• by M.P. Azevedo, Managing Director, PwC, Advisory

Over the past several years, the international regulatory community has expended a great deal of effort to end the “too big to fail” phenomenon through resolution planning. Authorities in the United States and Europe have made significant progress, but greater cross-border collaboration is essential as we attempt to work through the specific details of how these plans would play out.

In a major advancement at the international level, the Financial Stability Board’s “Key Attributes of Effective Resolution Regimes”1 now serves as the global standard for the resolution of systemically important financial institutions (“SIFIs”). The FSB, the International Monetary Fund, and the World Bank are currently preparing an assessment exercise to measure adherence to these key attributes jurisdiction-by-jurisdiction, which will likely result in even more harmonization of resolution requirements.

SIFIs and national authorities have also moved forward in resolution planning. In the United States, Title I of the Dodd-Frank Wall Street Reform Act (“Dodd-Frank”) requires bank holding companies with global assets in excess of $50 billion and a U.S. presence to prepare credible and comprehensive plans that demonstrate their resolvability under the U.S. Bankruptcy Code and other applicable “normal course” resolution regimes (so-called “living wills”).2

As of now, three waves of filers (from the largest U.S. SIFIs and foreign SIFIs with the largest U.S. footprints to the large group of mostly foreign banking organizations with global assets merely in excess of $50 billion and a presence in the U.S.) have had to submit Title I plans to the Federal Deposit Insurance Corporation (“FDIC”) and the Board of Governors of the Federal Reserve System. Additionally, the FDIC has developed a “single-point-of-entry” (“SPOE”) strategy under its Orderly Liquidation Authority, conferred by Title II of Dodd-Frank, to resolve bank- and investment bank-centric SIFIs in the event they cannot be resolved in an orderly fashion under normal insolvency regimes.3 This approach has been generally embraced by foreign authorities as the strategy least likely to cause severe market disruptions.4 Work is also underway to devise effective resolution strategies for nonbank SIFIs, such as large insurance groups, as well as for financial market utilities.

Jurisdictions abroad have formed or designated SIFI resolution authorities5 and the European Commission is considering new legislation that would grant powers to effect SIFI resolutions.6 In almost all jurisdictions, national authorities are responsible for preparing institution-specific resolution plans. Under a timetable formulated by the FSB and agreed to by the G-20, resolution plans for the first group of firms designated as SIFIs by the FSB were due to be completed by home country resolution authorities by December 2013. This goal was largely met by the most active jurisdictions to varying degrees. The FSB’s principles also demand participation in “crisis management groups” (“CMGs”), the resolution-focused corollary to supervisory colleges. In these CMGs, home country resolution authorities must present the plans for orderly resolution of each SIFI to host authorities, and CMG members must discuss each plan’s credibility.7 The wisdom goes, through this process of sharing of firm-specific information and plans, the prospects for the successful resolution of a SIFI are likely to be increased. Moreover, these discussions lead to the identification of potential obstacles and how they should be mitigated, as well as how necessary preconditions should be met. One solution, identified by the FSB’s key attributes, is the completion of firm-specific, multilateral cooperation agreements (“CoAgs”).8

Within CMGs and various bodies of the FSB there has been ongoing debate as to how much detail institution-specific cross-border cooperation agreements should contain. One school of thought is that they should be frameworks, setting the stage for specific commitments among a group of concerned jurisdictions that participate in the firm’s CMG when and if a SIFI resolution occurs. The dominant view among FSB members appears to be that more specific commitments can only be made after taking into account the facts and circumstances presented to regulators at the time of a SIFI failure. Another constituency believes these CoAgs should detail specific commitments made by each jurisdiction to forgo certain actions in the event of the resolution of a specific SIFI. Under the FSB’s work program, these CoAgs were supposed to be developed by mid-2013.

Collaboration: Easy to Describe, Harder to Achieve

Throughout the “too big to fail” debate, skeptics have questioned the ability of the home and host resolution authorities and prudential regulators to work together effectively. Cooperation and coordination among regulators is critical in SIFI resolution given the vast geographic footprint, many licenses, complex business lines, and interdependencies that exist among various legal entities in any particular SIFI. Global SIFIs are often active in 85 or more jurisdictions, and their activities are often dependent on funding from, or shared services provided by, entities located across national borders. Even the most promising resolution strategy, the SPOE, necessitates a degree of coordination among key jurisdictions, even if the home country regulator leads resolution, and even if no foreign legal entity technically fails. Precipitous actions by foreign hosts, such as ordering a ring-fencing of funding that normally flows freely or forcing the liquidation of a local bank branch, can make an orderly resolution very difficult, if not impossible.

Of particular concern are cross-group guarantee structures.9 Though effective to enhance and support group creditworthiness in normal times, they can prove to be unwieldy in the SIFI resolution context. Their existence can give rise to termination rights of counterparties in derivatives transactions booked with entities that do not fail in a single-point-of-entry resolution scenario, but whose obligations are guaranteed by a failed parent of the group. The notional principal amounts of these contracts frequently involve numbers in the trillions, and the unwinding of such transactions, which involve huge amounts of underlying securities and other financial instruments, could introduce massive disorder into the markets. This phenomenon is commonly referred to as a “fire sale.”

Actions by countries that host significant shared services, such as securities transaction processing or data warehousing, which limit the ability of such subsidiaries to provide critical shared services to the rest of the group in resolution, can also adversely impact resolution actions that depend on continuing operations and services that are systemically important to the home or host authority. In fact, the cessation of such services can bring business-as-usual to a hard stop in many jurisdictions that host critical operations of a SIFI.

Two Approaches For Global Coordination

Assuming all agree that there is a need for global coordination in resolution, what is the best way to achieve it? Having participated in numerous workshops on resolution related matters I have observed two commonly held views.

The first view favors a multilateral framework of some type, such as a treaty. I call this the “silver bullet solution” because on its face it appears to be the cleanest and most comprehensive. SIFIs, and their advisors, often find this appealing because it allows them to shift the burden of some challenging tasks in resolution to the regulators.

The second view is that global coordination of a SIFI’s resolution will require several steps involving detailed planning, as well as an assessment of the facts and circumstances that surround a particular SIFI’s failure. The first step is to identify the jurisdictions that are critical to the success of a specific strategy such as SPOE for a particular SIFI. These jurisdictions are, typically, where the SIFI has its most material operations as measured by assets and off balance sheet activities, or where material support operations are housed. These often also include locations where excess liquidity is pooled in a global funding model. The FDIC engages in such “heat mapping” for the largest U.S. based SIFI.

After identifying a list of jurisdictions for a particular SIFI, the home country resolution authority can then discuss and determine specific actions needed in host countries, as well as vice versa. Such actions might include expedited approvals for the transfer of control of a material investment banking operation to a bridge holding company or mutual commitments to ensure sufficient liquidity. Such liquidity must be provided to material host operations from abroad and locally with a reciprocal commitment to allow excess liquidity to flow out of a jurisdiction to be used to support the needs of foreign affiliates. These commitments might not be known until the facts and circumstances of a SIFI failure are known, and will certainly vary from jurisdiction to jurisdiction. Thus, holders of the second view believe any commitments of such specific nature will have to be bilateral between home and host, and can be definitive only at such time as the particular facts and circumstances of a SIFI’s failure and the operating plan for its resolution are known. Certainly, they can be identified and discussed as a “menu of options” in the process of resolution planning (e.g., in CMGs or through bilateral workshops or simulations), but any commitment to act will need to await the actual event.

Commitments Are Only as Good as the Home and Host’s Capacity to Execute

Resolution authorities have voiced common concerns about cross-border cooperation. These include:

• Meeting particular SIFIs’ needs for liquidity for local operations that will continue during the resolution.
• Ensuring that continuing operations have access to financial market utilities.
• Addressing any termination rights that may arise in connection with qualified financial contracts (“QFCs”) that may have been cross guaranteed by, or contain events of default language regarding the failure of an ultimate parent.
• The need for expedited actions by host authorities in approving any changes of control, or re-authorizations (e.g., of new bank branches where the top of house is an operating universal bank).

Reaching a conclusion on any of these concerns can be challenging. On liquidity needs, for example, assurances about continued access to central bank liquidity facilities are a common request and expectation. The capacity of a home or host central bank to assure continued access to their facilities during resolution can be limited by law or preconditions. In the U.S., for example, Dodd-Frank removed the Federal Reserve’s ability to provide firm-specific liquidity assistance unless it is part of a broad-based program.10 Other central banks, such as the Swiss Central Bank, are prohibited by law from lending to a bank once it reaches a certain level of insolvency. As to sourcing liquidity from resolution authorities themselves, it is more the exception than the rule that such authorities will have access to liquidity to deploy in a resolution. The best known example of this is the Orderly Liquidation Fund in the U.S., essentially a line of credit at the U.S. Treasury available to the FDIC to assist in a SIFI’s Title II (but not Title I) resolution.11 The E.U. is also looking to form a resolution fund.12

Continuity of access to the services of clearing and settlement infrastructures is another particularly tricky area. These infrastructures are risk-managed by their members subject to rulebooks that are often hard to gain access to and whose interpretation and application may be subject to discretion. Thus, commitments in advance from these infrastructures that they will not terminate access to operating affiliates of a SIFI parent undergoing resolution may be difficult or impossible to obtain by a local resolution authority.

Stays on the termination of QFCs is also a very controversial topic. Under Dodd-Frank, the FDIC may impose a 24-hour stay on the termination of QFCs by counterparties during a SIFI Title II resolution.13 The E.U.’s Bank Recovery and Resolution Directive proposed a 48-hour stay to avert wholesale terminations and fire sale liquidations of massive amounts of collateral.14 However, some other jurisdictions that are hosts to significant off-balance sheet activity do not have the powers to stay terminations during resolution, which encumbers the host’s ability to support an orderly resolution.

Achieving the Necessary Quantum of Cooperation: What Will It Take?

What will it take to achieve an acceptable level of global coordination and cooperation in resolution? A short answer is not easy, but to start: active involvement and contributions by the SIFIs, the national resolution and prudential authorities, the multilateral institutions, the financial market utilities, and other market participants. Here’s a brief list of what we should expect for progress in resolution collaboration over the next year or so:

1. Resolution authorities will pressure firms to enumerate and share with authorities specific needs for jurisdictional cooperation in their resolution plans, and firms will not assume the authorities will be able to catalogue all such specific actions. This, in turn, will enable more focused and meaningful dialogue both bilaterally and multilaterally among resolution and prudential authorities.
2. Authorities will take a closer look at firm structures; examine loss absorptive capacity, funding and liquidity sources, and cross-border dependencies; and identify deficiencies in such areas as management information systems and collateral management practices where improvements would enable a quicker assessment of needs in a resolution setting.
3. Authorities will engage in full and candid dialogue about access to funding and liquidity in the run up to, and at the commencement of, resolution from a broad range of official and unofficial sources in home and in host jurisdictions.
4. Financial market utilities will engage more fully in the SIFI resolution planning process and reach a better understanding of the role they would play.
5. Resolution and prudential authorities will increase their focus on cross-border obstacles, and mitigating actions, in part through the use of firm-specific tabletop scenarios and simulations. As more detailed, operationalized resolution plans come forth, more of these exercises will be possible.

Ultimately, all participants stand to benefit when each coordinates and cooperates to make effective cross-border resolution a reality. •