPLs from a bank to a publicly-supported AMC, depending on the TP of the NPLs and the regulatory capital position of the bank. Each scenario implies different regulatory conditions and consequences and involves different relevant authorities: Scenario 1 - No State aid: When a publicly supported AMC buys NPLs from a bank at market value, it acts as a market economy operator and, thus, provides no economic advantage to the ailing bank. Hence, neither State aid nor extraordinary public financial support is granted to the bank, and the measure is not subject to the EU's State aid and bank resolution framework. Scenario 2 - Resolution: In the context of resolution of a bank, the use of the asset separation tool (AST) requires the creation of an AMC. The purpose of such AMC is to separate selected assets from a bank’s balance sheet. Scenario 3 - Insolvency proceedings under national law: NPLs are transferred in the context of insolvency proceedings under national law. In this case, the standard practice would be to split the failed bank and perform an asset separation so that the "good" part can be sold, provided that this is possible under the national insolvency framework. Centralising the management of impaired assets in an AMC may increase efficiency in the recovery of impaired assets sharing common characteristics. State-aid rules allow Member States to facilitate the liquidation of an ailing bank under ordinary insolvency proceedings through State measures. Such liquidation aid can be considered compatible with the internal market to facilitate the exit of non-viable players in an orderly manner without endangering financial stability. Scenario 4 - Precautionary recapitalisation: Precautionary recapitalisation is a form of State aid that can be given under exceptional circumstances, which, provided that the conditions set out in Art. 32(4)(d)(iii) of the BRRD are complied with, does not trigger a "failing or likely to fail" (FOLF) determination for the bank. This tool is usually not used to support the transfer of NPLs to a publicly supported AMC but targeted at providing an extra capital buffer to a bank that is likely to become distressed if economic conditions were to worsen materially. The conditions for its application are therefore more general in nature. Nonetheless, precautionary recapitalisation can also be used in the specific case of a transfer of impaired assets to a publicly supported AMC, provided that it is ensured that such transactions pursue the same objectives as capital injections and that the specific State aid conditions for impaired asset measures (IAMs) are also respected. Diagnostic exercise The general purpose of a diagnostic exercise is to help determine the scope of banks transferring NPLs to an AMC, the assets to be transferred, and the terms and conditions under the applicable EU legal frameworks under which a bank can transfer assets to an AMC. Authorities should also use the diagnostic exercise to demonstrate that AMCs have an advantage over other NPL reduction measures for the entire banking system. If a transfer of a bank's NPLs to an AMC is to be (partially) financed with a precautionary recapitalisation under the BRRD, that bank should first participate in a national or EU-wide asset quality review (AQR), stress testing or similar exercise. EBA guidelines provide further details on such exercise , which needs to have the following features:

-a precise timeline; -a predefined scope, including a sample of banks justified by economic or prudential reasons; -a common reference date (i.e. the "cut-off" date for the balance sheet data used for the AQR/stress test); -a common methodology, including a range of hurdle rates and a common macroeconomic scenario; -a quality assurance process, carried out by the relevant authorities. In the case of establishing an AMC supported by State aid , the purpose of the diagnostic exercise would be two-fold. First, it should help the authorities to determine an appropriate transfer price, which typically lies between the (estimated) market value (EMV) and the real economic value (REV) of the concerned assets. Second, it should also inform the calibration of the potential related capital needs of the banks transferring assets to the AMC and the maximum amount of State aid that can be granted. Therefore, and in order to achieve clarity on the health of bank balance sheets, the diagnostic exercise should consist of an AQR and a stress test. The AQR does not have to cover the entire balance sheet of the banks subject to the diagnostic exercise. Rather, to maximise efficiency of the exercise, it could target a well-identified part of assets that are likely to be separated and deconsolidated from the bank balance sheets through the transfer to an AMC. To do so, the type(s) of assets that constitute the main source(s) of a bank's vulnerability must be well-known and captured within the scope of the AQR. The entire asset perimeter should then be reviewed, to identify a potential misclassification of NPLs and remedy the related provisioning shortfalls. Ideally, this should be carried out at the level of individual debtors, in order to maximise the usefulness of the AQR results for the AMC. The AQR methodology should facilitate the Commission's estimation of the EMV and the REV of the concerned assets, so that the results can feed into the related valuation process. The result of the AQR should serve as the departure point for the macroeconomic scenarios employed in the stress test. The stress test exercise could be aligned with the well-established EU-wide or national stress testing exercises. However, the regular EU-wide stress test exercise is only performed periodically. Alternatively, and to address the potential need for methodological adjustment that would adapt the methodology better to the context of an AMC, authorities should consider running a parallel stress test review of credit risk and NPL valuations under adverse economic conditions. This review could use the adverse scenario of the EU-wide stress test, as long as it remains relevant, and the valuation models already established for the AQR. The diagnostic exercise should cover either the entire banking system of the Member State, or, where not practically possible due to the large number of banks, all banks above a predefined exposure to NPLs, expressed in absolute and relative terms. In case of a large number of smaller banks with a collectively significant NPL stock, the authorities should carry out the diagnostic exercise on a representative sample of loans, covering a critical mass of relevant NPL portfolios. Hence, the stress test exercise should in this case be a top-down exercise run by the authorities, taking into account resource constraints of these authorities, rather than applying a bottom-up approach, which is the case of the EU-wide stress testing exercises. The duration of this diagnostic exercise should be kept as short as possible. Nonetheless, based on past experience, the usual duration of an EU-wide stress test, from its launch to conclusion, stands at about 5 months. An AQR preceding the stress test will add at least two months to the process. Hence, a diagnostic exercise covering both an AQR and a stress test is likely to require 6 and 12 months to execute. Design and set-up of a centralised AMC The objectives, oversight, roles, functions and main design features of a centralised AMC must be based in legislation. To the extent that the AMC is set up in a resolution context, several elements in the existing framework on resolution (BRRD and SRMR) need to be complied with. If specific legislation is needed for the set-up of the AMC, it must take the specific AMC design into consideration and subsequently communicate this clearly. The AMC's mandate must be clear and unambiguous. Any secondary objectives should be avoided unless clearly subordinated to its primary objectives. Legislation should also contain strong oversight elements, which will ensure that the objectives of the AMC are disrupted and that the AMC’s operations are free of influence or lobbying. Following from design and financial stability considerations, legislation should ensure that the AMC is established as a one-off vehicle: the asset transfers should be completed in a single round, and there should be no further opportunities for asset transfers to the AMC thereafter, outside of exceptional circumstances. Without these provisions, risks to the objective of the AMC and to financial stability more broadly may emerge. Banks deemed by the diagnostic exercise to be in scope of transfer to the AMC may hence need to be obliged to transfer NPLs falling within the identified asset perimeter to the AMC. Obliging banks via national legislation to transfer NPLs to the AMC would encroach on their fundamental rights and would therefore need to be justified in the public interest (e.g. for financial stability purposes) and be proportional in nature. The AMC should be designed with the objective to maximise the recovery value of its assets. The AMC should therefore aim to cover its costs. If it would be able to make significant profits, this would imply that transfer prices of assets were too low, penalising banks and, potentially, having imposed costs on tax payers associated with bank recapitalisations. Equally, an entity set up to make losses is not credible, not least from a public finance perspective, which will demand that future loss expectations for the public sector, be minimised. The risk-taking of the AMC should be limited to the areas that are strictly related to the work-out of its assets. Furthermore, the AMC's legal toolkit must not be unduly restricted. In particular, it should be able to enforce collateral and take collateral on its own balance sheet, also with a view of developing its assets to maximise their value. The AMC should be free to liquidate assets that it had once considered viable, if that is justified by changed circumstances. The AMC should not be granted a banking license or an asset management license. Granting a banking licence would subject the AMC to bank regulation and supervision as well as stricter disclosure requirements, which may obstruct the discharge of its responsibilities. Regardless whether the AMC has public support or not, it should operate as an independent legal entity, and not as a governmental agency. It should have full budgetary independence and be protected from political interference. Managerial appointments at the AMC should be merit-based and stay outside of political control, as the AMC requires highly specialised expertise in order to fulfil its mandate. Being run as a private sector entity, the AMC can demonstrate its distance from governmental and political influence. Greater flexibility in staffing, etc., can also be attained in this way. Asset perimeter and size

The success of a centralised AMC critically hinges on its scope. A few principles are key for identifying, within a given market, the appropriate size and scope of such AMC: ·Economies of scale and scope: oAs the main holder of a specific set of impaired assets in a banking system, AMCs can achieve specific expertise and economies of scale in recovering value from specific assets. These, however, will be diminishing, as the number of assets and debtors increases. Historical experience also shows that significant economies of scope for various asset classes are rarely achievable for AMCs. oUnder the right circumstances, the centralised AMC could aim at taking over a large share of impaired assets of a certain asset class to achieve greater economies of scale. Financial constraints related to the size of the AMCs and/or the impact of the asset transfers on banks may justify choosing a narrower scope for the AMC. The AMC will nevertheless need to be sufficiently large to achieve the objectives of minimizing financial stability risks. ·Maintaining critical size: oEconomies of scale might diminish for an AMC beyond a certain size and complexity. This would suggest that the centralised AMCs should have a critical minimum size while not being too large relative to the market in which it operates. Furthermore, the transferred assets should not be overly diverse in their nature. The centralised AMC should assume assets for which it has a comparative advantage in working out. oThe wider the asset scope, the larger the AMC may become. Controlling the size and perimeter of the AMC will mitigate a range of serious consequences, e.g. for fiscal budgets, as well as funding and capitalisation challenges for the AMC. A larger or more complex entity that relies on government guarantees will also create a larger and/or riskier potential contingent liability to the Member State. Equally, an entity with a wider scope will be more difficult to manage and hence will have more difficulties realising efficient recovery values. Moreover the larger the vehicle, the more capital it will require at set-up, which may lead to issues, including from a public finance perspective. Collateral attached to the assets transferred to the AMC are important, as they can help increase the recovery value from NPLs over time. In a crisis the value of collateral is usually depressed, but it can recover with improving macroeconomic conditions. Without sufficient collateral, the AMC may achieve insufficient recoveries. Commercial real estate (CRE) assets offer relatively easier value recovery in this regard than residential real estate (RRE). This has an impact on the suitability of these assets for inclusion in AMCs. Realising collateral for RRE will be highly problematic due to legal, social and political realities. Therefore, the AMC should only in exceptional cases be considered as the instrument to do so. In principal, any type of loan can be transferred to an AMC. However, past experience suggests the following principles regarding asset transfer to the AMC: ·Loans secured by commercial real estate (CRE) can be transferred to the AMC - including those to small or medium-sized enterprises (SME), since they tend to have relatively large unit sizes, which allows the AMC to maintain a relatively light operation. Moreover, these assets have a strong connection with real assets (often property). ·Loans to large companies that are not secured by CRE can also be considered for transfer to the AMC since they exhibit some important suitable characteristics. The exposures are often relatively large and are therefore relatively cost-efficient to manage and service for the AMC. Corporate exposures will typically be large and complex. Their complexity will require a high degree of work-out intensity; but these inherent costs can be outweighed by the return on working out large exposures. ·Beyond these two primary categories, there is scope to consider other, residual, portfolios for transfer. Banks' own holdings of commercial or residential real estate have been successfully transferred to centralised AMCs in the past. In taking a debtor approach, the AMC should be willing to accept residual portfolios beyond the perimeter outlined above, to ensure that all of a given’s debtors loans are captured. In this context, the AMC may also consider acquiring portfolios of non-performing buy-to-let mortgages. Although in such cases, this should only take place where the legislation underpinning the AMC endows it with sufficient legal powers to effectively manage these loans. ·Exceptions to these principles could be considered in highly specific contexts. It may be the case that a Member State identifies highly specific cases where it is desirable to transfer other asset classes to the AMC, including, for example, residential real estate mortgages and SME loans. In general, these are unsuitable for AMC workout, but highly limited transfers could be considered in cases where, for example, the transfer would allow a bank to eliminate its exposure to a given business line or region, thereby aiding in its restructuring; where transfer would allow internal bank workout to be more concentrated on other exposures; or where other, highly evident synergies with the AMC could be identified. In order to reduce the risk that such exceptions are misused and threaten the viability of the AMC, strict criteria and limits must apply to such circumstances. In such cases, the value and the number of assets should not exceed 15% of total AMC assets. This exception may not be binding where the debtor-level approach leads to a higher proportion of other assets being transferred. The rationale for this limit is to prevent too many unsuitable assets being transferred to the AMC, rendering it unduly burdened. On the other hand, this 15% envelope allows a “debtor-level” approach, i.e. the complete transfer of a given debtor's exposures. In this case, however, a significant majority of the transferred assets must be CRE-related and/or corporate loans, and exceed the minimum size thresholds, while not excluding residual transfers of other asset class exposures of the debtor. Other asset classes, mainly unsecured retail loans, are more suitable for other types of impaired asset measures and should not be considered for transfer to the centralised AMC. The duration of these loans are often shorter, offering less time for the AMC to recover any sufficient value. Furthermore, they have the dual downside of potential political interference and very small individual loan sizes that lead to high complexity and costs related to servicing. A minimum size threshold for loans to be transferred to the AMC would usefully exclude small and granular exposures and retain only the more complex large-ticket exposures for the centralised AMC, for which the AMC has comparative advantages. These thresholds should be differentiated according to asset type, while taking into consideration the impact of the threshold on the total portion of assets affected. There should also be a minimum threshold at debtor level in order to avoid saddling the AMC with too many small debtors, which would strain its work-out capacity. The Blueprint proposes indicative levels of such thresholds in section 4.3: Asset valuation In the interest of sound management, it is crucial that transfer prices are set in a way that provides an optimal level of relief for the troubled bank while ensuring the AMC is able to recover in an adequate manner all costs implied by its operations. In a stressed environment, it is likely that market values of impaired assets are significantly depressed. If the AMC receives State aid, these considerations are especially important considering its potential impact on public finances. A transfer at market value would provide no capital relief to the troubled bank because it would crystallise high losses and erode its capital buffers, but could lead to the potential gains from the recovery of assets by the AMC later on. Instead, publicly-supported AMCs can intervene by purchasing troubled assets at a higher price than their market price (but not higher than the assets' real economic value (REV) and thus provide aid equalling the amount by which the transfer price exceeds the current market price. In this case, all future cash flows and costs generated by the management of the impaired assets should be taken into account in an adequate manner in the determination of the transfer price. Accounting aspects

In case the AMC is a non-listed limited liability company without a banking license, it has to prepare and publish financial statements in accordance with national Generally Accepted Accounting Principles [GAAP]. The national GAAP must be aligned with the EU accounting Directive. However, Member States have the option under the IAS Regulation to allow or require the use of EU-endorsed IFRS for companies or public interest entities (including banks). If the AMC issues shares or debt securities on an EU regulated market it must use IFRS for its consolidated accounts. So, the applicable accounting framework for the preparation of financial statements by the AMC is either EU endorsed IFRS or national GAAP. Within the limits outlined above, and depending on how Member States have exercised their options, the applicable accounting framework can be chosen when setting-up the AMC. When exercising that choice, the objective of the AMC should be considered, i.e. to recover the long-term economic value of the assets over the specified term and to foster financial stability. In particular, the choice of the accounting framework should take into account the risks related to the funding structure and the associated knock-on effects on the willingness of private investors to participate in the ownership structure. A higher relative use of fair value in the accounting framework could lead to more volatility of the P&L or capital than the use of historic cost combined with credit loss provisions. Even though there might be no legal requirement to prepare financial statements according to IFRS, AMCs may apply EU endorsed IFRS if Member States have allowed that for non-listed companies. The application of IFRS may increase transparency for the stakeholders involved in the AMC, being beneficial especially in the case where AMC bonds are placed with third-party investors without the protection of government guarantees. The current common use of IFRS in the financial sector in a Member State may be another argument for considering the use of IFRS. Data Transferring banks should be required to run rigorous internal controls and quality checks to ensure that data provided to the AMC are as complete, accurate, reliable, consistent and timely as possible. Banks should be required to use the EBA NPL data templates at an early stage and to comply with their validation rules before submitting data to the AMC. The AMC should perform a thorough data quality assurance before taking on new assets, based on the EBA data templates that banks should use prior to the transfer. Immediate necessary actions upon establishment of the AMC include data collection and clearing, categorisation and prioritisation of assets and the setting up of specialised work-out teams. Furthermore, data cleansing processes are very important for correct asset pricing and for the sale process. In addition, a regular (i.e. bi-annual) quality assurance process is deemed necessary in order to secure minimum acceptable standards of data quality and ensure data relevance. After transferring the assets, AMCs need to maintain their database up-to-date. When organising loan servicing, they need to ensure access to all necessary information to maintain the database up-to-date. In addition to loan data, also collateral related valuation data should be updated on an ongoing basis. If there are no liquid markets for loans or collateral values available, valuation updates need to be performed at least annually. This will enable AMCs to perform accurate and timely valuations. The AMC is expected to share its data with potential buyers / investors. For this purpose, it should use the relevant EBA NPL templates for portfolio screening to ensure consistency across market participants. A clear market standard based on the EBA NPL templates will help to widen the investor pool. Clear rules for data sharing must be in place. Data storage will have to be done in a way that at no point in time any confidential data can be accessed by third parties. Funding The AMC, if publically supported, would ideally acquire assets by issuing senior unsecured bonds to transferring banks. The senior bonds would carry a full and irrevocable guarantee of the national Treasury and would be eligible for use as collateral in Eurosystem credit operations by their holders. The bonds will be bullet securities with a call option available to the issuer. Market funding without a guarantee should be explored as part of the national AMC design process and, if feasible, may be preferred over the government-guaranteed funding. However, historical experience indicates that such market-based solutions prove difficult to implement and may require a significantly larger equity contribution. The senior bonds should be structured against the background of cash flow uncertainty and liquidity risk. The AMC is expected to improve cash flow generation over time, as its recoveries tend to come late in its life cycle. However, the maturity of the bonds may need to be shorter than the expected lifetime of the AMC, in order to minimise the total funding cost paid by the AMC. While the large majority of the funding should consist of senior guaranteed bonds, subordinated bonds could be issued and placed with participating banks or with equity providers. The latter is preferable as it would fully remove exposure to the transferred assets from the transferring banks as any remaining exposure means a continued dependence of the banks on NPL performance. The equity part should be sufficient to cover the expected Day 1 loss related to the initial recognition of assets at fair value and to provide a buffer that would allow the AMC to work out assets and carry out the necessary hedging strategy without being at risk of falling into negative equity. Part of that buffer could be structured as subordinated debt, for example calibrated to cover the unexpected loss on the assets. In the start-up period, the AMC may require a bridge loan to cover its initial outlays and working capital needs. This could be provided by participating banks against state guarantee, and repaid once the AMC generates income. The government guarantee would need to be remunerated in line with the EU State aid rules. Appropriate controls must be put in place to ensure that AMC redeems senior debt, rather than building cash reserves or diverting resources to other interests. To ensure that an AMC’s overarching goal – the timely wind down of its portfolio – is achieved and not diverted, strict guidelines should be laid down to ensure that an AMC reduces its outstanding liabilities at every reasonable opportunity. Impact on public finances and national accounts One of the key determinants of the fiscal impact of AMCs is their sector classification in national accounts. The choice is between S.12 (financial corporations) and S.13 (general government). AMCs would be classified as part of general government when they do not place themselves at risk and instead the government is carrying risks and rewards associated with asset management and the incurrence of liabilities by the AMC. The government puts itself in this position for public policy purposes, and direct or indirect financial support received by such AMCs implies a redistribution of income and wealth through their operations, which justifies their classification inside general government. If such risks and rewards are instead predominantly with the banking sector, the AMC would be classified in the financial corporations sector. If an AMC is classified inside general government, its operations will be relevant for the 'Maastricht deficit'. The largest impact on deficit usually relates to the set-up of the structure and/or the transfer of the assets, if the value of cash provided by the government or the liabilities assumed by the government exceeds the market or fair value of the assets. If the AMC is classified outside general government, government guarantees on the (realisation of the) assets could have an effect on public finances at inception. Government deficit and debt might also be affected in cases when an AMC is classified as a financial corporation, but some transactions and associated liabilities are considered as done or incurred on behalf of the government. Conversely, if the AMC is classified inside general government, the impact on debt is more straightforward, due to the gross nature of the 'Maastricht debt': any obligation of an AMC towards units outside general government (e.g. to originating banks) that has a nature of deposit, debt security or loan will add to the government's 'Maastricht debt'.

Units holding predominantly impaired assets (usually referred to as 'defeasance structures' in statistical methodology) show considerable heterogeneity as regards their legal and administrative features, forms of government support, size and origin/background. It is also clear that the national context and framework in which these entities are created differ considerably from one MS to another. It is therefore important that the statistical impact of each case is always separately analysed by the Commission (Eurostat). Safeguard mechanisms and supervision Safeguard mechanisms aim to protect the taxpayers against future liabilities created by an AMC. Historically such mechanisms have been more important in countries with weak legal and institutional environments, especially when the financial sector cannot thoroughly assess the performance of an AMC or weak governance is predominant. An AMC should consider implementing the following safeguard mechanisms: (1)Time limits: in order to ensure that the AMC acts expeditiously; (2)Financial: to avoid that an AMC becomes a fiscal burden; (3)Risk management: to ensure that prudent risk management practices; (4)Other safeguard mechanisms: to ensure best market practices are followed. There may be a trade-off between a fully-fledged implementation of safeguard mechanisms and the effectiveness of an AMC. Therefore, a thorough cost-benefit assessment should be performed before deciding on such safeguard mechanisms Supervision An AMC does not need to attract any deposits or issue new loans. Therefore, it does not require a banking license and thereby adhere to banking supervisory regulations. The AMC would hence be considered neither as a credit institution, nor as an investment firm. It would subsequently not be subject to CRR/CRD supervision. However, even without a banking license, the AMC will need proper oversight. The appropriate oversight institution would need to be identified by the government under whose jurisdiction the AMC would be set up. Entities which might be designated for this purpose (in the following: supervisor) are the Competent Authority for prudential supervision/resolution, the central bank, comptroller’s office / court of auditors or a joint oversight committee of these authorities. In addition, if public funding is at stake, an observer function for the European authorities could be considered. Effective operations in an AMC Organisation and staffing, internal controls and transparency An AMC should be able to hire and adjust staffing as needed during its lifetime. It should also be able to pay market price for specialised skills needed in the work-out process. Moreover, it should not aim to develop its own heavy servicing platforms, with a possible exception for single large, bespoke exposures. Rigorous, best-practice, internal controls must be in place to secure the financial soundness of the AMC and to maintain the entities credibility. These controls should cover all relevant aspects of the AMCs governance and operations. AMCs should have well-defined disclosure requirements and be, more broadly, transparent to the public. Transparency will be critical in the implementation phase, where it must be demonstrated that asset perimeters, participation perimeters and transfer pricing are rules-based and not subject to possible corruption or cronyism. Strategic planning, asset and financial management A general strategic plan should be designed for an AMC’s entire life. The three most important parts of a strategic plan are: ·Setting an objective with the consideration of the mandate; ·Selecting an approach for reaching the objectives and; ·Assessing performance and reviewing the whole process (strategic plan review).

The strategic plan should be set in multiple stages, preferably by defining the timespan of each stage. A clear performance measurement should be established, also in order to avoid the interference of external parties, especially as mechanisms against political interference. Performance could be measured by considering the speed of disposal and the profit/recovery percentage, while appropriately considering the operating environment and social benefits. For each stage, a milestone should be set, ideally in form of a threshold of disposed assets. The performance of the AMC should be assessed regularly in order to evaluate the adequacy of the strategic plan and effectiveness of its execution. Disposal strategies AMCs have a mix of disposal strategies available to them. The first step in defining the possible spectre of solutions is identifying the viability of the borrower (either going or gone concern). Depending on the nature of the assets managed, the urgency of cash generation, and their life span, AMCs can choose between five main disposal strategies: -Foreclosure and sale of collateral; -Insolvency proceeding and liquidation; -Sale of the loan; -Restructuring (traditional, debt-to equity swap); -Out-of-court arrangements (and quick recovery programmes). Interaction with transferring banks To address moral hazard, banks need to share the potential losses of an AMC (at least in part). This should be achieved through banks being obliged to hold shares in the AMC. There should however be no interaction or clawbacks after the transfer in order to ensure an effective risk transfer. Solutions that include clawbacks or requesting participating banks to provide collateral would create several problems and should be avoided. Most notably either the clawback is inefficient, meaning the public funds remain exposed to a failure of the transferring bank, or the very purpose of the transfer of NPLs into the AMC is defeated. The bank would then remain exposed to further losses on the AMC portfolio, and the NPL transfer would not definitively eliminate the risk from the bank’s balance sheet but merely shift it from the asset side to the liability side of the balance sheet. Furthermore, requesting banks to provide collateral against future losses would raise issues in the context of the valuation of these assets and the market volatility at which the bank would expose itself or the assets (if listed). Another key issue with clawback solutions is the governance and timing regarding the valuation decision (with clawbacks legal risks would be increased). Hence, it should be a direct transfer taking the bank out of the decisions / activities post-transfer. Lastly, if possible, originating banks should not be involved in the servicing of the loans beyond a certain interim period, as they are faced with an inherent conflict of interest, to the degree that they are holding similar assets themselves. Closing the AMC The lifespan of the AMC should be finite, and defined in its business plan. It should be realistic, but challenging, to reduce room for complacency and intransigence, and to maintain pressure on management to reduce assets. At the same time, an AMC should have some flexibility in its lifespan, to react to emerging developments, to allow it fulfil its primary mandate (maximisation of asset values) and based on the fundamental rationale of an AMC: to bridge intertemporal pricing gaps. Criteria for flexibly deviating from the planned lifespan should be set down out the outset of operations. Executive incentives should be provided to strengthen the determination of the AMC’s management to meet the deadlines, however, without creating an excessive pressure for asset resolution ahead of the target. A not-for-profit enterprise may aide in these incentives. The legislation should not provide any opportunities to refocus the AMC towards a different business model, to prolong its lifespan beyond what is strictly necessary to resolve the assets, or to reopen the AMC to later asset transfers. A pre-determined lifespan would need to be set at the outset, with a clear and measurable path towards wind-down, specified in the business plan, contingent upon reasonable assumptions about key parameters of baseline macroeconomic and asset recovery scenarios.



I.Introduction Historically, and especially in the wake of the financial crisis, asset management companies (AMCs) have been an important part of solutions to clean up banks’ balance sheets in some Member States. For instance, in the case of Ireland and Spain, NAMA and SAREB were policy choices in the face of acute financial sector distress and were partly carried out in the context of resolution. General lessons on how AMCs can be set up and how their operations can be run in an effective and efficient manner can be learned from such historical instances, while keeping in mind that they were set up before the introduction of the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRMR). The main aim of AMCs has been to remove troubled assets from banks' balance sheets and reduce related uncertainty premia, to accelerate the restructuring of banks with high levels of distressed assets and thereby stabilise the national banking sectors at large. AMCs have contributed to addressing financial stability concerns in countries with high levels of non-performing loans (NPLs) and to eliminating a significant impediment to the flow of new credit to the economy. Thanks to the fact that national banking sectors today are in far better condition (with decreasing yet still large NPL stocks), potential positive effects from a systemic NPL removal are likely to materialise in the area of credit extension rather than financial stability.

AMCs can also act as a catalyst to develop secondary markets for distressed debt. However, if poorly designed and/or managed, AMCs may also contribute to financial stability risks, including, in the case of publicly supported or guaranteed vehicles, potentially reinforcing the so-called sovereign feedback loop. It is important to recognise that such undesired and adverse consequences would bear the risk of undermining a fundamental principle of the BRRD and of the SRMR that is breaking the link between private losses and public finances. Overall, past experience has demonstrated that AMCs attain their objectives only when they are part of a wider and comprehensive strategy. Hence, AMCs should not and cannot be considered as a panacea. More specifically, AMCs can offer a variety of potential benefits to the financial system. They procure expertise, can benefit from economies of scale, creditor coordination and they provide relief to affected banks that are struggling to manage their NPLs and aid them to re-focus on lending to viable firms and households. They also help to bridge the intertemporal valuation gap which is necessary to adopt structural reforms that take hold and hence improve the price of NPLs in secondary markets. However, there are also limitations and costs associated with setting up AMCs. For instance, the transfer of loans to AMCs can involve a loss of information on the debtor, which can hinder restructuring and delay recoveries. In addition, protracted discussions on the potential set-up of an AMC could discourage the banks to take swift and necessary actions themselves. Furthermore, other issues that should be kept in mind and carefully considered include: set-up costs, the potential need for new capital to be raised by transferring banks, the capital requirements for the AMC itself, etc. The objective of this blueprint is to provide practical guidelines for the design and set-up of AMCs at a national level, building upon best practices from past experiences. AMCs can be private or (partly) publicly funded with no need of State aid if the State can be considered to act in a similar way as a market economy operator would. The option of an AMC involving State aid should not be seen as the default solution since AMCs can take multiple forms and can be structured and financed in several ways. Considering the setting up of state-supported AMCs with a State aid element as an exceptional solution, this blueprint clarifies key success factors and the permissible design for such state-sponsored AMCs, consistent with the EU legislative framework, particularly the BRRD and SRMR, which are fully in force and aim at limiting government interventions, and State aid rules. The context in which impaired asset problems emerge can vary significantly. Impaired assets can be the result of a specific macro-financial stress concerning a limited number of asset types (e.g. real estate bubble driven by excessive lending growth), or gradually build up during generalised long and/or deep recessions undermining the capacity to repay of a wide span of borrowers and thereby affecting the quality of a broad range of assets. Impaired assets can also result from deficiencies in loan origination practices or risk management. The presence of substantial stocks of impaired assets on banks' balance sheets can raise uncertainty regarding their valuation, which could undermine confidence in the concerned banks, threaten financial stability and hamper bank lending to the real economy. In such circumstances, reducing the NPL stock in the banking system becomes a public policy objective to put distressed banks once again on a stronger and healthier footing. As recent history shows, for the banks that fail to restore their financial health through market mechanisms, the public policy response can be translated into a wide variety of impaired asset measures, which themselves need to be embedded in a broad and comprehensive strategy (see section 2.2 for more details). A Member State's choice of the most effective impaired asset measure depends on its specific situation and primarily hinges on the pervasiveness of the problem within the domestic banking sector, the asset classes that are concerned, and banks' own capacity to manage and work out NPLs. A centralised AMC, which is the focus of the present blueprint, is a very effective measure in specific circumstances, namely when impaired assets affect a large part of the domestic banking system and mainly cover loans secured by commercial real estate and large corporate exposures (section 4.3). These asset classes AMCs enjoy a comparative advantage in working out impaired loans. If these circumstances are not present (for instance when the banking system's impaired assets are very heterogeneous), alternative impaired asset measures may be more appropriate and have been implemented with success in recent years by various Member States. Alternative impaired asset measures may include, among others, bank-driven initiatives, securitisation-based approaches, guarantees or asset protection schemes as well as ad-hoc AMCs common to one or a limited number of banks. Furthermore, various types of interventions can complement each other, thereby allowing for tailored approaches to the specific impaired asset situation, which a Member State is confronted with. Figure 1: Example decision tree for authorities in the face of a NPL crisis Source: Commission Services (DG COMP) The Blueprint has been developed by the Commission in close cooperation with all relevant institutions, i.e. the ECB/SSM, EBA and SRB. It puts forward a number of common principles, such as the relevant asset perimeter, the participation perimeter, considerations regarding the asset-size threshold, asset valuation rules, the appropriate capital structure, and the governance and operations of the AMC. II.Preconditions for centralised AMCs 2.1.Maximising the benefits and efficiency of AMCs There are a number of conditions that, if fulfilled, can maximise the usefulness and the efficiency of AMCs. AMCs are most useful when banks due to internal or external constraints lack the capacity to deal with impaired assets on their own. An AMC has the potential to pool exposures from distressed debtors and therefore make management more effective and efficient. It could also centralize scarce human resources and expertise and can therefore often handle and work out NPLs better than embattled banks that may suffer from weak management and poor credit policies. This should not prevent banks that are failing or likely to fail (FOLF) from being liquidated or resolved under the BRRD, which provides for an efficient framework enabling market exit of troubled banks while minimising costs to the taxpayer and negative repercussions to the economy. A careful design of the AMC and of its mandate is crucial to ensure its success. The choice of one centralised AMC vs. numerous decentralised AMCs in a Member State, with a wide vs. narrow mandate, is closely linked to the number of banks with high NPL ratios and the composition of the NPLs in the system, the capacity to achieve economies of scale and the possibility to restructure distressed borrowers back to viability. Other fundamental choices regarding the transfer price and the AMC's funding and ownership also play a critical role in its future success and need to be carefully reflected upon. Under a decentralized approach, NPLs are left with the individual bank to deal with, whereas the centralized approach sees NPLs transferred to a centrally managed AMC. Each choice has its distinct advantages and disadvantages, with several trade-offs to be carefully considered. For instance, having one very large, centralised AMC may obtain economies of scale but could also become unwieldy. This could potentially hinder the ability to react swiftly, e.g. in sales transactions. Conversely, the decentralised AMC allows for a more customised approach. This would be more appropriate when the NPLs are not systemic but rather isolated and bank-specific, and when the causes are not markedly shared by other banks in the system. The decision regarding the mandate of the AMC, be it either wide or narrow, depends on: (1) the size of the NPL problem in a given Member State; and (2) the state of the market. Especially when the amount of NPLs in the system is large and the market for loans is distressed, fire sales should be avoided. In such a case, the AMC should be endowed with a wide mandate, enabling the AMC to collect, restructure and dispose of participating banks' impaired assets over the long term, hence restoring viability of these banks (e.g. SAREB, NAMA). Conversely, a narrow mandate is more appropriate when the amount of NPLs in the financial system is more limited, and when banks can be resolved and assets liquidated, taking away the need for a wide mandate (e.g. UKAR, Finansiel Stabilitet). In a centralised AMC, management practices and expertise may be weaker than in private structures, and conflicts of interest and political pressure can be more frequent, reducing the efficiency and effectiveness of its operations. To mitigate these risks, sound governance is absolutely necessary: managers and administrators must fulfil strictly defined fit-and-proper requirements, conflicts of interest should be closely monitored and independence from political bodies must be ensured. Managers' remuneration (including all kinds of advantages) need to be transparent and well-defined. Ideally, they should be performance based. Strong political will and a supportive legal framework are also instrumental in the success of an AMC. The design of the AMC and the transfer of impaired assets must strictly abide by EU regulation, in particular the bank resolution framework (BRRD/SRMR) and State aid rules. Finally, transferring assets is costly and harms business continuity. Good documentation of loans and collaterals as well as active collaboration of the staff handling the impaired assets in the banks can greatly facilitate the transfer and reduce the costs. Therefore, the transactions should be structured in such a way so as to keep the transferring bank's incentives aligned with maximising recovery values.

2.2.Commitment to comprehensive macro and structural reforms, as well as banking sector reforms A vital prerequisite for the success of an AMC is its alignment with relevant structural reforms. This is because the investors' pricing of the assets includes risk premia linked to enforcement prospects, which can be addressed by policymakers. European AMCs were often created within comprehensive macro-financial recovery programmes that included a set of structural reforms with a view to address weaknesses that were brought to the surface in the course of the crisis. In this regard, insolvency, bankruptcy and foreclosure laws need to be robust in order to ensure that the AMC as well as prospective asset buyers can access insolvent debtors’ collateral under fair terms and within a reasonable timeframe. Moreover, a variety of restructuring models should be readily available for cases where further active engagement with the debtor would ultimately increase the asset value more than a collateral sale. This is especially important in the context of safeguarding viable but indebted businesses. Experience shows that the success of an adjustment programme – and hence also the price recovery of the distressed financial assets – can rarely be expected unless investors are sufficiently convinced by the authorities' ability to adopt and implement appropriate measures. In the context of the use of an AMC there might be a need for important changes in the banking sector regarding many dimensions, such as banks' loan origination practices, monitoring, cost efficiency, disclosure and internal governance. In this respect, different types of banking sector reform initiatives that should be undertaken include: ·preventive measures addressing the emergence of NPLs, most notably sound underwriting practices; ·measures addressing the piling up of already existing NPLs, most notably sound NPL management frameworks, as addressed by ECB’s NPL guidance, and timely provisioning/ write-off practices; ·high degree of transparency and NPL data availability to support other NPL workout measures and to enhance market confidence more generally. Finally, it is important that banks have adequate credit risk management practices in place. NPLs may be a by-product to bank lending and cannot be fully avoided. Nevertheless, one of the most important lessons learnt from past crises is the need for banks to implement sound underwriting standards and practices. Some banks' lending and monitoring practices and strategies before the financial crisis were one of the key drivers of the ex-ante build-up of the high stock of NPLs in a number of Member States. National Authorities will therefore need to make sure that loan origination standards are set to prevent the build-up of high levels of new NPLs in the future. 2.3.Considerations of financial stability and public funds at risk The case for any AMC rests on the ability of the AMC to achieve higher recovery rates over its lifetime than the participating banks would do on their own and on remedying a significant threat to financial stability. The former justification informs the choice of the eligible assets to be transferred to the AMC and the participation perimeter. The latter, however, goes beyond operational and managerial considerations. Traditionally, centralised AMCs have been a part of a comprehensive policy response to an acute solvency and liquidity distress affecting entire national banking sectors. That context, arguably, is less relevant currently. The design of the AMC should follow the identified best practices, as set out throughout this Blueprint. Otherwise, the AMC may have a negative impact on financial stability and public finances. As an example of pitfalls, an undercapitalised AMC may have an incentive to extend short-term forbearance to non-viable debtors, which in the longer run would be destructive to sound borrowers and may also lead to losses within the AMC itself. In the worst case, a loss-making AMC may have to be liquidated under the relevant corporate law, which would trigger the fire sale that the AMC is precisely intended to avoid. Similarly, the size of any asset removal scheme, including an AMC, and its riskiness will need to be limited for several reasons. In the case of a publicly supported AMC, compliance with the current legal framework (i.e. the BRRD and the SRMR) has to be ensured. In particular, capital shortfalls that may arise in banks whose assets have been transferred to an AMC as a result of this transfer at a price not exceeding the assets' real economic value (REV), i.e. in most cases below the current carrying value, will qualify as extraordinary public financial support and, will in principle, trigger the determination that the bank is FOLF. Furthermore, the scale of a publicly supported AMC must be limited to mitigate liabilities of the State. From a public finance perspective, if the AMC was to be state-controlled and classified in the general government sector, the capacity of the state to absorb the increase in public debt would have to be assessed, along with the need to provide adequate capital for the vehicle to operate. In addition, second-round effects may need to be considered, including the potential for later recapitalisation needs for the AMC or even the banking sector in adverse conditions, although appropriate design and implementation principles should help mitigate this risk. The impact of contingent liabilities not just on public finances, but also on perceptions of sovereign creditworthiness should also be assessed, in light of the potential for negative sovereign-bank feedback loops to emerge. A majority or fully privately-controlled AMC may be classified outside the government sector, and would therefore not result in an increase in government debt, provided that a number of conditions are met. A privately-controlled AMC may limit the upfront costs of the AMC to the state, particularly when combined with an appropriate funding scheme. However, a number of challenges arise in achieving such status, stemming from the size of the entity. The vehicle will have to be adequately capitalised in order to ensure that any losses incurred by the AMC will not ultimately have to be borne by the state. When public funding or guarantees are involved, the ESA 2010 provisions need to be borne in mind. Finally, while a privately-controlled AMC may have desirable features, insofar as its liabilities are guaranteed, a publicly supported AMC may remain a contingent liability of the state and adverse developments could under certain circumstances have an impact on its status. This again raises the discussion on size, as a very large entity relative to the state may pose risks, perceived or otherwise. III.Conditions for asset transfer to AMCs 3.1.Consistency with EU legal framework (bank resolution and State aid) Applicable regulatory frameworks AMCs need to be fully compliant with the existing EU legal framework. Practically this entails that, in the case the AMC receives public support, compliance with State-aid rules, the BRRD and the SRMR has to be ensured. A transfer of NPLs by a bank to a publicly-supported AMC is, as noted above, subject to two EU regulatory frameworks: ·the bank resolution framework, consisting of the BRRD and the SRMR. ·the State aid framework, under which at present aid to banks can be considered compatible with the internal market , if the aid complies with the provisions of a number of successively developed Crisis Communications. General principles of the bank resolution framework Under the EU's bank resolution framework, a bank requiring extraordinary public financial support – for instance to address a regulatory capital shortfall – may be declared "failing or likely to fail" (FOLF) by the competent or resolution authority. This triggers either the bank's resolution (if considered in the public interest by the resolution authority) or, alternatively, its liquidation under national ordinary insolvency proceedings. Where impaired asset aid granted in the context of a transfer of NPLs from a bank to a publicly-supported AMC qualifies as extraordinary public financial support , a bank benefitting from such an IAM should thus in principle be resolved or liquidated.

However, the bank resolution framework provides for an exception to this general principle which is relevant in context of NPL transfers to a publicly-supported AMC, namely when extraordinary public financial support is needed inter alia "to remedy a serious disturbance in the economy of a Member State and to preserve financial stability", whereby the support takes the form of "an injection of own funds or purchase of capital instruments" and a number of further specific conditions (further discussed below) are met. If all conditions for a "precautionary recapitalisation" are met, a bank will not be considered FOLF. Neither resolution nor liquidation under national ordinary insolvency proceedings is thus triggered. Irrespective of whether extraordinary public financial support is granted to a bank in a context of precautionary recapitalisation, resolution or liquidation under national insolvency proceedings, the general principles of the EU's State aid framework, as outlined above, continue to be fully applicable, alongside the applicable bank resolution framework provisions. General principles of the State aid framework Under the EU Treaty on the Functioning of the EU (TFEU), State aid can be granted only after it has been authorised by the Commission. The first question when confronted with a transfer of impaired assets to a publicly-supported AMC is therefore to verify whether it contains State aid or not. If the impaired assets are bought by the publicly-supported AMC at the assets' market price – i.e. the price which private investors would pay at the same moment for the same assets – the transaction (impaired asset measure or IAM) does not involve State aid, and State aid rules are hence not applicable. As often the assets at stake are not traded and their price can therefore not be directly observed, the market price has to be estimated based on observable transactions for similar types of assets, yielding the Estimated Market Value (EMV). If the assets are bought by the AMC at a price exceeding the EMV, then the transaction involves State aid, which amounts to the difference between the actual transfer price (TP) and the EMV. The transaction has then to be approved by Commission before it can be implemented. A first condition for authorising such aid, which is laid down in the Impaired Asset Communication of 2009, is that the assets' TP cannot exceed the said NPLs' REV . Losses resulting from the write-down of NPLs from their net book value (NBV) (in the books of the transferring bank) up to the TP are to be borne by the bank (i.e. by private means) and are not covered by the impaired asset aid. The valuation of impaired assets should be conducted by independent experts and validated by the competent authority based on the valuation provisions in the Communication. Figure 2: Calculation of impaired asset aid under EU State aid rules Second, any impaired asset aid to a going-concern bank must comply with the general requirements applicable to restructuring aid, laid down in the Commission's Banking Communication of 2013 and the Restructuring Communication of 2009. In particular, the following general requirements must be met, and this before the aid is granted: ·Restoration of the bank's long-term viability: The Member State and the bank have to submit and implement a restructuring plan that demonstrates how the beneficiary bank's long-term viability will be restored and how the IAM in question is both necessary and sufficient to achieve this goal. ·Limiting State aid to the minimum necessary through burden-sharing and own contribution: First, the bank must try to finance the restructuring costs with its own resources as much as possible. Therefore, the bank's restructuring plan should contain cost-cutting measures and propose the sale of non-core activities. In addition, the aid can only be authorised if shareholders and junior debtholders have contributed to the bank's losses first. In practice, this means that shareholders are written down or diluted while junior debtholders are converted (to equity) and/or written down. ·Limiting distortions of competition: Measures must be taken to mitigate competition distortions arising as a result of the IAM. The nature and form of such measures is dependent on the aid amount, the circumstances under which the aid was granted and the characteristics of the market(s) where the beneficiary bank operates. The measures typically include structural measures, behavioural measures and market-opening measures. Possible scenarios Considering both the general principles of the EU's State aid and bank resolution framework, a number of scenarios in which a bank transfers NPLs to a publicly-supported AMC can be conceived in function of the TP of the NPLs and the regulatory capital position of the bank. Each scenario implies different regulatory conditions and consequences and involves different relevant authorities. Figure 3: Regulatory scenarios for NPL transfers to a State-owned AMC Scenario 1: No State aid When a publicly-supported AMC buys NPLs from a bank at market value, it acts as a market economy operator, thus providing no economic advantage to the ailing bank. Hence, neither State aid nor extraordinary public financial support is granted to the bank, and the measure is consequently not subject to the EU's State aid and bank resolution framework. Scenario 2: Resolution

In the context of resolution of a bank, including State aid or Fund aid, the use of the asset separation tool (AST) requires the creation of an AMC. The purpose of such AMC is to separate selected assets from a bank’s balance sheet. The AST constitutes one of the four resolution tools conferred to resolution authorities under the new EU resolution framework, the others being the sale of business tool, the bridge bank tool and the bail-in tool. It should be noted that the AST may be applied only in combination with another resolution tool to prevent the creation of an undue competitive advantage for the failing entity. Preconditions In order to transfer assets, rights and liabilities to an AMC one of the following conditions must be satisfied: ·the situation of the particular market for those assets is of such a nature that their liquidation under normal insolvency proceedings could have an adverse effect on one or more financial markets; ·the transfer is necessary to ensure the proper functioning of the entity under resolution or of a bridge institution; or ·the transfer is necessary to maximise liquidation proceeds. Concerning the first condition, the relevant EBA Guidelines apply. As such, resolution authorities would need to assess the situation of the market for these assets, and the impact of a disposal of these assets on the markets where they are traded and on financial stability. Characteristics and requirements The AMC set up by the resolution authority will need to meet the following requirements: ·The AMC will have to be created in accordance with the applicable national law. ·The AMC is wholly or partially owned by one or more public authorities, which may include the resolution authority. ·The AMC is controlled by the resolution authority (in particular the resolution authority approves the strategy and risk profile of the AMC and approves the remuneration of the members of the management body and determines their responsibilities). ·The AMC has been created for the purpose of receiving some or all of the assets, rights and liabilities of one or more institutions under resolution or bridge institution. ·The AMC’s existence is not required to be restricted in time. ·The rights, assets and liabilities may be transferred on one or several occasions. ·The rights, assets and liabilities may be re-transferred from the AMC to the entity under resolution under certain conditions. Valuations and transfer of assets, rights and liabilities To inform and carry out the resolution action, the valuation of all assets, rights and liabilities will be performed, in principle, by an independent third party appointed by the resolution authority. This valuation will determine the disposal value of the transferred assets, rights and liabilities. This valuation will then inform the decision of the resolution authority on the value of any consideration to be paid to the institution under resolution. All losses in relation to the transfer will, in principle, be borne by the resolved bank’s existing shareholders and creditors. Aid provided through the resolution fund

The AMC created under the AST will likely incur significant costs (e.g. establishment costs or ongoing operational costs). In addition, an adequate level of capitalisation and liquidity must be ensured. The Single Resolution Fund (SRF) and the resolution financing arrangements in non-participating Member States may be used under certain circumstances to ensure the efficient application of resolution tools and the exercise of the resolution powers. Any use of the SRF is subject to the Union State aid rules and requires authorisation from the European Commission. Support by the SRF requires a minimum contribution to loss absorption and recapitalisation of 8% of total liabilities including own funds by shareholders and creditors of the entity in resolution (bail-in), if losses are indirectly passed on to the SRF. In that case, the upper ceiling for contributions by the SRF is capped at 5% of the total liabilities including own funds of the entity under resolution. Alternative funding sources may be activated in extraordinary circumstances and only in the event that the 5% limit has been exhausted and after a full bail-in has been implemented. Scenario 3: Insolvency proceedings under national law Where resolution under the BRRD/SRMR is not considered to be in the public interest NPLs can be transferred, in combination with State aid, within the context of insolvency proceedings under national law. In this case, the standard practice would be to split the failed bank and perform an asset separation so that the "good" part can be sold, provided that this is possible under the national insolvency framework. Regarding the impaired assets, centralizing their management by means of an AMC may help to reap the efficiency benefits of AMCs in the recovery of impaired assets sharing common characteristics. The Commission's Banking Communication of 2013 allows Member States to facilitate the liquidation of an ailing bank under ordinary insolvency proceedings through State measures. The latter may involve the mobilisation of public resources through the national deposit guarantee scheme (DGS) or other resources imputable to the State to set up an AMC to which the impaired assets are transferred. Such liquidation aid can be considered compatible with the internal market to facilitate the exit of non-viable players in an orderly manner without endangering financial stability. Notwithstanding the latter objective, the overarching principle of limiting the amount of aid should remain a key priority. In that sense, Member States could favour a pure exit of non-viable banks rather than their (partial) sale to competitors, which is subject to additional State aid requirements. State aid in the form of an asset transfer to an AMC in the context of ordinary insolvency proceedings, irrespective of whether it is provided through the national DGS or other resources imputable to the State, must still comply with the general principles of the State aid framework, set out above. Specifically for aid in the context of the orderly winding down of an ailing bank, the 2013 Banking Communication states that its compatibility will be assessed on the same lines mutatis mutandis as set out in sections 2, 3 and 4 of the Restructuring Communication (2009). Aid measures in this context must therefore comply with the above-mentioned general principles of the State aid framework, further tailored to a bank liquidation context: ·Limitation of liquidation costs: The aid should enable the ailing bank to be effectively wound up in an orderly fashion, while limiting its amount to the minimum necessary. ·Limitation of competition distortions: To avoid undue distortions of competition, the winding-up phase should be limited in time while the beneficiary ailing bank must neither actively compete on the market nor pursue any new activities as long as it continues to operate. ·Burden sharing: To minimize moral hazard and to ensure appropriate own contribution to the costs of winding down by the aid beneficiary, the claims of the shareholders and subordinated debtholders must not be transferred to any continuing economic activity. In addition to the criteria mentioned above, the compatibility of a transfer of impaired assets from an ailing bank to a publicly-supported AMC is also to be assessed under the Commission's Impaired Assets Communication of 2009. It is crucial to note however that the complete liquidation of the institution under ordinary insolvency proceedings does not require the transfer price of the NPLs to be below the loans' REV, as the residual entity will be facing constraints which limit distortions of competition and will totally exit from the market. Finally, an IAM during an orderly liquidation procedure can be part of a wider State measure that also includes the sale of (part of) the ailing bank. The latter may entail State aid to the buyer, unless the sale is organized via an open and unconditional competitive tender and the assets are sold to the highest bidder. The compatibility of the sale would also imply a verification that the sale can contribute to the restoration to long-term viability of the transferred economic activity. The buyer would need to be viable and capable of absorbing the transfer of the troubled bank. Scenario 4: Precautionary recapitalisation Precautionary recapitalisation is a form of State aid that can be given under exceptional circumstances, which – provided that the conditions set out in Art. 32(4)(d)(iii) of the BRRD are complied with – does not trigger a "failing or likely to fail" (FOLF) determination for the bank. This tool is usually used for providing an extra capital buffer to a bank which is likely to become distressed if economic conditions were to worsen materially. Nonetheless, precautionary recapitalisation can also be used in the specific case of a transfer of impaired assets to a publicly supported AMC, where the objectives pursued by such a transfer are the same as in case of a direct capital injection; and provided that the specific State aid conditions for impaired asset measures (IAMs) are also respected. The general conditions for the use of the precautionary recapitalisation tool and the concrete steps for its practical application are presented below. A.General principles established in the BRRD and requirements in the State aid guidelines Objectives of the aid The precautionary recapitalisation is required "to remedy a serious disturbance in the economy of a Member State and preserve financial stability". In addition, the aid "shall be proportionate to remedy the consequences of the serious disturbance". Form and temporary nature of the aid Article 32(4) BRRD aims to ensure that in the presence of an unlikely loss a solvent bank is provided with temporary support to ensure it can preserve its capital position.

Article 32(4)(d)(iii) of the BRRD indicates that precautionary recapitalisation takes the form of "an injection of own funds or purchase of capital instruments". The notion of "own funds" refers to all CET1, AT1 and T2 capital instruments, as identified in the Capital Requirements Regulation (CRR). The aid "shall be of a precautionary and temporary nature". Also, Article 32 BRRD requires that the measure must be "proportionate to remedy the consequences of the serious disturbance". Subject to a case-by-case assessment, precautionary recapitalisation may be used to enable a removal of impaired assets from the beneficiary bank's balance sheet. Such a transaction, if properly structured, may achieve exactly the same recapitalisation objective for the beneficiary bank as a straight-forward injection of own funds or purchase of capital instruments. In case of a direct injection of own funds, the assets are sold at market price and the State contributes with capital (or other forms of own funds/capital instruments) to ensure that the bank maintains its capital position following the loss from the sale of the assets. In case of an impaired asset relief measure, the bank is allowed to sell the NPLs at a price higher than market price (but not exceeding the assets' real economic value (REV)). Therefore the capital position of the bank is preserved by reducing the upfront loss. For the transfer of impaired assets to a publicly supported AMC to be proportionate and of a temporary nature, as required by the second subparagraph of Article 32(4) BRRD, the extraordinary public financial support must be limited in terms of amount and time. To this effect, certain safeguards, in order to ensure compliance with the above-mentioned legal requirements, can be considered such as: -a conservative assessment of the assets' estimated market value and real economic value to ensure that unlikely losses are correctly identified; -the AMC liability side which is structured in a manner that reduces the overall risk for the State (e.g. a preference for guarantees over direct financing to the AMC, attracting private capital and funding to the maximum extent possible); -a clear exit strategy for the State from the extraordinary public financial support; -where appropriate, in particular where the estimated market price cannot sufficiently reflect the risk of a [further] deterioration of the market situation, a mechanism ensuring that the State will not bear losses higher than the difference between the transfer price and the market value. In the case of using an IAM, the exit strategy should be foreseen to make the State's intervention (through the publicly supported AMC) temporary. This strategy may consist of different elements: -Prior to its set-up, the AMC's lifespan should be clearly limited in time. The lifespan should also be proportionate to its objective of working out / selling the purchased impaired assets. -Furthermore, assets that the AMC would acquire will in general have a fixed duration (i.e. a set maturity date) and are thus not perpetual in nature. When the AMC is backed by public guarantees, this support should also be available only for a certain period of time. Remuneration clauses featuring a step-up fee on these guarantees could be added to incentivise the AMC to end its reliance on State support as soon as possible, hence further limiting the State's involvement. Financial health of the beneficiary bank The beneficiary bank must be solvent. The assessment of a bank's solvency pursuant to the BRRD/SRMR is the responsibility of the competent supervisory authority. In past cases, the ECB has determined a bank as solvent based on the fact that it meets the own funds requirements (Pillar 1) set out in Art. 92 of the Capital Requirements Regulation (CRR). In the context of a stress test and/or AQR, this implies that the bank should not have any shortfall of regulatory capital following the AQR and under the baseline scenario of the stress test (or the relevant shortfalls are covered by private means). As follow-up of the lessons learned from crisis cases, the ECB is currently reviewing its methodology for the assessment of a bank’s solvency in the context of precautionary recapitalisation. Furthermore, the beneficiary bank must not be deemed FOLF based on the criteria set out in Art. 32(4)(a/b/c) of the BRRD. This implies respectively that (i) the bank does not (and is not expected in the near future to) infringe its authorisation requirements in a way that would justify the withdrawal of its license, (ii) which also entails that the bank's assets are not (and are not expected to be in the near future) less than its liabilities, and (iii) that the bank is (and is expected to be in the near future) able to pay its debts or other liabilities as they fall due. The assessment of these FOLF criteria is the responsibility of the competent supervisory authority and, under certain conditions, the resolution authority. Compliance with EU State aid framework A precautionary recapitalisation is required to respect the general principles of the EU State aid framework. More specifically, the BRRD requires it to "be conditional on final approval under the Union State aid framework", in particular the Commission's Banking Communication (2013) and Restructuring Communication (2009), and that it is granted "at prices and on terms that do not confer an advantage upon the institution". Moreover, in the specific case where this tool is used to enable a transfer of NPLs to a publicly-supported AMC, compliance with the specific conditions provided for in the Commission's Impaired Asset Communication (2009) is also required. This implies that impaired assets can be purchased by the AMC at a transfer price (TP) that exceeds the estimated market price (EMV) of the assets but which does not exceed their real economic value (REV). In other words, if a State-controlled AMC buys the impaired assets at market value, there would be no State aid in the IAM. In such cases, the public intervention (i.e. IAM) would not qualify as extraordinary public financial support and therefore, the measure would not trigger FOLF-status for the entity and the assessment of the conditions for precautionary recapitalization would not be relevant. In operational terms, as explained in more detail below, a precautionary recapitalisation budget must be determined to identify the total maximum aid that can be granted. The budget is quantified on the basis of the capital shortfall which emerged from the stress test. The precautionary recapitalisation budget can be used for any combination of recapitalisation aid (injected into the bank to recapitalise it) and impaired asset aid (as a contribution to a higher price at which the bank transfers impaired assets to the AMC to help the bank avoid bearing the full extent of losses that would stem from the sale of the impaired assets in the market). The sum of the recapitalisation aid and the impaired asset aid cannot exceed the precautionary recapitalisation budget. B.Precautionary recapitalisation budget in the presence of a transfer of NPLs to a publicly-supported AMC: practical application

Step 1: Separating incurred, likely and unlikely losses and determining the precautionary recapitalisation budget The precautionary recapitalisation budget must be set in accordance with Art. 32(4)(d)(iii) of the BRRD, which requires it to be "limited to injections necessary to address capital shortfall established in the national, Union or SSM-wide stress tests, asset quality reviews or equivalent exercises by the European Central Bank, EBA or national authorities". These exercises should comply with the applicable EBA guidelines. Furthermore, a precautionary recapitalisation "shall not be used to offset losses that the institution has incurred or is likely to incur in the near future". In the context of a stress test and/or AQR, this implies that the bank should not have any shortfall of regulatory capital following the AQR and under the baseline scenario of the stress test (or the relevant shortfalls are covered by private means). In order to comply with the latter requirement, a methodology is needed to make a distinction between incurred, likely and unlikely losses. Ideally, such a methodology should be developed along the lines of the following practice. An asset quality review (AQR) conducted would identify incurred losses that cannot be covered by the precautionary recapitalisation. The baseline scenario of a stress test carried out following the AQR would identify likely losses which also cannot be covered by the precautionary recapitalisation. Only the losses emerging from the adverse scenario of a stress test conducted together with an AQR (cleared from overlaps, if any, with those of the baseline scenario) could in principle be eligible to be covered by the precautionary recapitalisation as they correspond to unlikely losses. A stress test and an AQR should be carried out as early as possible to ensure that data used to alculate the precautionary budget is up to date. If the most recent available stress test is deemed partially outdated by the competent authority, the application of the procedure described above becomes more complicated. In this case, other specific ad-hoc solutions might need to be applied. For instance, losses booked in published accounts after the date of the stress test could constitute the basis for estimating incurred losses, and losses due in the near term on the basis of a prudent valuation of assets could give indications on likely losses which may be used to complement and refine the information contained in the stress test. Figure 4: Determination of the precautionary recapitalisation budget As for likely losses, while these may include losses necessary to comply with the requests of the supervisor, they should not include losses stemming from competition measures necessary to authorize the State aid. Likely losses might therefore include, for instance, losses determined by the sale of impaired assets as requested by the supervisor, but should not encompass losses necessary to deleverage the bank's balance sheet (to avoid distortions of competition) which are a necessary condition to receive State aid. Step 2: Covering incurred and likely losses with private means As the precautionary recapitalisation can only cover unlikely losses, any losses stemming from the baseline scenario of the stress test and from the AQR (respectively considered likely losses and incurred losses) must be covered with private means. Items that are certainly to be counted as private means include CET1 capital in excess of Pillar 1 minimum requirements, cash deriving from asset sale proceeds, CET1 new issuances and capital generated by burden-sharing through the write-down or conversion of AT1 and T2 capital. In case private means are insufficient to cover incurred and likely losses, precautionary recapitalisation cannot be granted. Step 3: Addressing unlikely losses with State aid Once incurred and likely losses are fully covered by the bank's private means, State aid can be granted to cover in principle all the remaining losses (i.e. unlikely losses as identified by the shortfall in the stress test). The ultimate purpose of providing a precautionary recapitalisation is to remedy a serious disturbance in the market on a precautionary and temporary basis by covering the shortfall identified through the precautionary budget. To this end, the bank must be in a position, after receiving the aid, to meet its prudential requirements set by the supervisor. In general, a precautionary recapitalisation that does not allow the bank – also taking into account available private means – to meet its prudential capital requirements (set by the supervisor), after the recapitalisation has been implemented, cannot be authorized by the Commission. On