‘Living wills’ easier said than done

September 10, 2009

In the wake of the widespread chaos that accompanied the bankruptcy of Lehman Brothers last September, regulators have sought to find a better way to unwind global financial giants. One approach is that the banks themselves should prepare for their own orderly demise — a kind of “living will”.

That idea has been gathering steam of late. The G20 group of finance ministers and central bankers meeting in London over the weekend agreed to require “systemic firms to develop firm-specific contingency plans.”

The concept has wide appeal. The crisis has convinced politicians and regulators of all colours that even large financial institutions must be allowed to fail without imposing a huge burden on taxpayers. Many bankers see such a regime as a preferable alternative to more intrusive regulation.

However, drawing up a detailed “living will” is easier said than done.

Simon Gleeson of Clifford Chance argues that it is more important for regulators and legislators to establish a cross-border crisis-management and resolution regime than it is for individual firms to prepare for their own demise.

The mandate of the Financial Stability Board (FSB), the international body comprising finance ministries, central banks and financial regulators, was recently expanded to include contingency planning for cross-border crises. It published a series of relevant principles in April. However, as the Institute of International Finance (IIF) noted, it is “clear from the high-level nature of the principles and the aspirational language [that] there remains a lot to be done.”

The IIF is calling for the FSB to develop a convention on crisis management that would include detailed rules, including on early intervention. It also wants the FSB to run cross-border crisis simulations of the sort routinely carried out by domestic regulators.

But crisis-handling is only half the battle. Once a bank collapses, national priorities currently kick into action, not least because the responsibility for a bail-out rests with elected finance ministers rather than the technocrats who run financial regulators or central banks.

Politicians’ instincts will always be to minimise the harm to their own depositors, creditors and banking systems, regardless of the global cost.

Solvency law reinforces these nationalistic instincts. Like financial markets law, it is bounded by national borders. Administrators allocate the bank’s remaining assets among local creditors, regardless of the claims of creditors overseas. Indeed, they are often prohibited from cooperating with their foreign counterparts, even if they wanted to.

Solvency law is also wholly inadequate to the task of unwinding huge, interconnected financial firms.

One solution, as floated by Adair Turner, chairman of Britain’s Financial Services Authority, would be to require international banks to simplify their corporate structures. But this is likely to be resisted by the banks as it would eradicate all the efficiency benefits of a cross-border structure, as well as exposing tax-minimising schemes.

Instead, the IIF advocates that governments agree criteria for burden-sharing ahead of another crisis. A common fund could be established across borders, though the IIF sensibly recognises that the political challenges would be huge.

More pertinently, the IIF advocates that banks should be subject to a special resolution regime separate from those of regular commercial companies. Central to such a regime would be a cross-border agreement that governments could step in and override normal insolvency practices in order to avoid systemic disruption of the banking and payments systems.

Some of the issues posed by the financial crisis are intellectually difficult; some politically challenging. Devising a legal framework for “living wills” manages to be both. Any solution for dealing with a future Lehman remains a long way off.

The Year Since Lehman — related columns:

Banking? Keep it simple, stupid

A year on, it’s still a housing story


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