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

UBS, Switzerland and the United States can all claim a sort of victory from the settlement on Wednesday of their tax dispute.

UBS gets to avoid a fine that -- according to the Swiss justice minister -- would have threatened its existence. The Americans get the details of some 4,450 accounts that they say have held up to $18 billion, on which fat taxes may be payable. And the Swiss get to draw a line under a threat to their fundamental banking secrecy.

Even so, there will be many who want to keep their financial affairs private who will look for other homes for their cash.

The basics of the deal are as follows. The U.S. will drop its "John Doe" summons that looked for the names of as many as 52,000 Americans with accounts at UBS. This had prompted the Swiss to threaten that they would seize UBS's data rather than accede to what they saw as a fishing expedition that they said would break Swiss law.

The Americans now say they were never looking for so many accounts, which would include many law-abiding citizens.

Instead, the Swiss will hand over details of 4,450 (the Americans say it could be more than 5,000) accounts of Americans at UBS. The bank, which is the world's second-largest wealth
manager, will write to affected account-holders urging them to take part in an American tax amnesty, if appropriate.

The Americans gain twice over. First, the affected account-holders will, unless they are stupid, cough up any outstanding tax before the amnesty expires on Sept 23. Anyone with accounts at other foreign banks is also likely to put their affairs in order before Uncle Sam forces them to. Moreover, Americans will in future will careful to comply with U.S. tax law given the reach of the U.S. justice department.

For the Swiss, the chief attraction of this deal is that it allows them to claim that bank secrecy is upheld. After all, they already had agreements in place allowing an exchange of information in the case of suspected tax fraud. They can say that handing over these names is nothing new, but few will be convinced.

There is no doubt that the case, especially when allied to UBS's near-death experience following the credit boom, has tarnished Switzerland's image of solidity and respectability. There are new centres, like Singapore, offering discreet banking. They will grow at the expense of the Swiss incumbents.

– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –

Germany’s politicians seem to have rescued their bad bank. Pushing back the valuation date for toxic assets to before the Lehman collapse has made it more likely that banks will consign their dud investments to the voluntary scheme.

It had looked as if the banks might simply boycott it. However, while the government has scored a political goal, it is no closer to its aim of boosting lending to a credit-starved German economy.
The essence of the scheme is that banks will be able to transfer some 250 billion euros of toxic assets into “eine Bad Bank”. In exchange they receive government-backed paper that they can count towards regulatory capital.

In principle this will raise their lending capacity. However, because the Germans do not want to reward reckless banks, the banks will pay an annual fee to participate, and will be liable for any shortfall at the end of the scheme. In other words, there is no fundamental risk transfer from the banks and the uncertainty about their eventual liability remains.

The breakthrough this week is that the government has pushed the valuation back to before the collapse of Lehman last autumn — when valuations were much higher.

One of the perverse effects of the revision is that some banks may enjoy a gain on the value of their impaired bonds because they have already been written down. This explains why shares in Commerzbank jumped by almost 20 percent when the news emerged on July 1.

However, like the original plan, the amendment is simply a sleight of hand. The government is still putting no cash into the scheme. The German public is dead against bailing out reckless banks, and the government, mindful of September’s general election, is in no mood to trifle with voters.

All that this plan does is to buy the banks time. Indeed, by giving the banks a higher starting value, the government is increasing the annual charge that banks will have to pay.

The risk is that banks will behave according to this economic reality rather than to the accounting and regulatory fiction conjured up by the government. Under pressure from shareholders to return to health, they may shrink their balance sheets and curtail lending.

Merkel may have succeeded in avoiding a bailout of Finanzplatz Deutschland for now, but perhaps at the cost of financing Deutschland AG.

(Additional reporting by Paul Taylor)
(Editing by David Evans)

– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –

Barclays’ proposed sale of BGI may be an eye-catching deal thanks to its size, but it is unlikely to be the last bank that gets out of the fund management business.

Banks have debated whether they need to control their asset management arms for years. In the United States, Citigroup and Merrill Lynch were early sellers of their divisions in 2005 and 2006.

Those moves were prompted by growing concerns among regulators that banks might sell clients their own, inferior, funds. Instead, banks were encouraged to offer customers a range of funds from a variety of different managers in a structure dubbed “open architecture”.

Today, banks are selling their asset managers because they need the cash. There are few buyers for regular banking assets at anything other than fire-sale prices. But because asset managers are not heavy users of capital, most of the proceeds of a sale flow straight through to the capital ratio.

That explains why Lloyds is considering selling part of the Insight Investment arm that it acquired with HBOS and why Santander tried (unsuccessfully) to exit from its fund management arm last year.

Even without the capital pressures that banks are under at the moment, there are sound reasons why banks should not own asset management businesses.

Many banks and insurers acquired asset managers during the early 1990s. Management consultants touted the idea, arguing that banks were full of hot leads who could be cross-sold a multitude of high-margin products, from insurance to structured notes.

However, many of these mooted synergies have failed to materialise. Meanwhile, many banks have been left with sub-scale fund managers that deliver less-than-striking performance figures.

Bank executives have also pointed to the diversification benefits of owning asset managers, whose fee-based earnings would be more stable than banks’ highly-cyclical core profits, or losses.

But those earnings have proven to be more volatile than they hoped, as fund management revenues dived along with the stock market. Moreover, given the lowly rating assigned by investors to asset managers within banks, shareholders would be better off owning them independently.

There are also strong arguments for believing that asset managers do a better job when they are independent, rather than owned by a banking behemoth.

Banks do have a valuable asset in their millions of customers, brand recognition and high street presence. However, they can best exploit that by earning commission from independent asset managers rather than trying to do the job themselves.

You have to hand it to Barclays. The reported sale of BGI, its fund management arm, to BlackRock  for $13 billion is probably the best way that the bank could bolster its capital ratio.

It looks like it will end up with around $8 billion in cash and a fifth of the enlarged asset manager.

The gain on the sale would lift its equity tier 1 ratio to 6.8 percent from just over 6 percent, according to Nomura.

Combined with the strong earnings coming through from BarCap, its investment bank, this should be high enough for Barclays to survive both the further losses on legacy assets that it has so far resisted and recessionary write-downs.

The terms of the sale have not yet been disclosed, but they look like they will be much better for Barclays than April’s proposed sale of iShares, the most attractive part of BGI, to CVC, a private equity group.

An astute go-shop clause, which expires on June 18th, has enabled Barclays to exploit rising markets to drive a harder bargain. The proposed iShares deal would have been 80 percent vendor-financed, on pretty appealing terms, by Barclays.

This time it looks like the purchasers are raising cash themselves. Larry Fink, the BlackRock boss, is reported to have sought backing for the deal from the same Middle Eastern wells of capital — Abu Dhabi and Qatar — which invested so successfully in Barclays last November, as well as the Kuwait Investment Authority.

By taking a 20 percent stake in an enlarged BlackRock, Barclays retains exposure to the stable asset management business that it had declared to be “core” before it realised it needed to raise some capital.

Even if Barclays’ voting rights are capped, it will have a say through its two expected board seats. One of those seats is likely to be filled by Bob Diamond, president of Barclays.

Diamond looks set to receive around $21 million from the deal (not all of which is profit because he paid for his existing stake and must also pay to exercise options he holds).

Barclays insists that — as with the iShares deal — Diamond has not been involved in the talks.

However, he is clearly the architect of the strategy to sell BGI, and the negotiations have been led by Rich Ricci, one of his closest colleagues. Some shareholders might find Diamond’s payout unpalatable. Others may be simply relieved that he has played a difficult hand with some skill.

– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –

By Margaret Doyle

Barclays has avoided the dead hand of state shareholding and, on Thursday’s evidence, it looks as though it will escape completely.

Barclays Capital has enjoyed a storming first quarter — so good it is hard to see it being sustained — which has allowed the bank to make more big write-downs and still report a 15 percent increase in pre-tax profit.

The key question is whether its provisions against so-called level 3 (hard to value) assets are sufficient.

On the face of it, they do not appear to be, because they have provided for a write-down of 24 percent on an alphabet soup of American junk assets. That compares to a write-down of 75 percent taken on a bunch of similar assets by Societe Generale, which unveiled an unexpected first-quarter loss.

Both bought insurance against a deterioration in the value of these assets, in Barclays’ case, 27 billion pounds-worth, from “monoline” insurers.

Analysts have questioned the value of such insurance, as the survival of the monolines themselves has been called into question. Barclays’ defence is straightforward: it says the likelihood of being hit by both a default on the underlying asset and on the insurer is very low. And it is taking more write-downs with each quarter’s results.

But are these haircuts just big enough to be comfortably covered by Barclays’ profits? Is it simply trying to earn its way out of the credit crunch?

It is, of course, in Barclays interests to play a long game. It gave Middle Eastern state investors great terms on a capital injection last autumn in order to avoid having Her Majesty’s Government on the share register.

I-shares, only recently considered to be a core asset, was also ditched in order to help it pass a British stress test. Had it failed, it would have had to buy insurance on punitive terms from the government.

Shareholders have bought the story. The stock price has risen six-fold from its January low. Whether it will continue to rise depends on whether BarCap can continue to turn in profits faster than its American junk goes bad.

– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –

It’s tough on Ukraine, but European banks should pull out. It may not be the only Eastern European economy giving its western bankers a headache but that country’s political chaos and weak corporate governance outweigh the prospects of a return to growth.

Hungarians and Romanians, the bulk of whose loans are in foreign currencies, have seen their debts rise as their own currencies fall. And Sweden’s SEB and Swedbank have taken a pasting in their neighbouring Baltic states.

Austria’s Erste Bank managed to make a profit in the Czech Republic, Slovakia, Croatia, Serbia, Hungary and even Romania, (where it lifted bad loan provisions five-fold), albeit at a lower level than last year.

However, like the Swedes, it came a cropper in Ukraine.

The EU and the International Monetary Fund (IMF) have stepped in to the rot, but Ukraine is still floundering.

Its economy is expected to shrink by 10 percent this year and its politics are in chaos. Within the ruling elite, poisonous personal rivalries have prevented agreement on the basic economic reforms that the IMF is demanding before it writes more cheques.

The downturn is hurting the western banks: Erste, Swedbank and SEB all lost money there in the first quarter. Both the Swedes have written down all their remaining goodwill there.

All three are pulling in their horns. Erste has laid off 300 local staff. SEB has ditched its expansion plans. Swedbank concedes that short term growth in Ukraine will be curtailed, although a cheerful message on its website says it hopes “to capture the possibility for long-term growth.”

They should all capture the certainty offered by a near-term exit. Ukraine represents a tiny proportion of all three banks’ assets. The recovery, when it comes, will have only a marginal effect on profits, but in the meantime the country offers plenty of scope for management hassle.

Banks are generally slow to pull out of countries because of the political backlash. They will be accused of abandoning Ukraine when it most needs western support, but that only matters if a bank expects to set up there again. Unfortunately, Ukraine will remain the wild east for some years to come.

-- Margaret Doyle and Paul Taylor are Reuters columnists. The opinions expressed are their own --

LONDON/PARIS, April 23 (Reuters) - Germany is to set up a system of bad banks before the summer recess to hold some 250 billion euros of toxic assets. Finance Minister Peer Steinbruek has assured taxpayers that his solution -- called "eine Bad Bank" (there is no German word for the concept) -- will not weigh on the budget.

He is fooling them, if not himself. If the rescue really were such a free ride for the taxpayer, some savvy commercial investor would have stepped in. Under the proposed scheme, the taxpayer will end up carrying the risk of "Schrottpapiere" (scrap paper).

Like governments everywhere, the Germans are desperate to get their banking systems moving again -- to save the economy by saving the banks, as British minister Baroness Vadera put it.

The snag is simple. Crystallising all the losses in the banking system might lead to widespread nationalisation of banks -- something most governments are keen to avoid.

But the alternative is equally unpalatable: that the state buys lots of "Schrottpapiere" from troubled banks at unrealistic prices, essentially mutualising all the losses and leaving the banks to keep their profits in private hands.

A German Finance Ministry document seen by Reuters admits this, saying, "Finance ministry examination has shown that in all models, there remains an insurmountable contradiction between the aim of removing assets from the balance sheet and the protection of the taxpayer: if the bank is to be unburdened, the taxpayer has to take on a substantial part of the risk."

The German plan is to allow banks to recognise losses on structured products over their lifetime, perhaps up to 20 years. The government would still guarantee those assets, but would only pay up at maturity if the final value of the assets is less than the "fair value" for which the banks must make provision.

That means any nasties would be pushed out -- certainly well beyond this September's Federal election, and probably one or two beyond that.

By giving the banks time to reserve for impaired assets, it allows them to earn their way out of trouble. And, the politicians get to pretend that there is no damage to Germany's vaunted fiscal stability.

However, it leaves a question-mark over the health of the banks. There is no real severance between the good and bad bank. And the need to build up reserves over a protracted period could act as a drag on the performance of banks -- and their willingness to lend.

It is puzzling why the German government needs to go down this tortuous route of creating special vehicles, with neutral parties to value assets and new accounting rules for reserving.

It is widely acknowledged that the biggest users of the scheme will be the Landesbanks, most of which are themselves owned by regional governments (although some have minority private sector shareholders). They have long been accused of using cheap state-backed credit to provide unfair competition to the commercial banking sector.

That these institutions, created to support regional economic development, ended up buying risky U.S. structured products shows just how far they had strayed from their original purpose. The state could in theory just break them up as it saw fit.

Pushing any assistance out into the future -- and structuring any asset protection on the basis that it can be argued that the shareholders had to take a hefty first whack -- seems designed to obfuscate the scale of any such rescue.

It is always a mistake, as Barack Obama's chief of staff Rahm Emanuel, memorably observed, to let any crisis go to waste.

A better course of action in this instance would be for Berlin to admit that the Landesbank model is broken, insist that their assets be run off over time, and give the private banking system a better chance to flourish when conditions improve.

The British government is considering whether to set up a mega public-private fund to invest in early-stage ventures. This would be a mistake. While British — and European — entrepreneurs have largely failed to produce huge successes like Google and eBay, bunging taxpayers’ money at the problem is not the answer.

In a policy document published on April 20, the government said it is evaluating whether to set up a public-private fund with similar objectives to the Industrial and Commercial Finance Corporation, the precursor to 3i. That was established with 10 million pounds in 1945 as Britain struggled to recover from war. Such a move has been urged on Lord Mandelson, the business secretary, by the Confederation of British Industry (CBI), the National Endowment for Science, Technology and the Arts (NESTA) and the British Venture Capital Association (BVCA). NESTA is looking for a 1 billion pounds fund; BVCA for 1 billion pounds-plus and the CBI for a round 1.5 billion pounds. The idea is for the government would lead the fund-raising by putting up an unspecified portion of the total pot.

Venture capital bigwigs speak of a calamity if the state does not step in. Britain risks “a lost generation of innovation”, says Simon Walker, the BVCA’s boss. NESTA warns that the country could lose 44 billion pounds in annual revenues unless it invests in growth businesses. Indeed, Walker believes the government shouldn’t waste time evaluating things and should simply start writing checks. Unless it does so, hundreds of early-stage businesses that need of capital may go to the wall. The BVCA recently published figures showing that investment in British venture capital collapsed by 62 percent from its peak in 2006, to 346 million pounds last year. Whether this had anything to do with the investment decisions that venture capitalists made in this period, BVCA didn’t say.

However, the industry’s argument that there is an “equity gap” that the government should fill is hokum. Returns to venture capital in Britain — and more broadly in Europe — have been dire.

The BVCA says that the median net internal rate of return between 1980 and 1997 (it would not give figures younger than 12 years old, though the returns turned negative over the tech bubble years) was 9 percent. This is a pretty mediocre given the riskiness of the sector. The picture across Europe is even worse. Data from Thomson Reuters and the European Venture Capital Association show an annual net internal rate return to investors of -1.1 percent (yes, minus 1.1 percent) from early-stage venture capital over twenty years to the end of 2008. Industry insiders say these numbers put European VC consistently at the bottom of the private equity heap.

Indeed, against this backdrop, it’s quite impressive that investors were willing to stump up 346 million pounds in British VC in 2008. Moreover, this number only looks low compared to the bubble years of 2006 and 2007.

Indeed one could even argue that, given the dismal returns, too much has been invested in European VC rather than too little. The problem may rather be cultural, or stem from excessive red tape. After all, European science if widely regarded to be up to that in America, but Europe has not turned that research into Google or an eBay yet (though Index, the darling of the sector, did a very good job flogging Skype to eBay).

There have been lots of reasons advanced for why U.S. VC has performed much better than Europe: the cluster of high-tech around Silicon Valley, a sophisticated and supportive venture capital industry, the bigger scale of the U.S. market or simply the American “can do” attitude. No one has claimed that it is because insufficient American taxpayers’ money has been put into venture capital. Mandelson should keep private equity’s hands out of taxpayers` pockets.

– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –

Investors’ faith in banks may be reviving, but 2009 is shaping up as a year of reckoning for private equity. Two of Europe’s most prominent listed buyout funds — Candover Investments and SVG Capital — are considering their options, with sale or dismemberment a serious prospect.

How the mighty are fallen! For more than a decade, the listed PE funds outperformed the market, and the managers earned rich fees nicknamed “2 and 20″ — 2 percent of funds under management and 20 percent of performance above a certain benchmark. But that outperformance has disappeared in little more than a year with many funds languishing in the “90 percent club” of shares that trade for less than 10 percent of their peak. Funds are blaming a killer combination of lousy returns, a debt drought and an investors’ strike.

Even when the current storm abates, PE will be a smaller, humbler industry. For starters, many PE funds are so cash-strapped that they are unable to meet their commitments to invest in the latest funds. In Candover’s case, it had to allow other investors to scale back their commitments to the 2008 fund too. Moreover, it has suspended all investments from its 3 billion euro 2008 fund and to levy fees only on that tiny portion of the fund already invested.

This recognition of commercial reality will cost in the region of 25 million pounds this year. It is a sign of the new balance of power between PE firms and their investors.

SHAKY FOUNDATIONS

PE relies on a continuous cycle: raise money, invest it, add lashings of debt, tart up the portfolio companies and sell them at a profit. Once any link is broken, the whole edifice becomes extremely shaky. This is the situation the industry finds itself in now.

Of the handful of exits over the past 18 months, many have been forced, with PE firms walking away from companies that can never service their massive debts. This has not only hurt the equity investors, but also the banks that have provided the majority of the funds for deals. While they are reducing lending in general, they are especially reluctant to extend credit to PE, which they feel has sold them a pup. Write-offs have contributed to huge fund write-downs — 50 percent is not uncommon. Moreover, the humiliation is more public than ever.

Thanks to top-of-the-market listings by Blackstone and KKR and new transparency rules, much of the PE world has to admit the unpalatable truth about its performance.

GO-GO DAYS ARE GONE

In the go-go days, secondary investments in PE traded at a premium to underlying net asset values. Unfortunately investors in funds are now finding that PE is as difficult to exit as it once was to enter. PE works by gathering commitments rather than cash, and drawing on them as investments are made, like cashing post-dated checks. This structure appealed to investors because it contained hidden leverage. Part of their commitment would be funded by recycled cash released from the funds. That meant every 100 pounds of exposure only “cost” them a portion of this, say, 70 pounds.

However, this merry-go-round depended on a regular stream of profitable sales. With such exits as rare as house buyers, investors are being asked to invest cash they don’t have with people who have already lost a lot of their money. No wonder they want to tear up those checks.

Guy Hands bought out three cash-strapped investors in his Terra Firma fund at a discount. Permira allowed SVG to reduce its commitment by 40 percent, but at a cost. SVG has to pay fees on its original commitment, and must give up 25 percent of the eventual payout. That suggests that Permira’s bosses, like Candover’s, are more focused on the short than the long term.

They could be right. The current downturn in PE is no temporary phenomenon. The 7:3 leverage ratio that juiced returns will not return any time soon. Without it, the 30 percent-plus returns that attracted investors and justified long lock-ups and high fees are gone. Even the juicy fees are not immutable, as Candover has shown. With slimmer pickings, fewer bright sparks will seek to make their fortune in PE.

The industry will simply shrink, as building societies (thrifts) and life assurers have done before them. Some, like one-or-two branch building societies, will be picked up by firms whose bigger balance sheets provide the ballast to ride out the current recession. Others, like life assurers that no longer underwrite new policies, will be put into “run-off,” ie take on no new business, but be run solely to maximize the value of businesses already on the books.

The challenge for Candover and its ilk is to negotiate their most important exit: their own.