Flipping the Promissory Note – The Legal Relationships, Consequences of the IBRC Liquidation and how it was done
1. What was the Promissory Note?
The promissory note was an obligation created by the Irish State in favour of IBRC. It was a unilateral promise by the State to pay IBRC the sum of €30.6bn plus interest, in instalments between March 2011 and March 2031. The €3.1bn payment scheduled for March 2013 would have been the State's third payment on the promissory note to IBRC. When interest on the capital amount of the promissory note is taken into account, the total projected payments from the State to IBRC to March 2031 would have been €47.9bn.
2. Why did the State give a Promissory Note to IBRC?
The requirement for the promissory note arose from the capital inadequacy of Anglo Irish Bank Corporation plc and Irish Nationwide Building Society. Neither institution was capable of funding itself in the markets, via deposits or through Central Bank funding against eligible collateral.
Accordingly, each institution borrowed money on an emergency basis from the Central Bank of Ireland in order to repay depositors and bondholders, under a scheme known as Exceptional Liquidity Assistance (ELA). IBRC was formed in 2011 as the institution comprised of the former Anglo Irish Bank Corporation plc and Irish Nationwide Building Society. Today IBRC's liabilities are predominantly liabilities to the Central Bank of Ireland accrued under the ELA programme. By the end of 2011 these liabilities were approximately €40.1bn.
These ELA advances addressed the liquidity issues faced by IBRC but did not address its capital adequacy. Therefore, in order to address this, the State issued a promissory note to IBRC. The State used a promissory note because the State could not borrow the funds at reasonable rates in the market.
3. Where did The Central Bank of Ireland get money to lend to IBRC?
It didn't. The Central Bank of Ireland, like all other Eurozone national central banks, is a component of the Eurosystem, which is the monetary authority of the Eurozone. Part of the role of the Eurosystem is the supply of liquidity (i.e. cash) to Eurosystem banks. The injection of liquidity in this way is referred to as a "refinancing operation" and is conducted on a decentralised basis by the national central banks. The ELA funding was provided by the Central Bank to IBRC under its powers pursuant to the Central Bank Act 19421, which powers are subject to the restrictions set out in the EU Treaty  and the European Central Bank Statute.3
Pursuant to these legal provisions, the Central Bank created money, which money was then advanced to IBRC as part of its ELA programme. IBRC is obliged to repay such ELA advances to the Central Bank of Ireland and, as security for the ELA advances, IBRC charged all of its assets and undertaking to the Central Bank of Ireland.
On receipt of repayments of ELA, the Central Bank of Ireland should simply cancel the money it has previously created. This process is known as "sterilisation" and exists to counter the inflationary consequences of money creation.
4. What role has the ECB?
If national central banks were free to provide ELA without a system of checks and balances, they could be tempted to do so without restraint, creating inflationary pressures and devaluing the euro. Accordingly, the ECB has powers under its Statute to restrict the money creation activities of the national central banks.
In summary, the ECB must be consulted when ELA is issued by a national central bank and it will assess whether or not the proposal to provide ELA interferes with the ECB's broad monetary policy stance. Therefore, it is likely that ECB approval was obtained in relation to the provision of ELA by the Central Bank of Ireland to IBRC.
ELA is not long term funding. It is usually repayable over very short periods (weeks or months). Therefore it needs to be refinanced and rolled over regularly. Accordingly if a State or national central bank does something which is contrary to ECB policy, the ECB could object to the continued provision of ELA by that national central bank.
5. Why liquidate IBRC?
In return for the ELA, IBRC charged of all its assets to the Central Bank of Ireland. One of those assets was the right to call on the promissory note given by the State to IBRC.
The liquidation of IBRC means that the Central Bank of Ireland, pursuant to the charge given to it by IBRC, became the beneficial owner of the promissory note.
Section 17 of the Irish Bank Resolution Corporation Act 2013, passed on 7 February 2013, gave the Minister power to redeem and cancel any of the Minister's obligations to the Central Bank of Ireland (i.e. the promissory note) in return for the issue of securities at an interest rate and with such conditions regarding repayment as the Minister sees fit.
6. What did the Minister do?
Once the Act was passed, the Minister made the special liquidation order. Then, pursuant to section 17 of the Act, he redeemed the promissory note and issued securities on better terms for the State. The securities that have been issued in exchange for the promissory notes are Irish Government bonds with maturities of up to 40 years. The government announced on 7 February 2013 that the first payment of principal will be made in 2038 and the last payment will be made in 2053 and that the average maturity will be approximately 34 years. The average maturity of the promissory notes was 7 to 8 years. The reported benefit to the State is estimated to be €1bn annually.
7. What did the ECB do?
The ECB took no action. The Governing Council of the ECB could have objected, by a two thirds majority, to the replacement of the promissory note4. However, the Governing Council simply "unanimously took note" of what had taken place.
8. What affect does the liquidation have on creditors?
The Act provides that the winding up is analogous to an official liquidation. Therefore the liquidator's job is to gather in the assets and pay the creditors according to law. That means the liquidator will continue to maximise recoveries from all assets of IBRC and then will pay creditors in the following way:
First: preferential creditors as identified in the Companies Acts.
Second: the holder of the floating charge, currently the Central Bank of Ireland.
Third: unsecured creditors.
Unsecured creditors will include deposit holders, bond holders and trade creditors. However, deposit holders and some bond holders have the benefit of guarantee schemes namely, the Deposit Guarantee Scheme and the Eligible Liabilities Guarantee Scheme and they can claim against the State pursuant to those schemes if they qualify. There are no special arrangements for trade creditors.
9. What is the effect on employees?
The Act provides that the employment of each employee of IBRC was terminated with immediate effect on the making of the liquidation order. However, the Act also provides that the special liquidator may engage any person so terminated on such terms as the special liquidator sees fit where the special liquidator considers such engagement to be necessary or beneficial for the ordinary conduct of the winding up.
Accordingly, it is likely that most employees will be re-engaged on similar terms to those that they enjoyed previously.
10. What is the impact on borrowers?
There is effectively no impact on those who have obligations to IBRC. IBRC in liquidation will continue to be entitled to enforce borrowers' obligations. When IBRC sells its loans and associated security to NAMA or others, those purchasers will equally be able to enforce borrowers' obligations. Receivers appointed by IBRC prior to its liquidation should not be affected, save that they will have to account for their recoveries to any purchasers of IBRC's loans.
11. What is the role of NAMA?
The Act envisages NAMA being directed by the Minister to bid for and acquire IBRC's assets, which would include loans owed to IBRC and related security. The Act provides that other parties can bid for such assets. However, it appears that NAMA will be the purchaser of last resort at a price to be determined by a process of independent valuation. NAMA would then work out such acquired assets in a similar manner to its other assets.
1 The Central Bank of Ireland has powers under section 5B(d) of the Central Bank Act 1942 to "provide loans and other kinds of financial accommodation to credit institutions and other persons on the security of such assets and on such terms and conditions the Board considers appropriate".
2 Article 131 of the Treaty on the Functioning of the European Union states that: "Each Member State shall ensure that its national legislation including the statutes of its national central bank is compatible with the Treaties and the Statute of the ESCB and of the ECB."
3 The key restrictions on the activities of the Central Bank of Ireland are contained in Article 14 of the Statute of the European System of Central Banks and of the European Central Bank.
4 Article 14.4 of the Statute of the European System of Central Banks and of the European Central Bank.
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