SPE and MPE – which are you?

Introduction

On 14 October, the Bank of England published a speech given by Paul Tucker, Deputy Governor Financial Stability, at the Institute of International Finance 2013 Annual Membership meeting on 12 October 2013 on the subject of ‘too big to fail’.

Mr Tucker made five general points:

  1. The US authorities could resolve most US SIFIs right now on a ‘top-down’ basis pursuant to the powers granted under Title II of the Dodd Frank Act;
  2. Single Point of Entry (SPE) versus Multiple Point of Entry (MPE) may be the most important innovation in banking policy in decades;
  3. There is no such thing as a “bail-in bond”.  Bail in is a resolution tool.  All creditors can face having to absorb losses.  What matters is the creditor hierarchy;
  4. Some impediments to smooth cross-border resolution need to be removed; and
  5. The resolution agenda is not just about banks and dealers.  It is about central counterparties too, for example.

Reorganisation

Mr Tucker noted that Europe is not far behind the US in its enactment of resolution powers.  However, of more interest to the industry will be his belief that most banking groups will have to undergo some kind of reorganisation, irrespective of the camp into which they fall.  SPE groups will need to establish holding companies from which loss-absorbing bonds can be issued.  In addition, key subsidiaries will need to issue debt to their holding companies that can be written down in times of distress.  MPE groups will need to do more to organise themselves into well-defined regional and functional subgroups.  In addition common services, such as IT will need to be provided by stand-alone entities that can survive the break-up of an MPE group.  Capital requirements for regional subsidiaries forming part of an MPE group may also be higher due to the absence of a parent/holding company that can act as a source of strength through a resolution process.

Bail-in

On the subject to bail-in, creditors of SPE groups will be interested to read Mr Tucker’s comments about how, within the context of a top-down resolution, bonds issued by a holding company will absorb losses before debt issued by an operating subsidiary.  In effect, the holding company’s creditors are structurally subordinated to the operating company’s creditors.

Impediments to Resolution

On the subject to impediments to cross-border resolution, Mr Tucker noted that, in order to provide clarity on its previous ‘in principle’ commitment, the Bank of England needs to set down detailed conditions under which it would step aside and allow US authorities to resolve the UK subsidiaries of a US banking group.  In turn, other resolution authorities, and particularly the US, need to make the same ‘in principle’ commitment as the Bank of England.

Extension of the Resolution Regime

Finally, on the subject of the resolution agenda, Mr Tucker confirmed that CCPs are the most important example of where resolution regimes need to apply.  However, he did not rule out resolution regimes being extended to cover shadow banking, funds and SPVs.

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Single Point of Entry or Multiple Point of Entry: the Choice is Yours?

Here is a link to an article in today’s FT explaining that, following the FSB guidance issued on 16 July 2013 (see this blog post for more detail), banks seem likely to be given more ‘choice’ between single point of entry and multiple point of entry.  This seems to represent a subtle shift away from the previous consensus that had been developing within regulatory circles regarding the benefits of single point of entry over multiple point of entry.  However, the quid pro quo is that banks will have to implement potentially wide-ranging changes in order to make their business models more consistent with their chosen resolution mechanism.

Paul Tucker Speech on Resolution

On 20 May 2013, Paul Tucker, Deputy Governor of Financial Stability at the Bank of England gave a speech entitled “Resolution and future of finance” at the INSOL International World Congress in the Hague.

Within the wider context of discussing solutions to the problem of “too big to fail”, the speech gives a useful summary of the ways in which both “single point of entry” and “multiple point of entry” resolution would operate in practice.  It also touches upon the interaction between resolution regimes and bank structural reform, noting the way in which bank ring-fencing, as will be implemented in the UK via the Financial Services (Banking Reform) Bill, represents a back-up strategy to resolution, under which essential payment services and insured deposits would be provided by a “super-resolvable” ring-fenced and separately capitalised bank.  This, it is believed, should make it easier for the UK authorities to “retreat to maintaining at least the most basic payments services” if a preferred strategy of top-down resolution of a whole group could not be executed.

Cross-border Resolution Compromised by US capital and liquidity plans?

This is a link to an article in Risk Magazine regarding proposed US capital and liquidity rules for foreign banks that may undermine attempts to address the issue of “too-big-to-fail” with respect to international banking institutions.

In December 2012, the Federal Reserve Board published proposals designed to provide greater comfort that US operations of foreign banks would not be required to rely on foreign parents, or the US taxpayer, in the event of their collapse.  Specifically, the proposals would require foreign banks in the US to group their US subsidiaries under an “intermediate holding company” (IHC).  The IHC would then be subject to the same capital and leverage rules as US banks. In addition, IHCs with more than USD 50 billion in assets in the US would be required to hold a liquidity buffer and conduct liquidity stress tests.

However, there are concerns that these proposals could actually make it more difficult to resolve a failing institution.  The article notes the developing international consensus amongst regulators regarding “single-point-of-entry” or “top down” resolution, whereby resolution actions (including bail-in) are triggered by home state resolution authorities.  This contrasts with “multiple-point-of-entry” resolution, whereby resolution action can also be triggered by one or more host regulators.  In imposing its own capital and liquidity rules, the Federal Reserve Board does not assume the operation of a single-point bail-in process through which capital would flow down from the foreign parent company to the local entity.  In contrast, in trapping capital and liquidity at a local level the US rules assume an “every man for himself” model.  This, it is believed, may compromise the ultimate resolvability of a banking group due to the fact that:

  • in practice, the power of a home state resolution authority would be limited by virtue of the fact that localised pools of capital and liquidity (which would assist in resolving the institution) exist but remain beyond reach; and
  • if a host resolution authority for one part of a banking group triggered bail-in, then confidence in the remaining parts of the institution might be damaged, risking a domino effect under which multiple defaults are triggered as local regulators all strive to limit damage in their own jurisdictions.