11 May 2016

Insolvency reform: is it still the really high-hanging fruit?

In 2014, the Commission issued a Recommendation but few Member States implemented it and then rather selectively. So the February 2015 Consultation on CMU raised the question again of what principles might be needed to remove obstructions to a CMU. Commissioner Hill is now bravely advancing the case – focussing on business re-structuring – with a consultation that closes on 14th June. The need for an effective regime flows directly from the rising success of the single market: the more that companies trade across borders, the more they will have creditors outside their home country. Moreover, investors will want to know that they can realise assets from borrowers effectively – or they will only lend at a high price that reflects the inefficiencies of the borrower’s domestic legal system rather than the borrower itself. This is a recipe for a vicious circle indeed.

In January this year, Eurogroup agreed it would be useful to establish a set of common principles and benchmarks. In March, the group agreed on some core common principles that would be a signpost for reform of national insolvency systems that remain a creature of their national legal system. “Speed, cost and predictability are of the essence for efficient national insolvency regimes, together with clear rules on cross-border insolvency… In particular, creditor claims in secured lending should be enforced in an effective manner.” Naturally enough, a trigger for the whole discussion was the need for Eurozone banks to clean up their balance sheets so they could resume proper lending to the real economy.

The macro-economic effects of poor insolvency processes in a world of high debt levels have also been recognised so the Country Specific Recommendations for 2016 specified improvements for a number of countries, and also the Eurozone as a whole. As a result, the economic policy establishment is now obliged to engage with the problem rather than just leave it to obscure, specialist lawyers who may be those with a vested interest in prolonging proceedings - at correspondingly high cost and unpredictability.

The core principles identified are the following: Clear rules on cross-border insolvency; Allowing distressed debtors a genuine fresh start; Effective enforcement of creditor claims in secured lending; Availability, accessibility and affordability of insolvency procedures; Availability of early restructuring procedures; Early identification of debt distress.

But reforming the legislation is not expected to be the end of the story as further policy measures may be needed to improve the efficiency of insolvency processes themselves. A particular effort will need to be made to enhance the institutional framework so Courts will require adequate resources, and the specialisation of judges in insolvency may help to develop specific skills that speed the process. But the effectiveness and speed of insolvency procedures also depends on the quality of information on the debtor's assets – such as via common collateral registries – and its liabilities and income. For banks especially, supervisory measures and other incentives may assist the balance sheet clean-up.

However, the exercise in benchmarking the quality of insolvency laws across Member States proved challenging due to the limitations of existing data sources and, most importantly of all, the specific foibles rooted deep in national legal systems. The Eurogroup `background paper’  provided some illuminating statistics  from ”Rankings from the World Bank Doing Business "Resolving insolvency" indicators, 2016”. These show the results of stylised examples rather than actual data as the lack of data at all – let alone comparable statistics - is a major analytical problem.

The best recovery rates as a going concern are achieved by Finland and Belgium at around 90%, with Italy at 60%. The worst is Greece with a 30% recovery rate in a piecemeal liquidation.  The `time taken’ indicator for Greece (at 3.5 years) is second only to Slovakia but Italy scores surprisingly well at less than 2 years. This author uses the terms `surprisingly’ for Italy as 7 years is usually bandied around at conferences of capital market participants with experience of the Italian judicial system. Another major indicator of the efficiency of the system is cost. Finland and Belgium again score well – at about 4% of assets – but Italy is by far the most expensive at about 23%.

Commissioner Hill is committed to reaching for a high-hanging fruit that has eluded his predecessors for decades. A proposal is expected later this year and he may yet succeed because the problem is now seen as a serous macro-economic one - especially in states where the consequence of the debt overhang have become an urgent political problem for `growth and jobs’. The necessary `political will’ may finally be at hand.

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© Graham Bishop