* This chapter was prepared for the Thirteenth Annual International Banking Conference held at the Federal Reserve Bank of Chicago on 23–24 September 2010. The views expressed are those of the author in her personal capacity and do not necessarily reflect the views of the FSB or its members.
1 Eva Hüpkes, ‘“Too Big to Save”—Towards a Functional Approach to Resolving Crises in Global Financial Institutions’ in D. Evanoff and G. Kaufman (eds), Systemic Financial Crisis: Resolving Large Bank Insolvencies (World Scientific Publishing, 2005).
4 An example for this approach is the creation of Continuous Linked Settlement (CLS) bank which insulates the clearing and settlement function for foreign exchange contracts from failure of individual market participants. The efforts underway to expand central counterparty (CCP) clearing into OTC derivatives markets, including the credit default swap (CDS) market, and to move as much trading as possible to an organized exchange are another example. In the United Kingdom, the Independent Commission on Banking (ICB) in its final report of September 2011 proposed structural measures that insulate retail activities from other activities within financial institutions.
5 Key Attribute 3.4 ‘Resolution authorities should have the power to establish one or more bridge institutions to take over and continue operating certain critical functions and viable operations of a failed firm, including: (i) the power to enter into legally enforceable agreements by which the authority transfers, and the bridge institution receives, assets and liabilities of the failed firm as selected by the authority; (ii) the power to establish the terms and conditions under which the bridge institution has the capacity to operate as a going concern, including the manner under which the bridge institution obtains capital or operational financing and other liquidity support; the prudential and other regulatory requirements that apply to the operations of the bridge institution; the selection of management and the manner by which the corporate governance of the bridge institution may be conducted; and the performance by the bridge institution of such other temporary functions as the authority may from time to time prescribe; (iii) power to reverse, if necessary, asset and liability transfers to a bridge institution subject to appropriate safeguards, such as time restrictions; and (iv) the power to arrange the sale or wind-down of the bridge institution, or the sale of some or all of its assets and liabilities to a purchasing institution, so as best to effect the objectives of the resolution authority.’
6 FSB Key Attribute 6.3 stipulates that ‘[j]urisdictions should have in place privately-financed deposit insurance or resolution funds, or a funding mechanism for ex post recovery from the industry of the costs of providing temporary financing to facilitate the resolution of the firm.’
7 See Key Attributes 3.5 ‘Powers to carry out bail-in within resolution should enable resolution authorities to (i) write down in a manner that respects the hierarchy of claims in liquidation (see Key Attribute 5.1) equity or other instruments of ownership of the firm, unsecured and uninsured creditor claims to the extent necessary to absorb the losses; and to (ii) convert into equity or other instruments of ownership of the firm under resolution (or any successor in resolution or the parent company within the same jurisdiction), all or parts of unsecured and uninsured creditor claims in a manner that respects the hierarchy of claims in liquidation; (iii) upon entry into resolution, convert or write-down any contingent convertible or contractual bail-in instruments whose terms had not been triggered prior to entry into resolution…’ and 3.6.
8 Key Attribute 3.3 ‘Resolution authorities should have the power to transfer selected assets and liabilities of the failed firm to a third party institution or to a newly established bridge institution. Any transfer of assets or liabilities should not (i) require the consent of any interested party or creditor to be valid; and (ii) constitute a default or termination event in relation to any obligation relating to such assets or liabilities or under any contract to which the failed firm is a party’ (see Key Attribute 4.2).
9 Provided the obligations under the contract, including payment and delivery obligations, and provision of collateral, continue to be performed following transfer of the contract. See Key Attribute 4.3 and Annex IV.
10 FSB Key Attribute 5.1 ‘Resolution powers should be exercised in a way that respects the hierarchy of claims while providing flexibility to depart from the general principle of equal (pari passu) treatment of creditors of the same class, with transparency about the reasons for such departures, if necessary to contain the potential systemic impact of a firm’s failure or to maximise the value for the benefit of all creditors as a whole. In particular, equity should absorb losses first, and no loss should be imposed on senior debt holders until subordinated debt (including all regulatory capital instruments) has been written-off entirely (whether or not that loss-absorption through write-down is accompanied by conversion to equity).’
11 Basel Committee on Banking Supervision, Report on progress on resolution policies and frameworks issued by the Basel Committee, 6 July 2011, available at <http://www.bis.org/press/p110706.htm>.
12 For instance, in all likelihood the law of the jurisdiction where the assets are located will govern the tangible property and the law of the jurisdiction that is the situs of the contract or the law chosen by the parties will govern the contractual rights. It is important to distinguish between the creation of rights and the validity of claims under the law designated as applicable law in accordance with the conflict of law rules of the forum or as agreed by contract, and the treatment that these rights and claims receive in case of insolvency, which is be determined by the insolvency law of the forum.
13 See for more details E. Hüpkes, ‘Rivalry in Resolution: How to Reconcile Local Responsibilities and Global Interests?’ in (2010) 7(2) European Company and Financial Law Review 216–39.
14 See discussion in Basel Committee on Banking Supervision. 2010, Report and Recommendations of the Cross-Border Bank Resolution Group (March). Basel: Bank for International Settlements <http://www.bis.org/publ/bcbs156.htm>; Paul Tucker, ‘Resolution of Large Complex Financial Institutions—the Big Issues’, Speech at the European Commission’s Conference on Crisis Management, Brussels, 19 March 2010; T.C. Baxter, J.M. Hansen, and J.H. Sommer, ‘Two Cheers for Territoriality: An Essay on International Bank Insolvency Law’ (2004) 78(1) American Bankruptcy Law Journal 57–92.
15 L.M. LoPucki, ‘The Case for Cooperative Territoriality in International Bankruptcy’ (2000) 98 Michigan Law Review 2216.
16 A.M. Kipnis, ‘Beyond Uncitral Alternatives to Universality in Transnational Insolvency’, 3 July 2006, available at SSRN: <http://ssrn.com/abstract=913844>. Notable exceptions are the European Directives on the Reorganisation and Winding-up of Credit Institutions of 4 April 2001 and of Insurance Undertakings of 19 March 2001.
17 J.L. Westbrook, ‘A Global Solution to Multinational Default’ (June 2000) 98 Michigan Law Review 2276.
18 R.K. Rasmussen ‘A New Approach to Transnational Insolvencies’ (1997) 19 Michigan Journal of International Law 1; P. Wallison, Debtor Selection: Resolving Insolvent Globally Active Financial Institutions (American Enterprise Institute for Public Policy Research, March, 2010).
19 For instance, when a function provided by a financial institution is critical in one jurisdiction but not in another, but depends on services and operations provided by entities in other jurisdiction.
20 LoPucki, see n 15; Baxter et al, see n 14.
21 S. Claessens, R. Herring, and J.D. Schoenmaker, A Safer World Financial System: Improving the Resolution of Systemic Institutions, Geneva Reports, Centre for Economic Policy Research, July 2010.
22 C. Cumming and R. Eisenbeis, ‘Resolving Troubled Systemically Important Cross-Border Financial Institutions: Is a New Corporate Organizational Form Required?’ in R. Herring (ed), Issues in Resolving Systemically Important Financial Institutions (Wharton Financial Institutions Center, 2010).
23 According to J.P. Morgan, ‘Global Banks—Too Big to Fail? Big Can (also) Be Beautiful’ (17 February 2010), 40. Bank of America has 2,321 legal entities, Deutsche Bank has 2,250, and even AIG had over 4,000 legal entities.
24 The Economist, 9 September 2010, observed that the guarantee claims by Lehman affiliates on Lehman’s holding company as of March 2010 amounted to US$223.9 bn.
25 According to the Basel Committee, see n 14, the Lehman Brothers Group consisted of 2,985 legal entities in 50 countries. The lines of business did not necessarily map to the legal entity lines of the companies. The group was organized so that some essential functions, including the management of liquidity, were centralized.
26 D. Staehlin, ‘No Substantive Consolidation in the Insolvency of Groups of Companies’ in H. Peter, et al (eds), Challenges of Insolvency Law Reform in the 21st Century (Schulthess Verlag, 2006).
27 Christine Cumming and Robert A. Eisenbeis, ‘Resolving Troubled Systemically Important Cross-Border Financial Institutions: Is a New Corporate Organizational Form Required?’, Federal Reserve Bank of New York Staff Reports, no 457, July 2010.
28 The OECD proposed the creation of a holding-type structure where each financial activity (banking, securities trading, fund management, etc) would be conducted out of a separately capitalized entity. See OECD, The Financial Crisis Reform and Exit Strategies (2009).
29 The FSB Recommendations (2010) stipulate that service agreements are appropriately documented and cannot be abrogated by the service provider in resolution. See also Notice of Proposed Rulemaking, ‘Special Reporting, Analysis and Contingent Resolution Plans at Certain Large Insured Depository Institutions’ FDIC Release RIN 3064–AD59 (11 May 2010), 75 Fed Reg 27464 (17 May 2010), available at <http://www.fdic.gov/news/board/May01.pdf>.
30 eg under the European Winding Up Directive, the administrative or judicial authorities of the home Member State are be empowered to decide on the implementation of reorganization or liquidation measures with respect to a credit institution, including branches established in other Member States. The measures will be fully effective in accordance with the legislation of that Member State throughout the Community without any further formalities, including as against third parties in other Member States, even where the rules of the host Member State applicable to them do not provide for such measures or would otherwise make their implementation subject to conditions which are not satisfied.
31 The Basel Committee (2010) observes that ‘National resolution authorities will seek, in most cases, to minimise the losses accruing to stakeholders (shareholders, depositors and other creditors, taxpayers, deposit insurer) in their specific jurisdiction to whom they are accountable. For financial institutions in which the public purse or a public or quasi-public fund is often called upon for institutional support or protection of certain creditors (at a minimum, insured depositors), the likelihood of the application of measures that seek to protect local interests and stakeholders is increased by the public and policy pressure to allocate financial resources in a way which reduces the burden for their own taxpayers.’
32 Scott Alvarez, General Counsel of the Board of Governors of the Federal Reserve system in his statement before the Financial Crisis Inquiry Commission on the acquisition of Wachovia Corporation by Wells Fargo & Co, 1 September 2010, observed that ‘…if the least-cost resolution did not support foreign depositors, the resolution would end what was a significant source of funding for several other major U.S. financial institutions’.
33 The Dodd-Frank Wall Street Reform and Consumer Protection Act provides that the FDIC receives a senior claim to recoup any financial assistance provided. Dodd-Frank Wall Street Reform and Consumer Protection Act, s 204. It also permits the FDIC to seek assessments from the financial industry. Assessments are first imposed on those creditors who received additional payments from the FDIC pursuant to its authority to treat certain creditors better than others.
34 See FSB Key Attribute 7.3 ‘The resolution authority should have resolution powers over local branches of foreign firms and the capacity to use its powers either to support a resolution carried out by a foreign home authority (for example, by ordering a transfer of property located in its jurisdiction to a bridge institution established by the foreign home authority) or, in exceptional cases, to take measures on its own initiative where the home jurisdiction is not taking action or acts in a manner that does not take sufficient account of the need to preserve the local jurisdiction’s financial stability. Where a resolution authority acting as host authority takes discretionary national action, it should give prior notification and consult the foreign home authority.’
35 See FSB Key Attribute 7.2 ‘Legislation and regulations in jurisdictions should not contain provisions that trigger automatic action in that jurisdiction as a result of official intervention or the initiation of resolution or insolvency proceedings in another jurisdiction, while reserving the right of discretionary national action if necessary to achieve domestic stability in the absence of effective international cooperation and information sharing.’
36 The existing Basel Concordat and subsequently developed Basel principles governing cross-border supervision, which make cross-border banking subject to the existence of effective supervisory arrangements in home and host countries, would need to be revised to make cross-border banking subject to effective crisis management and resolution arrangements in home and host countries. A financial firm would be granted access to a market only if it had a recovery and resolution plan and it were established on this basis that its operations could be wound down in an orderly manner. See Hüpkes, see n 13.
37 Key Attribute 9.1 calls for institution-specific cooperation agreements to be in place at a minimum for all G-SIFIs. It stipulates that the agreement provide, amongst other elements, ‘an appropriate level of detail with regard to the cross-border implementation of specific resolution measures, including with respect to the use of bridge institution and bail-in powers.
38 See Key Attributes Annex I (Essential elements of institution-specific cross-border cooperation) and Key Attribute 7.2 (iii) which requires cooperation to set out the available ‘funding arrangements in home and host jurisdictions to support the implementation of the resolution measures and restore market confidence’.
39 The UK Financial Services Act 2010 places a duty on the FSA to make rules requiring the production of recovery and resolution Plans (RRPs). In August 2011, the UK FSA published a Consultation Paper and Discussion Paper on its proposals for Recovery and Resolution Plans. Under s 165(d) of the Dodd-Frank Act, the Federal Reserve Board (FRB) must require each FRB-supervised non-bank financial company and bank holding company with at least $50 billion in total consolidated assets to report periodically to the FRB, FSOC, and FDIC on its plan for rapid and orderly resolution in the event of material financial distress or failure. The plan must include information on the manner in which affiliated insured depository institutions are adequately protected from risks of other activities; a description of ownership structure, assets, liabilities, and contract obligations; the identification of cross-guarantees on securities, major counterparties, and process for determining to whom collateral is pledged.
40 CMGs, which consist of representatives from supervisory agencies, central banks, and resolution authorities from the key home and host jurisdictions, have been established for the major international financial firms. The objective of these groups is to promote the elaboration of firm-specific recovery and resolution measures and to assess these firms’ resolvability. See FSB report to the G-20 Finance Ministers and Governors, April 2010.
41 Charles Goodhart has referred to this as the ‘time inconsistency’ problem in resolution and noted that authorities may be reluctant to apply even the best resolution tools out of concern about adverse systemic consequences of their actions. Charles Goodhart, ‘Remarks at the European Commission’s Conference on Crisis Management’, 19 March 2010.
42 See Statement by Thomas C. Baxter, Jr, Financial Crisis Inquiry Commission, 1 September 2010.
43 Such a reorganization procedure would transform the firm’s capital and liability structure, with capital being written down and certain categories of the liabilities (depending on their seniority) being transformed into equity so that the firm can absorb the losses that led to the need for intervention and continue to operate as a going concern. See T. Huertas, ‘The road to better resolution: From bail-out to bail-in’, paper presented at the Euro and the Financial Crisis conference, hosted by The Bank of Slovakia on 6 September 2010; Squam Lake Working Group on Financial Regulation, An Expedited Resolution Mechanism for Distressed Financial Firms: Regulatory Hybrid Securities, Working Paper, April 2009.
44 Baxter, see n 14, noting that ‘banks in advanced jurisdictions seldom enter reorganisation’.
45 See Report of the Contact Group on the Legal and Institutional Underpinnings of the International Financial System, Insolvency Arrangements and Contract Enforceability, September 2002, available at <http://www.bis.org/publ/gten06.htm〉 noting that bank resolution proceedings are typically official-centred.
46 See Art 29 Swiss Banking Act of 1934 (as amended in 2011). In Switzerland, the Swiss regulator FINMA initiates reorganization proceedings. Reorganization can provide for a write-down of equity and debt claims, and may also provide for a conversion of debt into equity. The reorganization plan is not subject to shareholder vote, even if it affects their rights. Also, it does not need to be formally approved by the creditors, subject to the condition that creditors do not receive less in a restructuring than they would in a liquidation.
47 Credit Institution Reorganisation Act (Gesetz zur Reorganisation von Kreditinstituten).
48 Section 9 of the German Credit Institution Reorganisation Act. A debt-to-equity conversion requires creditor consent.
49 Section 19(2) and (3) of the German Credit Institution Reorganisation Act.
50 For instance, UBS needed to hold an extraordinary shareholders’ meeting to increase the capital of the bank to deal with its subprime exposure. In the Fortis case, Belgian shareholders brought a case before the Belgian Commercial Court claiming that the sale to BNP Paribas, which had already been agreed by contract, required shareholder approval. In the AIG case, it was possible to invoke an exception to a shareholder approval requirement under the New York Stock Exchange’s Shareholder Approval Policy.
51 An amendment of 2 June 2010 to the Belgian Law of 22 March 1993 concerning the status and supervision of credit institutions empowers the board of directors to act in derogation of restrictions arising from the statutes of the institution to the extent that their acts are necessary to avert systemic risks to the financial system (see §8).
52 Swiss Commission of Experts for limiting the economic risks posed by large companies, Final Report, Swiss Department of Finance, 4 October 2010.
53 Articles 11 and 12 of the Swiss Banking Act of 1934 as amended in September 2011 provide that the shareholders could delegate all aspects of the issuance of contingent convertible bonds, including determination of amounts, triggers, and conversion rates, to the board of directors. The articles of incorporation must determine the maximum amount of the share issue, the share type, including any pre-emptive rights, and any limitation to the transferability of new registered shares. The general meeting of shareholders may also delegate the determination of these aspects to the board of directors. The amount and the duration of the reserve capital is not limited by law.
54 The general meeting of shareholders has the power to determine the share type, including any pre-emptive rights, any limitation to the transferability of the shares, and the principles according to which the issue amount is to be calculated, but can delegate the authority to determine these aspects to the board of directors in the articles of incorporation. See Art 13 of the Swiss Banking Act of 1934 as amended in September 2011.