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US and UK publish cross-border proposals for winding up global financial services firms

UK and US banking authorities have set out their plans for safely winding down the so-called 'too big to fail' complex global banks in the event of financial difficulties.10 Dec 2012

A joint paper (18-page / 311KB PDF), produced by the Federal Deposit Insurance Corporation (FDIC) in the US and the Bank of England, sets out an approach based on legal powers created by both countries since the 2008 financial crisis. It also makes reference to powers that could be granted to the UK if the proposed EU draft Recovery and Resolution Directive (RRD) is approved. The FDIC is the US body that compensates savers in the event of a bank collapse. It also provides certain oversight functions.

Paul Tucker, the Bank of England's Deputy Governor for Financial Stability, said that the approach set out in the paper was designed to ensure that any sound parts of a failing institution would be able to continue trading.

"The 'too big to fail' problem simply must be cured," he said. "We believe it can be and that this joint paper provides evidence of the serious progress that is being made."

The report proposes a 'top-down' resolution strategy, with one regulatory authority deemed responsible for overseeing the winding up of the parent company of a globally active, systemically important financial institution (G-SIFIs). This would allow a coordinated cross-border approach in the event that a large bank fails, rather than having national bodies deal with the bank's individual subsidiaries in each country.

The strategy would see a single receivership applied to the parent company, with losses assigned to shareholders and unsecured creditors of the holding company ('holdco'), should US regulators be tasked with winding up the G-SIFI. Unaffected, 'sound' subsidiaries would then be transferred to a new, solvent operating company ('opco'). Should UK regulators take the lead, shareholders at the top of the group would 'bail in' the failed parent company under new powers at an EU and UK level in order to restore the whole group to solvency.

"Both the US and UK approaches ensure continuity of all critical services performed by the operating firm(s), thereby reducing risks to financial stability," the document said. "Both approaches ensure activities of the firm in the foreign jurisdictions in which it operates are unaffected, thereby minimising risks to cross-border implementation ... Sound subsidiaries (domestic and foreign) would be kept open and operating, thereby limiting contagion effects and crossborder complications."

Senior management found "culpable" in the event of a G-SIFI getting into financial difficulties would be "replaced" under both approaches, the paper said.

The paper also requires G-SIFIs to hold enough capital, or debt that can easily be converted into capital, at parent company level. This capital would be used to absorb any losses generated during the resolution process.

Banking law expert Tony Anderson of Pinsent Masons, the law firm behind, questioned the introduction of a third set of banking resolution proposals. He pointed out that the measures proposed by the paper made recommendations for additional capital requirements that went beyond those proposed earlier this year by the EU, and by Sir John Vickers' Independent Commission on Banking (ICB) in the UK.

"Whilst it is positive to see a form of consensus between UK and US regulators, it is still evidence that the amount of capital banks will need to absorb potential losses remains very much an open question," Anderson said.

"The 'top down' measures foreshadowed would require further internal changes to accommodate additional capital and resolution measures at 'holdco' and 'opco' levels within banks. These aren't currently envisaged under either the Vickers (UK) or Liikanen (EU) bank reform proposals," he said.

Published in October, the Liikanen Report proposed that European banks be restructured so that high-risk trading activities are provided by a different entity to that providing retail banking activities. The proposals reflect those currently being taken forward in the UK as a result of the recommendations of the ICB, and the 'Volcker Rule' under the Dodd-Frank Act in the US.

Under the Dodd-Frank Act, G-SIFIs are required to periodically submit resolution plans setting out rapid and orderly resolution procedures to the FDIC and Federal Reserve. The same Act allows the FDIC to wind up these institutions in the event of failure. In the UK, the Banking Act gives the Bank of England similar powers over deposit-taking banks and building societies; however the UK regime does not provide a "wholly effective solution" in the event of the failure of an international bank.

The EU RRD as drafted will introduce a statutory bail-in resolution tool, giving national regulators in EU member states the power to 'write down' or convert the liabilities of a failing firm into equity. The Financial Services Bill, which is currently before Parliament, will extend the provisions of the existing Banking Act to cover non deposit-taking financial firms such as investment banks and clearing houses.