EU Court clears bail-in of subordinated bondholders

The court issued the opinion at the request of the Slovenian Constitutional Court, which has admitted several applications brought by subordinated bondholders, who suffered an estimated EUR 600m in losses.

At issue was in particular whether a European Commission communication of August 2013 formed a sufficient legal basis for legislative changes in Slovenia that were invoked for the wiping out of subordinated bondholders as well as shareholders of banks bailed in in late-2013.

The EU Court said the communication was valid as the Commission has the discretion to adopt guidelines setting criteria on the basis of which it plans to verify compliance with internal market rules of state aid measures to be taken by the member states.

Nevertheless, the communication does not automatically create an obligation on a member state, instead the Commission must individually check each state aid application by a member state even if they do not meet the criteria set in the communication.

The court also stressed that all investors must participate in the "burden sharing measures" in order to prevent the distortion of competition.

In the initial phases of the financial crisis creditors did not have to accept losses when banks were bailed out, but this does "not put creditors in a position to rely on the principle of protection of legitimate expectations," according to the court.

While the focus has been on subordinated bondholders, some of the applications have also been brought by bank shareholders that were wiped out.

For them, the court says that shareholders should contribute to the absorption of the losses suffered by banks to the same extent as if there were no state aid, which means that the Commission's communication "cannot be regarded as adversely affecting their property right."

Finally, the court says the aim of burden sharing measures is to "restore the financial position of credit institutions" and to "preserve or re-establish the financial situation of a credit institution."

While the case is yet to be finally decided by the Constitutional Court, the opinion will come as a relief for the government, which faced a potential EUR 600m bill for the bail-in.

It could also help the beleaguered central bank, which was recently raided by police based on criminal complaints by junior bondholders and the suspicion that the bank capital shortfall was calculated incorrectly.