Restructuring

G-SIFI.  You’d be forgiven for mistaking this latest acronym for a new jeans brand in SoHo or an American hip hop group.  In a joint paper published recently, the Bank of England (BoE) and the Federal Deposit Insurance Corporation (FDIC) released its long awaited: “Resolving Globally Active, Systematically Important, Financial Institutions,” aiming to kick start the creation of an orderly resolution process for globally active, systemically important, financial institutions.  These G-SIFIs, as they are known, may never be as popular as G-Star Raw or G-Unit.  However, if the BoE and FDIC’s plan works, they probably should be.
The G-SIFI list is currently set and maintained by the Financial Stability Board, a body made up of regulators, central bankers and international bodies, with the G-SIFI list being updated every November.  The current list is below in case you want to take a look, or you can click here.
The joint paper outlines a resolution strategy for failed or failing G-SIFIs using a “single point of entry” and “top down” approach.  This resolution strategy aims to maintain systemically important operations and contain threats to financial stability.  Having witnessed the loss of vast quantities of taxpayer funds worldwide during the recent financial crisis, losses are assigned under the joint paper to shareholders and unsecured creditors in the financial group, thereby avoiding the need for a bailout by taxpayers.  Another objective of the resolution process is to give market participants greater predictability about how financial regulators may approach a resolution in practice, so that the anticipated resolution process can be accurately priced into securities.
The resolution process concept outlined in the joint paper is simple: a distressed G-SIFI would see its existing management replaced by its primary regulator, followed by a debt-for-equity exchange in which bondholders would replace existing shareholders, who would be wiped out.  Once restructured, the surviving G-SIFI would be returned to private hands.
The joint paper itself is high level.  It details a “top-down” resolution strategy for the U.S. and UK that involves a single resolution authority applying its powers at the parent company level of a financial group (depending on where it is headquartered) and discusses how such a top-down strategy could be implemented for a U.S. or UK financial group in a cross-border context.  The strategy for both regulators is based on recent financial legislation, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) in the U.S. and the Banking Act of 2009 in the UK.  A top-down resolution approach aims to establish new capital structures at the top of the group and determine losses accordingly in a G-SIFI financial restructuring scenario.  It also maintains the corporate structure of a G-SIFI intact, which can run to hundreds or thousands of legal entities.  The key advantage of the top-down, single point of entry approach, the joint paper argues, is that it avoids the need to commence separate territorial and entity-focused insolvency proceedings, which based on past experience are disruptive, time-consuming and expensive.
The joint paper anticipates a single point of entry resolution strategy.  In the U.S., the FDIC will be appointed receiver of the top-tier parent holding company of the financial group under the orderly liquidation authority (OLA) provisions of Title II of the Dodd-Frank Act following the company’s failure.  Immediately after the parent holding company is placed in to receivership, the OLA will transfer assets from the receivership estate to a bridge financial holding company (while leaving behind substantial unsecured liabilities and stockholder equity in the receivership), with the idea that this would immediately result in a well-capitalized holding company.  Much in the way that CIT continued operating once its parent entity was filed for chapter 11 (and you can read more about this here), subsidiaries of the parent entity in receivership can remain open and operating under this structure, limiting the need for destabilizing insolvency proceedings at the subsidiary level.  Once the G-SIFI has been stabilized by the OLA, the surviving operations can be transferred to private hands, with existing stockholder equity being wiped out.  The joint paper anticipates the OLA looking to subordinated debt holders or even senior unsecured debt claims as the immediate source of capital, while original debt holders would expect to see their claims written down to reflect any losses in the receivership not covered by existing equity holders, and these debt holders would also see their claims left in the receivership.  Finally, the remaining claims of debt holders would be converted, in part, into equity securities or convertible subordinated debt that will serve to capitalize the new operations.  If you want to read more about the rules issued by the FDIC implementing certain key sections of the Dodd Frank Act, click here, or review all of our Dodd Frank related posts by clicking here.
The UK’s approach involves the same top-down resolution process for its single point of entry resolution strategy.  The plan would be to transfer equity and debt securities from shareholders and debt holders to an appointed trustee.  The trustee would then hold the securities during a valuation period in which the losses of the G-SIFI are established, and the amount of recapitalization determined.  A bail-in announcement would then be made to the previous security holders that would include the details of the full write down or conversion.  Completion of the exchange would see the trustee transfer the equity and written down debt securities back to the original creditors of the G-SIFI, once the organization had been restored to a position whereby it is solvent and viable.  The trust would then be dissolved, leaving the recapitalized G-SIFI owned by the appropriate layer of original creditors.  It all sounds simple, in theory.
So what are the initial reviews?  The Financial Times’ Lex column thinks a formalized bondholder bail-in plan will raise the cost of debt for G-SIFIs and that funds that cannot hold equity would avoid buying G-SIFI debt on the basis that, if the institution were in need of resolution, such funds would not be able to hold the resulting equity.  It is worth noting that the joint paper does anticipate this problem and provides that creditors unable to hold equity securities would be able to request that the trustee in the UK sell the equity securities on their behalf.  The Financial Times’ second, more fundamental criticism is that other national regulators may not follow the lead of the BoE and FDIC.  That being said, someone has to take the lead, and it may as well be the regulators with the dubious distinction of having enjoyed the lion’s share of the world’s major financial restructurings.  The joint paper will also be a useful blueprint for other financial regulators to determine whether such a resolution process strategy is possible under their own national laws.  If it isn’t, they can plan accordingly (and set the expectation of their international counterparts), or seek to have national law amended to accommodate the strategy.  Lastly, though the Financial Times complains that this is just another piece in post-crisis financial regulation, perhaps some direction and movement is better than none.
A coordinated and consistent approach between national regulators, in particular ones as significant as the U.S. and UK regulators, is obviously encouraging.  The joint paper sets out one resolution strategy for G-SIFI’s though it notes that “other strategies may be more appropriate depending on the structure of a group, the nature of its business, and the size and location of the group’s losses.” To paraphrase Helmuth Karl Bernhard Graf von Moltke (one of the great strategists of the 19th century), “No plan survives first contact with the financial markets.”  On the other hand, having a plan is always a good start.
Group of global systemically important banks (G-SIBs)
In November 2011, the Financial Stability Board (FSB) published an integrated set of policy measures to address the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs).  In that publication, the FSB identified an initial group of G-SIFIs, namely 29 global systemically important banks (also known as G-SIBs):