SIFI Resolutions And Living Wills: The Financial Stability Board Proposal (And Some U.S. And UK Observations)

Author:Mr Dwight Smith, John F. Delaney, Barbara R. Mendelson, David M. Lynn, Alexandra Steinberg Barrage, Larren Nashelsky, Charles M. Horn, Larry Engel and Anna Pinedo
Profession:Morrison & Foerster LLP

On July 19, 2011, as part of a broad program to enhance the regulation of systemically important financial institutions ("SIFIs"), the Financial Stability Board ("FSB") published a consultative document, "Effective Resolution of Systemically Important Financial Institutions" (the "FSB Paper").1 The paper proposes several additions to and improvements in domestic and cross-border resolution regimes, including the preparation of Recovery and Resolution Plans ("RRPs"). Comments are due by September 2, 2011.

The proposals in the FSB Paper are not unexpected, and many have been telegraphed over the past several months at least. The release of the paper and the FSB's plan to make final recommendations to the G-20 in November will, however, cause the large majority of SIFIs to focus on these proposals.

In addition, nearly all SIFIs will need to assess the impact of the proposals in the FSB Paper in the light of other proposals in the United States, the European Union and the United Kingdom.2 Today we are publishing another client alert that discusses the UK Paper in detail.3 The proposals share the same underlying policies, but there are differences that present the possibility of divergence in resolution policy, particularly in early stage planning. Actual or potential differences that exist include such issues as the universe of SIFIs covered, the scope of resolution plans, the nature of a "resolvability" assessment, "bail-in" power, the treatment of branch offices or subsidiaries of SIFIs based elsewhere, and the treatment of custodial functions.


The FSB Paper is a companion piece to another FSB Paper (the "BCBS Paper") published the same day by the Basel Committee on Banking Supervision ("BCBS").4 The BCBS Paper describes a scoring system for determining systemic importance of global banking organizations and a set of capital surcharges for those that are systemically important. We discussed the BCBS Paper in a news bulletin last week.5 One tentative lesson to draw from the BCBS Paper is that the BCBS and the FSB contemplate a smaller universe of SIFIs than is provided for in Dodd-Frank or anticipated by at least some U.S. regulators.

The starting point for the FSB Paper and the BCBS Paper is the framework for SIFI regulation that the G-20 Leaders approved at their November 2010 meeting.6 The framework has four elements: (i) improvements in resolution regimes; (ii) additional loss absorption capacity by SIFIs; (iii) more intensive supervisory oversight of SIFIs; and (iv) robust core financial market infrastructure to reduce contagion risk from the failure of individual SIFIs. The FSB has described the FSB Paper and the BCBS Paper as the "bookends" to this framework. The FSB Paper addresses the first of the four elements and the BCBS Paper the second. The FSB and the BCBS have begun work on the others, although no proposals or studies have been released.7 The FSB intends to present a final set of recommendations on resolutions and loss absorption to the G-20 Leaders at their November meeting in Cannes.


The FSB Paper is based on four building blocks, each of which is discussed in greater detail below:

Strengthened national resolution regimes. A designated resolution authority should have a broad range of powers and tools to resolve a financial institution that is no longer viable and has no reasonable prospect of becoming so. Among other powers, the resolution authority should be able to "bail in" unsecured creditors. Cross-border cooperation arrangements. Countries should enter into bilateral or multilateral institution-specific cooperation agreements, underpinned by national law, that will enable resolution authorities to act collectively to resolve cross-border firms in an orderly way. Improved resolution planning by firms and authorities. The home-country resolution authority should conduct ex ante resolvability assessments of SIFIs. These assessments could lead to changes in national law and in individual firm structures and business practices. Each SIFI should prepare a Recovery and Resolution Plan ("RRP"). The resolvability assessment and the RRP are intertwined and likely would be completed at the same time. Additionally, each SIFI's RRP will be reviewed by its home-country resolution authority and by the authorities in all of the SIFI's host countries. Measures to remove obstacles to resolution. SIFIs should address issues that may hinder an orderly resolution, specifically including fragmented information systems, intra-group transactions, reliance on service providers and the provision of global payment services. The FSB Paper also requests comment on two legal issues. First, the statutory priorities of creditor claims may vary among jurisdictions, particularly the issue of a separate preference for depositors. The differences could complicate a cross-border resolution. The FSB does not suggest a particular solution, although it is difficult to imagine any country, such as the U.S., adjusting its treatment of bank depositors to suit international needs. Second, early termination clauses that are a standard part of many financial contracts may enable counterparties to exit the transactions at the moment of resolution. The home country regulator typically can address the issue for contracts governed by home-country law. For contracts with early termination rights but governed by host-country law, the home-country authority cannot take appropriate action. The FSB proposes four possible solutions: contractual provisions in which a counterparty agrees to abide by the resolution requirements in the home country, the grant of authority to host jurisdictions to order compliance with home-country actions, judicial action in the host country, or a full-faith-and-credit-type statute.

Strengthened national resolution regimes

The FSB Paper identifies several functions of an effective resolution regime, a list that, while not groundbreaking, is perhaps the best single summary of the need for special resolution powers for SIFIs. According to the FSB, a regime is effective if it:

Ensures continuity of systemically critical financial services and functions Protects insured depositors and insurance policy holders and ensures the rapid return of segregated client assets Allocates losses on firm owners (shareholders) and unsecured and uninsured creditors in their order of seniority Does not rely on public solvency support and does not create an ex ante expectation that such support will be available Avoids unnecessary destruction of value, and therefore minimizes the overall costs of resolution in home and host jurisdictions Provides for speed and transparency and as much predictability as possible through legal and procedural clarity and advanced planning for orderly resolution Provides a mandate in law for cooperation, information exchange, and coordination domestically and among relevant foreign resolution authorities before and during a resolution Ensures that nonviable financial institutions can exit the market in an orderly way Is credible and thereby provides incentives for market-based solutions These functions require a resolution regime with several "key attributes," including a statute creating an authority with broad powers, requiring extensive planning for a resolution (or a recovery), and precluding, to the extent possible, the use of public funds in resolutions.

Resolution statute. To these ends the FSB recommends the enactment of a comprehensive statute governing resolutions. A SIFI would enter the resolution process when the firm is no longer viable or likely to be no longer viable and other measures have proved insufficient to prevent failure.8 A firm need not be balance sheet-insolvent in order to be placed in resolution.

Resolution authority. The statute would designate an authority with broad powers to resolve SIFIs for which it is the home-country authority,9 significant nonregulated operational entities within a SIFI, and branches of foreign institutions. The authority should have the legal power to enter into cross-border agreements. The authority should have unimpeded access to information from financial firms. From a political perspective, the agency should, on the one hand, have operational independence but should, on the other, be subject to rigorous evaluation and accountability. Further, the agency should be able to initiate resolution essentially unilaterally.

Resolution powers. The FSB Paper enumerates 13 powers that the resolution authority should have. Most of these powers will be familiar to...

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