First wave of U.S. living wills has limitations, but offers useful start
By Bora Yagiz
NEW YORK, July 9 (Thomson Reuters Accelus) -Â The “living will” resolution plans submitted to U.S. regulators by nine big banks last week suffer from a number of limitations, including narrow scenarios of financial distress and an assumption that regulators will be coordinated in their approach. But there will be plenty of opportunity to perfect the blueprints.
Five major U.S. banking organizations and four foreign-based bank holding companies with $250 billion or more in total nonbank assets submitted on July 2 theirÂ resolution plans, or â€śliving wills,â€ť to the Federal Reserve Board and Federal Deposit Insurance Corporation (FDIC) as required byÂ section 165(d) of the Dodd-Frank Act (DFA). This constituted the first of the three waves of submissions of a staggered schedule arranged according to the banksâ€™ sizes and due to be completed by end-2013. These plans to complement the recovery plans that are designed to maintain firms under extreme stress as going concerns, will serve as the official point of entry for bankruptcy.This first wave of submissions is also supposed to be a â€śfirst impression,â€ť serving as a valuable blueprint for the successive waves. Far from being finalized, the plans, at this initial stage, will provide a crucial learning experience for banks through a process including further discussions with the regulators, and will allow them to understand regulators’ expectations and subsequently fine-tune their plans. And not for the bankers only: â€śThe regulators are not out there to flunk any pupils, as this will be as much of a learning experience for the regulators as it is for the bankersâ€ť said Charles Horn, a partner with Morrison & Foerster.
Ultimately, the plans will be â€śbusiness as usualâ€ť for the banks, which will periodically update them as circumstances warrant. The regulators will then be able to use the plans in determining how to most effectively unwind a distressed institution they deem as systemically important. Failure to provide effective resolution plans by the firms could result in regulators imposing stricter capital, liquidity or leverage standards, or limitations on certain operations or activities. If warranted, the regulators can require divestiture of assets, though FDIC made clear that the agency would have recourse to this only as a last resort.
The underlying intent of the resolution plans is relatively straightforward: to bring a failing institution under the aegis of the FDICâ€™s resolution authority and have its units dismantled in an orderly fashion through advanced planning and co-ordination with the regulators. In theory, this would help protect the stability of the financial markets in two important ways: first, by avoiding the creation of a panic-stricken atmosphere that would perpetrate the crisis through fire-sale of assets or runs on areas of shadow banking considered to be safe (as evidenced in the Lehman debacle), and second, by replacing the ad-hoc measures the regulators had to take to contain the last crisis with a more orderly process.
The plans are also intended to effectively end the â€śtoo big to failâ€ť syndrome, whereby previously certain institutions deemed too critical for the functioning of the financial system had obtained costly government bail-outs through implicit guarantees.
A jointly-issued rule in September 2011 by the Federal Reserve Board and the FDIC has provided some general guidance on the required content of the plans. Accordingly, the firms were asked to provide a detailed account of their ownership structure and contractual obligations, a list of their major counterparties, clarification on cross-guarantees tied to different securities, to whom their collateral is currently pledged, and an analysis explaining resolution options.
So, how much of these requirements were addressed in the living wills provided? And, more importantly, how convincingly?
Aside from the occasional peppering of terms such as â€śfortress balance sheetâ€ť and â€śbeing the best place to workâ€ť to make showcase of their strengths, the firmsâ€™ public summaries include the requested information, albeit in limited extent, probably owing to the nature of the highly sensitive confidentiality of the topics. One would expect the non-public portions provided to the regulators to include the granularity around their alternative resolution options.
The public summaries of the resolution plans suffer from a number of deficiencies.
First and foremost, the common set of baseline scenario regulators provided under which the plans would operate, appear to be unrealistic. Specifically, these initial assumptions fail to provide a holistic approach where the only variable in the equation is the firmâ€™s experiencing a sudden and idiosyncratic financial distress, while holding as constants the healthy condition of the market and other market participants.
Second, co-ordination among supervisory bodies in different jurisdictions is taken for granted. It is not clear how a firm with legal entities operating in multiple countries would be wound down in a harmonious way.
Third, by focusing narrowly on systemically important institutions rather than their systemically important activities, the regulators may once again fall into a â€śregulatory gap,â€ť failing to foresee what sections of capital markets may seize up in times of stress.
Lastly, the resolution plans provide a mere test in a vacuum, without taking into consideration the repercussions of the interconnected nature of a globally systemic crisis. It is unclear, for example, how Citigroup would be able to carry on its plans to sell off its brokerage business in a financial distressed environment. Who would be there to buy? And, for how much?
The plans are not without benefits. They provide for the first time a clear structure of the firmsâ€™ corporate governance and decision-making processes. Judging from the public portions, firms have vastly improved on their management information systems as well, enhancing their risk-management systems on a real-time basis, thus allowing their senior managements to be informed of time sensitive risk measures such as counterparty exposures, amount and quality of collateral and collateral arrangements. The plans will also allow regulators to weigh in different resolution methods and decide whether they are cost-effective and realistic.
Still, many experts remain skeptical about the main objective the living wills aim to accomplish. Asked whether she expected the living wills would allay the fears about the â€śtoo big to fail syndromeâ€ť in the market, Nancy Bush, a contributing editor to SNL, a financial industry research service, said, â€śHaving seen how hopelessly complex these firms are, no. In fact, it is quite the opposite.â€ť
In the end, it certainly makes sense to put the exit sign, check the sirens and implement fire drills for a movie theater for security purposes. But how much assurance can one draw out of this in avoiding a stampede when the building is going up in flames?
(This article was produced by the Compliance Complete service of Thomson Reuters Accelus.Â <a href=”http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/” target=_new”>Compliance Complete</a> provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators andÂ exchanges.)