FDIC and BoE Publish Strategy Paper on Resolution Plans

Introduction

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.

Asset Transfer

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.

Valuation

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

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.

Ownership Transfer

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:

Equity/Debt Transfer

Initially, existing equity and debt securities will be transferred to an appointed trustee.

Listing Suspension

Subsequently, the listing of the company’s equity securities (and potentially debt securities) would be suspended.

Valuation

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.

Bail-In

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.

Re-Transfer

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 future

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.

European Banking Federation Publishes Study on Reform of EU Banking Sector

Introduction

On 24 July 2012, the European Banking Federation (“EBF”) published a “Study on the issue of possible reforms to the structure of the EU Banking Sector”.  The report is related to the ongoing work of the High Level Expert Group established by the EU Commission to examine the same issue.

The report distinguishes regulatory reform (such as CRD IV, RRP, EMIR and MiFID) from structural reform – a reference to the Vickers report in the UK and the Volcker rule in the US.

Regulatory Reform

In general, the EBF is supportive of regulatory initiatives.  However, on the subject of RRP, it cautions that “a reasonable balance must be struck between effective, robust supervision and supervisory approaches which are overly intrusive into the normal, day-to-day running of a healthy business”.  The EBF also approves of the concept of “bail-in”, favouring a wide definition of bail-in-able debt so as to reduce the possibility of arbitrage and the need for a statutory minimum quantity of bail-in-able debt to be issued by firms.  However, the EBF believes that the “timing and the implementation of any bail-in mechanism…must…avoid imposing an excessive funding cost that could impair the provision of credit to the real economy and result in an excessive deleveraging”.

Structural Reform

The EBF believes that the objectives of the G20 and the EU are to:

  • increase the stability of the European financial sector by reducing risk;
  • ensure orderly resolution of financial institutions without taxpayer support; and
  • maintain the integrity of the Internal Market and to ensure the ability of banks to serve the real economy.

It claims that all of these objectives can be achieved by the finalisation and implementation of the regulatory reform agenda without the necessity of structural reform.  Citing the ECB’s report on EU Banking Structures, the EBF claims that “there is no convincing evidence that structural reform has a direct influence on systemic risk and would make restructuring or resolution easier in the event of a crisis.”  Quite the opposite, it expresses the view that “the disadvantages deriving from a potential adoption of UK- or US- style structural reforms for the EU would be much larger than the eventual benefits that they would generate” due to the possibility that it will lead to fragmentation of financial markets in the EU and create incentives to circumvent the rules.  As such, it concludes that any structural change should be delayed until the regulatory reform agenda has been completed so that its impact can be properly assessed.

Conclusion

The views of the EBF regarding the definition of bail-in-able debt are interesting.  They accord with opinions expressed by the buyside, such as AIMA,  and are undoubtedly correct.  The more narrow the definition, the greater the risk that the protection afforded by bail-in debt will be rendered toothless at the structuring desks of investment banks around the globe.

The reluctance of the EBF to embrace structural change is understandable.  Whilst the political benefits are clear and opinion both amongst regulators and the industry seems to be swinging behind these initiatives (see, for example, here), the economic case for reforms such as those proposed by Vickers has yet to be made definitively.  Unfortunately for the banks, however, neither the UK nor the US governments seem to have a reverse gear where Vickers and Volcker are concerned.

If you have an hour to spare I would recommend that you read this study for no other reason than it provides an excellent review of the history and developments across the entire regulatory landscape within the EU.

FDIC Publishes Resolution Plans for Systemically Important Financial Institutions

As required by Parts 360.10 and 381.8(c) of Title 12 of the Code of Federal Regulations, the resolution plan of every insured depository institution with USD 50 billion or more in total assets and every systemically important financial institution is required to split into a public section and a private section.  The Federal Deposit Insurance Corporation has published the public sections of the resolution plans for the following institutions on its website:

  • Bank of America Corporation
  • Barclays PLC
  • Citigroup Inc
  • Credit Suisse Group AG
  • Deutsche Bank AG
  • The Goldman Sachs Group Inc
  • JP Morgan Chase and Co
  • Morgan Stanley
  • UBS AG

However, those hoping to discover any real insights into the resolvability of these institutions will be disappointed.  Understandably, the public sections of each resolution plan reveal no commercially sensitive information.   Rather, they take the form of a standard summary which provides the following high-level information: 

  • The names of material entities;
  • A description of core business lines;
  • Consolidated or segment financial information regarding assets, liabilities, capital and major funding sources;
  • A description of derivative activities and hedging activities;
  • A list of memberships in material payment, clearing and settlement systems;
  • A description of foreign operations;
  • The identities of material supervisory authorities;
  • The identities of the principal officers;
  • A description of the corporate governance structure and processes related to resolution planning;
  • A description of material management information systems; and
  • A description, at a high level, of the covered company’s resolution strategy, covering such items as the range of potential purchasers of the covered company, its material entities and core business lines.

 

Large Banks Submit First Resolution Plans Under Dodd-Frank

2 July 2012 was the deadline for nine of the largest US and foreign banks to submit their first resolution plans to the FDIC and the Federal Reserve Board pursuant to requirements enacted under the Dodd-Frank Act.  An executive summary of each resolution plan will be published by close of business on 3 July 2012.  Smaller institutions will have until 2013 to submit their first resolution plans.  The banks which are subject to the initial deadline are:

  • Bank of America Corporation
  • Barclays PLC
  • Citigroup Inc
  • Credit Suisse Group AG
  • Deutsche Bank AG
  • Goldman Sachs Group Inc
  • JP Morgan Chase & Co
  • Morgan Stanley & Co LLC
  • UBS AG

FDIC approves final rule requiring resolution plans

On 17 January 2012 the Federal Deposit Insurance Corporation (the “FDIC”) approved a final rule requiring insured depository institutions with USD 50 billion or more in total assets to periodically submit to the FDIC contingency plans for resolution in the event of the institution’s failure.  This rule follows a separate final ruling, adopted jointly by the FDIC and the Federal Reserve approved in September 2011 under Section 165(d) of the Dodd-Frank Act, which requires certain systemically important nonbank financial companies and bank holding companies to prepare resolution plans.

The main purpose of the ruling is to:

  • ensure that depositors receive access to their insured deposits within one business day of the institution’s failure (two business days if the failure occurs on a day other than a Friday);
  • maximise the net-present-value return from the sale or disposition of the failing institution’s assets; and
  • minimise the amount of any loss to be realized by the institution’s creditors.

Currently, 37 insured depository institutions are covered by the final rule, together holding approximately USD 4.14 trillion in insured deposits (or nearly 61 percent of all insured deposits), as of Sept. 30, 2011.

The rule becomes effective on 1 April 2012 and we shall be looking at it in more detail over the coming weeks.

All the best

Michael.