Addressing Priority issues in Cross-Border resolution

May 2011

 Thisreportsetsoutaglobalfinancialservicesindustryperspectiveonanumberof priorityissuesincrossborderresolution.Theglobalindustrystronglysupportsthe developmentofaninternationalframeworkfortheresolutionofcrossborderfinancial firms.Thisiskeytoensuringdurablefinancialstabilityconsistentwithsustainable growthoftheglobaleconomy.Achievingthiswillrequireboththewilltoaddressthis challengeaswellassolutionstoanumberofdifficulttechnicalquestions.Thisreportis designedtocontributetobothoftheseaspects.Itarticulatesanindustryconsensuson anumberofkeychallengesandputsforwardproposalsforapproachingthem. ThereportbuildsontheInstitutesearliersubmissionstotheFinancialStabilityBoard onthesubject:AGlobalApproachtoResolvingFailingFinancialFirms:AnIndustry Perspective(May2010)andPreservingValueinFailingFinancialFirms(September 2010). Onpreservingcriticalfunctions,thereportadvocatesasharplyfocusedapproachtothe identificationofcriticalfunctions,notingthatthepreservationofsuchfunctionsinthe eventofafailureisnotacostfreeexercise.Thisshouldbedealtwithaspartof resolutionplanning.Firmshavearesponsibilitytoprovidetheinformationand explanationsthatneedtobeavailabletosupervisorstoachievethis.Whiletheindustry doesnotbelievethereisacaseforroutinedemandsfromsupervisorsforstructural changessuchasmodularizationofbusinessesorrequiredsubsidiarization,itis incumbentonfirmstoensurethatproperlyidentifiedcriticalfunctionscanbe maintainedandtransferredintheeventofafirmsfailure. Thereportsupportstheuseofbailintechniquestoreducelossofvalueinfailingfirms andavoidsystemictrauma.Theprimaryfocusofbailinshouldbesubordinateddebt, whichcouldbeexpected,inamajorityofcases,tobesufficienttoachievethe objectives.Thebailinginofunsecuredseniordebtshouldoccuronlyinthespecial circumstances,thatthisisnecessaryasalastresortalternativetowindingdownor liquidation,withcertainrequirementsimposedonauthoritiesiftheywishtousethese supplementaryseniordebtbailinpowers.Creditliabilitiesarisingfromtradingactivities shouldbeexcludedfromthescopeofbailin,andtheintroductionofbailinshouldbe onaprospectivebasisonly. Aneffectiveframeworkfortheresolutionofcrossborderfirmsrequiresboth convergenceofnationalregimesandenhancedcooperationandcoordinationamong resolutionauthorities,basedonlegallyeffectivecrisismanagementagreements.Such agreementshavethecapacitytoallowforapproachestoresolutionthatareconsistent 1

withthestructuralandorganizationalapproachesadoptedbyfirms,andwhichavoid increasedringfencingofcountriesandfragmentationoftheinternationalmarketplace. Therearesignificantbenefitstotheglobalandlocaleconomiesderivingfromthe diverserangeofapproachesandstructuresthatglobalfirmsdeploy.Crossborder resolutionarrangementsneedtopreservethese.Tobeeffectivesuchcrisis managementagreementsneedtobeembeddedinnationalresolutionframeworks incorporatinganumberofprovisionsdesignedtounderpinandsupportthe internationalmarketinfinancialservices. Theglobalindustryisstronglycommittedtothedevelopmentofaneffective internationalframeworkfortheresolutionofcrossborderfinancialfirms.Weconsider that,buildingontheworktodatebytheFSBanditsmembersaswellasbyindustry representatives,thisgoalisnowpotentiallywithinourgrasp.TheIIFispleasedto presentthisreportasanindustrycontributiontotheworkinthisarea.Theindustry standsreadytoparticipateinfurtherworkanddialogueinordertoleveragetheinsights andsolutionsofallpartiestowardtheachievementofthisstronglysharedobjective.

JosefAckermann ChairmanoftheManagementBoard andtheGroupExecutiveCommittee, DeutscheBankAG PeterSands GroupChiefExecutive, StandardChartered,PLC

UrsRohner ChairmanoftheBoardofDirectors CreditSuisseGroupAG CharlesH.Dallara ManagingDirector InstituteofInternationalFinance

Contents
Preface IIFBoardofDirectors IIFSpecialCommitteeonEffectiveRegulation IIFWorkingGrouponCrossBorderResolution ExecutiveSummary Introduction 1 4 7 12 16 21 23 30 42 53 55 57 60

Section1Effectiveresolutionplanningensuringthecontinuanceofcriticalfunctions Section2Avoidingsystemictraumamakingbailintechniquesoperational Section3Resolvingcrossborderfinancialfirmsaddressingkeyissues

Annex1:KeycomponentsofaneffectiveresolutionframeworkassetoutinIIFReport, AGlobalApproachtoFailingFinancialFirms:AnIndustryPerspective Annex2:Criticalfunctionssomeputativeexamplestobeconsidered Annex3:SummaryofIIFPaper,PreservingValueinFailingFirms Annex4:Legalissuesingroupsupportandresolution

IIFBoardofDirectors
Chairman JosefAckermann* ChairmanoftheManagementBoardand theGroupExecutiveCommittee DeutscheBankAG Chairman Chairman Chairman FranciscoGonzlez* RobertoE.Setubal* RickWaugh* ChairmanandChief PresidentandChief PresidentandChief ExecutiveOfficer ExecutiveOfficer,Ita ExecutiveOfficer BBVA UnibancoBancoS/A Scotiabank andViceChairmanof theBoardofIta UnibancoHoldingS/A Treasurer MarcusWallenberg* ChairmanoftheBoard SEB Mr.MichaelSmith Ms.SuzanSabanciDincer ChiefExecutiveOfficer ChairmanandExecutiveBoardMember AustraliaandNewZealandBanking AkbankT.A.S. GroupLimited Mr.YannisS.Costopoulos* Mr.WalterBayly ChairmanoftheBoardofDirectors ChiefExecutiveOfficer AlphaBankA.E. BancodeCrditodelPer(BCP) Mr.PeterWallison Mr.BaudouinProt* SeniorFellow ChiefExecutiveOfficer FinancialPolicyStudies BNPParibas AmericanEnterpriseInstitute Mr.HassanElSayedAbdalla Mr.RobertP.Kelly* ViceChairmanandManagingDirector ChairmanandChiefExecutiveOfficer ArabAfricanInternationalBank BNYMellon

Mr.VikramPandit ChiefExecutiveOfficer Citigroup,Inc. Mr.MartinBlessing ChairmanoftheBoardofManaging Directors CommerzbankAG Mr.UrsRohner ChairmanoftheBoardofDirectors CreditSuisseGroupAG Mr.AndreasTreichl ChairmanoftheManagementBoard andChiefExecutiveOfficer ErsteGroupBankAG Mr.GaryD.Cohn PresidentandChiefOperatingOfficer Goldman,Sachs&Co. Mr.DouglasFlint GroupChairman HSBCHoldingsplc Mr.K.VamanKamath ChairmanoftheBoard ICICIBankLtd. Mr.JiangJianqing ChairmanoftheBoardofDirectorsand President IndustrialandCommercialBankofChina Mr.JanHommen ChairmanoftheExecutiveBoard INGGroup Mr.CharlesH.Dallara(exofficio)* ManagingDirector InstituteofInternationalFinance 5

Mr.CorradoPassera ManagingDirectorandChiefExecutive Officer IntesaSanpaoloS.p.A. Mr.JesStaley ChiefExecutiveOfficer InvestmentBank J.P.MorganChase&Co. Mr.YoondaeEuh Chairman KBFinancialGroupInc. Mr.YasuhiroSato PresidentandChiefExecutiveOfficer MizuhoCorporateBank,Ltd. Mr.JamesGorman PresidentandChiefExecutiveOfficer MorganStanley Mr.IbrahimS.Dabdoub GroupChiefExecutiveOfficer NationalBankofKuwait Mr.FrdricOuda ChairmanandChiefExecutiveOfficer SocitGnrale Mr.PeterSands GroupChiefExecutive StandardChartered,PLC Mr.WalterB.Kielholz ChairmanoftheBoardofDirectors SwissReinsuranceCompanyLtd. Mr.NobuoKuroyanagi* Chairman TheBankofTokyoMitsubishiUFJ,Ltd.

Mr.OswaldGruebel GroupChiefExecutiveOfficer UBSAG

Mr.MartinSenn ChiefExecutiveOfficer ZurichFinancialServices

*MemberoftheAdministrativeandNominationsCommittee

IIFSpecialCommitteeonEffectiveRegulation
Chairman Mr.PeterSands GroupChiefExecutive StandardChartered,PLC Mr.DavidHodnett Mr.GerdHusler GroupFinancialDirector ChiefExecutiveOfficer ABSAGroupLimited BayernLB Mr.BobPenn Ms.MariaAbascalRojo Partner ChiefEconomistRegulationandPublic Allen&OveryLLP Policy BBVAResearch BBVA Ms.AlejandraKindelnOteyza HeadofResearchandPublicPolicy TheHonourableKevinLynch Communications,GroupMarketingand ViceChair ResearchDivision BMOFinancialGroup BancoSantander Mr.RobEverett Mr.BaudouinProt EuropeanChiefOperatingOfficer ChiefExecutiveOfficer BankofAmericaMerrillLynch BNPParibasGroup Mr.RobertPitfield Mr.ChristianLajoie GroupHead,ChiefRiskOfficer HeadofGroupPrudentialAffairs/Co BankofNovaScotia headofGroupPrudentialandPublic Affairs Mr.RichardQuinn BNPParibasGroup Director,RegulatoryAffairs GroupCompliance Mr.MarkMusi Barclays EVP,ChiefComplianceandEthics Officer Mr.MarkHarding BNYMellon GroupGeneralCounsel BarclaysPLC

Mr.BrianRogan ViceChairmanandChiefRiskOfficer BNYMellon Ms.JillConsidine Chairman ButterfieldFulcrumGroup Mr.MichaelHelfer GeneralCounselandCorporate Secretary CitigroupInc. Mr.SimonGleeson Partner CliffordChanceLLP Dr.StefanSchmittmann ChiefRiskOfficerandMemberofthe BoardofManagingDirectors CommerzbankAG Mr.JrgErlebach DivisionalBoardMember GroupRiskControlling&Capital Management CommerzbankAG Dr.RodneyMaddock ExecutiveGeneralManager GroupStrategyDevelopment CommonwealthBankofAustralia Mr.HubbertdeVauplane DirectionJuridiqueetConformit Groupe CrditAgricole Mr.OlivierMotte HeadofPublicAffairs MemberoftheManagement Committee,CACIB CreditAgricoleCIB 8

Mr.JrmeBrunel HeadofPublicAffairs,Memberofthe ExecutiveCommittee CrditAgricoleSA. Mr.UrsRohner ChairmanoftheBoardofDirectors CreditSuisseGroupAG Dr.RenBuholzer ManagingDirector,GlobalHeadPublic Policy CreditSuisse Mr.RobertWagner ChiefAnalyst GroupFinance,Regulation DanskeBank Dr.HugoBanziger ChiefRiskOfficer&Memberofthe ManagementBoard DeutscheBankAG Mr.BjrnErikNss GroupExecutiveVicePresident GroupFinanceandRiskManagement DnBNORASA Mr.RoarHoff ExecutiveVicePresident,HeadofGroup RiskAnalysis DnBNORASA Mr.WolfgangKirsch ChiefExecutiveOfficer DZBANKAG Dr.FlorianStrassberger GeneralManager HeadofNewYorkBranch DZBank

Dr.ManfredWimmer ChiefFinancialOfficer,Chief PerformanceOfficer,andMemberof theManagementBoard ErsteGroupBankAG Mr.BarryStander HeadofBanksActCompliance RegulatoryRiskManagement FirstRand Mr.FaryarShirzad ManagingDirector,GlobalHead OfficeofGovernmentAffairs GoldmanSachs Mr.GregoryWilson President GregoryP.WilsonConsulting Ms.LaradeMesa HeadofPublicPolicy ResearchDepartment GrupoSantander Mr.NasserAlShaali ChiefExecutiveOfficer GulfCraft Mr.JamesChew DeputyHead,StrategyandPlanning GMOInternational HSBC Mr.KoosTimmermans MemberoftheExecutiveBoardand CRO INGGroup Mr.CarloMessina ChiefFinancialOfficer IntesaSanpaoloSpa 9

Mr.RobertoSetubal PresidentandCEOofItauUnibancoS/A andViceChairmanof theBoardofItauUnibancoHoldingS/A ItaUnibancoS/A Dr.JacobFrenkel Chairman JPMorganChaseInternational Dr.MarkLawrence ManagingDirector MarkLawrenceGroup Mr.PhilipHrle Director McKinseyandCo. Mr.MasaoHasegawa ManagingDirector,CRO,andCCO MitsubishiUFJFinancialGroup,Inc Mr.DaisakuAbe ManagingExecutiveOfficer,Chief StrategyOfficer,ChiefInformation Officer,GeneralManagerofGroup StrategicPlanning MizuhoFinancialGroup,Inc. Mr.DavidRusso ChiefFinancialOfficer Institutional MorganStanley Ms.ClareWoodman ChiefOperationsOfficerEMEA MorganStanley Mr.IbrahimDabdoub GroupChiefExecutiveOfficer NationalBankofKuwait,S.A.K.

Mr.ParksonCheong GeneralManagerandGroupChiefRisk Officer GroupRiskManagement NationalBankofKuwait,S.A.K. Mr.DavidBenson ViceChairman,NomuraHolding NomuraInternationalplc Mr.SamuelHintonSmith Director,PublicAffairs CorporateCommunications Nomura Mr.AriKaperi ExecutiveVicePresident,ChiefRisk Officer GroupRiskManagement NordeaBankAB Mr.JohnDrzik PresidentandChiefExecutiveOfficer OliverWyman Mr.WilliamDemchak ViceChairman PNCFinancialServicesGroup Mr.JohnW.Campbell Partner AdvisoryFinancialServices PricewaterhouseCoopersLLP Mr.EugeneA.Ludwig FounderandChiefExecutiveOfficer PromontoryFinancialGroup,LLC Mr.FernandoBarnuevoSebastiande Erice ManagingDirector RHJISwissManagement 10

Mr.MortenFriis ChiefRiskOfficer RoyalBankofCanada Mr.RussellGibson Director,RegulatoryAffairs,Group RegulatoryAffairs& Compliance RoyalBankofScotlandGroup Mr.NilsFredrikNyblaeus SeniorAdvisortotheChiefExecutive Officer SEBGroup Mr.PierreMina HeadofGroupRegulationCoordination SocitGnrale Mr.RodginCohen SeniorChairman Sullivan&CromwellLLP Mr.NobuakiKurumatani ManagingDirector SumitomoMitsuiBankingCorporation Mrs.KerstinafJochnick ManagingDirector SwedishBankersAssociation Mr.PhilippeBrahin Director RiskManagement SwissReinsuranceCompanyLtd Mr.DonaldF.Donahue ChairmanandChiefExecutiveOfficer TheDepositoryTrust&Clearing Corporation

Mr.TakashiOyama CounselloronGlobalStrategyto PresidentandtheBoardof Directors TheNorinchukinBank Dr.SteveHottiger ManagingDirector&Head GroupGovernmentalAffairs UBSAG Mr.SergioLugaresi SeniorVicePresidentHeadof RegulatoryAffairs InstitutionalandRegulatoryStrategic Advisory UniCreditGroup

Mr.RichardYorke EVP&GroupHead InternationalGroup WellsFargo&Company Mr.KevinNixon HeadofRegulatoryReform Westpac Dr.PeterBuomberger GroupHeadofGovernmentand IndustryAffairs ZurichFinancialServices Dr.MadelynAntoncic

11

IIFWorkingGrouponCrossBorderResolution
Chairman Mr.UrsRohner ChairmanoftheBoardofDirectors CreditSuisseGroupAG Mr.JohnWhittaker Mr.DiederickvanMierlo GroupOperationalRiskDirector ManagingDirectorCorporate&Markets BarclaysBankPLC Risk CentralRiskManagement Ms.MariaAbascalRojo ABNAMRO ChiefEconomistRegulationandPublic Policy Mr.BobPenn BBVAResearch Partner BBVA Allen&OveryLLP Mr.ChristianLajoie Ms.SuzanneChomiczewski HeadofGroupPrudentialAffairs/Co Director headofGroupPrudentialandPublic CorporateTreasury/GRRP Affairs BankofAmerica BNPParibas Mr.MarkLunn Mr.BradleyGans SeniorVicePresident ChiefLegalOfficer BankofAmerica Europe,MiddleEast&Africa Mr.MichaelD'Souza Citi ManagingDirector BankofAmericaMerrillLynch Ms.TinaLocatelli ManagingDirector&GeneralCounsel Mr.RichardQuinn IndependentRisk Director,RegulatoryAffairs CitigroupInc. GroupCompliance Barclays Mr.SethGrosshandler Partner ClearyGottliebSteen&HamiltonLLP

12

Mr.SimonGleeson Partner CliffordChance Mr.JrmeBrunel HeadofPublicAffairs,Memberofthe ExecutiveCommittee CrditAgricoleSA. Mr.VolkerBtz Director Treasury CreditSuisse Mr.D.WilsonErvin SeniorAdvisortotheCEO CreditSuisse Mr.AndrewProcter GlobalHeadofGovernment& RegulatoryAffairs Government&RegulatoryAffairs DeutscheBankAG Mr.KarlHeinzvonOppenkowski Director,CreditRestructuring CreditDepartment DZBank Ms.GerdaHolzingerBurgstaller HeadofChairmansSupport ChairmansOffice ErsteGroupBankAG Dr.OliverSchtz HeadofEULegislativeandRegulatory Affairs ErsteGroupBankAG Mr.StephenDavies ManagingDirector Finance GoldmanSachsInternational 13

Ms.LaradeMesa HeadofPublicPolicy ResearchDepartment GrupoSantander Ms.SherylSlater HeadofAssetandLiabilityManagement AsiaPacificFinance HongKongandShanghaiBanking CorporationLimited Mr.JamesChew DeputyHead,StrategyandPlanning GMOInternational HSBC Mr.AlainC.Stangroome HeadofGroupCapitalPlanning GroupFinancialPlanningandTax HSBCHoldingsplc Mr.HenkHuisman DeputyDirector Public&GovernmentAffairs INGGroup Ms.EllenBish LegalCounselRegulatoryAffairs CorporateLegalDepartment INGGroup Mr.LuigiRuggerone HeadofCountryRisk RiskManagementDepartment IntesaSanpaoloS.p.A. Ms.KarenLinney ManagingDirectorandEMEA InvestmentBankGeneralCounsel JPMorganChase&Co. Mr.MichaelOffen MD,CorporateFinance JPMorganChase&Co.

Ms.SandraBoss Director McKinsey&Company Mr.AkihiroKitano SeniorManager Basel2ImplementationOffice MitsubishiUFJFinancialGroup,Inc. Mr.HideyukiToriumi SeniorManager Basel2ImplementationOffice MitsubishiUFJFinancialGroup,Inc. Mr.TetsuoIimori ExecutiveOfficerandGeneralManager ofCorporatePlanning MizuhoFinancialGroup,Inc. Mr.GuyClayton ManagingDirector LegalandCompliance MorganStanley Mr.ParksonCheong GeneralManagerandGroupChiefRisk Officer Credit&RiskManagementGroup NationalBankofKuwaitS.A.K. Mr.JohnBovenzi Partner OliverWyman Ms.SherylKennedy ChiefExecutiveOfficer PromontoryFinancialGroup,Canada ULC Mr.RalphRicks Head,GroupRegulatoryDevelopments GroupRegulatoryAffairs RoyalBankofScotland 14

Mr.SeanMcGuckin SeniorVicePresidentandHead,Risk Policy&CapitalMarkets Scotiabank Dr.ByungChulLim ManagingDirector ShinhanFSBResearchInstitute ShinhanFinancialGroup Mr.DenisDevers HeadofFinancialManagement DEVL/FIN SocitGenerale Ms.FrdriqueMarchal CapitalPlanningandRegulations FinanceDepartment SocitGnrale Mr.GarethBerney Head,CapitalOptimisation GroupTreasury StandardCharteredBank Mr.TetsuroYoshino JointGeneralManager CorporatePlanning SumitomoMitsuiBankingCorporation Mr.PhilippeBrahin Director RiskManagement SwissReinsuranceCompanyLtd. Mr.ThomasPohl ExecutiveDirector,HeadExecutive& InternationalAffairs GroupGovernmentalAffairs UBSAG

Mr.SergioLugaresi SeniorVicePresidentandHeadof RegulatoryAffairs InstitutionalandRegulatoryStrategic Advisory UniCreditGroup

Mr.KevinNixon HeadofRegulatoryReform Westpac Mr.EdmundBosworth HeadofRiskReward GroupFinance WestpacBankingCorporation

15

ExecutiveSummary
1. ThissubmissionbuildsupontheInstitutesprevioussubmissionstotheFSB:A GlobalApproachtoResolvingFailingFinancialFirms:AnIndustryPerspective(May 2010)andPreservingValueinFailingFinancialFirms(September2010). Effectiveresolutionisessentialinachievinglongtermresilienceandfinancial stability.Itplaysakeyroleinaddressingmoralhazardandissuesassociatedwith systemicallyimportantfirms. Thispaperaddressesthreekeycomponentsofaneffectiveframeworkforcross borderresolution:(a)resolutionplanningforthemaintenanceofcriticalfunctions, (b)bailinmechanismsand(c)addressingkeycrossborderissues.

2.

3.

Resolutionplanningforcriticalfunctions
4. Highqualityrecoveryandresolutionplanningisanessentialcomponentof effectiveresolution.Suchplanningshouldtakeplaceonagroupwidebasis.There shouldbeasingleresolutionplanforthegroupasawhole,thoughthisshould addressthesituationinthedifferentpartsofthegroupandshouldbedeveloped onthebasisofstrongcoordinationbetweentheauthoritiesinthedifferent jurisdictionsinthecontextofawellfunctioningfirmspecificcrisismanagement group. Maintainingcriticalfunctionsisnotacostfreeexercise.Inadditionto administrativecoststotheextentthatgoodassetsaretransferredtosupport criticalliabilitiestheremaybefewersuchassetsavailabletocoverlossesinthe failingfirm.Itisimportantthereforetoadoptatightdefinitionofcritical functions. Resolutionplanningistheprimaryresponsibilityoftheauthorities.Firmshavea responsibilitytoprovidetheinformationnecessarytoallowtheauthoritiestoplan effectively. Planningforthecontinuanceofcriticalfunctionsshouldnotinvolverequeststo firmsasamatterofcoursetochangetheirorganizationalstructures.Inparticular, forcedmodularizationorsubsidiarizationshouldnotbecomethepreferredchoice ofauthorities.Itisimportantthatagroupsstructureandorganizationreflectits businessmodelandstrategy.Arequirementtomoveawayfromsuchanapproach willgiverisetosignificantinefficienciesandeconomiccosts. Firmshavetheresponsibilitytoprovidetheinformationandexplanation necessarytoenable: a) Anassessmentofthedegreeofthefunctionscriticalitytotheeconomy; 16

5.

6.

7.

8.

b) Clearunderstandingofthefunctioninquestion,includingitskeyfeaturesand thescaleofprovisionbythefirm; c) Identificationofhowthatfunctionisprovidedbythefirm; d) Separationandtransferofthefunctioninacrisis;and e) Understandingofhowthefunctionisfinanced,andwillcontinuetobe financedinatransfersituation. 9. Inthecontextofcrossbordergroups,authoritiesmustcooperateandcoordinate onthebasisofeffectivefirmspecificagreementstocarryoutresolutionplanning thatavoidstheimpositionofparticularorganizationalstructuresandthe fragmentationofinternationalmarkets.

Bailinmechanisms
10. Itisimportanttoavoidthatthefailureofafinancialfirmgivesrisetolossesof suchascalethatsystemictraumaoccurs.Itisimportantthatthefailureofsucha firmdoesnot,throughitsinterconnectednesswiththebroadersystem,giverise toasystemiceventthatunderminesfinancialstability. Incontrastwiththesituationinvolvinganonfinancialfirm,thesimplefactofthe declarationofafirmsinsolvencyandliquidationcancauselossofbusinessvalue sufficienttocausesystemicdamage.InthecaseofLehman,thelosstocreditors postdeclarationofinsolvencyisexpectedtobeanumberoftimesgreaterthan thelossofassetvalueincurredpriortothedeclarationofinsolvency. Bailincanforestallprecipitouslossofvalueandsystemicshockbyrecapitalizing thefirmandallowingittoberestructured. Asetofprinciplesisputforwardasasuggestedbasisforthedevelopmentofbail inregimesindifferentjurisdictions. Whilegoodprogresshasbeenmadeindevelopingproposalstomakethebailin conceptmoreoperational,thereremaindifficultquestionstoberesolvedand challengestobeovercome.Accordingly,inanumberofareastheneedforfurther workhasbeenidentified. Theviewsofinvestorswillalsobeimportantinarrivingatfinalproposalsfora bailinmechanism.InputtingforwardnowthesuggestedapproachinSection2,it isenvisagedthatthisapproachcanformthebasisforawellgrounded engagementwiththeinvestorcommunity. Theobjectiveofabailinistopreservesystemicstability.Accordingly,allfinancial institutionsshouldpotentiallybeabletobethesubjectofabailindetermination. 17

11.

12. 13. 14.

15.

16.

Inpractice,onlythosethefailureofwhichwouldbesystemicinthecircumstances asdeterminedbytheauthoritiesshouldactuallybesubjecttobailin. 17. Theorderofprioritybetweenclassesofshareholdersandclassesofcreditors shouldbemaintainedinallcases.Withinaclass,certaincreditorsmaybebailedin whileothersarenot.However,nocreditorshouldbeleftworseoffastheresultof abailinthans/hewouldhavebeenintheliquidationofthefirm. Itisproposedthattheprimaryscopeofabailinmechanismshouldbelimitedto subordinateddebt.Inmanycasesthisislikelytobesufficienttorecapitalizethe firmsoastoachievetheobjectivessetout.Suchanapproachcanhelpaddress someofthepotentialdisadvantagesofbailin,includingenhanceduncertainty, increasedpricingofdebt,andpossiblefundingarbitrage.Moreover,suchan approachhelpslockintightlyadherencetothestrictorderofprioritiesinan insolvency. However,itisacknowledgedthatitisnotpossibletocalibratepreciselyexante thescaleofthepotentialneedforfreshcapitalinacrisissituation.Thereforeitis envisagedthatasalastresort,andsubjecttoclearrequirementsandcriteria,it maybenecessarytobailinaproportionoftheseniordebtofthefirmasan alternativetothewindingdownofthefirm. TheIndustrybelievesthatobligationsarisingfromthetradingactivitiesofthefirm shouldbeexcludedexantefromthescopeofthisexceptionalpowerofbailin. Whetherthescopeofthisbailinshouldbemorepreciselydeterminedexante forexample,bytheexclusionofliabilitieswithamaturityoflessthan365days,or ofuninsureddepositsisakeyissuerequiringfurtherconsideration. Inallcases,theorderofprioritybetweendifferentclassesofshareholderand debtholdermustbemaintained.Whilethisprincipleisimmutable,furtherworkis neededtoidentifythebesttechnicaloptionstoachievethis. Bailinallowsthefirmtoberestructured,weakmanagementtobereplaced,and therecapitalizedfirmtoaccesssourcesofliquidityasbeingnowfirmlycapitalized. Inthecaseofcrossborderfirms,thepreferredapproachisfortheFinancial StabilityBoard(FSB)toreachagreementontherequirementforeachcountryto adoptabailinmechanism.Thiswouldavoiddivergentapproaches.Totheextent thatthisisnotachievedcontractualsolutionswillberequired.

18.

19.

20.

21.

22. 23.

Keyaspectsinresolvingcrossborderfirms
24. Nationalresolutionregimesmustformconsistentandconvergentcomponentsof aninternationalframeworkfortheresolutionofcrossborderfirms.

18

25.

Firmsadoptavarietyofstructuralandorganizationalapproachestotheoperation oftheircrossborderbusinesses.Suchapproachesaredeterminedprimarilybythe natureofthebusinessofthefirmandthebusinessmodeladopted.Assuch, materialdisbenefitswouldfollowfromanyattempttorequirefirmstoadopt particularstructuresororganizationalapproaches. Forcertaintypesofbusinessandundercertainbusinessmodels,theabilityof groupstoruntheirbusinesssoastooptimizethegroupinterestcanresultin enhancedoutcomesforallpartiesandtheeconomy.However,thereisapotential mismatchbetweensuchagroupinterestconceptandthelegalentitybased natureofresolutionregimes.Moreover,insuchcasestherequirementfor authoritiesprimarilytopursueoutcomesdefinedinnationaljurisdictiontermscan also,dependinguponthenatureofthebusiness,producenegativesum outcomes. TheworkbeingcarriedoutbytheFSBonfirmspecificcrisismanagement agreementsisimportantandhasthepotentialtoachievesignificantprogressin thisregard.Tobesuccessful,however,theseagreementsshouldestablishlegally effectiveresolutionmodalitiesthatreflecttheorganizationalstructureand businessmodelofthegroup.Thisinturnrequiresthatnationalresolution frameworksareadaptedtogiveeffecttosuchagreements. Amongthecomponentsofsuchframeworksshouldbe: Internationalmandatesforauthorities; Arequirementofnondiscriminationagainstcreditorsofthegrouponthe basisoftheirlocationornationality; Aobjectivetooptimizeoutcomesforcreditorsofthegroupasawhole; Arequirementforjointplanninginthecontextofcrisismanagementand resolutioncolleges,andclearcooperationandcoordinationagreementsledby thehomeauthority; Arequirementforauthoritiestoshareallrelevantinformationonthebasisof strictconfidentiality;and Principlesfortheeffectiveandfairinteroperationoffundingarrangementsin respectoftheadditionalcostsofresolution.

26.

27.

28.

29.

Resolutionandresolutionplanninginrespectofahostbranchneedstotakeinto accountlocalrequirements,regulations,anddepositorprotectionarrangements. Itshouldgenerallybeledbythehomeauthorityinclosecooperationwiththe hostauthority(thoughtheremaybeexceptionalcasesinwhichtheparticular

19

configurationmakesitmoreappropriatefortheresolutiontobeledbythehost authority). 30. Inthedevelopmentoffirmspecificresolutionagreementsbetweenauthorities, oneoftheissuestoaddresswillbeachievingfairoutcomesamongcreditors acrossthegroup.Thedevelopmentofmechanismsthatcanachievethisin particularbyaddressingthedistributionofresourcesinthegroupduringa resolutionremainsadifficultandchallengingsubject.Intensifiedworkandclose dialoguebetweentheofficialandprivatesectorsisneededtotryanddevelop optimalsolutions.

20

Introduction
31. ThispaperhasbeenpreparedbytheInstitutesCrossBorderResolutionWorking Group(CBRWG),chairedbyUrsRohner,ChairmanoftheBoardofDirectors, CreditSuisseGroupAG,asacontinuationoftheIndustryscontributiontothe effortsaimedatestablishinganeffectiveinternationalframeworkforthe resolutionofcrossborderfinancialfirms.Theworkhasbeencarriedoutunder theauspicesoftheSpecialCommitteeonEffectiveRegulation,chairedbyPeter Sands,GroupChiefExecutive,StandardCharteredPLC.

Buildingonpreviouswork
32. InMay2010,theInstitutepublishedareportdevelopedbytheCBRWG,AGlobal ApproachtoFailingFinancialFirms:AnIndustryPerspective 1 ,whichoutlinedthe keyelementsofaframeworkthatwouldmakeitpossibleforanyfirm,irrespective ofitssizeorinterconnectedness,toexitthemarketwithoutcausingsystemic disruptionandwithoutanyexpectationthattaxpayersmoneywillbeused.Sucha frameworkiskeytoachievingadurablyresilientfinancialsystem.Asummaryof thekeycomponentsofaneffectiveresolutionframeworkascontainedintheMay 2010reportaresetoutinAnnex1. AftertheMay2010report,theInstitutesubmittedtotheFSBthepaper, PreservingValueinFailingFirms 2 inSeptember2010,focusedonthepowerfor authoritiestoconvertsomeofthedebtofthefirmtocapitaltobringaboutits recapitalization(creditorbailinorbailin).Thepaperwaslargelyexploratory anddidnotseektoreachfinalconclusionsonseveralkeyissues;however,it expressedconsiderablemeritinexaminingbailinarrangementsfurther.

33.

Importanceofresolvability
34. TheInstitutebelievesthateffectiveresolutionisessentialtoachievinglongterm resilienceandfinancialstability.Sucheffectiveresolutionplaysakeyrolein addressingmoralhazardandissuesassociatedwithsystemicallyimportantfirms. AstheInstitutehassaidpreviously,westronglybelievethataddressingsystemic riskrequiresanapproachbasedonfourmutuallyreinforcingcomponents: (a)Enhancedregulation, (b)Improvedindustrypractices, (c)Strengthenedsupervision,and
1 2

35.

http://www.iif.com/download.php?id=Oq+9y23X4Us= http://www.iif.com/download.php?id=ryVjoux4FSs=

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(d)Effectivelyfunctioningmarkets. 36. Notonlyisthebalancedintegrationofthesefourcomponentsnecessaryto achievelongtermstability,failuretoachievesuchbalanceislikelytohave significantadverseconsequences.Thereiscurrentlyarealriskofdisproportionate relianceontheregulatorycomponentattheexpenseoftheotherthree,and thereissignificantpotentialforadverseconsequencesflowingfromthis. Aneffectiveframeworkfortheresolutionofallfinancialfirms,includinglarge, complexfinancialinstitutions,isakeycomponentinachievingeffectively functioningmarketsandfindingabalancedintegrationofthefourcomponents outlined.Puttinginplaceeffectivelyfunctioningresolutionregimesisthereforea keypriority.

37.

Structureofthepaper
38. ThispapercontinuestheIndustrysworkinthisarea.Inparticular,threebroad priorityareashavebeenidentifiedforfurtherwork.Thesearereflectedinthe threesectionsofthispaper: Section1considerstheneedtoensurethecontinuanceofcriticalfunctionsinthe eventofthefailureofalarge,complexfinancialfirm. Section2continuestheInstitutesworkonbailin.Itseekstooutlinean effectiveandeconomicallyviablemechanismwherebythesystemicshock potentiallyarisingfromthefailureoffinancialfirmissignificantlyreduced.The sectiondevelopsadraftsetofprinciplesthatmightbeenvisagedforthecreation ofabailinregime. Section3developsananalysisofthekeyobstaclestoachievingtheeffective resolutionofcrossborder,asopposedtopurelydomestic,financialfirmsand proposessolutionstotheseobstacles.

39. 40.

41.

22

Section1Effectiveresolutionplanningensuringthe continuanceofcriticalfunctions
42. Forfinancialinstitutionstobeabletoexitthemarketinanorderlymanner,itis necessarythattheirdoingsodoesnotcauseafailureinessentialserviceprovision withinthefinancialsystemsuchthatthewidereconomysuffersamajor disruption. Thissectionseekstoadvancetheanalysisaimedatachievingthatobjective.The issueiscloselytiedto,indeedformsanintegralpart,ofthebroaderissueof resolutionplanning.Ensuringthecontinuanceofcriticalfunctionsisakeyaspect ofsuchplanning.Accordinglytheanalysisinthissectionseekstoenhancethe qualityandeffectivenessofsuchplanning.

43.

Themeaningofcriticalfunction
44. Itisimportanttobeclearaboutwhatismeantbyacriticalfunction.Thisis necessaryfortworeasons.First,differentobjectivesmaybeachievedbydifferent tools.Beingpreciseabouttheparticularobjectiveinviewforexample, maintainingcriticalfunctions,asopposedto,say,avoidingcontagion,preserving value,orminimizingcoststothedepositprotectionschemecancontribute significantlytothedesignofaneffectiveresolutionframework.

Notacostfreequestion 45. Second,thepreservationofcriticalfunctionsmaynotbeacostfreeexercise.To takeasimplestylizedexample:thetransferoftheliabilitiesthatconstitutethe essenceofthecriticalfunctiontoabridgebankwillrequirethetransferofgood assetsofatleastthesamevaluetosupportthoseliabilities.Thismeansand indeeditdependsforitseffectivenessonthefactthatthetransferredliabilities areprotectedfromlosses.Ontheotherhand,thoseliabilitiesleftbehindinthe rumpinstitutionareexposedtogreaterlossesthantheywouldotherwisebe,due totheremovaloftheiraccesstothetransferred,goodassets.Becauseofthe principlethatnocreditorshouldbeworseoffthans/hewouldbeinaliquidation, andassumingthatthevalueinthefailingfirmtakenasawholeislessthanits liabilities,thiswouldresultinashortfallthatneedstobesomehowmadegood. Morerealistically,itislikelythatthedecisionwillbemadetotransferafull businesslineincorporatingthecriticalfunction.Thiswillencompassboththe liabilitiesandtheassetsthatconstitutethatbusiness.Ofcourse,iftheassetsare impairedthepurchaserwillwishtoseefurtherassetsprovidedtoensurethat whats/heisreceivingisatleastaparityofassetvalueandliabilities.Inthiscase,it maybelikelythatthefranchisevalueofthebusinesslinewillalsocontribute

46.

23

materiallytothevaluetransferredsothatthevaluegapcreatedintherump firm(tobebornebytheresidualcreditors)mightbesignificantlyreduced. Systemicrelevancenecessary,butnotsufficient 47. Inthepaper,GuidancetoAssesstheSystemicImportanceofFinancialInstitutions, MarketsandInstruments:InitialConsiderations(October2009),theFSB,the InternationalMonetaryFund(IMF),andtheBaselCommitteeonBanking Supervision(BCBS)providedabroaddefinitionofasystemicevent: Thedisruptiontotheflowoffinancialservicesthatis(i)causedbyan impairmentofallorpartsofthefinancialsystem;and(ii)hasthepotentialto haveseriousnegativeconsequencesfortherealeconomy. 48. Thefollowingkeyelementscontributetothesystemicrelevanceofthedisruption: a. b. nonsubstitutability:thedisruptedservicescannotbesubstitutedwithina reasonabletimeandatacceptablecosts; negativeexternalities:thefailureofoneinstitutionandthediscontinuanceof itscriticalfunctionscausefrictionandspillovertoothermarketparticipants; and realeconomyimpact:thedisruptionbothdirectlyandthroughitsnegative externalitiescausesasignificantspilloverintotherealeconomy.

c. 49.

Toanimportantextent,thesethreecriteriaarerelevantforthedeterminationof whatisacriticalfunctionforcurrentpurposes.Itisclearthatitisanecessary conditionforaparticularfunctiontomeettherequirementsofsystemicrelevance inordertobeconsideredacriticalfunction.

Clarityastomodeofsystemicness 50. However,somefurtherspecificationmayberequiredtoarriveatapractical definitionofcriticalfunctionsforthispurpose.Forexample,thefactthatafirmis connectedtoalargenumberofcounterpartiesbecauseitoperatesaverylarge derivativesbusinessmightmeanthatthefirmissystemicduetothecounterparty contagionrisktowhichitgivesrise.However,itdoesnotmeanthatitsderivatives businessisacriticalfunction. Thereareanumberofmeansbywhichthesystemicrelevanceofafirmwillbe addressedtheseinclude,forexample,ensuringthatcreditorsareawarethat theywillbefixedwithlossandshouldthereforemanagetheirriskmore effectivelyexante;ensuringthatacontinuumofeffectivepowersareavailableto authorities;enhancingtheresilienceofmarketinfrastructure;andputtinginplace

51.

24

possiblemeasuressuchasbailintechniquesandcontingentcapitalinstruments toreducerisksofcontagion. 52. Theconceptofcriticalfunctionisdesignedtoaddressjustoneaspectof systemicrelevance:thatiswherethereisanessentialfunctionorservice performedbytheinstitutionandtheonlywaythatitcanreasonablybedealtwith istocarveitoutandtransferitintheeventofthefailureofafirm. Oneimportantaspectofthisquestionthereforeisthataparticularfunction shouldnotbedeemedcriticaljustbecauseitwillgiverisetosomedisruptionifit fails.Rather,itshouldbedeterminedtobecriticalonlyifitismoreorless essentialthattheservicenotbedisrupted,oratleastthatthedegreeof disruptionlikelytoresultisverygreat. Afurtherrelevantconsiderationistheextenttowhichusersoftheservicemight reasonablybeexpectedtotakeappropriatemeasuresexantetoinsulate themselvesfromthedisruptiveeffectsofthefirmsfailure.Forexample,large corporatescanbeexpectedtoensurethattheyarenotexclusivelydependent upononefinancialfirmfortheirongoingliquidityandshouldnotbeincentivized nottodosobythetreatmentofsuchliquidityprovisionasacriticalfunction. Accordingly,aserviceshouldbeconsideredcriticalwhenthefollowingcriteriaare met: a. thefunctionrepresentsacriticalpartofthefinancialsysteminfrastructure; b. usersoftheservicecouldnotreasonablybeexpectedtohaveputalternative, fallbackoptionsinplaceexante; c. theservicecannotbesubstitutedinatimelymanner;and d. theserviceisessentialtothefinancialsystemandtheeconomyanditsfailure wouldcauseseveretrauma. Consideringcriticalfunctions 56. Ingeneraltermsitisnotpossibletosayintheabstractwhetheraparticular functioniscriticalornotwithoutaspecificassessmentofthewidercontextin whichitisprovided.Fornotonlyisthenatureofthefunctionkeytothis determination,sotooisthescaleuponwhichtheserviceisprovidedbythefailing bank,andtheprevailingfinancialsectorandeconomiccircumstances.Themarket shareoftheactivityenjoyedbythefirminquestionwillbeakeyquestionin determiningwhetherornotafunctionshouldbedeemedcritical. Criticalityoffunctionisthereforeamatterwhichfallstobedeterminedonafirm byfirmbasis.Nonetheless,itisusefultoconsider,bywayofexample,anumber 25

53.

54.

55.

57.

ofputativecriticalfunctionstoexaminehowthedeterminationofwhetherthey may,infact,becriticalfunctionsmightbeapproached.InAnnex2weconsiderthe potentialcriticalityofanumberoffunctions. 58. Careisrequiredinconsideringtheseexamplesasanumberoffine,ifimportant, distinctionsaremade.Forexample,itissaidthatdeposittakingisunlikelytobea criticalfunction.Howeverthismeansonlythattheprovisionofdeposittaking servicespersebyaparticularfirmisunlikelytobecritical.Thisdoesnotmean thatinsureddepositorswillnotrequiretoreceiverepaymentoftheirfundsina timelymanner;northatthepaymentserviceaspectofsuchaccountsmaynotbe critical.Itsimplymeansthat,beingpreciseinourthinking,theapproachtoa failingfirmsdeposittakingactivitiesshouldbedeterminednotbycriticalfunction considerationsperse,butratherbytheneedtoavoidalossofconfidence amongstconsumersandoutcomesconsideredunfair.Accordinglythekeymeans ofaddressingtheissueofinsureddepositorswillbe(a)byhavinginplacean appropriatedepositprotectionscheme;and(b)bymakingsurethatarrangements areinplacetoprovideprotecteddepositorswithtimelyaccesstotheirinsured funds. Itisalsoimportanttotakethetimehorizonintoconsideration.Thecontinuanceof certainservicesmaybenecessaryonlyoverashorttimeframetoallowother providerstostepinandfillthegap. Thedifferentcircumstancesprevailinginthecontextofanidiosyncraticfailureas comparedwithanepisodeofwidersystemictraumashouldalsobetakeninto consideration.Saletoathirdpartyinthecontextofthelattermaybemore challengingwithgreaterresultingneedfortheuseofbridgebankarrangements.

59.

60.

Resolutionplanning
61. AswesaidinourMay2010report,resolutionplanningisprimarilythe responsibilityofauthorities.Thisisdistinctfromrecoveryplanning,theprimary responsibilityforwhichfallsonthefirm.Intheeventoftheneedforaresolution, itwillbetheauthoritieswhowillbeincontroloftheprocess,withthefirmplaying anassistiverole.Thekeypurposeofresolutionplanningistoensurethatboth firmsandauthoritiesarewellpositionedtohandlethesituationifandwhenafirm fails.

Nomatterofcourserequestsforrestructuring 62. Firmshavearesponsibilitytoprovidealloftheinformationnecessarytoallow authoritiestocarryoutresolutionplanning.Itislegitimateandappropriatefor authoritiestowishtobesatisfiedthatispracticableandfeasibleforcritical functionsprovidedbythefirmtobeisolatedandtransferredwithallduespeedin theeventoftheimminentfailureofthefirm.

26

63.

Wedonotbelievethatitisappropriateornecessaryforthistobesoughttobe achievedbymatterofcourserequestsbyauthoritiesforfirmstorestructure themselvessoastoisolateparticularfunctionsindedicatedlegalentitiesorto requireamodularizationofthefirmalongentityandfunctionlines. Itisimportantthatagroupsstructureandorganizationreflectitsbusinessmodel andstrategy.Arequirementtomoveawayfromsuchanapproachwillgiveriseto significantinefficienciesandeconomiccosts. OurMay2010reportconsidersthisquestionatsomelength. 3 Itsetsoutthe Industrysconcernthatifregulatorydemandsforchangestoorganizational structurebecomeanormalaspectofrecoveryandresolutionplanning,thatwill leadtoaproliferationofrequirementsforchangethatcouldresultinasignificant mismatchbetweenafirmsorganizationalstructureanditsoverallbusiness model.Thisisarealriskthatcouldcausesignificantharmoverthelongrun. Thereisalsoconsiderableconcernthatsuchinterventionsinhowfirmsstructure themselveswillleadtoincreasednationalringfencing. Thoughfirmsshouldbeabletodemonstratehowacriticalfunctioncould otherwisebeextricatedandtransferred,afirmsorganizationalandlegal structuresshouldreflectandbedeterminedbyitsbusinessmodel.Thereare manyreasonswhymorecomplexapproachesmaybenecessary.Indeed,such servicesoftenmakemostsenseandaddthemostvalueforclientswhen embeddedinthebroaderbusinessofthefirm. Whatisessentialisthatitismadeclearbyafirmhowtheseparationandtransfer ofcriticalfunctionscanbeachievedinaspeedymanner.Firmsfulfillmentofthis requirementwillobviateanyneedforoverprescriptivenessbyauthoritiesasto themannerinwhichthisshouldbedone.

64.

65.

66.

67.

orseparation 68. Astothedesirabilityofrequiringfirmstocompletelyseparatetheirretailand wholesalebankingactivities,asdiscussedabove,wedonotagreethatallformsof retailactivityarenecessarilytobedeemedcriticalfunctionswithinthestrict meaningofthattermaswehavedefinedithere.Moreover,forthereasonsset outintheprecedingparagraphs,whileitistheresponsibilityoffirmstoexplain anddemonstratehowcriticalfunctionscanbemaintainedintheeventofthe failureofthefirm,thisdoesnotmeanthatsuchfunctionsarerequiredtobe separatedexanteandsubjectedtomodularization.

Section 2.

27

Firmsresponsibilities 69. Thereis,therefore,animportantobligationonfirmstoprovideclearinformation andexplanationstotheauthoritiesastohowanycriticalfunctionactivitiescanbe isolatedandtransferredintheeventoffailure.Thereisaneedforaclearand concretedescriptionofhowthiscanbedone. TheIndustryisoftheviewthattheexplanationandinformationtobeprovidedby firmsforcriticalfunctionsshouldcoverthefollowing: a) b) Acleardescriptionofthefunctioninquestion,includingitskeyfeaturesand thescaleofprovisionbythefirm. Identificationofhowthatfunctionisprovidedbythefirm.Thisshould include: c) Keyaspectsofthecontractualbasisuponwhichtheserviceprovided rests; Whethertheserviceformspartofanintegratedsuiteofservices providedtoclients,orisamorestandaloneservice; Howtoidentifywhichclientsusetheservice; Whereandhowtheassetsandliabilitiesarisingfromtheprovisionofthe servicearebooked; HowtheserviceissupportedintermsofinfrastructureandIT;and Howtheserviceissupportedintermsoffunding.

70.

Separatingandtransferringthefunctioninaneventoffailure: Whatcontractual/legalissuesarise? Isitneededtotransferalargepartofrelevantclientsbusinesswiththe firm,orjustspecificaccounts?Ifspecificaccounts,aretheselimitedto thecriticalactivityoraretheybroader? Whatdoesitmeaninpracticetotransferthisbusiness:Whowillbethe newlegalparties?Bywhom/howwilltheITbeprovided?Whatisthe transfermechanism?Whatinterdependenciesneedtobeaddressed?

d)

Financingthefunction/financingthetransfer: Assumingthatthemainmovingpartsoftheservicetobetransferredare liabilitiestoclients,whatassetswillbetransferredtosupportthose 28

liabilities?Howwilltheseassetsbeidentified?Howwilltheybe transferred?

Maintainingcriticalfunctionsonacrossborderbasis
71. Itisessentialthatresolutionframeworksareeffectivenotjustinthedomestic butalsotheinternationalcontext.Indeed,giventheinternationalnatureof manyofthefirmsfallingwithinthecurrentmoralhazarddiscussion,itisin manywaysevenmoreimportantthatsuchregimesareeffectiveinacross bordercontext. Theissueofachievingeffectiveresolutionofspecificallycrossborderfirmsis consideredinfulldetailinSection3.Wenotehere,however,theimportance ofbeingabletohandlethemaintenanceofcriticalfunctionsonacrossborder basis. Crucialtothiswillbecoordinationamongauthoritiesindifferentjurisdictions. Determiningwhichfunctionsarecriticalbethatlocallyorinternationally andhowtheyshouldbedealtwithintheeventofthefailureofafirmrequires closecooperationandcoordinationamongauthorities.Thisshouldbean importantcomponentoftheworktoestablishfirmspecificresolution agreementsamongauthoritiescurrentlyunderwayintheFSBandakeyaspect forconsiderationinthefirmspecificcrisismanagementgroups.

72.

73.

29

Section2Avoidingsystemictraumamakingbailintechniques operational
74. Ontheissueofbailin,theInstitutemadeasubmissiontotheFSBinSeptember 2010:Preservingvalueinfailingfirms. 4 Sincethattime,theInstitutethroughits WorkingGrouponCrossborderResolution(CBRWG)hascontinuedtoworkon thetopic,inparticulartoaddressanumberofthedifficultissuesthatarisein makingbailintechniquesoperational. TheFSBsreport,Reducingthemoralhazardposedbysystemicallyimportant financialinstitutions,ofOctober20,2010,totheG20leadersnotedthatbailin couldpotentiallyformpartofthehigherlossabsorbencyrequiredofsystemically importantfirms.TheEuropeanCommissionisalsoconsideringthequestionof bailinmeasuresaspartofitsrecentconsultativedocument,Technicaldetailsofa possibleEUframeworkforbankrecoveryandresolution, 5 publishedonJanuary6, 2011. Inthetextbelowwesetoutasetofprinciplesforoperationalizingbailin techniques.Itshouldbenoted,however,thatthisremainsachallengingareaand inanumberofplacesfurtherworkwillberequiredtoarriveatfinalconclusions.

75.

76.

IIFsPreservingValuepaper
77. InourearlierPreservingValuepaper,weexpressedthepreliminaryviewthat therewasconsiderablemerittoexaminingtheintroductionofabailinregime. Wesaidthatthetechniqueofferedapromisingmeansofforestallingthe disorderlyliquidationofsystemicallyimportantfirms,withtheattendant instabilitythatmightresultfromsuchanevent.However,thepaperalso recognizedandcautionedontheneedtoaddressanumberofopenissuesanda rangeoftechnicalmattersthatneededfurtheranalysisinordertohaveaclearer understandingofhowsucharegimecouldoperate.Keyaspectsoftheanalysis containedinthePreservingValuepaperaresetoutinAnnex3.

Scopeofliabilitiessubjecttobailin 78. AkeyissueinthePreservingValuepaper,andonethatwereturntobelow,isthe scopeofliabilitiesthatshouldbesubjecttoabailinpower,andtheextentto whichthisshouldbedecidedexanteorexpost. Supportingalimitedscope/exanteapproachwerethedegreeofclarityand certaintythatthiswouldbringtothesituation.Thisapproachwasconsideredto havebenefitsintermsofmakingitcleartocertaincategoriesofcredit

79.

4 5

http://www.iif.com/download.php?id=ryVjoux4FSs= January6,2011

30

counterparties,includingtradingcounterparties,shorttermcreditorsandliquidity providers,anduninsureddepositors,thattheywouldnotbesubjecttobailin measures,thusminimizingthelikelihoodofflight.Bydetermininginadvance whichcategoriesofcreditcounterpartymightbesubjecttobailinitwaspossible toincreasetheconsensualnatureofthemechanism.Beyondthisitwasalsothe viewofanumberofMembersthatbylimitingclearlythescopeofbailinitwould bepossibletolimitanypotentialincreaseinbankfundingcosts. 80. Anumberofdisadvantagesassociatedwithanexantelimitedscopeapproach alsowereidentified.Thisapproachhasthepotentialtocontributetomoralhazard inthesystem,asthoseliabilitiesexplicitlyexemptedfromthebailinmechanism maybeperceivedasreceivingconsiderableadditionalprotectionagainstlosses. Thatsignificantdistortionswouldbeintroducedunderanexanteapproachalso wasidentifiedasanimportantrisk,withfundingtechniquesbeingarbitragedto avoidpotentialbailinexposures.Onthecostofbankfundingsomearguedthata broadorcomprehensiveapproach,byreplicatingaprepackagedbankruptcy bywayofaresidualpowervestedinauthorities,wouldminimizeanypossible increaseinfunding. Inthetextthatfollowsweseektoresolvethetensionbetweenthesedifferent approaches.Inparticular,itisenvisagedthattheprimaryscopeofbailinpowers willbelimitedtosubordinateddebt.Inproposingthisapproachweareinfluenced bysomeresearchindicatingthatinmanycasesadequaterecapitalizationoffirms indifficultymightbeachievedonthebasisoftheconversionofsubordinateddebt only.However,itisacknowledgedthatitisnotpossibletocalibratepreciselyex antethescaleofthepotentialneedforfreshcapitalinacrisissituation.Therefore itisenvisagedthatasalastresort,andsubjecttoclearrequirementsandcriteria, itmaybenecessarytobailinaproportionoftheunsecuredseniordebtofafirm asanalternativetothewindingdownofthefirm.

81.

Operationalizingbailin
82. BuildingupontheinitialworkinPreservingValue,theobjectiveinthissubsequent contributionistomakemoreoperationaltheconceptandindoingsotoaddressa numberofthekeychallengesidentifiedinthatearlieranalysis.Inparticular,we nowseektoarticulateamoreconcreteelaborationoftheconceptandprovidea moredetailedspecificationofthekeybuildingblocks. Tothisend,thisSectionputsforwardadraftsetofprinciplesthatmightbe envisagedtounderpinthedevelopmentofabailinregimeindifferent jurisdictions.Byputtingforwardthissetofprinciples,supportedbyappropriate commentaryanddiscussion,itishopedtobothprovideaclearpathtothe solutionofoutstandingdifficultiesandpromoteanagreementonthesubject amongkeyparticipantsacrossthedifferentjurisdictions.

83.

31

Timing
84. ThegeneralviewamongIndustryparticipantsisthatitwouldnotbeappropriate toretrospectivelysubjectexistingdebttoanewpowerofbailin.Moreover,itis considereddesirablethatthereshouldbetotheextentpossibleagraduated, ratherthanabrupt,adjustmentofLossGivenDefault(LGD)estimatesinrespectto suchdebt.Accordingly,itisproposedthatbailintechniquesshouldbe prospectiveonly.

Bailinsandbridgebanks:theDoddFrankapproach
85. Thediscussioninthefollowingtextfocusesonthedesirabilityofamechanism thatallowsafirmtoberecapitalizedbyconvertingacertainproportionofdebt intoequitysoastopreventaprecipitouslossofvalueandaresultingsystemic shock.Itisarguedbysomethattheseoutcomescouldalsobeachievedbytheuse ofabridgebankmechanismdeployedinaparticularwayatthepointof insolvency.ThisquestionisofimportanceastheapproachenactedintheUnited StatesunderDoddFrankwhileitrequiresthewindingupoffailingfirmsalso envisagestheuseofbridgebankmechanismstooptimizeoutcomes. Itmayindeedbepossiblethatbailinoutcomescould,dependinguponthelegal contextofaparticularjurisdiction,beachievedbysuchalternativemeans. Whetherthisisthecaserequiresfurtherstudy.Inthisregardsee,forexample,the article,TheOrderlyLiquidationofLehmanBrothersHoldingsInc.underthe DoddFrankAct. 6

86.

Thekeyelementsofabailinregime
87. Setoutbelowisasetofsuggestedprinciplesthatmightformthebasisforbailin regimestobeadoptedindifferentjurisdictions.Theprinciplesareaccompanied byexplanatorytext.

GENERALOBJECTIVESANDGOVERNINGPRINCIPLES 1.1Thegeneralobjectivesofbailinarrangementsareasfollows: Tocreatetheconditionswherebyeveryfinancialfirmmayberestructured throughanorderlyfailureintheeventthatitisnolongerabletomeetits obligationsorbecomesotherwisenotviable; Toavoidthefinancialinstabilitythatmayresultfromthedisorderly liquidationofasystemicallyimportantfirm;

FDIC,April2011

32

 Toreducemoralhazardandexpectationsthatrisksandlosseswillbeborne bytaxpayers.Lossesshouldbebornebyshareholders,providersofotherforms ofcapital,andcreditors;and Toforestallprecipitousandmajorlossofvalueinthefirm,whichcouldgive risetotraumaticeffectsonthefinancialsystemandthebroadereconomy. 1.2Theseobjectivesshouldbepursuedinaccordancewiththefollowing conditions: Propertyrightsmustberespected.Thisincludes,inparticular,fullrespectfor securityandcollateralrights.Theseshouldnotbeabrogated. Creditorsshouldnotbeworseoffthantheywouldbeinanormalbankruptcy. Bailinshouldbeseenaspartofthecontinuumofmeasuresandtools necessarytoprotectthefinancialsystem,andespeciallytoensurethatallfirms canberesolvedsafelyintheeventoftheirfailureorimminentfailure.Bailin measuresshouldbedeployedonlyaftersuchothermeasuresandtoolshave beenexhausted. Triggersshouldbeclearlydefined,avoidingundueuncertainty.Thereshould beconsistencyacrossjurisdictions. Whenrelevant,effectivecrossbordercoordinationshouldbeensuredand fragmentednationalresponsesprevented. Totheextentthatadditionalcostsareincurredinresolvingafirmina mannerthatavoidssystemicdamage,suchcostsshouldnotbeimposedon creditors(oraparticulargroupofcreditors). COMMENTSONGENERALOBJECTIVESANDGOVERNINGPRINCIPLES 88. 89. Thissetofprinciplessetsoutthecentralobjectivesofabailinregimeandthekey conditionsforsucharegime. Thekeyobjectivesoffacilitatingrestructuringorallowinganorderlyfailurewhile preservingfinancialstabilityarebroadenoughtocoveringeneraltermsanumber ofconcernsoftenhighlightedbytheofficialsector,forexample,protectingretail depositorsandprotectingsystemicallyimportantfunctions. Allowingeveryfinancialfirmtoundergoanorderlyfailureintheeventthatitis nolongerabletomeetitsobligationsorbecomesotherwisenotviablemustbea keyfeatureofanyresolutionregime.Bailinisatoolthatcontributestoachieving thisobjective;itshouldbeseenasaformofrestructuringforafirmthathas failed.

90.

33

91.

Theobjectiveofanyresolutiontoolsshouldnotbethesurvivalofafailingfirmper se,butratherallowingfirmstofailinanorderlywaywithoutanycostto taxpayers;however,abyproductofabailinmechanismisthatfirms,insome form,survivelegallyatleastadinterim,andiftheeffortisfullysuccessfully,inthe longerterm.Inthisrespecttheoutcomescanbeseenasrathersimilartothe potentialoutcomeofaChapter11bankruptcyintheUnitedStates.

SCOPE 2.1Unlessotherwisedeterminedinaccordancewiththeseprovisions,afinancial firmthatfailsshouldexitthemarketinaccordancewiththenormalrulesforthe resolutionofsuchfirms. 2.2Allfinancialinstitutionsmaybepotentiallysubjecttobailin. 2.3Afinancialinstitutionshouldonlybesubjecttobailinmeasurestotheextent determinedbythedesignatedauthorities: (a)thattoallowthefirmtobesubjecttonormalresolutionruleswouldcarrya significantriskofcausingsignificantfinancialinstability; (b)thatsuchriskwouldderivefromaprecipitouslossofvalueaffectingthe assetsofthefirmduetoadeclarationofinsolvencyand/oraffectingthewider financialsystemduetotheinterconnectednessofthefirmwiththewider market;and (c)thatthereisareasonableprospectofsuchlossofvaluebeingavertedor significantlyreducedifthemeasuresinthissetofprinciplesaredeployed. COMMENTSONSCOPE 92. TheeffectoftheseScopeprinciplesistogivebailinmeasuresabroadpotential scopeintermsofthefirmstowhichtheymaypotentiallyapplyandtoclarifythat, whenanumberofconditionsaremet,anyfinancialinstitutionmaybesubjecttoa bailin. ThisisconsistentwithIIFsviewthatsystemicriskcannotbelinkedtoany particularcategoryoffirms.Moreover,anypossibleperceptionthataregime directedonlyatsomefirmsmayleadtoanonlevelplayingfield(and,specifically, mightgivelargefirmssomeadvantage)needstoberejected.Thequestionofthe systemicimportanceofafirmneedstobemadeonacasebycasebasisagainst thebackdropoftheprevailingcircumstances. Itisimportantthatthepurposeforwhichbailinpowerscanbeexercisedbe clearlyandtightlydrawn.Suchpowerssignificantlyenhancetheadministrative poweroftheStatetointerveneinprivatecontracts.Iftheconditionsforuseare 34

93.

94.

drawntoobroadly,thereismaterialriskthatitcouldbeexercisedtooearly(see theBailInTriggersprinciplesbelow)ortoobroadly,givingrisetoundue interferencewithprivatecontracts.Inshort,unlessthepowerisdefinedtightly thereisariskofadisproportionateincreaseinfinancialfirmfundingcostsas creditorsconfidenceandcertaintyisunderminedbythepotentialforsignificant Stateadministrativeintervention. 95. Thebenefitofbailintechniquesascomparedwiththeapplicationofgeneral resolutionprovisionsisthatabailincanforestallaprecipitatelossofvaluesuch asthatseenintheLehmanscase. 7 Itissuchlossofvaluethat,eitherdirectlyor indirectlythroughtheinterconnectednessofthefirm,cangiverisetosystemic instability.Accordingly,onlywhereitisdeterminedthatthereisasignificantrisk ofsuchlossofvalueshouldbailinmeasuresbedeployed.

BAILINTRIGGERS 3.1Thedecisiontotriggerthebailinpowershouldbeexercisedbythedesignated authority(ies)inconsultationwithrelevantauthoritieswhoarenotthedesignated authority(ies),including,asappropriate,theresolutionauthority,thesupervisory authorities,thecentralbank,andthefinanceministry. 3.2Thetriggerforabailinshouldbethesametriggerthatappliesfora determinationthatafinancialfirmsactivitiesrequiretoberesolvedorwound down. COMMENTSONTRIGGERS 96. Wedonottakeaviewatthisstageastowhichauthority(ies)shouldbethe designatedauthorityforbailinpurposes.(Morebroadly,wehavenottakena viewastowhichauthorityshouldhavethepowertodeterminethatafirmshould beresolved.)Differentmodalitiesarepossible.However,indecidingwhich authorityshouldhavethispower,itwillneedtobeensuredthatriskof authoritiesforbearanceisavoided.Moreover,thedecisionshouldbeexercisedin consultationwithrelevantauthoritieswhoarenotthedesignatedauthorities, including,asappropriate,theresolutionauthority,thesupervisoryauthorities,the centralbank,andthefinanceministry.

Inourreport,PreservingValueinFailingFinancialFirms(September2010),pp.89,weestimatethata lossofassetvalueintheestimatedrangeof$25billionbecame,postdeclarationofinsolvency,alossto creditorsofpossibly$150billion.Ititsarticle,TheOrderlyLiquidationofLehmanBrothersHoldingsInc. undertheDoddFrankAct,(April2011),theFDICassumesforthepurposesofillustrationthatthelosses onassetspriortothedeclarationofinsolvencywouldhavebeen$40billion,representingalossrateof60 percentto80percenton$50to$70billionofassetsidentifiedbypotentialacquirersasbeingimpairedor ofquestionablevalue,representingalossofvaluesignificantlylessthancurrentlyexpectedunderthe bankruptcy.

35

97.

Itisdesirablethatbailinmeasuresaretriggeredascloseaspossibletothetime thatthefirmwouldotherwisebecomeinsolventandgointobankruptcy.Toavoid undueuncertaintyorthepotentialbringingforwardofinsolvency,therelevant triggermustbetightlydrawn,andthejudgmentoftheauthoritytightly constrained.Forthisreasonthetriggerforabailinshouldbethesameasfora determinationthatafinancialfirmrequirestoberesolvedorwounddown.

THEBAILINPOWER 4.1.Thebailinpowersreferredtohereare: Powertodiluteshareholdersorwriteoffsharesofthefirm,and

Powertoalterthetermsandconditionsofsubordinateddebtofthefirm, includingtheconversionofsuchdebtclaimsintoequity. 4.2.Intheexerciseofsuchpowersnocategoryofequityholderorcreditorhaving priorityoveranotherintheeventofbankruptcy/insolvency,shouldbetreated otherthaninlinewiththatpriority. 4.3.Seniormanagement Theresolutionauthoritiesshouldhavepowertoreplaceanyorall membersoftheseniormanagementand/orboard. Overtheperiodfollowingtheexerciseofthebailinmeasures,steps shouldbetakentoinvestigatethereasonsforthefailureofthefirmandto identifythosemembersoftheboardandseniormanagementconsideredto bedirectlyresponsibleforthedecisionsand/oractionsleadingtothefailure. Suchindividualsshouldbereplaced. COMMENTSONBAILINPOWERS 98. AsdiscussedintheintroductiontothisSection,thequestionofthescopeof liabilitiesfallingwithinthebailinpowerisadifficultoneuponwhichtheindustry hashadmuchdiscussion. Acrucialissueiswhetheranyunsecureddebtmight,atleastinprinciple,be consideredbailinable(withanumberofselectedexclusionsdeterminedexpost onacasebycasebasisbytheresolutionauthority),orwhetherabailin mechanismshouldbebuiltonanexantedeterminationastowhichliabilities should(potentially)besubjecttobailin.

99.

100. Theapproachsuggestedaboveistolimittheprimaryscopeofapplicationto subordinateddebt.OnthebasisofanalysiscarriedoutbysomeMemberfirms,it isbelievedthatinmanycasestheavailabilityofsuchdebtislikelytoprovide

36

sufficientresourcesforeffectivelyrecapitalizingafirm.Asindicatedinprinciple5 below,however,itmaybethatintheparticularcircumstancesofthecasethe bailinofsubordinateddebtwillbeinsufficientforthepurpose.Inthiscase authoritiesshouldhavethepowertobailinthenecessaryproportionofsenior debt. 101. Principle4.2aimstoensurethattheorderofprioritiesinbankruptcybe respected.Onceagain,differentmodalitiesarepossibleforexample,an approachwherebyallequityisfullywrittendownandextinguishedbeforedebtis convertedor,ifthisisnotoptimal,wherebyremainingoriginalequityremains subordinatedtoconverteddebt.Alternatively,anotherwaytoachievethismaybe toseektoensurethattheeconomicvaluesofthedifferentinstruments(including theirrelativevalues),whichreflecttheirrankingintheloomingresolution,are maintained.Whilebeingveryclearthatitisessentialthattheorderofpriorities mustnotbesubverted,theIndustryhasnotyetreachedafirmviewastowhether thisshouldbeachievedbymeansthatareprimarilylegalinnatureorprimarily economic. 102. Concerningprinciple4.3,whichdealswithseniormanagement,theIndustry believesthatitisimportantthatthoseconsidereddirectlyresponsibleforthe failureofthefirmbeheldaccountable. ADDITIONALPOWERTOBAILINSENIORDEBT 5.1Inparticularcircumstances,itmaybethecasethatthebailinofall subordinateddebtwillbeinsufficienttorecapitalizethefirmsufficientlytoachieve theobjectivessetoutabove.Inthiscasewherethereisnootherappropriate alternativetoachievetheobjectivessetoutabove,thedesignatedauthorities shouldhavethepowertobailinawidercategoryofcreditorsasdescribedbelow. 5.2Thesupplementarynatureofsuchpowershouldberecognizedinthe requirementfortheauthoritiestotakeaseparatedecision,clearlydocumented andreasoned,andthesubjectofareporttobemadepubliclyavailableastothe basisuponwhichtheirdecisionwasreached.Thereportshouldinteraliasetout howthedecisionoftheauthoritiescomplieswiththekeyprinciplesof reasonableness,proportionality,andfinalnecessity. 5.3Theliabilitiessubjecttothispoweroffurtherbailinshouldbetheunsecured seniorobligationsofthefirmexceptobligationsofcounterpartiesarisingfromthe tradingactivitiesofthefailingfirm.[Whetherthescopeofprinciple5.3shouldbe extendedwillbethesubjectoffurtherconsiderationseecommentsbelow.] 5.4Thedesignatedauthoritiesshoulddecide,incompliancewiththeprinciplesset outabove,andtakingintoaccountguidancetobepublishedbytheauthorities,

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whethertolimitthetypesofseniorobligationstobesubjecttothepowerof furtherbailinand,ifso,towhichtypeofobligations. 5.5Inexercisingthispower,alloftheprinciplesgoverningthebailinof subordinateddebtshallapply. COMMENTSONADDITIONALPOWERTOBAILINSENIORDEBT 103. Theapproachdescribedhereistomakethebailinofanynonsubordinateddebt alastresortwhenaconversionofsubordinateddebtisdeterminedtobe insufficienttoachievethepurposessought. 104. Theindustryhasreachedtheviewthattradingobligationsshouldnotbesubject tosuchfinalstagebailin,astodosowoulddefeatonepurposeofthe mechanismtopreservethefranchisebusinessofthefirm.Byincludingsuch obligationsinthepotentialscopeofabailin,tradingcounterpartiesconfidence wouldbeunlikelytobemaintained,witharesultingsignificantlossofbusiness value. 105. Theindustryhasnotyetreachedafinalviewastowhetherotherformsofsenior obligationshouldbeexcludedexanteorlefttobedeterminedonacasebycase basisandinaccordancewithadministrativeguidancetobepublishedbythe authorities.TheIndustrywillbeworkingonthisissuefurtherinthecoming period. SAFEGUARDSFORCREDITORSANDJUDICIALREVIEW 6.1.Judicialreview:Unlesstheboardofdirectors(orsimilargoverningbody)ofthe companyhasacquiescedorconsentedtotheactivationofthebailinpower,it shouldhavethepossibilitytofileapetitionforimmediatejudicialreview.Such reviewshouldbelimitedtothelegalityandlegitimacyofthedecisionandensure thatthebailinmechanismisnotactivatedarbitrarily,andanyjudicialhearing shouldbestrictlyprivate. 6.2.Safeguardsforcreditors:Nocreditorofthecoveredfirmthathasseenthe amountthatitisowedwrittendownorthetermsandconditionsoftheinstrument itholdsamendedshouldbeworseoffthanitwouldhavebeenundernormal bankruptcy/insolvencyprocedures.Thedeterminationastowhetheracreditoris worseoffshallbemadeXXyear(s)aftertheexerciseofthebailinpowers. 6.3.Authoritiesshouldnotbeheldliablefornegligenceinthemakingofa determinationtoexercisetheirbailinpowers. 38

COMMENTSONSAFEGUARDSANDJUDICIALREVIEW 106. Itwillbenecessarytoachieveaneffectivebalancebetweentheneedtoensure adequatejudicialsafeguardsandreviewandtheneedtoensurethatabailin mechanismcanbedeployedswiftlyandwithoutcreatingundueuncertaintiesin themarket. CROSSBORDERASPECTS 7.1.Theseprinciplesshouldapplytotheliabilitiesofthefirmregardlessofthe jurisdictioninwhichtheyareheldandofthenationallawgoverningthem. 7.2.Foreigncreditorsshouldhavetherightofdirectaccesstotheresolution authoritiesandtojudicialauthoritiestoobtainthesafeguardsdescribedin principle6. 7.3.Totheextentthatthejurisdictionwheretheliabilityholderissituateddoesnot provideforarecognitionoftheproceedingslaunchedundertheseprinciples,there shouldbeincorporatedinthetermsofalltherelevantliabilitiesofthefirma contractualprovisionrenderingitsubjecttobailinmeasuresassetoutinthese principles. COMMENTSONCROSSBORDERASPECTS 107. Theseprinciplesseektooutlinearesponsetothecoordinationproblemsthat arisewhendeployingabailinmechanisminacrossbordercontext.Themain routetoensuringeffectivecrossbordercoordinationimpliesagreementamong FSBmemberscommitting: toundertakethoselegalchangesneededtoachieveconvergentand internationallyconsistentresolutiontools,and torecognizeaforeignproceedingandensurethenecessarycrossborder cooperationandcommunicationamongrelevantresolutionauthorities.

108. Asupportingalternativeapproachissetoutinprinciple7.3.Thisrepresentsthe hybridapproachoutlinedinthePreservingValuepaper:abankshould,inits countryofincorporation,besubjecttoastatutoryregimewhoseeffectwouldbe torecognizethebailininnationallaw;thebankwouldthenberequiredtoensure thatforanycreditoreligibleforabailinwhoseclaimsweregovernedbyanyother law,theagreementwiththatcreditorwouldincludeaclauserecognizingthe statutorypower.

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GROUPISSUES 8.Where: theliabilitiessubjecttotheexerciseofthebailinpowerssetoutinthese principlesrepresentliabilitiesofanentitythatisasubsidiaryofanotherentity; theretentionoftheparentsubsidiarylegalrelationshipisdeterminedbythe resolutionauthoritiestobenecessarytoachievetheobjectivesofthese principles;and itisnecessarytodosotopreservesuchparentsubsidiarylegalrelationship theequityinterestreceivedbythosecreditorsofthefirmbyvirtueofthe exerciseofthepowerssetoutintheseprovisionsshallbeswappedforequityof theparentofequivalentvalue. COMMENTSONGROUPISSUES 109. Mostlargebanksaremembersofgroups,anditisfrequentlythecasethatina bankgroupthereisanunregulatedbankholdingcompanyabovethebank.Inthe casebelow:

Bank Holding Company

Senior creditors

Bank

Other Group Entities

ifthebailinweretobeconductedatthebanklevel,theeffectcouldbetobreak thegroupstructuresince,withthecreditorsbecomingtheshareholders,thebank wouldceasetobeasubsidiaryoftheholdingcompany.Theapproachproposedin principle8requiresequityreceivedinthefailingbanktobeswappedforequityin theparententity/holdingcompanywhenthatisnecessarytoachievethebailin objectives.Thisissueshouldbeidentifiedandaddressedaspartoftheresolution planninginrespectofthegroup. NONEFFECTOFDEFAULTOROTHERTRIGGERCLAUSES 9.Theexerciseofbailinpowersasdescribedintheseprovisionsshallnotbe consideredadefaultforlegalpurposes.Anyclauseinanycontractthatseeksto

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identifytheexerciseofbailinpowersasaneventsimilartodefaultforthe purposesoftriggeringlegalconsequencesshallbeinvalid. COMMENTONNONEFFECTPRINCIPLES 110. Commonpracticeinmanyderivatives,repo,bondagreements,etc.,isthatforced resolutionmeasuresbyregulatorsarealsodeemedtobeaneventofdefault, whichwouldallowthecounterpartstoterminateoutstandingagreements.To achievethebailinobjectiveofavoidingthecollapseofthefirmandaresulting majorlossofvalueandtraumatothesystem,measuresareneededtoestablish thattheexerciseofabailinpowerwouldnotbeconsideredaneventofdefault amongcounterpartiesofthefirminquestion.ISDAmasteragreementswillbe particularlyimportantinthisregard.Itislessclearthatthesamewouldneedto beachievedinrespectofcreditderivativecontractsreferencingthefirm.This latteraspectrequiresfurtherconsideration.

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Section3Resolvingcrossborderfinancialfirmsaddressing keyissues
Introduction
111. Thissectionseekstodevelopananalysisofthekeyobstaclestoachievingthe effectiveresolutionofsystemicallyimportantcrossborder,asopposedto domestic,financialfirmsandproposingsolutionstosuchobstacles.Intheperiod sincethecrisis,theconceptualandpracticallandscapehaschangedquite significantly.Thismeansthatthechallengenowinachievinganeffective frameworkofcrossborderresolutionissomewhatdifferentthanitwastwelve monthsago.Therehasbeenimportantprogress.Itisimportanttotakestockof thedevelopmentsthathaveoccurredinordertoassessprogresstowardthe ultimateobjectiveandtomoreaccuratelyspecifythechallengesthatremain. 112. Itisusefultoremindourselveswhatwemeanbyeffectivecrossborder resolution.Whatwemeanisthatalargefinancialservicesgroupoperatingina numberofjurisdictionseitherbymeansofsubsidiariesorbranchesiscapable ofexitingthemarketinanorderlymannerandwithoutaperceptionofunfairness inhowthelossesincurredbythegroupareallocatedamongstakeholders.To preservethebenefitsofprogresstowardanintegratedinternationalfinancial system,itisimportantthatthisprocessbeachievedwithoutrequiringringfencing ortheforcingofsignificantstructural/organizationalchangeonfinancialgroups thathavedevelopedtheirorganizationalstructuretooptimallyreflecttheir businessmodelandthenatureoftheiractivities. Lessrisktotaxpayers 113. Oneofthemajorconcernsofauthoritiesisthat,intheeventofthefailureofa crossbordergroup,thetaxpayersintheirjurisdictionwillincurlossesand, further,thattheselosseswillbeunfairasbetweenjurisdictions.Thisisacentral concernthatliesbehindmovestowardringfencingandnationalselfsufficiency approaches. 114. Significantprogresshasbeenachieved,orcanbeachieved,towardsignificantly reducingtheextenttowhichtaxpayersareexposedtolossesintheeventof failure.Theworkthatisintraintoensurethatshareholdersandcreditorsbear theirlossesintheeventofafailureshouldgoalongwaytowardachievingthis. 115. Theacceptancebythefinancialservicesindustryofitsresponsibilitytofundthe costsofeffectiveresolutionmechanismswillalsomakeamaterialcontribution towardprotectingtaxpayersfromlosses.

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butmoretootherstakeholders 116. Itisnot,however,simplydisproportionatelossestotaxpayersthatareofconcern tonationalauthorities.Theyarealsoconcernedaboutdisproportionateorunfair lossesaccruingtostakeholdersintheirjurisdictionsmoregenerally.Forexample, intheLehmancase,therewerenolossesaccruingtohostcountrytaxpayers. Nonetheless,concernastosuboptimaloutcomesforcreditorsofhostcountry subsidiarieswasamajorfactorinthereactiononthepartofhostcountry authorities. 117. Giventhatanimportantobjectiveofeffectiveresolutionistoplaceshareholders andcreditorsmoreatriskoflossthanwasthecaseinthepast,thisaspectofthe situationhasbecomemorechallengingthanheretofore. 118. Theprotectionoftaxpayersislikelytobeasignificantlygreaterimperative politicallythantheprotectionofcreditors(atleastuninsuredcreditors),whoare betterpositionedtolookafterthemselves.Accordingly,theoverallpicturemaybe oneofapotentialmaterialeasingoftheextenttowhichauthoritiesfeelat politicalriskiftheydonotmanagetoringfence.However,thepressurestoring fencearelikelytoremainconsiderableasthingscurrentlystand.

Typologiesandapproaches
119. Ingeneral,crossborderfinancialinstitutionscanadoptarangeofapproachesto achievingaphysicalpresenceinahostcountry.Whiletheycandosoeitherby establishingabranchorbyestablishingasubsidiary,itisimportanttothinkof crossbordergroupsnotinbinarytermsbutratherasorganizingthemselvesalong aspectrumofmodalitiesasindicatedbytheirparticularbusinessmodel. 120. Atoneendofthespectrumaregroupsthatorganizethemselvesonthebasisof largelystandalonesubsidiariesinteractingwitheachotheronstraightforward commercialterms(thoughwithinthestrongnexusoftheirintragroup relationships).Attheotherend,therecanbetheuseofoverseasbranchesthat, bothpracticallyandlegally,operatemoreorlessasthepresenceofthehome entityinthehostjurisdiction.Andbetweentheseextremes,therearearangeof hybridapproaches:manygroupsutilizebothbranchesandsubsidiaries,many makeuseofsubsidiariesinthecontextofanintegratedgroupapproach, 8 and othersmakeuseofbranchesthatoperatetoacertainextentandincertain respectsasstandaloneentities.

Wewouldnotethatwithinthecontextofmoreintegratedgroupsalso,transactionsbetweengroup entitiesarecarriedoutonmarketbasedcommercialterms.Seefurtherthequestionofgroupinterest approachesdiscussedbelow.

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Generalproposals
121. InourMay2010report,AGlobalApproachtoResolvingFailingFinancialFirms,we arguedthatsuccessintheareaofcrossborderresolutionrequiredthe establishmentofaninternationalcrossborderframework. 122. Thisdidnotrequiretheestablishmentofaninternationalinsolvencylaw.Rather, wecalledontheG20/FSBtosetupahighleveltaskforcewithaviewto establishingaroadmaptowardthecreationofsuchaninternationalframework fortheresolutionofcrossborderfirms.Thiswouldinvolveinternational agreementcombinedwithnationaljurisdictionmeasures. 123. Amongthekeycomponentswouldbe: (a)convergenceofnationalregimestoincorporateagreeduponkeyfeaturesof effectiveresolutionframeworks.TheFSBreportofOctober20,2010,appearsto indicatethepotentialforgoodprogressinthisregard; (b)enhancedcoordinationamongresolutionauthorities,includingaleadauthority approach,possiblybasedonthemodifieduniversalismapproachsuggestedby some;and (c)exploringmethodsforachievingequitablecrossborderoutcomes. 124. Inthefollowingsectionsweconsiderindetailwhatisneededtotakethese proposalssuccessfullyforward.

Resolvingcrossbordergroups:respectingstructuralarrangements determinedbybusinessmodels
125. AstheInstitutehasdiscussedinanumberofplaces, 9 itisimportantthatfinancial groupscontinuetobeabletochoosethemodeoforganizationanddegreeof integrationofthemanagementoftheirgroupthatmostconformstothenatureof theirbusinessmodelandtheneedsoftheirbusiness.Aforcedrequirementthat allfirms,regardlessoftheirbusinessmodel,adoptamodularapproachtotheir organizationbasedonthestandaloneselfsufficiencyofeachlegalentityoreach nationalsubgroupwoulddampeneconomicperformance. 126. Aswesaidabove,ifregulatorydemandsforchangestoorganizationalstructure becomeanormalaspectofrecoveryandresolutionplanning,thisislikelytoresult inasignificantmismatchbetweenafirmsorganizationalstructureanditsoverall
9

See,forexample,RestoringConfidence,CreatingResilience:AnIndustryPerspectiveontheFutureof InternationalFinancialRegulationandtheSearchforStability(July2009);SystemicRiskandSystemically ImportantFirms:AnIntegratedApproach(May2010);andAGlobalApproachtoResolvingFailing FinancialFirms:AnIndustryPerspective(May2010).

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businessmodel.Thereisalsoconsiderableconcernthatsuchinterventionsinhow firmsstructurethemselveswillleadtoincreasedringfencingofcountriesand fragmentationoftheinternationalmarketplace. 127. Dependinguponthenatureofthebusinessbeingcarriedon,amongstthebenefits thatcanbederivedfromgroupstrengthandstrategycanbethefollowing: Theabilitytodeploycapitalandliquidityefficientlyforthegroupasawhole; Theabilitytosupportcustomersincrossbordertradeandinvestmenttothe benefitoftheeconomyingeneral; Theabilitytodevelopandimplementhighquality,stronggovernanceandrisk managementstrategiesatthegrouplevelfortheadvantageofallentities; Thedevelopmentofastrongandreliablebrandthatyieldsbenefitsbothfor thegroupanditsstakeholdersandforconsumersandtheeconomyingeneral; and Thestrengthandresiliencethatcanderivefromtheabilitytoprovidesupport fromonepartofthegrouptoanotherintimesofdifficultyorstress.

Note:Aswellaspoliticalobstacles,therearealsoanumberoflegalissuestobe consideredinrelationtotheprovisionofgroupsupportforentitiesthatgetinto difficulty.TheseareconsideredinAnnex4. Avoidingnegativesumoutcomes 128. Undercurrentarrangementsauthoritiesindifferentjurisdictionsareinan invidiousposition.Legislationrequirestheadoptionofalegalentitybased approachintheresolutionand/orinsolvencyphase.Suchanapproachmeansthat asthepointoffailureapproaches,itbecomesincreasinglycriticalastowherethe assetsofthegrouparelocated. 129. Equally,theauthorityandlegalmandateofauthoritiestoasignificantextent relatestothepursuitofcertainoutcomeswithintheirjurisdictionandtothe promotionoftheinterestsofstakeholdersdepositors,taxpayers,theeconomy withinthatjurisdiction.Thismeansthattotheextentthatthereareinformational andfirstmoveradvantagesarisingtosomeauthoritiesascomparedwithothers, thereisamaterialriskofoutcomesthatare,whenlookedatfromtheperspective ofthegroupasawholeandacrossallofthejurisdictionsinwhichitoperates, suboptimalandpotentiallyunfair. 130. Accordingly,itisimportanttoaddressthedifficultiesthatarisefromapproaches toresolutionthatareuncoordinatedamongnationalauthoritiesandbased

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exclusivelyonthepursuitofobjectivesdefinedintermsofjurisdictionalinterests, whichinrelevantcasescanproducesuboptimaloutcomes. Leveraginggroupinterest 131. Theconceptofgroupinterestisanimportantoneinthisarea.Different approacheshavedifferentadvantagesdependinguponthenatureofthebusiness andthebusinessmodeladopted.Asubsidiarymodelcan,forexample,encourage thestandalonestrengthofthedifferentpartsofthegroup,limitintragroup contagion,andsimplifytheinsolvencyproceduresinsomecases.Amore integratedmodelcan,ontheotherhand,anddependingagainonthenatureof thebusiness,allowforamoreefficientdeploymentofcapitalandequity, integratedriskmanagement,etc.Dependinguponthebusinessofthegroup, strategyanddecisionstakentooptimizethegroupinterestoroutcomesforthe groupasawholecanmateriallyenhancetheoutcomesforallentitiescomprising thegroupandtheirstakeholdersincertaincases.Inotherwords,andagain dependinguponthenatureofthegroupsbusinessandincertaincases,the adoptionofagroupperspectiveintherunningofthebusinessacrossthe constellationoflegalentitiescanresultinbetteroutcomesforstakeholdersand fortheeconomy. 132. Thedifficultyariseswhen,assuchagroupentersaperiodofcrisis,withthe potentialneedforresolutionloomingincreasinglylarge,thelegalentityprism becomesdominant. 10 Atthispoint,withtheemphasisincreasinglyshiftingtothe locationofassetsandtheclaimsofthecreditorsofthedifferentlegalentities,the groupinterestperspectivebeginstobecomeanomalous. 133. Theissuethereforecanbeseentobethetensionbetweenthegroupinterest perspectivethatcan,dependinguponafirmsbusiness,addsignificantvaluein therunningofthebusinessofthegroup,andthelegalentityperspectivethat, undercurrentarrangements,dominatesduringtheresolutionphase.Successin thisareawillcomefromprogressinreducingthetensionbetweenthesetwo differentperspectivesdominatingdifferentphasesofthelifecycleofagroup. 134. Wenoteagain,asidentifiedthroughout,thatthereareamultiplicityof approachesadoptedregardingthestructureandorganizationofcrossborder financialgroupsdependinguponthenatureofthebusinessandthebusiness modeladopted.Eachofthesehasitsparticularadvantagesinregardtothe businessinquestion.Whatisessentialisthatthesebenefitsarenotdiminishedby requiringagrouptoadoptanapproachthatisnotdeterminedbyandalignedwith itsbusinessmodel.

10

Including,inmanycases,anincreasedlegalobligationtocreditors.

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Makingprogressonresolvingcrossbordergroups
135. Thisisthereforeahighlycomplexarea.Progressdependsuponthe implementationofarangeofmeasuresandtechniquesdesignedontheonehand toensurethatthedegreeofcooperationandcoordinationamongauthoritiesis materiallyenhancedandontheotherthatthelegalframeworkfacilitatesthe adoptionofapproachestoresolutionthatreflectmorecloselythaniscurrently thecasetheapproachadoptedbythegrouptotherunningofitsbusiness. 136. AnimportantareaoffocusfortheFSBatpresentistheissueofinstitutionspecific cooperationagreementsbetweenrelevanthomeandhostauthorities.The informationavailabletodateonthisworkislimited;however,itisclearthat amongtheaspectstobeaddressedbysuchagreementsaretherolesand responsibilitiesinplanningandmanagingresolutions,arrangingforcooperationin theassessmentofrecoveryandresolutionplans,andsettingoutthelegalbasis forandmodalitiesofinformationsharing.Itisstatedthatauthoritiesshould exploreavenuestoformalizetheseagreementsandovertimemakethemmore binding. 11 137. Inviewofthecomplexityofthistopicandtheimportanceoftakingintoaccount thespecificcircumstancesofindividualgroups,theInstitutebelievesthereis considerablemeritinanapproachbasedonfirmspecificagreements.However, wealsonotethattobeeffectiveinthisarea,firmspecificagreementsneedtobe effectiveonthelegalandnotsimplytheoperationallevel.Accordingly,resolution frameworksinthedifferentjurisdictionswillneedtoincludethoseprovisions necessarytomakesuchagreementslegallyeffective. 138. Amongthestepsthatwillberequiredtomakefirmspecificresolutionagreements betweenauthoritieseffectivearethefollowing: Internationalmandate:Itshouldbepartofthelegalmandateofeachresolution authoritytocoordinateeffectivelywiththeauthoritiesofotherjurisdictionsinthe crisismanagementandresolutionofcrossbordergroups. Nondiscrimination:Itshouldberequiredofeachauthoritythatitadoptsan approachthatavoidsdiscriminationagainstcreditorsofthegrouponthebasisof theirlocationornationality. Optimizeoutcomesforcreditorsasawhole:Eachauthorityshouldhave,aspart ofitslegalmandate,arequirementtoacttooptimizeoutcomesforthecreditors ofthegroupasawhole.

11

FSB,Reducingthemoralhazardposedbysystemicallyimportantfinancialinstitutions,October20, 2010,p5.

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Jointplanning/crisismanagementandresolutioncolleges:Theauthorities responsiblefortheresolutionofacrossbordergroupshouldberequiredtoplan jointlyinthecontextofdedicatedcollegesforthecrisismanagementand resolutionofthegroupundertheleadershipofthehomeresolutionauthority. Cooperationandcoordinationagreement:Basedontheirjointplanning,the authoritiesshouldberequiredtoenterintoacooperationandcoordination agreementinrespectofthecrisismanagementandresolutionofthegroup.While requiringtobeflexibleandadaptivetochangingcircumstances,thisplanshould nonethelessbeinitskeycomponentslegallyeffective,including,inparticular,in crisissituations. Informationsharing:Therelevantauthoritiesshouldshareallrelevantinformation witheachotheronthebasisofstrictconfidentialityarrangements.Thisshallapply inboththegoingconcernandcrisissituations.Detailedconsiderationshallbe giventotheinformationtobesharedinbothcontexts. Jointplanimplementation:Authoritiesshouldhaveanobligation,intheeventof acrisisorresolution,toactinaccordancewiththekeyprinciplesandcomponents ofthecooperationandcoordinationagreement. Earlywarning:Eachauthorityshouldhaveanobligationtoalertotherauthorities withoutdelayintheeventofinformationsuggestingthatthegroupisatmaterial riskofapproachingacrisissituation. Burdensharing:ItistheviewoftheInstitutethatthereshouldbenogeneral expectationthatlosseswillbebornebytaxpayers.Accordingly,wedonotthink thatitwouldbedesirabletoenshrineburdensharingprinciplesasbetween governmentsinsuchcooperationandcoordinationagreements.Todosocould sendthewrongsignalsandincreasemoralhazard. Nonetheless,wenotethattherewillbeanincreasedroleforresolutionfunds(in themajorityIndustryview,expostfunds 12 )tomeetanyadditionalcoststhatarise intheresolutionoffinancialfirmsandthatarenotappropriatelyabsorbedby shareholdersorcreditors.Webelievethatitwillbedesirableandimportantto developprinciplesforthesharingofanysuchcostsamongthedifferentnational resolutionfundsthatmightbecalleduponinsuchasituation.

12

SeeIIF,AGlobalApproachtoResolvingFailingFinancialFirms:AnIndustryPerspective,May2010, Section6.

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Resolvinghostbranches
139. Thefactthatbranchesarelegallypartofthehomeentitycanhelptoachieve progresstowardaresolutionapproachthatisinaccordancewiththedegreeof integrationofthegroup. 140. TheFSBreport,Reducingthemoralhazardposedbysystemicallyimportant financialinstitutions,whichwaspresentedtoandendorsedbytheG20leadersat theirsummitmeetinginSeoulonNovember11122010appearstogointhis direction.Itsaysthatresolutionauthoritiesshouldberequiredtocooperatewith eachotherandthatnationalrulesthatposeobstaclestofaircrossborder resolution,suchasdepositorpriorityrulesthatgivepreferencetodomestic depositorsoverthoseofforeignbranchesorcertainautomatictriggerrules, shouldbeeliminatedwhereappropriate. 141. Wesupportthisdirectionoftravel.Progressshouldbemade,basedontheFSB report,toremovenationallegalobstaclessothattheresolutionofsuchafirmcan bebasedonanapproachfoundedonclosecooperationandcoordination betweenthehomeandhostauthorityledbythehomeauthority. 13 142. InourresponsetotheBaselCommitteeWorkingGroupsconsultationof September2009,weexpressedsupportforapproachessuchastheSwiss, whereby,subjecttotheprotectionofsecuredandprivilegedcreditors,tothe needforreciprocity,andtoarequirementfortheequaltreatmentofdomestic andforeigncreditors,theresolutionofafirmanditsoverseasbranchesisledby thehomestateadministrator. 143. Ensuringtheappropriateprotectionoflocaldepositorsislikelytoremainakey concernofhostauthorities.Thechallengesarisingfromthisaspectcan,however, beovercomeonthebasisofwellcoordinated,legallyeffective,firmspecificcrisis managementandresolutionagreementsenteredintobetweentherespective authorities.Clearagreementsshouldbeestablished,foundedintheresolution legislationinbothjurisdictions,enshriningprinciplesofreciprocity,non discrimination,andequaltreatmentofcreditors,andincorporatingrecognitionof theimperativesofdepositprotectionarrangements. 144. Setoutbelowarethefeaturesthatitshouldincorporatedinsuchfirmspecific agreements.(Wewouldnotethatmany,thoughnotall,oftheseprinciplesmight applyequallyinthecontextoftheresolutionofhostsubsidiaries.)

13

Itisnotedthattheremaybeexceptionalcasesinwhich,duetotheparticularconfigurationofagroup, itwouldmakesensefortheprocesstobecoordinatedbyahostauthority.Thisissomethingthatshould beaddressedinfirmspecificresolutionagreementsbetweentherelevanthomeandhostauthorities.

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(a)recognitionthatthehomeresolutionregimewillbeapplied(exceptin exceptionalcircumstanceswhereitmaybeappropriatetoagreethatahost regimeshouldbeapplied); (b)appropriateprotectionofdepositors; (c)equaltreatmentofcreditorsregardlessoflocationorgoverninglawoftheir contract; (d)incalculatingliabilities,security,etcthegoverninglawofthecontractin questiontobeapplied; (e)eliminationofassetmaintenancerequirementsinrespecttobranches; (f)eliminationofmeasuresdesignedtoensurethatunencumberedassetsareear markedforcertaincategoriesofcreditors; (g)arequirementforclosecooperationamongresolutionauthoritiesinthe differentjurisdictionstoensuresimultaneityofaction,effectivenessofmeasures, etc.;and (h)noobstacletothetransferofassets,collateral,etcbetweenjurisdictionsin furtheranceoftheresolution;

Achievingconsistencybetweengoingconcernapproachesandresolution requirements
145. Underagroupinterestapproachitisconceivablethatthedistributionofassets andliabilitiesacrosstheentitiesinthegroupwillbeotherwisethantheywould havebeenonastrictlylegalentitybasedapproach.Asdiscussedabove, dependinguponthenatureofthebusinessandassociatedbusinessmodel,inthe contextofagoingconcernorganization,notonlyisthisnotproblematic,itislikely tobesignificantlytothebenefitofthestakeholdersofthegrouptakenasawhole andtothewidereconomy.However,asthefailureofthegroupbeginstoemerge asapossibilityandacrisisbeginstocrystallize,themismatchbetween distributionsunderthegroupinterestasagainstthelegalentityapproach becomesmoresignificant. 146. WethinkthattheworkoftheFSBonfirmspecificcrisismanagementand resolutionagreementshasthepotentialtohelpaddressthisproblem.Wewould note,however,thatthisisoneofthemostdifficultissuestobeaddressed, thinkingremainsataveryearlystage,andfirmscontinuetohavedifferentviews astothebestwayforward.Theproposalunderthisheadingisthereforefor intensifiedworkandclosedialoguebetweentheofficialsectorandtheIndustryto seektoidentifyoptimalsolutions.

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147. Totakeanexampleofareastobeexplored:ifagrouporganizesitselfsothat resourcesaredistributedamongentitiesinlinewithagroupinterestapproach, andthoseentitiesaresubjecttointegratedbusinessandriskmanagement,thenit mightbeconsidereddesirable,inordertoforestallnationalrestrictionsbeing imposedonsuchanapproach,fortheretobeenteredintolegallybinding agreementsthatpermittheintegratednatureofthegroupsapproachtobe reflectedinanintegratedapproachtotheresolutionofthegroup,including ensuringthatcreditorsofthegrouphaveaccesstotheirfairshareofthegroups assets. 148. Suchanapproachwouldneedtobevoluntaryforthefirminquestion.Tothe extentthatitwishedtoincludecertainentitieswithinsuchanarrangement,the firmwouldbefreetodoso,andtotheextentthatitwishedtoexcludeentitiesor, indeed,thewholeofthegroup,itwouldbeequallyfreetodoso.Theremustbe noquestionofafirmsbusinessmodelandorganizationalapproachbeing underminedbytheimpositionofgroupsupportorsimilarrequirements. 149. Suchanapproachwouldalsoneedtobeembeddedinthelegalprovisions establishingnationalresolutionregimessothatthefirmspecificresolution agreementsarereliableandenforceableatatimeofdifficulty. 150. Properlycarriedoutandwithappropriateambitiontoarriveatlegallybinding arrangements,theapproachtothedevelopmentofinstitutionspecific agreementsmighthavethepotentialtomakeasignificantcontributiontothe achievementofaneffectiveinternationalframeworkofcrossborderresolution.

TheU.S.approach:anoteonDoddFrank
151. TitleIIoftheDoddFrankWallStreetReformandConsumerProtectionActis entitledOrderlyLiquidationAuthorityandestablishesaregimeforthe resolutionofsystemicallyimportantfirms. 152. ManyoftheprinciplesandtechniquesembodiedinthisTitleareinlinewiththe proposalstheInstituteputforthinitsMay2010report. 153. AswehavediscussedunderSection2above,theTitletakesawindingup approach.However,italsoallowsfortheestablishmentofabridgebankand othertechniquesdeemedusefultooptimizingoutcomes.Whetherabridgebank mechanismcanbeusedtoachievebailinoutcomesis,aswehaveseen,anopen question. 154. However,TitleIIremainsproblematicinthelimitedattentionthatitpaystocross borderissues.Itremainsanapproachgroundedinalegalentityphilosophyof resolutionandwindingup.Theresolutionframeworkcreatedcanapplytobank holdingcompanies,nonbankfinancialholdingcompaniessupervisedbythe

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FederalReserveBoard(FRB),companiespredominantlyengagedinfinancial activities,andanysubsidiaryofanyoftheforegoingpredominantlyengagedin financialactivities.Howeverthereisnoremitoverforeignsubsidiariesandno additionalrightstoconsolidateparentsandsubsidiaries. 155. WhatthismeansisthattheTitleIIapproachisstrictlynationaljurisdictionalin nature.SubsidiariesofforeigngroupsthatfallwithinthetermsoftheTitlefallto beresolvedindependentofandseparatefromhowtherestofthegroupmightbe dealtwith.Similarly,foreignentitiesofU.S.groupsdonotfalltoberesolved withinthecontextofthegroupasawhole. 156. Initsrecentarticle,TheOrderlyLiquidationofLehmanBrothersHoldingsInc. undertheDoddFrankAct, 14 theFDICindicatesthatintheeventthatLehman BrothershadfallentoberesolvedunderTitleIIofDoddFrank,theFDICwouldat anearlystagehavebeguncontactingkeyforeignfinancialauthoritiesona discretebasistodiscusswhatlegalorfinancialissuesmightariseoutofanFDIC receivership.Thearticlealsogivestheexampleofeffectivecooperationwiththe ChinaBankingRegulatoryCommissionandtheHongKongMonetaryAuthority concerningtheacquisitionbyEastWestBankofUnitedCommercialBank,San Francisco,withawhollyownedsubsidiaryinChinaandabranchinHongKong. Nonethelessitremainsthecasethatsuchcooperationandcoordinationis,under DoddFrank,dependentuponthegoodwillofthedifferentpartiesandperceived commoninterestinthecircumstances. 157. TheFDICis,however,requiredtocoordinatewithanyappropriateforeign financialauthoritiesregardingtheorderlyliquidationofaU.S.coveredfinancial companythathasanyassetsandoperationsoutsidetheUnitedStates. 158. Inaddition,theGovernmentalAccountabilityOfficeisrequiredtostudyand reporttotherelevantHouseandSenatecommitteesregardinginternational coordinationrelatingtotheorderlyliquidationoffinancialcompanies. 159. Much,accordingly,remainstobedonetorendertheDoddFrankapproach appropriateforapplicationinthecontextofcrossborderfinancialgroups.

14

April2011

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Annex1 KeycomponentsofaneffectiveresolutionframeworkassetoutinIIF Report:AGlobalApproachtoFailingFinancialFirms:AnIndustry Perspective 15

Thefollowingelementsrepresentthecornerstonesoftheapproachsetoutintheabove mentionedreport: Theoverallobjectiveistoadvancetheextenttowhichitispossibleforevery financialfirmtoexitthemarketinanorderlymanner. Theremustbenoexpectationthatlosseswillbebornebythetaxpayersthougha distinctionneedstobedrawnbetweensolvencyandliquiditysupport,andbetween normalexpectationsandwhatmightbenecessaryinasituationofsystemiccrisisin whichshorttermsupportcanyieldsignificantdividends. Thismeansthat: a) Itmustbepossibletoextricateanypartofthefirmthatisanessentialpartof thegeneralfinancialinfrastructureandmaintainitsoperationsbytransferring ittoathirdpartyorabridgebank. Theremustnotresultawidespreadcontagioneffectwherebylossesto stakeholdersinthefirmresultinknockonlosses(orthefearofknockon losses)tootherparticipantsinthefinancialsystemtosuchanextentthatthe systemsuffersmaterialtraumaandisputatriskofceasingtofunction effectively.

b)

Lossesshouldbebornebyshareholders,providersofotherformsofcapital,and creditorsinlinewiththeirplaceinthebankruptcy/insolvencyhierarchylaws. Propertyrightsmustberespected.Thisincludes,inparticular,fullrespectfor securityandcollateralrights;theseshouldnotbeabrogated. Totheextentthatadditionalcostsareincurredinresolvingafirminamannerthat avoidssystemicdamage,suchcostsshouldnotbeimposedoncreditors(ora particulargroupofcreditors);rather,theyshouldbebornebythefinancial industrygenerally(inlinewiththeprinciplesofresolutionfundingsetoutinthe May2010report).Thisreportindicatedthattherewasaclearmajoritywithinthe industryinfavorofexpostmechanismsformeetingsuchadditionalcostsoffailure ratherthanthecreationofanexantefund.

15

http://www.iif.com/download.php?id=Oq+9y23X4Us=

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Authoritiesshouldhaveafullrangeofpowersnecessarytoachievetheabove.

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Annex2 Criticalfunctions:someputativeexamplestobeconsidered
Paymentandsettlementsystems:Dependinguponthescaleofitsinvolvement,the activitiesofafailingfirminrespectofpaymentorsettlementsystemscanbepotentially criticalandthusneedtobepreserved.Afailuretodosocould,dependinguponthe scaleofthefirmsactivities,leadtosignificantdisruptionbothasaresultofthefailed settlementofitemscurrentlymakingtheirwaythroughthesystemandasaresultof thedisruptiontorealeconomyactivitythatcanarisefromcustomersbeingshutoutof paymentorsettlementsystemsforamaterialperiodoftime. Deposittaking:TheInstituteconsidersthatingeneral,deposittakingshouldnotbe consideredacriticalfunctionperse.Unlessthereareveryspecificprevailing circumstances,wethinkthatitisunlikelytobethecasethatacompetitorcouldnot quicklystepintoprovideareplacementservice. Itisimportanttobeclear,however,thatthisdoesnotmeanthatinsureddepositorswill notrequiretoreceiverepaymentoftheirfundsinatimelymanner,northatthemost effectivewayofachievingthismaynotbetotransferthedepositaccountstoabridge bankorthirdparty,northatthepaymentserviceaspectofsuchaccountsmaynotbe critical(seeabove).Whatitdoesmeanisthatmaintenanceofdeposittakingservicesby aparticularbankisnot,perseandundernormalcircumstances,acriticalfunctionthe costofpreservingofwhichneedstobemet. Clearly,robustandreliabledepositprotectionschemesareessentialtothemaintenance offinancialstability.However,itshouldberecognizedthatthesystemicfeaturethatis beingaddressedistheavoidanceoffinancialshockandlossofconfidenceratherthan thecontinuanceofacriticalfunction. Creditavailability:Ingeneral,itisconsideredthattheprovisionofcreditbyany particularfirmisunlikelytobeafunctioncriticaltothefinancialsystemortothe economy.Therecangenerallybeexpectedtobecompetitorsreadyandabletostepin tofillthegapleftbyanyindividualfailingfirm.Apossibleexceptiontothisisinrespect totheavailabilityofcreditfacilitiestosmallbusinesses.Suchfacilitiesmaybeimportant tocustomersforcashmanagementpurposesandmaytherefore,wherethescaleofthe provisionofsuchfacilitiesbythefinancialfirminquestionconstitutesamaterialfactor inthesmoothfunctioningoftheeconomy,representacriticalfunction. Derivativesactivities:Afirmsengagementinderivativesactivitiescanbevery significant;however,suchactivitiesshouldnotbeconsideredacriticalfunction.Theydo ofcoursehavethepotentialtocausesignificantlossestocounterpartiesand,through contagionorfearofsimilaroutcomeselsewhere,toparticipantsinthewidereconomy. Suchactivitiesshouldnot,however,beconsideredcriticalfunctions.Theseareactivities thatcanbequicklytakenupbyotherparticipants,andtheexitofthefirminquestion 55

doesnotunderminethecontinuanceofthefunctionsperse.Theissueofmajorlossand contagionis,ofcourse,averysignificantone.Itisconsideredinextensivedetailinthe Section2ofthispaper.Thekeypointhere,however,isthatsuchactivitiesdonot representacriticalfunctiontobepreservedonthebasisthatthecostofdoingso shouldbemetfromsomesourceexternaltothefirm. Inallofthecasesdiscussedaboveinwhichthereisapotentialforacriticalfunctionto bepresent,itisimportantthattheindividualcircumstancesbecloselyexamined.There arepotentiallysignificantcostsassociatedwiththepreservationofparticularbusiness activitiesoffailingfirms.Thesearecoststhatwillnot,giventheprinciplethatno creditorshouldbeworseoffthantheywouldhavebeeninaliquidation,haveanatural home.Theywill,accordingly,needtobeexternalizedoutsidethefirmandsoshould bekepttoanabsoluteminimum.Thequestionthereforeisnotwhetherdiscontinuance wouldbedisruptiveorregrettable,butwhetheritwouldcausemajordisruptiontothe realeconomy.

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Annex3 SummaryofIIFPaper,PreservingValueinFailingFirms
InSeptember2010, 16 theCBRWGmadeasubmissiontotheFSBontheissueofbailins: PreservingValueinFailingFirms.Setouthereisasummaryofthekeypointsofthe analysiscontainedinthatdocument. Partofacontinuum Thepapernotedtheimportanceofrecognizingabailinmeasureasoneinacontinuum ofmeasuresandpowers,runningfromthosedeployedbysupervisorsinthebusiness asusualphase,throughthoseusedduringcrisismanagementandemergingrisksof insolvencyto,attheotherendofthespectrum,resolutionandwinddownmechanisms, including,potentially,bailin. Needforclarity Thedistinctionbetweencontingentconvertiblecapitalinstruments(CoCos)andbailin measureswasconsidered,withthecentraldifferencebeingthoughttolieinthe contractualnatureofCoCoscombinedwiththestrictlydefinednatureoftheirtriggers ascomparedwiththemorestatutorynatureofabailinregimeandtherolegivento authoritiesininvokingbailinpowers. Avoidingprecipitouslossofvalue Itwasnotedthatthecentraleffectthatcouldbeachievedbybailinmeasureswaslikely tobetheavoidanceoftheprecipitouslossofvalueinthefailingfirmgivingrisetoa systemicevent.Suchlosscanoccurwhenafinancialfirmentersbankruptcyor liquidation.Itisthissharpandsignificantevaporationofvaluearisingfroma combinationofimpactonfranchise,customer,andworkforcevalue;theunwindingof financialcontracts,includingamovetomidmarketfrombid/askpricing;andfiresale effectsthatisattheheartofthesystemictraumaassociatedwithcontagionandfear offurtherfailuresandthatisakeyreasonwhythefailureofalarge,complexfinancial institutioncanbesoproblematic. Theinterconnectednessofsuchfirmsandthewiderfinancialservicesmarketcangive risetoasystemicshockthatneedstobeforestalled. Thebailinofcreditcounterparties,combinedwithrestructuringandachangeofsenior management,allowsthefirmtoberecapitalized,returnedtosolvency,andputback intoapositionwherebyliquidityisoncemoreavailabletoit.Whilelosseswilloccur, thesewillbeabsorbedbyequityholders,providersofotherformsofcapital,and,toa
16

September9,2010

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limitedextent,byseniorcreditcounterparties.And,indeed,totheextentthatthe recapitalizationissuccessful,someofeventheselossesmaybereversed. Tobeusedforsecuringsystemicstability ItwastheviewofthePreservingValuepaperthat,whilebailinwouldbelikelyto operatetothebenefitofthecreditorsofthefailingfirm,thegroundsfortheexerciseof thebailinpowershouldbelimitedtothatofsecuringsystemicstabilitythroughthe preservationofvalueandavoidanceoftraumaticlosses. Respectingprioritiesbetweenclasses Theorderofprioritybetweenequity,otherformsofcapital,subordinateddebt,and seniordebtneededtobepreserved.Totheextentthatthebailinmechanismmight eventuallyturnouttobeunsuccessful,itwasidentifiedasakeyprinciplethatno creditorsshouldemergeworseoffthantheywouldhavedoneinanormalliquidation. Determinationexanteorexpost AnimportantquestionconsideredinthePreservingValuepaperwastheextentto whichthoseliabilitiestobemadesubjecttothebailindecisionshouldbedecidedex anteorexpost.Itwasalsonotedthatthequestionoftheextenttowhichbailinshould restonacontractualversusastatutorybasiswouldbedeterminedbytheanswertothis priorquestion.Anumberofadvantagesanddisadvantagesofboththeexanteandthe expostapproacheswereidentified. Supportingalimitedscope/exanteapproachwerethedegreeofclarityandcertainty thatthiswouldbringtothesituation.Thisapproachwasconsideredtohavebenefitsin termsofmakingitcleartocertaincategoriesofcreditcounterpartiessuchastrading counterparties,shorttermcreditorsandliquidityproviders,anduninsureddepositors thattheywouldnotbesubjecttobailinmeasures,thusminimizingthelikelihoodof flight.Bydetermininginadvancewhichcategoriesofcreditcounterpartiesmightbe subjecttobailin,itwouldbepossibletoincreasetheconsensualnatureofthe mechanism.BeyondthisitwasalsotheviewofanumberofMembersthatbylimiting clearlythescopeofbailin,itispossibletolimitanypotentialincreaseinbankfunding costs. Countertothis,itwasidentifiedthattherewerealsoanumberofdisadvantages associatedwithanexantelimitedscopeapproach.Thisapproachhadthepotentialto contributemateriallytomoralhazardinthesystemasthoseliabilitiesexplicitly exemptedfromthebailinmechanismwouldbeperceivedasreceivingconsiderable additionalprotection.Therewasalsoidentifiedtobeconsiderableriskthatunderanex anteapproachsignificantdistortionswouldbeintroduced,withfundingtechniques beingarbitragedtoavoidpotentialbailinexposures.Onthecostofbankfundingissue, somearguedthatabroadorcomprehensiveapproach,byreplicatingaprepackaged

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bankruptcybywayofaresidualpower,wouldminimizeanypossibleincreasein funding. Triggers PreservingValuenotedtheimportanceofeffectivetriggerdesign.Whilebailins requiredadeterminationbytheauthorities,thejudgmentoftheauthoritiesshouldbe appropriatelyconstrainedsoastomaximizepredictability.Itwouldalsobecrucialto minimizetheextenttowhichthedevelopmentofabailinmechanismcouldhavethe effectofbringingforwardthepointoffailureoffinancialfirms. Terminationandcloseoutrights Thepapernotedthatforbailinmeasurestobeeffectiveitwouldbeimportantto incorporateinthelegislationestablishingbailinmechanisms,provisionswhichwould havetheeffectofsuspendingautomaticdefault,crossdefault,andcloseoutclauses. Groupissues Todealwiththecommonsituationwherebyafailingfinancialfirmispartofawider group,itwasidentifiedinthePreservingValuepaperthatitwouldbenecessaryto introducemeasurescapableofaddressingthecomplexitiesarisinginsuchacontext.It wouldbeimportantthatagrouplevelapproachbeadopted,includingnotablyinthe contextofrecoveryandresolutionplanning.Concerningthemechanicsofabailinin suchacontext,itwasenvisagedthattherewouldbeapotentialneedforprovisions enablingtheswapofequityinthebailedinentityforthatinthegroupparent. Crossborderaspects Becausetheyhavethepotentialtosignificantlyreducethelossesarisingfromfailureof acrossbordergroup,bailinmechanismswereseenashavingconsiderablepotentialto alleviatethedifficultiesthathavearisenpreviouslyindealingwiththefailureofcross borderfinancialfirms.Italso,however,givesrisetocomplexitiesofimplementationof thetechniqueitself.Thepaperidentifiedthatthiswaseffectivelyacoordination problemthatshouldbeaddressedbytheFSBachievingagreementamongitsmembers thattheywouldintroducebailinmechanismsintheirownjurisdictions.Failingthis,it mightbenecessarytosupplementthestatutoryapproachwithcontractualtechniques inparticularjurisdictions.

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Annex4 Legalissuesingroupsupportandresolution
Obstaclestogroupsupport Whereagroupisenteringresolution,thereareanumberofissuesthatariseoutofthe natureofthegroupthatmaycausedifficultyfortheeffectiveresolutionofthesituation. Limitationsontheabilityofgroupmemberstotransferassetsinterse. Thebasisofagroupstructureisthateachgroupmemberisaseparateentitysubjectto therelevantcompanylawregime.Companylawregimesgenerallyrestrictorprohibit directorsfromdealingwithcompanyassetsinawaythatisnotofsomebenefittothe companyconcerned.Thus,forexample,directorsofasolventsubsidiaryofatroubled parentbankmightbeprohibitedfromtransferringassetstotheparentinorderto ensureitsliquidity,andwillalmostinvariablybeprohibitedfromsubscribingfornew capitalintheparent. Theseissuescanvarydependingupontheconfigurationofthegroupconcerned: (1) Transfersfromaparenttoasubsidiaryaregenerallystraightforward,inthatthe parentwillgenerallysubscribenewcapitalintothesubsidiary.However,evenloans fromaparenttoasubsidiarycan,inextremecases,beprohibitedwhentheloanis almostcertainnottoberepaid. (2) Transfersfromsubsidiariestoparentsareconsiderablymorerestricted,andthey cannotbeusedtocreatenewcapitalattheleveloftheparent.Inaddition,anytransfer ofassetsfromasubsidiarytoaparentislikelytobecharacterizedasadividend,and companylawfrequentlyrestrictsorprohibitsthepaymentofdividendsincertain circumstances. (3) Directtransfersbetweensubsidiariesareingeneralsubjecttomanyofthe restrictionsimposedontransfersfromsubsidiariestoparents. Itisimportanttonotethattheseissuesconstituteaseparatesetoflegalissuesfrom thoseinvolvedindesigningaresolutionregime.WhereabankparentincountryAhasa solventnonbanksubsidiaryincountryB,itislikelytobethecasethatthesolvent subsidiaryincountryBwillnotbe(orpossiblycannotbe)placedinabankresolution regime.Thusthelegalmeasuresnecessarytodealwiththeissuesabovemustbe approachedthroughthecompanylawregimeincountryB.

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Resolutionofgroups Oneofthemostdifficultissuesintheconstructionofresolutionregimesarisesoutof theresolutionofcrossbordergroupscontainingmultiplebanks.IfbankAincountryAis theparentofbankBincountryB,themakingofaresolutionorderinrespectofBwill not,withoutsomesortofmutualrecognitionregime,resultinthemakingofa resolutionorderinrespectofA.Furthermore,ifBisinfinancialdifficultybutA (consideredasafreestandingentity)issolvent,theremaybedifficultiesforsupervisors andresolutionauthoritiesincountryAinplacingasolventinstitutionintoresolutionto assistintheresolutionofcountryB.However,ifthisisnotdonethentheresolutionof bankBmaybeseriouslyhindered. WhenbothbankAandbankBareinfinancialtroubleandareplacedinresolution,there arestillconsiderabledifficultiestoovercome.Mostimportant,anytransferofassets betweenthetwowilladvantagetheoneatthecostofdisadvantagingtheother.Ifthe objectiveoftheresolutionauthoritiesistoworktogetherforthebenefitofcreditorsas awhole,itmaybenecessaryforoneresolutionauthoritytomakeatransferwhose effectistoreducetheclaimsofthecreditorsoftheinstitutioninrespectofwhichheis appointed,andthisisclearlypoliticallyunpopular.

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institute of internAtionAl finAnCe

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