IIF Addressing Priority Issues in Cross Border Resolution May 2011

8/4/2019 IIF Addressing Priority Issues in Cross Border Resolution May 2011

1/63

May 2011

Addressing Priority issues

in Cross-Border resolution


2/63

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

supplementary

senior

debt

bail

in

powers.

Credit

liabilities

arising

from

trading

activities

shouldbeexcludedfromthescopeofbailin,andtheintroductionofbailinshouldbe

onaprospectivebasisonly.

Aneffectiveframeworkfortheresolutionofcrossborderfirmsrequiresboth

convergenceofnationalregimesandenhancedcooperationandcoordinationamong

resolutionauthorities,basedonlegallyeffectivecrisismanagementagreements.Such

agreementshavethecapacitytoallowforapproachestoresolutionthatareconsistent

1


3/63

withthestructuralandorganizationalapproachesadoptedbyfirms,andwhichavoid

increasedringfencingofcountriesandfragmentationoftheinternationalmarketplace.

Therearesignificantbenefitstotheglobalandlocaleconomiesderivingfromthe

diverserangeofapproachesandstructuresthatglobalfirmsdeploy.Crossborder

resolutionarrangementsneedtopreservethese.Tobeeffectivesuchcrisis

managementagreementsneedtobeembeddedinnationalresolutionframeworks

incorporatinganumberofprovisionsdesignedtounderpinandsupportthe

internationalmarketinfinancialservices.

Theglobalindustryisstronglycommittedtothedevelopmentofaneffective

internationalframeworkfortheresolutionofcrossborderfinancialfirms.Weconsider

that,buildingontheworktodatebytheFSBanditsmembersaswellasbyindustry

representatives,thisgoalisnowpotentiallywithinourgrasp.TheIIFispleasedto

presentthisreportasanindustrycontributiontotheworkinthisarea.Theindustry

standsreadytoparticipateinfurtherworkanddialogueinordertoleveragetheinsights

andsolutionsofallpartiestowardtheachievementofthisstronglysharedobjective.

JosefAckermann PeterSands

ChairmanoftheManagementBoard GroupChiefExecutive,

andtheGroupExecutiveCommittee, StandardChartered,PLC

DeutscheBankAG

UrsRohner CharlesH.Dallara

ChairmanoftheBoardofDirectors ManagingDirector

Credit

Suisse

Group

AG

Institute

of

International

Finance

2


4/63

3

Contents

Preface 1

IIFBoardofDirectors 4

IIFSpecialCommitteeonEffectiveRegulation 7

IIFWorkingGrouponCrossBorderResolution 12

ExecutiveSummary 16

Introduction 21

Section1 Effectiveresolutionplanningensuringthecontinuanceofcriticalfunctions 23

Section2 Avoidingsystemictraumamakingbailintechniquesoperational 30

Section3 Resolvingcrossborderfinancialfirmsaddressingkeyissues 42

Annex1:KeycomponentsofaneffectiveresolutionframeworkassetoutinIIFReport,

AGlobalApproachtoFailingFinancialFirms:AnIndustryPerspective 53

Annex

2:

Critical

functionssome

putative

examples

to

be

considered

55

Annex3:SummaryofIIFPaper,PreservingValueinFailingFirms 57

Annex4:Legalissuesingroupsupportandresolution 60


5/63

IIFBoardofDirectors

Chairman

JosefAckermann*

ChairmanoftheManagementBoardand

theGroupExecutiveCommittee

DeutscheBankAG

Chairman

RobertoE.Setubal*

PresidentandChief

ExecutiveOfficer,Ita

UnibancoBancoS/A

andViceChairmanof

theBoardofIta

UnibancoHoldingS/A

Chairman

FranciscoGonzlez*ChairmanandChief

ExecutiveOfficerBBVA

Chairman

RickWaugh*

PresidentandChief

ExecutiveOfficer

Scotiabank

Treasurer

MarcusWallenberg*

ChairmanoftheBoard

SEBMs.SuzanSabanciDincer

ChairmanandExecutiveBoardMember

AkbankT.A.S.

Mr.YannisS.Costopoulos*

ChairmanoftheBoardofDirectors

AlphaBankA.E.

Mr.PeterWallison

Senior

Fellow

FinancialPolicyStudies

AmericanEnterpriseInstitute

Mr.HassanElSayedAbdalla

ViceChairmanandManagingDirector

ArabAfricanInternationalBank

Mr.MichaelSmith

ChiefExecutiveOfficer

AustraliaandNewZealandBanking

GroupLimited

Mr.WalterBayly


BancodeCrditodelPer(BCP)

Mr.

Baudouin

Prot*


BNPParibas

Mr.RobertP.Kelly*

ChairmanandChiefExecutiveOfficer

BNYMellon

4


6/63

Mr.VikramPandit


Citigroup,Inc.

Mr.MartinBlessing

ChairmanoftheBoardofManaging

Directors

CommerzbankAG

Mr.UrsRohner


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

Chairman

of

the

Executive

Board

INGGroup

Mr.CharlesH.Dallara(exofficio)*

ManagingDirector

InstituteofInternationalFinance

Mr.CorradoPassera

ManagingDirectorandChiefExecutive

Officer

IntesaSanpaoloS.p.A.

Mr.JesStaley


InvestmentBank

J.P.MorganChase&Co.

Mr.YoondaeEuh

Chairman

KBFinancialGroupInc.

Mr.YasuhiroSato

PresidentandChiefExecutiveOfficer

MizuhoCorporateBank,Ltd.

Mr.JamesGorman


MorganStanley

Mr.IbrahimS.Dabdoub

GroupChiefExecutiveOfficer

NationalBankofKuwait

Mr.FrdricOuda


SocitGnrale

Mr.PeterSands

GroupChiefExecutive

StandardChartered,PLC

Mr.WalterB.Kielholz


Swiss

Reinsurance

Company

Ltd.

Mr.NobuoKuroyanagi*

Chairman

TheBankofTokyoMitsubishiUFJ,Ltd.

5


7/63

6

Mr.OswaldGruebel


UBSAG

Mr.MartinSenn


ZurichFinancialServices

*MemberoftheAdministrativeandNominationsCommittee


8/63

IIFSpecialCommitteeonEffectiveRegulation

Chairman

Mr.PeterSands

GroupChiefExecutive

StandardChartered,PLC

Mr.DavidHodnett

GroupFinancialDirector

ABSAGroupLimited

Mr.BobPenn

Partner

Allen&OveryLLP

Ms.AlejandraKindelnOteyza

HeadofResearchandPublicPolicy

Communications,GroupMarketingand

ResearchDivision

BancoSantander

Mr.RobEverett

EuropeanChiefOperatingOfficer

BankofAmericaMerrillLynch

Mr.RobertPitfield

GroupHead,ChiefRiskOfficer

BankofNovaScotia

Mr.RichardQuinn

Director,RegulatoryAffairs

GroupCompliance

Barclays

Mr.MarkHarding

GroupGeneralCounsel

BarclaysPLC

Mr.GerdHusler


BayernLB

Ms.MariaAbascalRojo

ChiefEconomistRegulationandPublic

Policy

BBVAResearch

BBVA

TheHonourableKevinLynch

ViceChair

BMOFinancialGroup

Mr.BaudouinProt


BNPParibasGroup

Mr.ChristianLajoie

HeadofGroupPrudentialAffairs/Co

headofGroupPrudentialandPublic

Affairs

BNPParibasGroup

Mr.MarkMusi

EVP,ChiefComplianceandEthics

Officer

BNYMellon

7


9/63

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

Crdit

Agricole

Mr.OlivierMotte

HeadofPublicAffairs

MemberoftheManagement

Committee,CACIB

CreditAgricoleCIB

Mr.JrmeBrunel

HeadofPublicAffairs,Memberofthe

ExecutiveCommittee

CrditAgricoleSA.

Mr.UrsRohner


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


DZ

BANK

AG

Dr.FlorianStrassberger

GeneralManager

HeadofNewYorkBranch

DZBank

8


10/63

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


GulfCraft

Mr.JamesChew

DeputyHead,StrategyandPlanning

GMOInternational

HSBC

Mr.KoosTimmermans

MemberoftheExecutiveBoardand

CRO

INGGroup

Mr.CarloMessina

ChiefFinancialOfficer

IntesaSanpaoloSpa

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

Morgan

Stanley

Mr.IbrahimDabdoub


NationalBankofKuwait,S.A.K.

9


11/63

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


OliverWyman

Mr.WilliamDemchak

ViceChairman

PNCFinancialServicesGroup

Mr.JohnW.Campbell

Partner

AdvisoryFinancialServices

PricewaterhouseCoopers LLP

Mr.EugeneA.Ludwig

FounderandChiefExecutiveOfficer

Promontory

Financial

Group,

LLC

Mr.FernandoBarnuevoSebastiande

Erice

ManagingDirector

RHJISwissManagement

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.

Donald

F.

Donahue


TheDepositoryTrust&Clearing

Corporation

10


12/63

11

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


13/63

IIFWorkingGrouponCrossBorderResolution

Chairman

Mr.UrsRohner


CreditSuisseGroupAG

Mr.DiederickvanMierlo

ManagingDirectorCorporate&Markets

Risk

CentralRiskManagement

ABNAMRO

Mr.BobPenn

Partner

Allen&OveryLLP

Ms.SuzanneChomiczewski

Director

Corporate

Treasury/GRRP

BankofAmerica

Mr.MarkLunn

SeniorVicePresident

BankofAmerica

Mr.MichaelD'Souza

ManagingDirector

BankofAmericaMerrillLynch

Mr.RichardQuinn

Director,RegulatoryAffairs

GroupCompliance

Barclays

Mr.JohnWhittaker

GroupOperationalRiskDirector

BarclaysBankPLC

Ms.MariaAbascalRojo

ChiefEconomistRegulationandPublic

Policy

BBVAResearch

BBVA

Mr.ChristianLajoie

HeadofGroupPrudentialAffairs/Co

head

of

Group

Prudential

and

Public

Affairs

BNPParibas

Mr.BradleyGans

ChiefLegalOfficer

Europe,MiddleEast&Africa

Citi

Ms.TinaLocatelli

ManagingDirector&GeneralCounsel

IndependentRisk

CitigroupInc.

Mr.SethGrosshandler

Partner

ClearyGottliebSteen&HamiltonLLP

12


14/63

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

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.

Karen

Linney

ManagingDirectorandEMEA

InvestmentBankGeneralCounsel

JPMorganChase&Co.

Mr.MichaelOffen

MD,CorporateFinance

JPMorganChase&Co.

13


15/63

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


Promontory

Financial

Group,

Canada

ULC

Mr.RalphRicks

Head,GroupRegulatoryDevelopments

GroupRegulatoryAffairs

RoyalBankofScotland

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

Executive

Director,

Head

Executive

&

InternationalAffairs

GroupGovernmentalAffairs

UBSAG

14


16/63

15

Mr.SergioLugaresi

SeniorVicePresidentandHeadof

RegulatoryAffairs

InstitutionalandRegulatoryStrategic

Advisory

UniCreditGroup

Mr.KevinNixon

HeadofRegulatoryReform

Westpac

Mr.EdmundBosworth

HeadofRiskReward

GroupFinance

WestpacBankingCorporation


17/63

ExecutiveSummary

1. ThissubmissionbuildsupontheInstitutesprevioussubmissionstotheFSB:AGlobalApproachtoResolvingFailingFinancialFirms:AnIndustryPerspective(May

2010)andPreservingValueinFailingFinancialFirms(September2010).

2. Effectiveresolutionisessentialinachievinglongtermresilienceandfinancialstability.Itplaysakeyroleinaddressingmoralhazardandissuesassociatedwith

systemicallyimportantfirms.

3. Thispaperaddressesthreekeycomponentsofaneffectiveframeworkforcrossborderresolution:(a)resolutionplanningforthemaintenanceofcriticalfunctions,

(b)bailinmechanismsand(c)addressingkeycrossborderissues.

Resolutionplanningforcriticalfunctions

4. Highqualityrecoveryandresolutionplanningisanessentialcomponentofeffectiveresolution.Suchplanningshouldtakeplaceonagroupwidebasis.There

shouldbeasingleresolutionplanforthegroupasawhole,thoughthisshould

addressthesituationinthedifferentpartsofthegroupandshouldbedeveloped

onthebasisofstrongcoordinationbetweentheauthoritiesinthedifferent

jurisdictionsinthecontextofawellfunctioningfirmspecificcrisismanagement

group.

5. Maintainingcriticalfunctionsisnotacostfreeexercise.Inadditiontoadministrativecoststotheextentthatgoodassetsaretransferredtosupport

critical

liabilitiesthere

may

be

fewer

such

assets

available

to

cover

losses

in

the

failingfirm.Itisimportantthereforetoadoptatightdefinitionofcritical

functions.

6. Resolutionplanningistheprimaryresponsibilityoftheauthorities.Firmshavearesponsibilitytoprovidetheinformationnecessarytoallowtheauthoritiestoplan

effectively.

7. Planningforthecontinuanceofcriticalfunctionsshouldnotinvolverequeststofirmsasamatterofcoursetochangetheirorganizationalstructures.Inparticular,

forcedmodularizationorsubsidiarizationshouldnotbecomethepreferredchoice

ofauthorities.Itisimportantthatagroupsstructureandorganizationreflectits

businessmodelandstrategy.Arequirementtomoveawayfromsuchanapproach

willgiverisetosignificantinefficienciesandeconomiccosts.

8. Firmshavetheresponsibilitytoprovidetheinformationandexplanationnecessarytoenable:

a) Anassessmentofthedegreeofthefunctionscriticalitytotheeconomy;16


18/63

b) Clearunderstandingofthefunctioninquestion,includingitskeyfeaturesandthescaleofprovisionbythefirm;

c) Identificationofhowthatfunctionisprovidedbythefirm;d)

Separation

and

transfer

of

the

function

in

a

crisis;

and

e) Understandingofhowthefunctionisfinanced,andwillcontinuetobefinancedinatransfersituation.

9. Inthecontextofcrossbordergroups,authoritiesmustcooperateandcoordinateonthebasisofeffectivefirmspecificagreementstocarryoutresolutionplanning

thatavoidstheimpositionofparticularorganizationalstructuresandthe

fragmentationofinternationalmarkets.

Bailinmechanisms

10. Itisimportanttoavoidthatthefailureofafinancialfirmgivesrisetolossesofsuchascalethatsystemictraumaoccurs.Itisimportantthatthefailureofsucha

firmdoesnot,throughitsinterconnectednesswiththebroadersystem,giverise

toasystemiceventthatunderminesfinancialstability.

11. Incontrastwiththesituationinvolvinganonfinancialfirm,thesimplefactofthedeclarationofafirmsinsolvencyandliquidationcancauselossofbusinessvalue

sufficienttocausesystemicdamage.InthecaseofLehman,thelosstocreditors

postdeclarationofinsolvencyisexpectedtobeanumberoftimesgreaterthan

thelossofassetvalueincurredpriortothedeclarationofinsolvency.

12. Bailincanforestallprecipitouslossofvalueandsystemicshockbyrecapitalizingthefirmandallowingittoberestructured.

13. Asetofprinciplesisputforwardasasuggestedbasisforthedevelopmentofbailinregimesindifferentjurisdictions.

14. Whilegoodprogresshasbeenmadeindevelopingproposalstomakethebailinconceptmoreoperational,thereremaindifficultquestionstoberesolvedand

challengestobeovercome.Accordingly,inanumberofareastheneedforfurther

workhasbeenidentified.

15. Theviewsofinvestorswillalsobeimportantinarrivingatfinalproposalsforabailinmechanism.InputtingforwardnowthesuggestedapproachinSection2,it

isenvisagedthatthisapproachcanformthebasisforawellgrounded

engagementwiththeinvestorcommunity.

16. Theobjectiveofabailinistopreservesystemicstability.Accordingly,allfinancialinstitutionsshouldpotentiallybeabletobethesubjectofabailindetermination.

17


19/63

Inpractice,onlythosethefailureofwhichwouldbesystemicinthecircumstances

asdeterminedbytheauthoritiesshouldactuallybesubjecttobailin.

17. Theorderofprioritybetweenclassesofshareholdersandclassesofcreditorsshouldbemaintainedinallcases.Withinaclass,certaincreditorsmaybebailedin

while

others

are

not.

However,

no

creditor

should

be

left

worse

off

as

the

result

of

abailinthans/hewouldhavebeenintheliquidationofthefirm.

18. Itisproposedthattheprimaryscopeofabailinmechanismshouldbelimitedtosubordinateddebt.Inmanycasesthisislikelytobesufficienttorecapitalizethe

firmsoastoachievetheobjectivessetout.Suchanapproachcanhelpaddress

someofthepotentialdisadvantagesofbailin,includingenhanceduncertainty,

increasedpricingofdebt,andpossiblefundingarbitrage.Moreover,suchan

approachhelpslockintightlyadherencetothestrictorderofprioritiesinan

insolvency.

19. However,itisacknowledgedthatitisnotpossibletocalibratepreciselyexantethescaleofthepotentialneedforfreshcapitalinacrisissituation.Thereforeitis

envisagedthatasalastresort,andsubjecttoclearrequirementsandcriteria,it

maybenecessarytobailinaproportionoftheseniordebtofthefirmasan

alternativetothewindingdownofthefirm.

20. TheIndustrybelievesthatobligationsarisingfromthetradingactivitiesofthefirmshouldbeexcludedexantefromthescopeofthisexceptionalpowerofbailin.

Whetherthescopeofthisbailinshouldbemorepreciselydeterminedexante

forexample,bytheexclusionofliabilitieswithamaturityoflessthan365days,or

ofuninsureddepositsisakeyissuerequiringfurtherconsideration.

21. Inallcases,theorderofprioritybetweendifferentclassesofshareholderanddebtholdermustbemaintained.Whilethisprincipleisimmutable,furtherworkis

neededtoidentifythebesttechnicaloptionstoachievethis.

22. Bailinallowsthefirmtoberestructured,weakmanagementtobereplaced,andtherecapitalizedfirmtoaccesssourcesofliquidityasbeingnowfirmlycapitalized.

23. Inthecaseofcrossborderfirms,thepreferredapproachisfortheFinancialStabilityBoard(FSB)toreachagreementontherequirementforeachcountryto

adoptabailinmechanism.Thiswouldavoiddivergentapproaches.Totheextent

thatthisisnotachievedcontractualsolutionswillberequired.

Keyaspectsinresolvingcrossborderfirms

24. Nationalresolutionregimesmustformconsistentandconvergentcomponentsofaninternationalframeworkfortheresolutionofcrossborderfirms.

18


20/63

25. Firmsadoptavarietyofstructuralandorganizationalapproachestotheoperationoftheircrossborderbusinesses.Suchapproachesaredeterminedprimarilybythe

natureofthebusinessofthefirmandthebusinessmodeladopted.Assuch,

materialdisbenefitswouldfollowfromanyattempttorequirefirmstoadopt

particularstructuresororganizationalapproaches.

26. Forcertaintypesofbusinessandundercertainbusinessmodels,theabilityofgroupstoruntheirbusinesssoastooptimizethegroupinterestcanresultin

enhancedoutcomesforallpartiesandtheeconomy.However,thereisapotential

mismatchbetweensuchagroupinterestconceptandthelegalentitybased

natureofresolutionregimes.Moreover,insuchcasestherequirementfor

authoritiesprimarilytopursueoutcomesdefinedinnationaljurisdictiontermscan

also,dependinguponthenatureofthebusiness,producenegativesum

outcomes.

27. TheworkbeingcarriedoutbytheFSBonfirmspecificcrisismanagementagreementsisimportantandhasthepotentialtoachievesignificantprogressin

thisregard.Tobesuccessful,however,theseagreementsshouldestablishlegally

effectiveresolutionmodalitiesthatreflecttheorganizationalstructureand

businessmodelofthegroup.Thisinturnrequiresthatnationalresolution

frameworksareadaptedtogiveeffecttosuchagreements.

28. Amongthecomponentsofsuchframeworksshouldbe: Internationalmandatesforauthorities; Arequirementofnondiscriminationagainstcreditorsofthegrouponthe

basisoftheirlocationornationality;

Aobjectivetooptimizeoutcomesforcreditorsofthegroupasawhole; Arequirementforjointplanninginthecontextofcrisismanagementand

resolutioncolleges,andclearcooperationandcoordinationagreementsledby

thehomeauthority;

Arequirementforauthoritiestoshareallrelevantinformationonthebasisofstrictconfidentiality;and

Principlesfortheeffectiveandfairinteroperationoffundingarrangementsinrespectoftheadditionalcostsofresolution.

29. Resolutionandresolutionplanninginrespectofahostbranchneedstotakeintoaccountlocalrequirements,regulations,anddepositorprotectionarrangements.

Itshouldgenerallybeledbythehomeauthorityinclosecooperationwiththe

hostauthority(thoughtheremaybeexceptionalcasesinwhichtheparticular

19


21/63

20

configurationmakesitmoreappropriatefortheresolutiontobeledbythehost

authority).

30. Inthedevelopmentoffirmspecificresolutionagreementsbetweenauthorities,oneoftheissuestoaddresswillbeachievingfairoutcomesamongcreditors

across

the

group.

The

development

of

mechanisms

that

can

achieve

thisin

particularbyaddressingthedistributionofresourcesinthegroupduringa

resolutionremainsadifficultandchallengingsubject.Intensifiedworkandclose

dialoguebetweentheofficialandprivatesectorsisneededtotryanddevelop

optimalsolutions.


22/63

Introduction

31. ThispaperhasbeenpreparedbytheInstitutesCrossBorderResolutionWorkingGroup(CBRWG),chairedbyUrsRohner,ChairmanoftheBoardofDirectors,

CreditSuisseGroupAG,asacontinuationoftheIndustryscontributiontothe

effortsaimedatestablishinganeffectiveinternationalframeworkforthe

resolutionofcrossborderfinancialfirms.Theworkhasbeencarriedoutunder

theauspicesoftheSpecialCommitteeonEffectiveRegulation,chairedbyPeter

Sands,GroupChiefExecutive,StandardCharteredPLC.

Buildingonpreviouswork

32. InMay2010,theInstitutepublishedareportdevelopedbytheCBRWG,AGlobalApproachtoFailingFinancialFirms:AnIndustryPerspective

1,whichoutlinedthe

keyelementsofaframeworkthatwouldmakeitpossibleforanyfirm,irrespective

ofitssizeorinterconnectedness,toexitthemarketwithoutcausingsystemic

disruptionandwithoutanyexpectationthattaxpayersmoneywillbeused.Sucha

frameworkiskeytoachievingadurablyresilientfinancialsystem.Asummaryof

thekeycomponentsofaneffectiveresolutionframeworkascontainedintheMay

2010reportaresetoutinAnnex1.

33. AftertheMay2010report,theInstitutesubmittedtotheFSBthepaper,PreservingValueinFailingFirms

2inSeptember2010,focusedonthepowerfor

authoritiestoconvertsomeofthedebtofthefirmtocapitaltobringaboutits

recapitalization(creditorbailinorbailin).Thepaperwaslargelyexploratory

anddidnotseektoreachfinalconclusionsonseveralkeyissues;however,it

expressed

considerable

merit

in

examining

bail

in

arrangements

further.

Importanceofresolvability

34. TheInstitutebelievesthateffectiveresolutionisessentialtoachievinglongtermresilienceandfinancialstability.Sucheffectiveresolutionplaysakeyrolein

addressingmoralhazardandissuesassociatedwithsystemicallyimportantfirms.

35. AstheInstitutehassaidpreviously,westronglybelievethataddressingsystemicriskrequiresanapproachbasedonfourmutuallyreinforcingcomponents:

(a)

Enhanced

regulation,

(b)Improvedindustrypractices,

(c)Strengthenedsupervision,and

1http://www.iif.com/download.php?id=Oq+9y23X4Us=

2http://www.iif.com/download.php?id=ryVjoux4FSs=

21


23/63

22

(d)Effectivelyfunctioningmarkets.

36. Notonlyisthebalancedintegrationofthesefourcomponentsnecessarytoachievelongtermstability,failuretoachievesuchbalanceislikelytohave

significantadverseconsequences.Thereiscurrentlyarealriskofdisproportionate

reliance

on

the

regulatory

component

at

the

expense

of

the

other

three,

and

thereissignificantpotentialforadverseconsequencesflowingfromthis.

37. Aneffectiveframeworkfortheresolutionofallfinancialfirms,includinglarge,complexfinancialinstitutions,isakeycomponentinachievingeffectively

functioningmarketsandfindingabalancedintegrationofthefourcomponents

outlined.Puttinginplaceeffectivelyfunctioningresolutionregimesisthereforea

keypriority.

Structureofthepaper

38. ThispapercontinuestheIndustrysworkinthisarea.Inparticular,threebroadpriorityareashavebeenidentifiedforfurtherwork.Thesearereflectedinthe

threesectionsofthispaper:

39. Section1considerstheneedtoensurethecontinuanceofcriticalfunctionsintheeventofthefailureofalarge,complexfinancialfirm.

40. Section2continuestheInstitutesworkonbailin.Itseekstooutlineaneffectiveandeconomicallyviablemechanismwherebythesystemicshock

potentiallyarisingfromthefailureoffinancialfirmissignificantlyreduced.The

sectiondevelopsadraftsetofprinciplesthatmightbeenvisagedforthecreation

ofabailinregime.

41. Section3developsananalysisofthekeyobstaclestoachievingtheeffectiveresolutionofcrossborder,asopposedtopurelydomestic,financialfirmsand

proposessolutionstotheseobstacles.


24/63

Section1 Effectiveresolutionplanningensuringthe

continuanceofcriticalfunctions

42. Forfinancialinstitutionstobeabletoexitthemarketinanorderlymanner,itisnecessarythattheirdoingsodoesnotcauseafailureinessentialserviceprovision

withinthefinancialsystemsuchthatthewidereconomysuffersamajor

disruption.

43. Thissectionseekstoadvancetheanalysisaimedatachievingthatobjective.Theissueiscloselytiedto,indeedformsanintegralpart,ofthebroaderissueof

resolutionplanning.Ensuringthecontinuanceofcriticalfunctionsisakeyaspect

ofsuchplanning.Accordinglytheanalysisinthissectionseekstoenhancethe

qualityandeffectivenessofsuchplanning.

Themeaningofcriticalfunction

44. Itisimportanttobeclearaboutwhatismeantbyacriticalfunction.Thisisnecessaryfortworeasons.First,differentobjectivesmaybeachievedbydifferent

tools.Beingpreciseabouttheparticularobjectiveinviewforexample,

maintainingcriticalfunctions,asopposedto,say,avoidingcontagion,preserving

value,orminimizingcoststothedepositprotectionschemecancontribute

significantlytothedesignofaneffectiveresolutionframework.

Notacostfreequestion

45. Second,thepreservationofcriticalfunctionsmaynotbeacostfreeexercise.Totake

a

simple

stylized

example:

the

transfer

of

the

liabilities

that

constitute

the

essenceofthecriticalfunctiontoabridgebankwillrequirethetransferofgood

assetsofatleastthesamevaluetosupportthoseliabilities.Thismeansand

indeeditdependsforitseffectivenessonthefactthatthetransferredliabilities

areprotectedfromlosses.Ontheotherhand,thoseliabilitiesleftbehindinthe

rumpinstitutionareexposedtogreaterlossesthantheywouldotherwisebe,due

totheremovaloftheiraccesstothetransferred,goodassets.Becauseofthe

principlethatnocreditorshouldbeworseoffthans/hewouldbeinaliquidation,

andassumingthatthevalueinthefailingfirmtakenasawholeislessthanits

liabilities,thiswouldresultinashortfallthatneedstobesomehowmadegood.

46. Morerealistically,itislikelythatthedecisionwillbemadetotransferafullbusinesslineincorporatingthecriticalfunction.Thiswillencompassboththe

liabilitiesandtheassetsthatconstitutethatbusiness.Ofcourse,iftheassetsare

impairedthepurchaserwillwishtoseefurtherassetsprovidedtoensurethat

whats/heisreceivingisatleastaparityofassetvalueandliabilities.Inthiscase,it

maybelikelythatthefranchisevalueofthebusinesslinewillalsocontribute

23


25/63

materiallytothevaluetransferredsothatthevaluegapcreatedintherump

firm(tobebornebytheresidualcreditors)mightbesignificantlyreduced.

Systemicrelevancenecessary,butnotsufficient

47.

In

the

paper,

Guidance

to

Assess

the

Systemic

Importance

of

Financial

Institutions,

MarketsandInstruments:InitialConsiderations(October2009),theFSB,the

InternationalMonetaryFund(IMF),andtheBaselCommitteeonBanking

Supervision(BCBS)providedabroaddefinitionofasystemicevent:

Thedisruptiontotheflowoffinancialservicesthatis(i)causedbyan

impairmentofallorpartsofthefinancialsystem;and(ii)hasthepotentialto

haveseriousnegativeconsequencesfortherealeconomy.

48. Thefollowingkeyelementscontributetothesystemicrelevanceofthedisruption:a.

non

substitutability:

the

disrupted

services

cannot

be

substituted

within

a

reasonabletimeandatacceptablecosts;

b. negativeexternalities:thefailureofoneinstitutionandthediscontinuanceofitscriticalfunctionscausefrictionandspillovertoothermarketparticipants;

and

c. realeconomyimpact:thedisruptionbothdirectlyandthroughitsnegativeexternalitiescausesasignificantspilloverintotherealeconomy.

49. Toanimportantextent,thesethreecriteriaarerelevantforthedeterminationofwhat

is

a

critical

function

for

current

purposes.

It

is

clear

that

it

is

a

necessary

conditionforaparticularfunctiontomeettherequirementsofsystemicrelevance

inordertobeconsideredacriticalfunction.

Clarityastomodeofsystemicness

50. However,somefurtherspecificationmayberequiredtoarriveatapracticaldefinitionofcriticalfunctionsforthispurpose.Forexample,thefactthatafirmis

connectedtoalargenumberofcounterpartiesbecauseitoperatesaverylarge

derivativesbusinessmightmeanthatthefirmissystemicduetothecounterparty

contagionrisktowhichitgivesrise.However,itdoesnotmeanthatitsderivatives

business

is

a

critical

function.

51. Thereareanumberofmeansbywhichthesystemicrelevanceofafirmwillbeaddressedtheseinclude,forexample,ensuringthatcreditorsareawarethat

theywillbefixedwithlossandshouldthereforemanagetheirriskmore

effectivelyexante;ensuringthatacontinuumofeffectivepowersareavailableto

authorities;enhancingtheresilienceofmarketinfrastructure;andputtinginplace

24


26/63

possiblemeasuressuchasbailintechniquesandcontingentcapitalinstruments

toreducerisksofcontagion.

52. Theconceptofcriticalfunctionisdesignedtoaddressjustoneaspectofsystemicrelevance:thatiswherethereisanessentialfunctionorservice

performed

by

the

institution

and

the

only

way

that

it

can

reasonably

be

dealt

with

istocarveitoutandtransferitintheeventofthefailureofafirm.

53. Oneimportantaspectofthisquestionthereforeisthataparticularfunctionshouldnotbedeemedcriticaljustbecauseitwillgiverisetosomedisruptionifit

fails.Rather,itshouldbedeterminedtobecriticalonlyifitismoreorless

essentialthattheservicenotbedisrupted,oratleastthatthedegreeof

disruptionlikelytoresultisverygreat.

54. Afurtherrelevantconsiderationistheextenttowhichusersoftheservicemightreasonablybeexpectedtotakeappropriatemeasuresexantetoinsulate

themselvesfromthedisruptiveeffectsofthefirmsfailure.Forexample,large

corporatescanbeexpectedtoensurethattheyarenotexclusivelydependent

upononefinancialfirmfortheirongoingliquidityandshouldnotbeincentivized

nottodosobythetreatmentofsuchliquidityprovisionasacriticalfunction.

55. Accordingly,aserviceshouldbeconsideredcriticalwhenthefollowingcriteriaaremet:

a. thefunctionrepresentsacriticalpartofthefinancialsysteminfrastructure;b. usersoftheservicecouldnotreasonablybeexpectedtohaveputalternative,

fallbackoptionsinplaceexante;

c. theservicecannotbesubstitutedinatimelymanner;andd. theserviceisessentialtothefinancialsystemandtheeconomyanditsfailure

wouldcauseseveretrauma.

Consideringcriticalfunctions

56. Ingeneraltermsitisnotpossibletosayintheabstractwhetheraparticularfunctioniscriticalornotwithoutaspecificassessmentofthewidercontextin

which

it

is

provided.

For

not

only

is

the

nature

of

the

function

key

to

this

determination,sotooisthescaleuponwhichtheserviceisprovidedbythefailing

bank,andtheprevailingfinancialsectorandeconomiccircumstances.Themarket

shareoftheactivityenjoyedbythefirminquestionwillbeakeyquestionin

determiningwhetherornotafunctionshouldbedeemedcritical.

57. Criticalityoffunctionisthereforeamatterwhichfallstobedeterminedonafirmbyfirmbasis.Nonetheless,itisusefultoconsider,bywayofexample,anumber

25


27/63

ofputativecriticalfunctionstoexaminehowthedeterminationofwhetherthey

may,infact,becriticalfunctionsmightbeapproached.InAnnex2weconsiderthe

potentialcriticalityofanumberoffunctions.

58. Careisrequiredinconsideringtheseexamplesasanumberoffine,ifimportant,distinctions

are

made.

For

example,

it

is

said

that

deposit

taking

is

unlikely

to

be

a

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.

59. Itisalsoimportanttotakethetimehorizonintoconsideration.Thecontinuanceofcertainservicesmaybenecessaryonlyoverashorttimeframetoallowother

providerstostepinandfillthegap.

60. Thedifferentcircumstancesprevailinginthecontextofanidiosyncraticfailureascomparedwithanepisodeofwidersystemictraumashouldalsobetakeninto

consideration.Saletoathirdpartyinthecontextofthelattermaybemore

challengingwithgreaterresultingneedfortheuseofbridgebankarrangements.

Resolutionplanning

61. AswesaidinourMay2010report,resolutionplanningisprimarilytheresponsibilityofauthorities.Thisisdistinctfromrecoveryplanning,theprimary

responsibilityforwhichfallsonthefirm.Intheeventoftheneedforaresolution,

itwillbetheauthoritieswhowillbeincontroloftheprocess,withthefirmplaying

anassistiverole.Thekeypurposeofresolutionplanningistoensurethatboth

firmsandauthoritiesarewellpositionedtohandlethesituationifandwhenafirm

fails.

Nomatterofcourserequestsforrestructuring

62. Firmshavearesponsibilitytoprovidealloftheinformationnecessarytoallowauthoritiestocarryoutresolutionplanning.Itislegitimateandappropriatefor

authoritiestowishtobesatisfiedthatispracticableandfeasibleforcritical

functionsprovidedbythefirmtobeisolatedandtransferredwithallduespeedin

theeventoftheimminentfailureofthefirm.

26


28/63

63. Wedonotbelievethatitisappropriateornecessaryforthistobesoughttobeachievedbymatterofcourserequestsbyauthoritiesforfirmstorestructure

themselvessoastoisolateparticularfunctionsindedicatedlegalentitiesorto

requireamodularizationofthefirmalongentityandfunctionlines.

64. Itisimportantthatagroupsstructureandorganizationreflectitsbusinessmodelandstrategy.Arequirementtomoveawayfromsuchanapproachwillgiverisetosignificantinefficienciesandeconomiccosts.

65. OurMay2010reportconsidersthisquestionatsomelength.3ItsetsouttheIndustrysconcernthatifregulatorydemandsforchangestoorganizational

structurebecomeanormalaspectofrecoveryandresolutionplanning,thatwill

leadtoaproliferationofrequirementsforchangethatcouldresultinasignificant

mismatchbetweenafirmsorganizationalstructureanditsoverallbusiness

model.Thisisarealriskthatcouldcausesignificantharmoverthelongrun.

Thereisalsoconsiderableconcernthatsuchinterventionsinhowfirmsstructure

themselveswillleadtoincreasednationalringfencing.

66. Thoughfirmsshouldbeabletodemonstratehowacriticalfunctioncouldotherwisebeextricatedandtransferred,afirmsorganizationalandlegal

structuresshouldreflectandbedeterminedbyitsbusinessmodel.Thereare

manyreasonswhymorecomplexapproachesmaybenecessary.Indeed,such

servicesoftenmakemostsenseandaddthemostvalueforclientswhen

embeddedinthebroaderbusinessofthefirm.

67. Whatisessentialisthatitismadeclearbyafirmhowtheseparationandtransferofcriticalfunctionscanbeachievedinaspeedymanner.Firmsfulfillmentofthis

requirementwillobviateanyneedforoverprescriptivenessbyauthoritiesasto

themannerinwhichthisshouldbedone.

orseparation

68. Astothedesirabilityofrequiringfirmstocompletelyseparatetheirretailandwholesalebankingactivities,asdiscussedabove,wedonotagreethatallformsof

retailactivityarenecessarilytobedeemedcriticalfunctionswithinthestrict

meaningofthattermaswehavedefinedithere.Moreover,forthereasonsset

outintheprecedingparagraphs,whileitistheresponsibilityoffirmstoexplain

and

demonstrate

how

critical

functions

can

be

maintained

in

the

event

of

the

failureofthefirm,thisdoesnotmeanthatsuchfunctionsarerequiredtobe

separatedexanteandsubjectedtomodularization.

3 Section 2.

27


29/63

Firmsresponsibilities

69. Thereis,therefore,animportantobligationonfirmstoprovideclearinformationandexplanationstotheauthoritiesastohowanycriticalfunctionactivitiescanbe

isolatedandtransferredintheeventoffailure.Thereisaneedforaclearand

concrete

description

of

how

this

can

be

done.

70. TheIndustryisoftheviewthattheexplanationandinformationtobeprovidedbyfirmsforcriticalfunctionsshouldcoverthefollowing:

a) Acleardescriptionofthefunctioninquestion,includingitskeyfeaturesandthescaleofprovisionbythefirm.

b) Identificationofhowthatfunctionisprovidedbythefirm.Thisshouldinclude:

Key

aspects

of

the

contractual

basis

upon

which

the

service

provided

rests;

Whethertheserviceformspartofanintegratedsuiteofservicesprovidedtoclients,orisamorestandaloneservice;

Howtoidentifywhichclientsusetheservice; Whereandhowtheassetsandliabilitiesarisingfromtheprovisionofthe

servicearebooked;

HowtheserviceissupportedintermsofinfrastructureandIT;and Howtheserviceissupportedintermsoffunding.

c) Separatingandtransferringthefunctioninaneventoffailure: Whatcontractual/legalissuesarise? Isitneededtotransferalargepartofrelevantclientsbusinesswiththe

firm,orjustspecificaccounts?Ifspecificaccounts,aretheselimitedto

thecriticalactivityoraretheybroader?

Whatdoesitmeaninpracticetotransferthisbusiness:Whowillbethenewlegalparties?Bywhom/howwilltheITbeprovided?Whatisthe

transfermechanism?Whatinterdependenciesneedtobeaddressed?

d) Financingthefunction/financingthetransfer: Assumingthatthemainmovingpartsoftheservicetobetransferredare

liabilitiestoclients,whatassetswillbetransferredtosupportthose

28


30/63

29

liabilities?Howwilltheseassetsbeidentified?Howwilltheybe

transferred?

Maintainingcriticalfunctionsonacrossborderbasis

71. Itisessentialthatresolutionframeworksareeffectivenotjustinthedomesticbutalsotheinternationalcontext.Indeed,giventheinternationalnatureofmanyofthefirmsfallingwithinthecurrentmoralhazarddiscussion,itisin

manywaysevenmoreimportantthatsuchregimesareeffectiveinacross

bordercontext.

72. TheissueofachievingeffectiveresolutionofspecificallycrossborderfirmsisconsideredinfulldetailinSection3.Wenotehere,however,theimportance

ofbeingabletohandlethemaintenanceofcriticalfunctionsonacrossborder

basis.

73. Crucialtothiswillbecoordinationamongauthoritiesindifferentjurisdictions.Determiningwhichfunctionsarecriticalbethatlocallyorinternationally

andhowtheyshouldbedealtwithintheeventofthefailureofafirmrequires

closecooperationandcoordinationamongauthorities.Thisshouldbean

importantcomponentoftheworktoestablishfirmspecificresolution

agreementsamongauthoritiescurrentlyunderwayintheFSBandakeyaspect

forconsiderationinthefirmspecificcrisismanagementgroups.


31/63

Section2 Avoidingsystemictraumamakingbailintechniques

operational

74. Ontheissueofbailin,theInstitutemadeasubmissiontotheFSBinSeptember2010:Preservingvalueinfailingfirms.

4Sincethattime,theInstitutethroughits

WorkingGrouponCrossborderResolution(CBRWG)hascontinuedtoworkon

thetopic,inparticulartoaddressanumberofthedifficultissuesthatarisein

makingbailintechniquesoperational.

75. TheFSBsreport,Reducingthemoralhazardposedbysystemicallyimportantfinancialinstitutions,ofOctober20,2010,totheG20leadersnotedthatbailin

couldpotentiallyformpartofthehigherlossabsorbencyrequiredofsystemically

importantfirms.TheEuropeanCommissionisalsoconsideringthequestionof

bailinmeasuresaspartofitsrecentconsultativedocument,Technicaldetailsofa

possibleEUframeworkforbankrecoveryandresolution,5publishedonJanuary6,

2011.

76. Inthetextbelowwesetoutasetofprinciplesforoperationalizingbailintechniques.Itshouldbenoted,however,thatthisremainsachallengingareaand

inanumberofplacesfurtherworkwillberequiredtoarriveatfinalconclusions.

IIFsPreservingValuepaper

77. InourearlierPreservingValuepaper,weexpressedthepreliminaryviewthattherewasconsiderablemerittoexaminingtheintroductionofabailinregime.

Wesaidthatthetechniqueofferedapromisingmeansofforestallingthe

disorderlyliquidationofsystemicallyimportantfirms,withtheattendant

instabilitythatmightresultfromsuchanevent.However,thepaperalso

recognizedandcautionedontheneedtoaddressanumberofopenissuesanda

rangeoftechnicalmattersthatneededfurtheranalysisinordertohaveaclearer

understandingofhowsucharegimecouldoperate.Keyaspectsoftheanalysis

containedinthePreservingValuepaperaresetoutinAnnex3.

Scopeofliabilitiessubjecttobailin

78. AkeyissueinthePreservingValuepaper,andonethatwereturntobelow,isthescopeofliabilitiesthatshouldbesubjecttoabailinpower,andtheextentto

whichthisshouldbedecidedexanteorexpost.

79. Supportingalimitedscope/exanteapproachwerethedegreeofclarityandcertaintythatthiswouldbringtothesituation.Thisapproachwasconsideredto

havebenefitsintermsofmakingitcleartocertaincategoriesofcredit

4http://www.iif.com/download.php?id=ryVjoux4FSs=

5January6,2011

30


32/63

counterparties,includingtradingcounterparties,shorttermcreditorsandliquidity

providers,anduninsureddepositors,thattheywouldnotbesubjecttobailin

measures,thusminimizingthelikelihoodofflight.Bydetermininginadvance

whichcategoriesofcreditcounterpartymightbesubjecttobailinitwaspossible

toincreasetheconsensualnatureofthemechanism.Beyondthisitwasalsothe

viewofanumberofMembersthatbylimitingclearlythescopeofbailinitwould

bepossibletolimitanypotentialincreaseinbankfundingcosts.

80. Anumberofdisadvantagesassociatedwithanexantelimitedscopeapproachalsowereidentified.Thisapproachhasthepotentialtocontributetomoralhazard

inthesystem,asthoseliabilitiesexplicitlyexemptedfromthebailinmechanism

maybeperceivedasreceivingconsiderableadditionalprotectionagainstlosses.

Thatsignificantdistortionswouldbeintroducedunderanexanteapproachalso

wasidentifiedasanimportantrisk,withfundingtechniquesbeingarbitragedto

avoidpotentialbailinexposures.Onthecostofbankfundingsomearguedthata

broadorcomprehensiveapproach,byreplicatingaprepackagedbankruptcy

bywayofaresidualpowervestedinauthorities,wouldminimizeanypossible

increaseinfunding.

81. Inthetextthatfollowsweseektoresolvethetensionbetweenthesedifferentapproaches.Inparticular,itisenvisagedthattheprimaryscopeofbailinpowers

willbelimitedtosubordinateddebt.Inproposingthisapproachweareinfluenced

bysomeresearchindicatingthatinmanycasesadequaterecapitalizationoffirms

indifficultymightbeachievedonthebasisoftheconversionofsubordinateddebt

only.However,itisacknowledgedthatitisnotpossibletocalibratepreciselyex

antethescaleofthepotentialneedforfreshcapitalinacrisissituation.Therefore

it

is

envisaged

that

as

a

last

resort,

and

subject

to

clear

requirements

and

criteria,

itmaybenecessarytobailinaproportionoftheunsecuredseniordebtofafirm

asanalternativetothewindingdownofthefirm.

Operationalizingbailin

82. BuildingupontheinitialworkinPreservingValue,theobjectiveinthissubsequentcontributionistomakemoreoperationaltheconceptandindoingsotoaddressa

numberofthekeychallengesidentifiedinthatearlieranalysis.Inparticular,we

nowseektoarticulateamoreconcreteelaborationoftheconceptandprovidea

moredetailedspecificationofthekeybuildingblocks.

83. Tothisend,thisSectionputsforwardadraftsetofprinciplesthatmightbeenvisagedtounderpinthedevelopmentofabailinregimeindifferent

jurisdictions.Byputtingforwardthissetofprinciples,supportedbyappropriate

commentaryanddiscussion,itishopedtobothprovideaclearpathtothe

solutionofoutstandingdifficultiesandpromoteanagreementonthesubject

amongkeyparticipantsacrossthedifferentjurisdictions.

31


33/63

Timing

84. ThegeneralviewamongIndustryparticipantsisthatitwouldnotbeappropriatetoretrospectivelysubjectexistingdebttoanewpowerofbailin.Moreover,itis

considereddesirablethatthereshouldbetotheextentpossibleagraduated,

ratherthanabrupt,adjustmentofLossGivenDefault(LGD)estimatesinrespectto

suchdebt.Accordingly,itisproposedthatbailintechniquesshouldbe

prospectiveonly.

Bailinsandbridgebanks:theDoddFrankapproach

85. Thediscussioninthefollowingtextfocusesonthedesirabilityofamechanismthatallowsafirmtoberecapitalizedbyconvertingacertainproportionofdebt

intoequitysoastopreventaprecipitouslossofvalueandaresultingsystemic

shock.Itisarguedbysomethattheseoutcomescouldalsobeachievedbytheuse

ofabridgebankmechanismdeployedinaparticularwayatthepointof

insolvency.ThisquestionisofimportanceastheapproachenactedintheUnited

StatesunderDoddFrankwhileitrequiresthewindingupoffailingfirmsalso

envisagestheuseofbridgebankmechanismstooptimizeoutcomes.

86. Itmayindeedbepossiblethatbailinoutcomescould,dependinguponthelegalcontextofaparticularjurisdiction,beachievedbysuchalternativemeans.

Whetherthisisthecaserequiresfurtherstudy.Inthisregardsee,forexample,the

article,TheOrderlyLiquidationofLehmanBrothersHoldingsInc.underthe

DoddFrankAct.6

The

key

elements

of

a

bail

in

regime

87. Setoutbelowisasetofsuggestedprinciplesthatmightformthebasisforbailinregimestobeadoptedindifferentjurisdictions.Theprinciplesareaccompanied

byexplanatorytext.

GENERALOBJECTIVESANDGOVERNINGPRINCIPLES

1.1Thegeneralobjectivesofbailinarrangementsareasfollows:

Tocreatetheconditionswherebyeveryfinancialfirmmayberestructuredthroughanorderlyfailureintheeventthatitisnolongerabletomeetits

obligationsorbecomesotherwisenotviable;

Toavoidthefinancialinstabilitythatmayresultfromthedisorderlyliquidationofasystemicallyimportantfirm;

6FDIC,April2011

32


34/63

Toreducemoralhazardandexpectationsthatrisksandlosseswillbebornebytaxpayers.Lossesshouldbebornebyshareholders,providersofotherforms

ofcapital,andcreditors;and

Toforestallprecipitousandmajorlossofvalueinthefirm,whichcouldgiverisetotraumaticeffectsonthefinancialsystemandthebroadereconomy.

1.2Theseobjectivesshouldbepursuedinaccordancewiththefollowing

conditions:

Propertyrightsmustberespected.Thisincludes,inparticular,fullrespectforsecurityandcollateralrights.Theseshouldnotbeabrogated.

Creditorsshouldnotbeworseoffthantheywouldbeinanormalbankruptcy.Bailinshouldbeseenaspartofthecontinuumofmeasuresandtoolsnecessary

to

protect

the

financial

system,

and

especially

to

ensure

that

all

firms

canberesolvedsafelyintheeventoftheirfailureorimminentfailure.Bailin

measuresshouldbedeployedonlyaftersuchothermeasuresandtoolshave

beenexhausted.

Triggersshouldbeclearlydefined,avoidingundueuncertainty.Thereshouldbeconsistencyacrossjurisdictions.

Whenrelevant,effectivecrossbordercoordinationshouldbeensuredandfragmentednationalresponsesprevented.

To

the

extent

that

additional

costs

are

incurred

in

resolving

a

firm

in

a

mannerthatavoidssystemicdamage,suchcostsshouldnotbeimposedon

creditors(oraparticulargroupofcreditors).

COMMENTSONGENERALOBJECTIVESANDGOVERNINGPRINCIPLES

88. Thissetofprinciplessetsoutthecentralobjectivesofabailinregimeandthekeyconditionsforsucharegime.

89. Thekeyobjectivesoffacilitatingrestructuringorallowinganorderlyfailurewhilepreservingfinancialstabilityarebroadenoughtocoveringeneraltermsanumber

of

concerns

often

highlighted

by

the

official

sector,

for

example,

protecting

retail

depositorsandprotectingsystemicallyimportantfunctions.

90. Allowingeveryfinancialfirmtoundergoanorderlyfailureintheeventthatitisnolongerabletomeetitsobligationsorbecomesotherwisenotviablemustbea

keyfeatureofanyresolutionregime.Bailinisatoolthatcontributestoachieving

thisobjective;itshouldbeseenasaformofrestructuringforafirmthathas

failed.

33


35/63

91. Theobjectiveofanyresolutiontoolsshouldnotbethesurvivalofafailingfirmperse,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

financialsystemduetotheinterconnectedness ofthefirmwiththewider

market;and

(c)thatthereisareasonableprospectofsuchlossofvaluebeingavertedor

significantlyreducedifthemeasuresinthissetofprinciplesaredeployed.

COMMENTSONSCOPE

92. TheeffectoftheseScopeprinciplesistogivebailinmeasuresabroadpotentialscopeintermsofthefirmstowhichtheymaypotentiallyapplyandtoclarifythat,

whenanumberofconditionsaremet,anyfinancialinstitutionmaybesubjecttoa

bailin.

93. ThisisconsistentwithIIFsviewthatsystemicriskcannotbelinkedtoanyparticularcategoryoffirms.Moreover,anypossibleperceptionthataregime

directed

only

at

some

firms

may

lead

to

a

non

level

playing

field

(and,

specifically,

mightgivelargefirmssomeadvantage)needstoberejected.Thequestionofthe

systemicimportanceofafirmneedstobemadeonacasebycasebasisagainst

thebackdropoftheprevailingcircumstances.

94. Itisimportantthatthepurposeforwhichbailinpowerscanbeexercisedbeclearlyandtightlydrawn.Suchpowerssignificantlyenhancetheadministrative

poweroftheStatetointerveneinprivatecontracts.Iftheconditionsforuseare

34


36/63

drawntoobroadly,thereismaterialriskthatitcouldbeexercisedtooearly(see

theBailInTriggersprinciplesbelow)ortoobroadly,givingrisetoundue

interferencewithprivatecontracts.Inshort,unlessthepowerisdefinedtightly

thereisariskofadisproportionateincreaseinfinancialfirmfundingcostsas

creditorsconfidenceandcertaintyisunderminedbythepotentialforsignificant

Stateadministrativeintervention.

95. Thebenefitofbailintechniquesascomparedwiththeapplicationofgeneralresolutionprovisionsisthatabailincanforestallaprecipitatelossofvaluesuch

asthatseenintheLehmanscase.7Itissuchlossofvaluethat,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)shouldbethedesignatedauthorityforbailinpurposes.(Morebroadly,wehavenottakena

viewastowhichauthorityshouldhavethepowertodeterminethatafirmshould

beresolved.)Differentmodalitiesarepossible.However,indecidingwhich

authorityshouldhavethispower,itwillneedtobeensuredthatriskof

authoritiesforbearanceisavoided.Moreover,thedecisionshouldbeexercisedin

consultationwithrelevantauthoritieswhoarenotthedesignatedauthorities,

including,asappropriate,theresolutionauthority,thesupervisoryauthorities,the

centralbank,andthefinanceministry.

7Inourreport,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


37/63

97. Itisdesirablethatbailinmeasuresaretriggeredascloseaspossibletothetimethatthefirmwouldotherwisebecomeinsolventandgointobankruptcy.Toavoid

undueuncertaintyorthepotentialbringingforwardofinsolvency,therelevant

triggermustbetightlydrawn,andthejudgmentoftheauthoritytightly

constrained.Forthisreasonthetriggerforabailinshouldbethesameasfora

determinationthatafinancialfirmrequirestoberesolvedorwounddown.

THEBAILINPOWER

4.1.Thebailinpowersreferredtohereare:

Powertodiluteshareholdersorwriteoffsharesofthefirm,and Powertoalterthetermsandconditionsofsubordinateddebtofthefirm,includingtheconversionofsuchdebtclaimsintoequity.

4.2.

In

the

exercise

of

such

powers

no

category

of

equity

holder

or

creditor

having

priorityoveranotherintheeventofbankruptcy/insolvency,shouldbetreated

otherthaninlinewiththatpriority.

4.3.Seniormanagement

Theresolutionauthoritiesshouldhavepowertoreplaceanyorallmembersoftheseniormanagementand/orboard.

Overtheperiodfollowingtheexerciseofthebailinmeasures,stepsshouldbetakentoinvestigatethereasonsforthefailureofthefirmandto

identify

those

members

of

the

board

and

senior

management

considered

to

bedirectlyresponsibleforthedecisionsand/oractionsleadingtothefailure.

Suchindividualsshouldbereplaced.

COMMENTSONBAILINPOWERS

98. AsdiscussedintheintroductiontothisSection,thequestionofthescopeofliabilitiesfallingwithinthebailinpowerisadifficultoneuponwhichtheindustry

hashadmuchdiscussion.

99. Acrucialissueiswhetheranyunsecureddebtmight,atleastinprinciple,beconsidered

bail

inable

(with

a

number

of

selected

exclusions

determined

ex

post

onacasebycasebasisbytheresolutionauthority),orwhetherabailin

mechanismshouldbebuiltonanexantedeterminationastowhichliabilities

should(potentially)besubjecttobailin.

100. Theapproachsuggestedaboveistolimittheprimaryscopeofapplicationtosubordinateddebt.OnthebasisofanalysiscarriedoutbysomeMemberfirms,it

isbelievedthatinmanycasestheavailabilityofsuchdebtislikelytoprovide

36


38/63

sufficientresourcesforeffectivelyrecapitalizingafirm.Asindicatedinprinciple5

below,however,itmaybethatintheparticularcircumstancesofthecasethe

bailinofsubordinateddebtwillbeinsufficientforthepurpose.Inthiscase

authoritiesshouldhavethepowertobailinthenecessaryproportionofsenior

debt.

101. Principle4.2aimstoensurethattheorderofprioritiesinbankruptcyberespected.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,theIndustrybelievesthatitisimportantthatthoseconsidereddirectlyresponsibleforthe

failureofthefirmbeheldaccountable.

ADDITIONALPOWERTOBAILINSENIORDEBT

5.1Inparticularcircumstances,itmaybethecasethatthebailinofall

subordinateddebtwillbeinsufficienttorecapitalizethefirmsufficientlytoachieve

theobjectivessetoutabove.Inthiscasewherethereisnootherappropriate

alternativetoachievetheobjectivessetoutabove,thedesignatedauthorities

shouldhavethepowertobailinawidercategoryofcreditorsasdescribedbelow.

5.2Thesupplementarynatureofsuchpowershouldberecognizedinthe

requirementfortheauthoritiestotakeaseparatedecision,clearlydocumented

andreasoned,andthesubjectofareporttobemadepubliclyavailableastothe

basisuponwhichtheirdecisionwasreached.Thereportshouldinteraliasetout

howthedecisionoftheauthoritiescomplieswiththekeyprinciplesof

reasonableness,proportionality,andfinalnecessity.

5.3

The

liabilities

subject

to

this

power

of

further

bail

in

should

be

the

unsecured

seniorobligationsofthefirmexceptobligationsofcounterpartiesarisingfromthe

tradingactivitiesofthefailingfirm.[Whetherthescopeofprinciple5.3shouldbe

extendedwillbethesubjectoffurtherconsiderationseecommentsbelow.]

5.4Thedesignatedauthoritiesshoulddecide,incompliancewiththeprinciplesset

outabove,andtakingintoaccountguidancetobepublishedbytheauthorities,

37


39/63

whethertolimitthetypesofseniorobligationstobesubjecttothepowerof

furtherbailinand,ifso,towhichtypeofobligations.

5.5Inexercisingthispower,alloftheprinciplesgoverningthebailinof

subordinateddebtshallapply.

COMMENTSONADDITIONALPOWERTOBAILINSENIORDEBT

103. Theapproachdescribedhereistomakethebailinofanynonsubordinateddebtalastresortwhenaconversionofsubordinateddebtisdeterminedtobe

insufficienttoachievethepurposessought.

104. Theindustryhasreachedtheviewthattradingobligationsshouldnotbesubjecttosuchfinalstagebailin,astodosowoulddefeatonepurposeofthe

mechanismtopreservethefranchisebusinessofthefirm.Byincludingsuch

obligationsinthepotentialscopeofabailin,tradingcounterpartiesconfidence

would

be

unlikely

to

be

maintained,

with

a

resulting

significant

loss

of

business

value.

105. Theindustryhasnotyetreachedafinalviewastowhetherotherformsofseniorobligationshouldbeexcludedexanteorlefttobedeterminedonacasebycase

basisandinaccordancewithadministrativeguidancetobepublishedbythe

authorities.TheIndustrywillbeworkingonthisissuefurtherinthecoming

period.

SAFEGUARDSFORCREDITORSANDJUDICIALREVIEW

6.1.Judicialreview:Unlesstheboardofdirectors(orsimilargoverningbody)ofthecompanyhasacquiescedorconsentedtotheactivationofthebailinpower,it

shouldhavethepossibilitytofileapetitionforimmediatejudicialreview.Such

reviewshouldbelimitedtothelegalityandlegitimacyofthedecisionandensure

thatthebailinmechanismisnotactivatedarbitrarily,andanyjudicialhearing

shouldbestrictlyprivate.

6.2.Safeguardsforcreditors:Nocreditorofthecoveredfirmthathasseenthe

amountthatitisowedwrittendownorthetermsandconditionsoftheinstrument

itholdsamendedshouldbeworseoffthanitwouldhavebeenundernormal

bankruptcy/insolvencyprocedures.Thedeterminationastowhetheracreditoris

worseoffshallbemadeXXyear(s)aftertheexerciseofthebailinpowers.

6.3.Authoritiesshouldnotbeheldliablefornegligenceinthemakingofa

determinationtoexercisetheirbailinpowers.

38


40/63

COMMENTSONSAFEGUARDSANDJUDICIALREVIEW

106. Itwillbenecessarytoachieveaneffectivebalancebetweentheneedtoensureadequatejudicialsafeguardsandreviewandtheneedtoensurethatabailin

mechanismcanbedeployedswiftlyandwithoutcreatingundueuncertaintiesin

the

market.

CROSSBORDERASPECTS

7.1.Theseprinciplesshouldapplytotheliabilitiesofthefirmregardlessofthe

jurisdictioninwhichtheyareheldandofthenationallawgoverningthem.

7.2.Foreigncreditorsshouldhavetherightofdirectaccesstotheresolution

authoritiesandtojudicialauthoritiestoobtainthesafeguardsdescribedin

principle6.

7.3.

To

the

extent

that

the

jurisdiction

where

the

liability

holder

is

situated

does

not

provideforarecognitionoftheproceedingslaunchedundertheseprinciples,there

shouldbeincorporatedinthetermsofalltherelevantliabilitiesofthefirma

contractualprovisionrenderingitsubjecttobailinmeasuresassetoutinthese

principles.

COMMENTSONCROSSBORDERASPECTS

107. Theseprinciplesseektooutlinearesponsetothecoordinationproblemsthatarisewhendeployingabailinmechanisminacrossbordercontext.Themain

routetoensuringeffectivecrossbordercoordinationimpliesagreementamong

FSB

members

committing:

toundertakethoselegalchangesneededtoachieveconvergentandinternationallyconsistentresolutiontools,and

torecognizeaforeignproceedingandensurethenecessarycrossbordercooperationandcommunicationamongrelevantresolutionauthorities.

108. Asupportingalternativeapproachissetoutinprinciple7.3.ThisrepresentsthehybridapproachoutlinedinthePreservingValuepaper:abankshould,inits

countryofincorporation,besubjecttoastatutoryregimewhoseeffectwouldbe

to

recognize

the

bail

in

in

national

law;

the

bank

would

then

be

required

to

ensure

thatforanycreditoreligibleforabailinwhoseclaimsweregovernedbyanyother

law,theagreementwiththatcreditorwouldincludeaclauserecognizingthe

statutorypower.

39


41/63

GROUPISSUES

8.Where:

theliabilitiessubjecttotheexerciseofthebailinpowerssetoutintheseprinciples

represent

liabilities

of

an

entity

that

is

a

subsidiary

of

another

entity;

theretentionoftheparentsubsidiarylegalrelationshipisdeterminedbytheresolutionauthoritiestobenecessarytoachievetheobjectivesofthese

principles;and

itisnecessarytodosotopreservesuchparentsubsidiarylegalrelationshiptheequityinterestreceivedbythosecreditorsofthefirmbyvirtueofthe

exerciseofthepowerssetoutintheseprovisionsshallbeswappedforequityof

theparentofequivalentvalue.

COMMENTSONGROUPISSUES

109. Mostlargebanksaremembersofgroups,anditisfrequentlythecasethatinabankgroupthereisanunregulatedbankholdingcompanyabovethebank.Inthe

casebelow:

Bank Holding Company

Bank Other GroupSenior

creditors

ifthebailinweretobeconductedatthebanklevel,theeffectcouldbetobreak

thegroupstructuresince,withthecreditorsbecomingtheshareholders,thebank

wouldceasetobeasubsidiaryoftheholdingcompany.Theapproachproposedin

principle8requiresequityreceivedinthefailingbanktobeswappedforequityin

theparententity/holdingcompanywhenthatisnecessarytoachievethebailin

objectives.Thisissueshouldbeidentifiedandaddressedaspartoftheresolution

planninginrespectofthegroup.

NONEFFECTOFDEFAULTOROTHERTRIGGERCLAUSES

9.Theexerciseofbailinpowersasdescribedintheseprovisionsshallnotbe

consideredadefaultforlegalpurposes.Anyclauseinanycontractthatseeksto

40


42/63

41

identifytheexerciseofbailinpowersasaneventsimilartodefaultforthe

purposesoftriggeringlegalconsequencesshallbeinvalid.

COMMENTONNONEFFECTPRINCIPLES

110.

Common

practice

in

many

derivatives,

repo,

bond

agreements,

etc.,

is

that

forced

resolutionmeasuresbyregulatorsarealsodeemedtobeaneventofdefault,

whichwouldallowthecounterpartstoterminateoutstandingagreements.To

achievethebailinobjectiveofavoidingthecollapseofthefirmandaresulting

majorlossofvalueandtraumatothesystem,measuresareneededtoestablish

thattheexerciseofabailinpowerwouldnotbeconsideredaneventofdefault

amongcounterpartiesofthefirminquestion.ISDAmasteragreementswillbe

particularlyimportantinthisregard.Itislessclearthatthesamewouldneedto

beachievedinrespectofcreditderivativecontractsreferencingthefirm.This

latteraspectrequiresfurtherconsideration.


43/63

Section3 Resolvingcrossborderfinancialfirmsaddressing

keyissues

Introduction

111. Thissectionseekstodevelopananalysisofthekeyobstaclestoachievingtheeffectiveresolutionofsystemicallyimportantcrossborder,asopposedto

domestic,financialfirmsandproposingsolutionstosuchobstacles.Intheperiod

sincethecrisis,theconceptualandpracticallandscapehaschangedquite

significantly.Thismeansthatthechallengenowinachievinganeffective

frameworkofcrossborderresolutionissomewhatdifferentthanitwastwelve

monthsago.Therehasbeenimportantprogress.Itisimportanttotakestockof

thedevelopmentsthathaveoccurredinordertoassessprogresstowardthe

ultimateobjectiveandtomoreaccuratelyspecifythechallengesthatremain.

112. Itisusefultoremindourselveswhatwemeanbyeffectivecrossborderresolution.Whatwemeanisthatalargefinancialservicesgroupoperatinginanumberofjurisdictionseitherbymeansofsubsidiariesorbranchesiscapable

ofexitingthemarketinanorderlymannerandwithoutaperceptionofunfairness

inhowthelossesincurredbythegroupareallocatedamongstakeholders.To

preservethebenefitsofprogresstowardanintegratedinternationalfinancial

system,itisimportantthatthisprocessbeachievedwithoutrequiringringfencing

ortheforcingofsignificantstructural/organizationalchangeonfinancialgroups

thathavedevelopedtheirorganizationalstructuretooptimallyreflecttheir

businessmodelandthenatureoftheiractivities.

Lessrisktotaxpayers

113. Oneofthemajorconcernsofauthoritiesisthat,intheeventofthefailureofacrossbordergroup,thetaxpayersintheirjurisdictionwillincurlossesand,

further,thattheselosseswillbeunfairasbetweenjurisdictions.Thisisacentral

concernthatliesbehindmovestowardringfencingandnationalselfsufficiency

approaches.

114. Significantprogresshasbeenachieved,orcanbeachieved,towardsignificantlyreducingtheextenttowhichtaxpayersareexposedtolossesintheeventof

failure.Theworkthatisintraintoensurethatshareholdersandcreditorsbear

theirlossesintheeventofafailureshouldgoalongwaytowardachievingthis.

115. Theacceptancebythefinancialservicesindustryofitsresponsibilitytofundthecostsofeffectiveresolutionmechanismswillalsomakeamaterialcontribution

towardprotectingtaxpayersfromlosses.

42


44/63

butmoretootherstakeholders

116. Itisnot,however,simplydisproportionatelossestotaxpayersthatareofconcerntonationalauthorities.Theyarealsoconcernedaboutdisproportionateorunfair

lossesaccruingtostakeholdersintheirjurisdictionsmoregenerally.Forexample,

in

the

Lehman

case,

there

were

no

losses

accruing

to

host

country

taxpayers.

Nonetheless,concernastosuboptimaloutcomesforcreditorsofhostcountry

subsidiarieswasamajorfactorinthereactiononthepartofhostcountry

authorities.

117. Giventhatanimportantobjectiveofeffectiveresolutionistoplaceshareholdersandcreditorsmoreatriskoflossthanwasthecaseinthepast,thisaspectofthe

situationhasbecomemorechallengingthanheretofore.

118. Theprotectionoftaxpayersislikelytobeasignificantlygreaterimperativepoliticallythantheprotectionofcreditors(atleastuninsuredcreditors),whoare

betterpositionedtolookafterthemselves.Accordingly,theoverallpicturemaybe

oneofapotentialmaterialeasingoftheextenttowhichauthoritiesfeelat

politicalriskiftheydonotmanagetoringfence.However,thepressurestoring

fencearelikelytoremainconsiderableasthingscurrentlystand.

Typologiesandapproaches

119. Ingeneral,crossborderfinancialinstitutionscanadoptarangeofapproachestoachievingaphysicalpresenceinahostcountry.Whiletheycandosoeitherby

establishingabranchorbyestablishingasubsidiary,itisimportanttothinkof

crossbordergroupsnotinbinarytermsbutratherasorganizingthemselvesalong

aspectrumofmodalitiesasindicatedbytheirparticularbusinessmodel.

120. Atoneendofthespectrumaregroupsthatorganizethemselvesonthebasisoflargelystandalonesubsidiariesinteractingwitheachotheronstraightforward

commercialterms(thoughwithinthestrongnexusoftheirintragroup

relationships).Attheotherend,therecanbetheuseofoverseasbranchesthat,

bothpracticallyandlegally,operatemoreorlessasthepresenceofthehome

entityinthehostjurisdiction.Andbetweentheseextremes,therearearangeof

hybridapproaches:manygroupsutilizebothbranchesandsubsidiaries,many

makeuseofsubsidiariesinthecontextofanintegratedgroupapproach,8and

others

make

use

of

branches

that

operate

to

a

certain

extent

and

in

certain

respectsasstandaloneentities.

8Wewouldnotethatwithinthecontextofmoreintegratedgroupsalso,transactionsbetweengroup

entitiesarecarriedoutonmarketbasedcommercialterms.Seefurtherthequestionofgroupinterest

approachesdiscussedbelow.

43


45/63

Generalproposals

121. InourMay2010report,AGlobalApproachtoResolvingFailingFinancialFirms,wearguedthatsuccessintheareaofcrossborderresolutionrequiredthe

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. Inthefollowingsectionsweconsiderindetailwhatisneededtotaketheseproposalssuccessfullyforward.

Resolvingcrossbordergroups:respectingstructuralarrangements

determinedbybusinessmodels

125. AstheInstitutehasdiscussedinanumberofplaces,9itisimportantthatfinancialgroupscontinuetobeabletochoosethemodeoforganizationanddegreeof

integrationofthemanagementoftheirgroupthatmostconformstothenatureof

theirbusinessmodelandtheneedsoftheirbusiness.Aforcedrequirementthat

allfirms,regardlessoftheirbusinessmodel,adoptamodularapproachtotheir

organizationbasedonthestandaloneselfsufficiencyofeachlegalentityoreach

nationalsubgroupwoulddampeneconomicperformance.

126. Aswesaidabove,ifregulatorydemandsforchangestoorganizationalstructurebecomeanormalaspectofrecoveryandresolutionplanning,thisislikelytoresult

inasignificantmismatchbetweenafirmsorganizationalstructureanditsoverall

9See,forexample,RestoringConfidence,CreatingResilience:AnIndustryPerspectiveontheFutureof

InternationalFinancialRegulationandtheSearchforStability(July2009);SystemicRiskandSystemically

ImportantFirms:AnIntegratedApproach(May2010);andAGlobalApproachtoResolvingFailing

FinancialFirms:AnIndustryPerspective(May2010).

44


46/63

businessmodel.Thereisalsoconsiderableconcernthatsuchinterventionsinhow

firmsstructurethemselveswillleadtoincreasedringfencingofcountriesand

fragmentationoftheinternationalmarketplace.

127. Dependinguponthenatureofthebusinessbeingcarriedon,amongstthebenefitsthat

can

be

derived

from

group

strength

and

strategy

can

be

the

following:

Theabilitytodeploycapitalandliquidityefficientlyforthegroupasawhole; Theabilitytosupportcustomersincrossbordertradeandinvestmenttothe

benefitoftheeconomyingeneral;

Theabilitytodevelopandimplementhighquality,stronggovernanceandriskmanagementstrategiesatthegrouplevelfortheadvantageofallentities;

Thedevelopmentofastrongandreliablebrandthatyieldsbenefitsbothforthe

group

and

its

stakeholders

and

for

consumers

and

the

economy

in

general;

and

Thestrengthandresiliencethatcanderivefromtheabilitytoprovidesupportfromonepartofthegrouptoanotherintimesofdifficultyorstress.

Note:Aswellaspoliticalobstacles,therearealsoanumberoflegalissuestobe

consideredinrelationtotheprovisionofgroupsupportforentitiesthatgetinto

difficulty.TheseareconsideredinAnnex4.

Avoidingnegativesumoutcomes

128. Undercurrentarrangementsauthoritiesindifferentjurisdictionsareinaninvidiouspo

Documents

IIF Addressing Priority Issues in Cross Border Resolution May 2011