FRB and FDIC Raise the Bar in RRP

On 15 April 2013, the Federal Reserve Board (FRB) and Federal Deposit Insurance Corporation (FDIC) issued a press release providing revised guidance for large US banks and foreign banks with USD 250 billion or more in total nonbank assets in completing their 2013 resolution plan submissions and granting an extension to the filing date for 2013 resolution plans from 1 July 2013 to 1 October 2013.

The revised guidance details the format of submissions and requires firms to provide more detailed information on a wide range of issues pertaining to resolution; including obstacles to resolvability, interconnectedness, funding and liquidity.  In particular, there appears to be an increasing focus on derivatives trading risks, with banks being required to provide information on:

  • processes for obtaining waivers of contractual termination rights from counterparties, particularly with respect to the impact of cross-default clauses;
  • strategies to mitigate the impact of contractual triggers associated with parent company guarantees, cross-default clauses and ratings downgrades or withdrawals;
  • the management of the collateral processes in resolution, particularly with respect to the ability to quickly identify:
    • legal rights to collateral pledged to, pledged by, or held in custody by, the bank; and
    • the amount, level and type of collateral held by jurisdiction and the impact of rehypothecation rights (both on counterparty collateral held by the bank and collateral pledged to counterparties); and
    • quantification of the additional liquidity requirement (both actual and contingent) associated with contractual obligations such as guarantees.

Fortunately, the extraction of key legal and commercial data from derivatives documentation is a process which many banks have already begun to address for internal risk management purposes.  In addition, the revised US requirements largely mirror the UK RRP requirements as documented in FS12/1 and so are not completely without precedent.  Nonetheless, the FRB/FDIC revisions highlight the importance of unlocking the risks inherent in large portfolios of derivative documentation, presenting that information in a manner that can be readily accessed across an entire bank and by a regulator, and establishing robust procedures for the continuing capture of legal and commercial reference data from legal documentation.

Heat Turned Up Over US Living Wills

In a sign that the political tide may be turning, the FT is reporting that the Federal Reserve and the Federal Deposit Insurance Corporation have raised the prospect of taking severe action against banks that submit deficient living wills, including increased capital requirements or even forced break-ups.

Whereas previously, it was accepted that RRP was an iterative process that may take a number of years to get fully up to speed, it seems that truly credible plans will now be required when the next round of RRP are submitted in July 2013.  This is due, at least in part, to the regulators’ disappointment at the lack of detail and clear proposals for resolution in the 2012 submissions.

“Key Attributes of Effective Resolution Regimes”: a Case of the Emperor’s New Clothes?

The FT is reporting that the Federal Reserve and the Federal Deposit Insurance Corporation have warned banks which are required to produce Recovery and Resolution Plans (RRP) not to assume that regulators will co-operate to avoid the failure of a financial group.  In contrast, they are being required to detail the types of legal filings, notices and applications they would need to submit in each jurisdiction to ensure co-operation among regulators and are being expected to describe the legislation in force within specific countries that would facilitate co-ordination.

If this is indicative of the likely response of authorities during a crisis, it would be a very worrying development indeed.  It is in stark contrast to the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions”, published in October 2011.  This sets the benchmark for national RRP regimes and requires the:

  • establishment of Crisis Management Groups (CMGs) between home and key host authorities with the objective of facilitating the management and resolution of a failing cross-border G-SIFI; and
  • creation of institution-specific cooperation agreements between home and host authorities to govern the development of RRPs and detail procedures concerning notification and consultation prior to an authority taking action against a failing firm.

Unfortunately, if authorities choose not to work together during a crisis, CMGs and cooperation agreements will count for nothing.  Without regulatory co-operation, RRP has some residual value as a data-gathering exercise but will fail to meet its primary objective of facilitating the orderly resolution of a globally significant financial institution in a way that ensures continuity of critical economic functions and minimises taxpayer exposure.  Will anyone tell the G20 that they risk being measured up for the Emperor’s new clothes before it’s too late?

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.

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

BoE, FSA and FDIC Plan “Top Down” Bail-In of Seven G-SIFIs

Below is a link to an FT article published this morning which discusses the progress being made by authorities in the UK and the US on the drafting of resolution plans for seven of the twenty-nine G-SIFIs, including Goldman Sachs, JP Morgan and Barclays.

Of more interest is the fact that the UK and US still seem to be blazing the trail with respect to finalising resolution plans with “the sceptics in Europe and Asia” bringing up the rear.

http://www.ft.com/cms/s/0/98dc0562-a284-11e1-826a-00144feabdc0.html

(subcription required)