Co-Authored by Heath Tarbert, Sylvia Mayer and Conray C. Tseng.
On July 19, 2011, the Financial Stability Board (“FSB”), an organization comprised of governmental and other financial authorities from around the world, including the SEC, Federal Reserve and Dept. of Treasury for the U.S., issued its “Consultative Document: Effective Resolution of Systemically Important Financial Institutions” (“FSB Report”). The FSB Report, which was prepared in response to a request by the G20 leaders, proposes international standards, policies and timelines to facilitate recovery and resolution planning for global systemically important financial institutions (“SIFIs”).
The FSB Report contains a comprehensive proposal to support the effective resolution of SIFIs with operations around the world, including:
- Regulator’s Authority: Each country should adopt a resolution regime enabling authorities to quickly intervene, avoid disruption of financial markets, and ensure prompt resolution.
- Consistent Tools: Consistent resolution tools should be available world-wide, including the ability to transfer ownership of all or part of a company to a third party or a bridge company, force recapitalization of a company (referred to as “bail-in within resolution”), and the division of a company into separate companies (good bank/bad bank concept).
- Planning Requirements: All global SIFIs should be required to develop a recovery plan and resolution plan. While companies should be responsible for creating and executing their recovery plans, for resolution plans, companies should be responsible for preparing strategic analysis, generating stress scenarios, and collecting supporting data, but regulatory authorities should be tasked with execution.
- International Cooperation: Cross-border cooperation is critical. Firm-specific cooperation agreements should be entered into between regulatory bodies in the home and all key host jurisdictions. In addition, there should be a Crisis Management Group (“CMG”) developed for each global SIFI. Each CMG will be comprised of representatives from the regulatory bodies in the home and key host jurisdictions for that company.
- Confidentiality: Confidentiality of the recovery and resolution planning information for each company should be respected through confidentiality agreements, personnel screens, formal procedures, or other measures to protect confidential information and other sensitive data.
Although created by regulators from around the world, the FSB Report closely tracks the concepts outlined in Dodd-Frank and the related proposed rules regarding recovery and resolution planning in the U.S. As a result, although prepared for global SIFIs, the FSB Report is an equally useful resource for U.S. domestic SIFIs as it provides insights into various aspects of the U.S. recovery and resolution planning requirements.
Below is a summary of the 74 page FSB report. To obtain a complete copy of the report, visit http://www.financialstabilityboard.org/publications/r_110719.pdf.
The FSB Report addresses four overarching topics: (1) what resolution powers and tools should be provided to regulatory agencies; (2) how cross-border issues should be addressed; (3) what framework is necessary for recovery and resolution planning; and (4) what steps can be taken to improve resolvability. The report also requests comments on whether creditor hierarchy, depositor preference, and depositor protections across different national jurisdictions should be harmonized and whether a temporary stay (e.g., two business days) should be imposed to suspend contractual early termination rights while regulatory agencies implement resolution plans.
Effective Resolution Regimes
The FSB advocates that governments establish strong national regulatory regimes with the tools necessary to intervene safely and quickly in the event a SIFI is no longer viable. The FSB believes such regimes should have the powers and tools to (i) preserve the SIFI’s operations that provide services to the financial system and the wider economy that, if disrupted, would cause system-wide damage, (ii) avoid unnecessary loss in value of financial assets and minimize contagion (direct and indirect) to other parts of the financial system, and (iii) ensure that losses are borne by those with who have chosen to bear the risk –shareholders, followed by unsecured and uninsured creditors – rather than taxpayers.
To achieve those goals, the FSB believes any regulatory agency must be able to pursue at least three possible options: (1) sale of the entire firm as an ongoing business to a new owner; (2) separation and eventual sale of all functions that are systemically important or have free standing franchise value while winding down residual parts of the firm (or, alternatively, carving out and transferring the “bad” assets to a separate asset management vehicle); and/or (3) recapitalization of the firm by restructuring its liabilities. Because resolution of a firm will likely take time, the FSB notes that a mechanism for an interim solution, such as a “bridge bank” or “bridge company” (for non-banks), may be necessary.
To assist regulatory agencies’ pursuit of such options, the FSB recommends that any regulatory agency be authorized to (i) take control of a firm, including by replacing management and directors if necessary, (ii) transfer underlying firm contracts to a sound third party or a bridge company, and/or (iii) operate and resolve a firm’s day-to-day operations. This would include the power to terminate, continue or assign contracts, purchase or sell assets, and implement any other actions necessary to restructure or wind down a firm’s operations. The FSB also recommends that any regulatory agency be mandated to respect the hierarchy of claims that would apply in a liquidation and ensure that no creditors are worse off in a resolution than they would be in a liquidation.
The FSB also proposes that regulators be empowered with “bail-in” powers that permit the agency to recapitalize a firm by writing-down equity or converting unsecured and uninsured claims into equity. The FSB recognizes that authorities may impose write-downs that end up being greater than needed to preserve stability and maintain confidence in a financial institution. To address this possibility, the FSB recommends that authorities implement a mechanism to compensate holders of bailed-in claims or written-off equity when the actual losses are finally determined (e.g., warrants).
Recognizing that a comprehensive international resolution regime is unlikely, the FSB proposes that nations implement bilateral or multilateral cooperation agreements on a SIFI-by-SIFI basis to dictate how those jurisdictions will cooperate. The FSB also recommends that nations implement a statutory framework to encourage cross-border cooperation through, among other things, the sharing of information. The FSB caveats, however, that such framework should not deprive regulatory agencies of the flexibility to act in the absence of cross-border cooperation.
Recovery and Resolution Planning
The FSB recommends that all SIFIs prepare recovery and resolution plans, which should be reviewed on an annual basis. To assist in such planning, the FSB proposes a uniform standard to assess the resolvability of firms, the feasibility of existing resolution tools, and the credibility of any resolution strategies. The FSB also suggests that certain measures be taken to improve resolvability, including, improved information systems, reduction and/or simplification of intercompany transactions, and negotiating such transactions at arms’ length.
Timeline for Implementation
The FSB also proposes a timeline to complete resolution planning and other regulatory improvements. Under the proposed timeline, SIFIs should have first drafts of recovery and resolution plans completed by December 2011 and June 2012, respectively. Final plans should be completed by December 2012.
The report also poses a number of questions and invites comments and suggestions. The comment period runs until September 2, 2011.