On January 25, the Federal Deposit Insurance Corporation (FDIC) Systemic Resolution Advisory Committee heard from Jim Wigand, Director of the FDIC’s Office of Complex Financial Institutions, and Michael Krimminger, Deputy Director, on the FDIC’s resolution strategy under Title II for the resolution of systemic financial companies. FDIC Acting Chairman Martin Gruenberg said in the 18 months since Dodd-Frank, the FDIC “has been working diligently to carry out these responsibilities” by establishing the Office of Complex Financial Institutions, completing “final core rulemaking” under Title II, and issuing a joint final rule with the Federal Reserve on living wills that systemically important financial institutions (SIFI) are required to prepare. Gruenberg added that the FDIC is actively engaged with foreign supervisors, the Financial Stability Board (FSB), G20 nations, and the Basel Committee, amongst others on these issues.
During the meeting, the amount of questions asked by the advisory committee made it evident that the FDIC still has a lot of work to do on Title II in terms of clarifying and defining certain terms, and fine-tuning certain issues in the resolution process. Gruenberg thanked the committee for their helpful discussion, but admitted that “it’s fair to say” the FDIC has not resolved all the issues.
Krimminger opened the discussion by listing five primary elements under Title II: 1) Application and authority under Title II; 2) Authority for immediate and decisive action; 3) Ability to provide continuity; 4) Access to liquidity; and 5) Prohibition of taxpayer bailouts.
Using the attached PowerPoint slide to guide the discussion, Krimminger said the Title II resolutions “are not the default option” for the resolution of large financial companies. Instead, Krimminger said the bankruptcy code is the primary default option. He added, whether “an entity is either a bank holding company of $50 billion in size or designated by the Council for heightened supervision… really has no relationship to whether or not they would actually be subject to Title II.” The statute, he added, “applies broadly.” The real question, according to Krimminger, is whether the provisions under Title II would help mitigate systemic risk caused by a bankruptcy resolution. He told the committee that advanced planning is key, adding the FDIC recognizes troubled financial institutions do not have the ability to wait weeks “to have a review or to make a decision.”
Immediate and Decisive Action:
Krimminger said it is critical in bank failures for the FDIC to take action and control over the enterprise “in its totality,” adding that the ability to continue operations “will preserve value and reduce potential contagion effects caused by the failure.” He called the one day stay on termination of derivatives contracts “critical,” adding the stay allows the FDIC to make a transfer of the contract over to the bridge entity, or a credit worthy third party, or determine that such moves are not necessary. With regards to creditor treatment, the FDIC has tried to make Title II as responsive to bankruptcy proceedings, with the exception that the “United States gets paid back as provided by Treasury under the orderly liquidation fund,” Krimminger said.
Krimminger touched on the importance of a bridge financial company as it provides for the maintenance and continuity of the operations of the prior entity and provides additional time for buyers and potential investors to understand how the company will operate. There is “broad authority” under Title II that provides the FDIC’s receiver with the ability to choose which assets to pass over to the bridge. The only stipulation is that an excess of assets over liabilities is passed over. Krimminger called the bridge institution a “temporary institution” with a short two year timeframe, which can be extended for an additional three years. Bridge companies can provide guarantees and assurances backed by the FDIC and its operation of the orderly liquidation fund (OLF). Draw downs to the fund are paid back from the sale of assets. Krimminger said there are “very flexible” resolution options under bridge authority, adding that “you can merge with another company,” have a charter conversion into a stand-alone company, or have a stock sale of the bridge company, amongst other ways.
Access to Liquidity Provided by OLF
A bridge company’s backup for access to immediate liquidity is the OLF, according to Krimminger. He referenced Lehman Brothers’ collapse during the financial crisis and said the firm’s inability to continue key contracts as a result of a lack of liquidity, cost Lehman dearly. The OLF is not funded in advance, but with a line of credit provided by the Treasury, and the FDIC will work closely with the Treasury on a mandatory repayment plan. Often repeated throughout the hearing, Krimminger said access to liquidity “is vital to preserve value and to limit systemic contagion.”
Krimminger and Wigand then guided the committee through an overview of the resolution strategy using a hypothetical company facing an orderly resolution process under Title II. Both Krimminger and Wigand explained the structural framework, financial framework, and governance under Title II liquidation. There were a number of concerns and questions raised by the committee on how a decision is made on which assets and liabilities are moved from receivership to a bridge entity. In addition, members and FDIC panelists voiced concern about issues with a holding company’s subsidiaries, the potential for cross-border issues, and how the panelists would price certain assets. Panelists acknowledged that trying to extract businesses and assets would be difficult to achieve in a short time frame as some subsidiaries are located across multiple legal authorities. Committee members also highlighted the fact that extracting assets from subsidiaries, transferring and pricing them could be difficult as each subsidiary has multiple creditors and stakeholders.
Committee members also asked the panelists how the FDIC would remove the management and board of the holding company that are culpable for causing a company’s failure. Panelists said there has to be a determination of culpability to figure out who ought to be removed. Wigand said the FDIC would apply two tests, a culpability test and market test. Pressed on how the panelists define “culpability” and how they would judge who is culpable or not, the FDIC panelists said there is a “wide degree of discretion” under the statute. Pressed further by some members on what happens to the definition of culpability if replacements are hard to come by, panelists said they were hopeful that in the process of creating living wills, companies “will be able to identify positions where the level of expertise is so great” that removing those parties will likely lead to value loss for the firm. In cases where it is difficult to find replacements, panelists said determinations may have to be made on a case-by-case basis. With regards to the market test, panelists said if the company is to be viable again, markets will need confidence and won’t display it if culpable parties are still in their respective positions. Gruenberg commented that replacement of a company’s board of directors and CEO is one of the “key challenges” faced by the FDIC under Title II resolution framework.
Other issues discussed included the role of creditors throughout the resolution process, the difference between single receivership versus multiple receiverships, and FDIC’s relationship with a newly appointed CEO and board of directors.
After a brief break, the Committee reconvened to discuss Title I of the Dodd-Frank Act and the FDIC’s international coordination efforts.
Under Title I, covered companies are required to submit an annual plan to the FDIC, FRB and FSOC for their rapid and orderly resolution under the Bankruptcy Code. Wigand defined covered companies as: bank holding companies, including foreign banks with U.S. operations, with $50 billion or more in total assets; and nonbank financial companies designated by FSOC for enhanced supervision by the FRB. Wigand said the annual plan must include a strategic analysis showing how to accomplish a rapid and orderly resolution in manner that “mitigates serious adverse effects on US financial stability,” and identifies core business lines and critical operations to legal entities.
The panel asked what the FDIC and the FRB hope to learn from requiring firms to draft living wills. John Simonson, Deputy Director of the Office of Complex Financial Institutions, said there are a number of things the FDIC hopes to learn, including information on a “firm’s structure, their operation, their complexity, their interconnections, and the mapping between legal entities and operations.”
“Ultimately,” John said, “the living will process keeps us informed about the state of a covered institution, making the Title II process more valuable.”
The panel asked Krimminger how he expects a company to draft a plan like the one stipulated, considering the amount of assumptions they would need to make about the markets and the bankruptcy process. Krimminger said “any firm worth its salt” needs to be able to do this kind of resolution planning to understand how their business could survive during crisis.
Wigand added that if the FRB and FDIC determine a plan is not credible or would not lead to orderly resolution, more stringent prudential requirements, and, ultimately restructuring, may be imposed. When asked how the FDIC will determine the notion of credible, Krimminger said a credible plan “is a reasonable plan that allows a firm to resolve itself through bankruptcy and the other existing regimes without causing systemic problems.”
Krimminger was also asked about the level of disclosure each firm would be subject to considering that sensitive data would be included. Krimminger said a portion of the submitted plan will be in the public domain, but the FDIC will work with firms to indentify sensitive data and keep it confidential. In regards to how much of the submitted plans will be public record, Krimminger said those details are still being discussed.
Insured Depository Institutions
The final rule, which takes effect on April 1, requires a covered insured depository institution (IDI) to submit an annual plan enabling the FDIC, as receiver, to resolve the institution under the Federal Deposit Insurance Act at the least cost to the institution’s creditors. Wigand said the purpose of the rule is to facilitate the FDIC’s resolution of the insured institution independently of its parent company and non-bank affiliates in manner which: 1)Provides depositors access to insured deposits within 1 day; 2) Maximizes NPV return on assets; and 3) Minimizes loss to creditors, including the deposit insurance fund.
The panel asked the committee about the type of feedback they were getting from firms that have gone through the process, and if they have determined it to be valuable. Krimminger said they have received several comments from officials involved in the process, and some have indicated that the process has given the firm a new perspective on their organization, causing them to tweak their organizational structure.
The panel also pressed Krimminger on how often the plans would need to be submitted, Krimminger said annually, but added that if there is a material change to the circumstances of an institution or conditions that affect an institution the firm would be required to resubmit the plan. He said the FDIC will require firms to alert them if a substantial change to their situation or business practice could alter their resolution plan.
International Resolution Coordination
M.P. Azevedo, Deputy Director of International Coordination, said the key to a successful cross-border resolution of a G-SIFI is to “keep it simple,” by: 1) identifying the key jurisdictions where important functions and critical operations of the SIFI are; 2) identifying the legal nature of the entity in those jurisdictions and determining the types of licenses and authorizations they hold; 3) Engaging in purposeful dialogue in advance with applicable local regulators to identify obstacles to orderly resolution and address them through bilateral cooperation or rule changes; and 4) concluding memorandums of understanding (MOUs) with the affected jurisdictions covering information sharing in connection with resolution preparation both in advance of, and during, a crisis.
“We have heard many times in this venue and elsewhere that the global footprint of the SIFI is very complicated,” Azevedo said. “The key to a resolution strategy, in a global sense, is to focus on what is meaningful in the global footprint, especially indentifying what jurisdictions contain activities and operations that are critical to the SIFIs’ failure and have systemic consequences.”
Azevedo also discussed some of her team’s findings when applying the above criteria to the top five U.S. SIFIs. She said over 90 percent of the total reported foreign activity of the firms is located in 1-3 foreign jurisdictions and over 80 percent of total reported foreign activity comes from legal entities located in the United Kingdom.
Additionally, Azevedo and her team identified five legal obstacles to the successful execution of an international resolution strategy, including: change of control requirements; ring-fencing and liquidation triggers; lack of broad based stay of closeout/netting of derivatives and other qualified financial contracts (QFCs); divergent insolvency legal frameworks; and diverse regulatory frameworks. She said ring-fencing, especially in the United Kingdom, is a particularly worrisome obstacle, and will require significant analysis to determine what triggers ring fencing and mandatory liquidation at the regulatory or board level and then develop a strategy for avoiding the triggering of those events when implementing a resolution plan.
The panel asked Azevedo how here team is handling asset management operations, specifically asking if she considers those assets as part of an entity or not. Azevedo said she does not consider them part of the SIFIs’ proprietary asset footprint, but said they “might want to look at it in terms of the materiality of the operations.”
In closing, Wigand said the international coordination group will also be working on the usage of financial market utilities by G-SIFIs and how the appointment of the receiver at the parent-level may affect a SIFI’s membership with critical FMUs, as well as, identifying the key data centers and process centers of SIFIs.
The PowerPoint presentations accompanying today’s advisory committee meeting can be found below:
Legal Framework Overview – PDF
Resolution Strategy Overview – PDF
Living Wills Overview – PDF
International Resolution Coordination Overview – PDF
For more information on the hearing, please click here.
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