On 8 January 2014, the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) published a consultation paper on “Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions” (NBNI G-SIFIs). The consultation period closes on 7 April 2014. Continue reading
On 12 December 2013, the European Banking Authority (EBA) published a consultation paper on draft regulatory technical standards (RTS) on the methodology for the identification of global systemically important institutions (G-SIIs) and draft implementing technical standards (ITS) on uniform formats and dates for the disclose of the values of the indicators used for determining the score of G-SIIS. Continue reading
On 11 November 2013, the Financial Stability Board (FSB) published an updated list of global systemically important banks (G-SIBs) using end-2012 data.
The Basel Committee on Banking Supervision (BCBS) has also separately published the denominators used to calculate G-SIB scores and the Cut-off score and bucket thresholds that were used to allocate G-SIBs to particular buckets. The denominators are to be updated annually, while the cut-off score and bucket thresholds will remain fixed until November 2017, the date when the first three year review of the G-SIB assessment methodology is due to completed. Continue reading
In the context of the continuing industry and regulator discussion regarding CCP resolvability, last week ISDA published a position paper entitled “CCP Loss Allocation at the End of the Waterfall”. The paper addresses two scenarios:
- “Default Losses” – i.e. losses that remain unallocated once the ‘default waterfall’ is exhausted following a clearing member (“CM”) default; and
- “Non-default Losses” – i.e. losses that do not relate to a CM default but exceed the CCP’s financial resources above the minimum regulatory capital requirements.
ISDA recognises the importance of central clearing for standard OTC derivatives, the difficulty of achieving optimal CCP recovery and resolution and the fact that no loss allocation system can avoid allocating losses to CMs. It takes the view that residual CCP losses should be borne not by the taxpayer, nor solely by surviving CMs who as guarantors have no control over losses. Rather, ISDA believes that all CMs with mark-to-market gains since the onset of the CCP default should share the burden of CCP losses. Accordingly, ISDA is an advocate of Variation Margin Gains Haircutting (“VMGH”) being applied at the end of the default waterfall.
Under a VMGH methodology, the CCP would impose a haircut on cumulative variation margin gains which have accumulated since the day of the CM default. In doing so, ISDA believes that:
- losses fall to those best able to control their loss allocation by flattening or changing their trade positions;
- CMs with gains at risk are incentivised to assist in the default management process; and
- in the event that the CCP runs out of resources, VMGH mimics the economics of insolvency.
ISDA believes that a VMGH methodology should not have an adverse impact on the ability of a CM to net exposures or gain the appropriate regulatory capital treatment for client positions held at the CCP. In contrast to contractual tear-up provisions or forced allocation mechanisms, VMGH allows a CM to assume that its portfolio of cleared transactions outstanding as of any given date will be the same as of the point of a CCP’s insolvency (because there is no mechanism by which they can be extinguished prior to any netting process). As such, because it has certainty with respect to its legal rights in the CCP’s insolvency, the CM should be able to conclude that netting sets remain enforceable. In addition, to the extent that VMGH provides incremental resources to the CCP, ISDA believes that it effectively protects initial margin held at a CCP and therefore strengthens segregation.
In theory, VMGH should always be sufficient to cover a defaulting CM’s mark-to-market losses in the same period. However, if in practice this was not the case (e.g. because the CCP was not able to determine a price for the defaulting CM’s portfolio) and in the absence of other CMs voluntarily assuming positions of the defaulting CM, ISDA advocates a full tear-up of all of the CCP’s contracts in the product line that has exhausted its waterfall resources and has reached 100% haircut of VM gains. ISDA contends that there should be no forced allocation of contracts, invoicing back, partial non-voluntary tear-ups, or any other CCP actions that threaten netting. Furthermore, prior to the point of non-viability, ISDA believes that resolution authorities should not be entitled to interfere with the CCP’s loss allocation provisions (as detailed within its rules) unless not doing so would severely increase systemic risk.
An example of Non-default Loss (“NDL”) would be operational failure. ISDA views NDL in a different light to Default Losses believing there to be no justification for reallocating NDL amongst CMs and other CCP participants. Accordingly, it does not believe that VMGH (or similar end-of-the-waterfall options) are appropriate for allocation of NDL. Rather, it considers that NDL should be borne first by the holders of the CCP’s equity and debt.
The ISDA paper is a useful contribution to the ongoing discussion around CCP resolvability. It suggests a sensible CCP default waterfall, but is probably most noteworthy for its opposition to initial margin (“IM”) haircutting as a resolution tool. In ISDA’s view, IM haircutting would distort segregation and “bankruptcy remoteness”. In doing so it would have significant adverse regulatory capital implications and would create disincentives for general participation in the default management process. In this sense, it adopts the opposite position to that detailed by the Committee on Payment and Settlement Systems (“CPSS”) and the International Organization of Securities Commission (“IOSCO”) in their recent consultative report on the Recovery of financial market infrastructures (see this blog post for more detail). CPSS/IOSCO see IM haircutting as an effective tool which may facilitate access to a much larger pool of assets than VMGH.
There is general agreement on the principle that the taxpayer should never again have to pick up the tab following the failure of a systemically important firm. On this basis alone, one suspects that IM haircutting will ultimately be included in the suite of resolution tools, if only to act as additional buffer between derivatives losses and the public purse. In fairness, it’s difficult to see how a general tear-up of contracts is consistent with one of the underlying goals of CCP resolution – to ensure the continuity of critical services. Ultimately, however, we will have to wait to see whether the contagion which may result from ISDA’s tear-ups outweighs the regulatory impact associated with CPSS/IOSCO’s IM haircutting.
On 12 August 2013, the Financial Stability Board published a consultation document regarding the “Application of the Key Attributes of Effective Resolution Regimes to Non-Bank Financial Institutions”, inviting comments by 15 October 2013.
The consultation document proposes draft guidance on how the Key Attributes should be implemented with respect to systemically important non-bank financial institutions. It deals with three main areas:
- The resolution of financial market infrastructure (FMI) and systemically important FMI participants;
- Resolution of insurers; and
- Client asset protection in resolution.
The proposed rules are, to a large extent, little more than the formalisation of existing thought and best practice regarding the resolution of non-bank financial institutions. However, this does not detract from the value of the document. Indeed, it highlights the practical challenge that institutions which are subject to the rules will face in providing the data necessary to facilitate the implementation of resolution measures by regulators.
Both FMIs and insurers will be required to maintain information systems and controls that can promptly produce, both in normal times and during resolution, all data needed for the purposes of timely resolution planning and resolution. In the case of FMIs, this will include:
- Information on direct and indirect stakeholders, such as owners, settlement agents, liquidity providers, linked FMIs and custodians;
- Exposures to each FMI participant (both gross and net);
- Information on the current status of obligations of FMI participants (e.g. whether they have fulfilled their obligations to make default fund contributions);
- FMI participant collateral information, such as:
- holding arrangements; and
- rehypothecation rights; and
- netting arrangements.
Insurers will also be required to generate data regarding:
- sources of funding;
- asset quality and concentration levels; and
- derivatives portfolios.
In addition, any entity holding client money, must have the ability to generate a wide variety of data that would facilitate its speedy return in a resolution scenario. That data must be in a format understandable by an external party such as a resolution authority or an administrator and includes information on:
- the amount, nature and ownership status of client assets held by the firm (directly or indirectly);
- the identity of clients;
- the location of client assets;
- the identity of all relevant depositories;
- the terms and conditions on which client assets are held;
- the applicable type of segregation (e.g. “omnibus” or “individual”);
- the effects of the segregation on client ownership rights;
- applicable client asset protections (particularly where client assets are held in a foreign jurisdictions);
- any waiver, modification or opting out by a client of the client asset protection regime;
- the ownership rights of clients and any potential limitations to those rights;
- the existence and exercise of rehypothecation rights; and
- outstanding loans of client securities arranged by the firm as agent, including details of:
- contract terms; and
- collateral received.
If the experience of banks is anything to go by, the capture, analysis, delivery and updating of this type of data is a significant undertaking. The FSB is clearly laying out its intentions and the direction of travel on this issue. As such, non-bank financial institutions would do well to start analysing their capabilities in these areas, with a view to upgrading their data architectures where necessary.
On 18 July 2013, the Financial Stability Board (FSB) published a press release endorsing the assessment methodology and policy measures published by the International Association of Insurance Supervisors (IAIS) discussed below, and naming the first nine globally systemically important Insurers (G-SIIs). The list will be published each November, starting in 2014 and initially comprises:
- Allianz SE;
- American International Group, Inc.;
- Assicurazioni Generali S.p.A.;
- Aviva plc;
- Axa S.A.;
- MetLife, Inc.;
- Ping An Insurance (Group) Company of China, Ltd.;
- Prudential Financial, Inc.; and
- Prudential plc.
On the same date the IAIS announced that it had published:
- a G-SII Initial Assessment Methodology;
- G-SII specific policy measures, and
- an overall G-SII framework for macroprudential policy and surveillance.
G-SII Initial Assessment Methodology
The methodology (which has already been criticised as being “opaque and arbitrary” on account of the fact that it contains no quantitative cut-off point for G-SII designation, preventing firms from knowing what actions would help them remain below the G-SII threshold) is designed to assess the systemic importance of insurers, using year-end 2011 data collected from selected insurers in 2012 and employing a three-step process involving:
- the collection of data;
- a methodical assessment based on five weighted categories and 20 indicators;
- non-traditional insurance and non-insurance (NTNI) activities (45% weighting);
- interconnectedness (40% weighting);
- substitutability (5% weighting);
- size (5% weighting); and
- global activity (5% weighting); and
- a supervisory judgment and validation process.
G-SII Policy Measures
The IAIS policy framework for G-SIIs is three-pronged, consisting of:
These measures entail the development of Systemic Risk Management Plans, enhanced liquidity planning and management and the granting of direct powers over holding companies to group-wide supervisors. There is also a reasonably detailed discussion of:
- the nature of traditional insurance versus NTNI activities; and
- effective separation of NTNI business.
Traditional versus NTNI Insurance
Traditional Insurance is broadly characterised by insured events which are accidental in nature, random in occurrence and subject to the law of large numbers. In contrast, NTNI broadly includes activities that are more financially complex than traditional insurance, where liabilities are significantly correlated with financial market outcomes (such as stock prices, and the economic business cycle) and have financial features such as leverage, liquidity or maturity transformation, imperfect transfer of credit risks, (i.e.“shadow banking”), credit guarantees or minimum financial guarantees.
Effective separation of NTNI
Whether NTNI activities are effectively separated goes to the heart of G-SII resolvability and the amount of Higher Loss Absorption (HLA) to be applied to a G-SII. The following conditions are relevant in this determination:
- Self-sufficiency: an effectively separated entity will be able to operate without the support of parent or affiliates;
- Operational independence of management;
- Regulated status: the effective separation of NTNI activities must not result in a non-regulated financial entity;
- Arm’s length dealings: any intragroup transactions or commitments with the separated NTNI entities must be executed “at arm’s length”; and
- Reputation risk: the risk that a parent or affiliate provides financial support to an entity even though there is no legal obligation to do so must be limited.
The IAIS’s proposals for the effective resolution of G-SIIs are based on the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions but takes account of the specificities of insurance. This entails the establishment of Crisis Management Groups, the development of recovery and resolution plans (RRPs), the conduct of resolvability assessments, and the adoption of institution-specific cross-border cooperation agreements.
Higher Loss Absorption Capacity
G-SIIs will be required to have HLA capacity. This may only be met by “highest quality capital”, being permanent capital that is fully available to cover losses of the insurer at all times on a going-concern and a wind-up basis. In applying this requirement a distinction may be made based upon whether a firm’s NTNI activities have been effectively separated from traditional insurance business. HLA may be targeted at the entities where systemically important actives are located and also take account of whether group supervisors have authority over any non-regulated financial subsidiaries.
Report on Macroprudential Policy and Surveillance in Insurance
In addition to the microprudential supervision measures constituting the G-SII Policy Measures, the IAIS also released a framework for implementing macroprudential policy and surveillance (MPS) in the insurance sector, designed to maintain financial stability. Its focus is on enhancing the supervisory capacity to identify, assess and mitigate macro-financial vulnerabilities that could lead to severe and wide-spread financial risk. Over time, the MPS framework will be refined through the issuance of guidance on the practical application of IAIS Insurance Core Principles, and the development of a toolkit and data template regarding early warning risk measures.
Key implementation dates are as detailed below:
|Implementation of enhanced supervision for G-SIIs||
|FSB to designate the initial cohort of G-SIIs based on the IAIS methodology||
|For designated G-SIIs, implementation commences of resolution planning and resolvability assessment requirements||
|IAIS to prepare a workplan to develop a comprehensive, group-wide supervisory and regulatory framework for internationally active insurance groups (IAIGs)||
|Finalisation of IAIG framework||
|Systemic Risk Management Plan (SRMP) to be completed||
|Crisis management groups (CMGs) to be established for initial set of G-SIIs||
|G-SII designation of major reinsurers||
|IAIS to develop straightforward, backstop capital requirements to apply to all group activities, including non-insurance subsidiaries||
|CMGs to develop and agree RRPs, including liquidity risk management plans for initial set of G-SIIs||
|IAIS to develop implementation details for HLA that will apply to designated G-SIIs starting from 2019||
|Implementation of SRMPs to be assessed||
|FSB to designate the set of G-SIIs, based on the IAIS methodology and 2016 data, for which the HLA policy measure will apply, with implementation beginning in 2019||
|HLA requirements to apply to those G-SIIs identified in November 2017||
On 18 April 2013, the Financial Stability Board (FSB) published a press release announcing the completion of a common data template for globally systemically important banks (G-SIBs).
The financial crisis highlighted major gaps in information on systemically important financial institutions, particularly the bilateral linkages between such institutions, or their common exposures and liabilities to financial sectors and national markets. In response, the G-20 charged the FSB with developing:
- a common data template for systemically important global financial institutions; and
- proposals for an international framework to support the collection and sharing of information on such institutions.
The G-SIB template represents the completion of stage 1 of the project. Stages 2 and 3 will involve the extension of the framework to include the collection of data on bilateral funding dependencies and consolidated balance sheet. The data will be held in a central data hub, hosted by the BIS, and will be shared on with national supervisory authorities which are part of the framework.
On 10 December 2012, the Federal Deposit Insurance Corporation (FDIC) and the Bank of England (BOE) published a joint strategy paper on the resolution of globally active, systemically important, financial institutions (G-SIFIs).
Broadly speaking, there are two main approaches to the resolution of G-SIFIs:
- “Single point of entry” (or “top down”) resolution pursuant to which a single national resolution authority applies resolution powers to the parent company of a failing financial group; or
- “Multiple point of entry” resolution whereby resolution powers are applied to different parts of a failing financial group by two or more resolution authorities in coordination.
The paper focuses on “top-down” resolution with respect to both UK and US cross-border financial services groups. The key advantage of “top-down” resolution is seen as being the ability for viable subsidiaries, both domestic and foreign, to continue to operate. Not only should this limit contagion but it will hopefully mitigate cross-border complications arising as a result of the institution of separate territorial and entity-focused insolvency proceedings. However, it is expressly recognised that there are certain circumstances where “multiple point of entry” resolution will be necessary, for example where losses are so great that they could not be absorbed by a group level bail-in or make the job of valuing the capital needs of the institution in resolution too difficult.
US approach to single point of entry resolution
The sequence of events with respect to a US single point of entry resolution is as follows:
Appointment of Receiver
The FDIC is appointed receiver of the parent holding company of the failing financial group.
The FDIC transfers assets (primarily equity and investments in subsidiaries) from the receivership estate to a bridge financial holding company. In contrast, shareholder claims and claims of subordinated and unsecured debt holders remain in the receivership. As such, the assets of the bridge holding company will far exceed its liabilities.
A valuation process is undertaken so as to estimate the extent of losses in the receivership and allow their apportionment to shareholders and unsecured creditors in accordance with insolvency rankings.
Bail-in occurs to ensure that the bridge holding company has a strong capital base. So as to provide a cushion against future losses, remaining debt claims are converted in part into equity claims in the new operation and/or into convertible subordinated debt. Any remaining debt claims are transferred to the new operation in the form of new unsecured debt.
Liquidity Concerns are Addressed
To the extent that liquidity concerns have not been addressed by the transfer of equity and investments in operating subsidiaries to the bridge holding company, the FDIC can provide assurances of performance and/or limited scope guarantees. As a last resort, the FDIC may also access the Orderly Liquidation Fund (OLF), a fund within the U.S. Treasury set up under the Dodd-Frank Act. However, the Dodd-Frank Act prohibits the loss of any taxpayer money in the orderly liquidation process. Therefore, any OLF funds used must either be repaid from recoveries on the assets of the failed financial company or from assessments made against the largest, most complex financial companies.
Firm is restructured
In this stage, the focus will be on making the failed firm less systemically important and more resolvable. Senior management are likely to be removed at this point.
The final stage of the process is to transfer ownership and control of the surviving operation to private hands.
UK approach to single point of entry resolution
The sequence of events with respect to a UK single point of entry resolution is as follows:
Initially, existing equity and debt securities will be transferred to an appointed trustee.
Subsequently, the listing of the company’s equity securities (and potentially debt securities) would be suspended.
A valuation process would then be undertaken in order to understand the extent of the losses expected to be incurred by the firm and, in turn, the recapitalisation requirement.
Following valuation, an announcement of the terms of any write-down and/or conversion pursuant to the exercise of bail-in powers would be made to the previous security holders. In writing down losses, the existing creditor hierarchy would be respected. Inter-company loans would be written down in a manner that ensures that the subsidiaries remain viable. Deposit Guarantee Schemes would also be bailed-in at this point. At the end of the process, the firm would be recapitalised and would likely be owned by its original creditors.
Liquidity Concerns are Addressed
So as to mitigate liquidity issues and facilitate market access, illiquid assets could be transferred to an asset management company to be worked out over a longer period. In the event that market funding was simply not available, temporary funding could be provided by authorities on a fully collateralized, haircut, basis. However, any losses associated with the provision of such temporary public sector support would be recovered from the financial sector as a whole.
Firm is Restructured
On completion of the bail-in process, the firm would be restructured to address the causes of its failure.
Subsequently, the trustee would transfer the equity (and potentially some debt) back to the original creditors of the firm. Any creditors which are unable to hold equity securities (e.g. due to mandate restrictions) would be able to request that the trustee sell the equity on their behalf.
Resumption of Trading
The final stage of the process would involve the dissolution of the trust and the resumption of trading in the equity and/or debt securities of the restructured firm.
Similarities Between the Regimes
Both approaches emphasise the importance of ensuring the continuity of critical services of the failing group, whether in the home jurisdiction or abroad. Shareholders under both regimes can expect to be wiped out and unsecured debt holders can expect their claims to be written down (to reflect any losses that shareholders cannot cover) and/or partly converted into equity (in order to recapitalise the entity in question). Existing insolvency hierarchies will be respected, but in both cases, a valuation process will be required. The precise mechanics of any such valuation are unlikely to be the same across both the UK and the US, but consideration is being given in both jurisdictions as to the extent to which the valuation process can be prepared in advance. Not only would the valuation process assess the losses that a firm had incurred and what financial instruments (if any) the different classes of creditors of the firm should receive, but it would also assess the future capital needs of the business necessary to restore “confidence” in the firm. It seems likely that this will be a level significantly higher than that required simply to restore viability. In both cases, resolution will be accompanied by an restructuring of the business. This may involve breaking an institution into smaller, less systemically important entities, liquidating or closing certain operations and a replacement of management.
The high level strategies detailed by the FDIC and BOE will be translated into detailed resolution plans for each firm during the first half of 2013. It is anticipated that firm-specific resolvability assessments will be developed by the end of 2013 on the basis of the resolution plans.
On 5 November 2012, the Financial Stability Board (FSB) published a letter dated 31 October 2012 addressed to the G20 regarding progress made with respect to financial regulatory reforms.
The FSB reported ‘solid but uneven’ progress” in the four priority areas identified by the G20, being:
- building resilient financial institutions (i.e. Basel III);
- ending “too big to fail” (i.e. RRP);
- strengthening the oversight and regulation of shadow banking activities; and
- completion of OTC derivatives and related reforms.
On the subject on ending “too big to fail”, the FSB noted that a peer review of national actions taken to legislate its “Key Attributes of Effective Resolution Regimes” document will now be published in the first half of 2013. More importantly, however, on the subject of resolution planning for Globally Systemically Important Financial Institutions (G-SIFIs), the FSB confirmed that the deadline for completion of operational resolution plans for Globally Systemically Important Banks (G-SIBs) has been extended by six months until mid-2013. Consequently, the FSB’s peer-based resolvability assessment process will now be delayed until the second half of 2013.
In November 2011, the Financial Stability Board (FSB) published its initial list of Global Systemically Important Banks (G-SIBs). On 1 November 2012, the list was updated, with BBVA and Standard Chartered being added to the list and Commerzbank, Dexia and Lloyds all being removed.
The significance of being classified as a G-SIB lies in the fact that, under Basel III, any bank identified as a G-SIB in November 2014 will be required to maintain additional loss absorbency. This requirement will be phased in between January 2016 and January 2019 and ranges between 1% and 2.5% of risk weighted assets depending on the significance of the individual firm. G-SIBs are also required to meet higher supervisory standards for risk management functions, data aggregation capabilities, risk governance and internal controls. Any firm newly designated as a G-SIB is required to implement certain resolution planning requirements within specified deadlines. Furthermore, even where a financial institution is no longer designated as a G-SIB it will continue to be subject to the requirement to prepare an RRP to the extent that it is assessed by its national regulator to be systemically significant or critical in the event of failure.
For the first time, the current list of G-SIBs has been allocated into provisional buckets corresponding to the required level of additional loss absorbency, as set out in more detail in Annex 1 below. The timetable for implementation of resolution planning requirements for newly designated G-SIFIs is detailed in Annex 2 below.
|G-SIB in alphabetical order within each bucket|
JP Morgan Chase
Bank of America
Bank of New York Mellon
Mitsubishi UFJ FG
Royal Bank of Scotland
Bank of China
Group Credit Agricole
Sumitomo Mitsui FG
|G-SIFI Requirement||Deadline for completion following date of G-SIFI designation|
|Establishment of Crisis Management Group (CMG)||
|Development of recovery plan||
|Development of resolution strategy and review within CMG||
|Agreement of institution specific cross-border cooperation agreement||
|Development of operational resolution plan||
|Conduct of resolvability assessment by CMG and resolvability assessment process||