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Legal Aspects of Bank Resolution: Designing the Powers and Solutions

Operational Aspects of Bank Resolution and Restructuring

EBRD, London, 19 March 2012

Charles Randell

511237483

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Overview

● Lessons from the global financial crisis

● What is bank resolution?

● International policy context

● Designing a national resolution regime

● Cross-border aspects of resolution

● Conclusions

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Lessons from the global financial crisis

● Without resolution powers, even quite small banks can be too big to fail and need to be bailed out

● Bailouts can threaten a country's solvency

● Resolution powers enable the burden of bank failure to be shared with creditors and other stakeholders

● Powers should be in place before the crisis arises

● Powers must be accompanied by adequate information and planning, including resolvable structures

● Well-designed deposit insurance schemes can help to contain the crisis

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What is bank resolution?

● Normal insolvency proceedings are unsuitable for banks:

may lead to freeze on payments and "fire sales"

give control to creditors or insolvency officials, who may not take account of impact on wider financial stability or the economy

● Bank resolution proceedings generally aim to enable:

greater control of the process by the authorities

rapid of transfer of deposits to another bank

transfer of assets to a "bridge institution"

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Aims of resolution regimes

Insolvency Resolution Proceedings Proceedings

Protect depositors

● Continuity of service

● Prompt payout of deposits ?

Protect/enhance financial stability

● Avoid fire sales

● Swift restructuring of activities ?

● Reduce "deadweight" costs

Protect public funds

● Viable alternative to bailout

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International policy context: resolution as part of integrated crisis management

Recovery planning &resolution planning

Healthy bank Troubled bank Failed bank

Implementation of recovery plan

Implementation of resolution

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Emerging international crisis management standards

● Financial Stability Board's "Key Attributes of Effective Resolution Regimes for Financial Institutions":

represent best practice standards

progress report by April 2012 on extending G-SIFI framework to nationally systemic institutions

● EU Crisis Management Directive:

expected shortly

likely to be consistent with the FSB's Key Attributes

● National regimes in individual countries (e.g. US Federal Deposit Insurance Corporation model, UK Banking Act 2009)

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Designing the right national regime

● National banking systems differ significantly:

Number and concentration of banks

Degree of state ownership

Nature of deposit insurance arrangements

Complexity of banks (universal vs. depository banks)

Extent of foreign currency assets and liabilities

Role of other savings institutions

Role of foreign banks in the system

● Crisis management regime design should take account of these issues

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Key issues in designing a regime

● Recovery and resolution planning

● Resolution tools

● Triggering resolution

● Allocation of roles to the authorities

● Scope of the regime

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Recovery and resolution planning

● Recovery planning

Bank's own recovery plans: capital issuance, standby liquidity, asset disposals

Early intervention powers: restrictions on business, asset transfers, appointment of special manager

● Resolution planning

Roles of the firm and the authorities

Resolvability assessments

Simplification of group structures

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Information and planning issues

● Group structure

● Group funding

● Information systems

● Critical contracts, assets and liabilities

Events of default

Foreign law

● Access to payment systems, exchanges, clearing houses, central counterparties

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Possible resolution tools

● Prompt depositor payout

● Transfer of assets and liabilities to another bank: "purchase-and-assumption" transaction

● Transfer of assets and liabilities to bridge institution

● Recapitalisation through bail-in

● Nationalisation

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Prompt depositor payout

● Involves payment of (insured) deposits, usually by the deposit insurer

● Government funding of deposit payout may be necessary where deposit insurance scheme is not pre-funded

● Special legal regime needed to make sure that the bank makes payments despite its insolvency

● Operational challenges of prompt payout

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Purchase-and-assumption transaction

Pays levyBanking Industry

Pays $48 balancing payment

Claims in insolvency

Deposit Insurer

Failed Bank Purchaser

Depositors $100

Depositors

Transfer of $50 of assets

Assumption of $100 of deposits

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Transfer to bridge institution

● Bridge institution is established and owned by the official sector: deposit insurer, central bank or finance ministry

● Transfer to bridge institution buys time for:

Sale to private purchaser

Split of "good bank" from "bad bank"

Orderly wind-down of assets

● Avoids fire sales …

● … but assets of bridge institution still need to be funded

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Recapitalisation through bail-in

● Converting subordinated/unsecured senior debt into equity

● Two methods:

Contractual bail-in

Statutory bail-in

● Two models:

High-trigger (going concern)

Low-trigger (bail-in within resolution)

● Key policy issues on defining debt that can be bailed in –tenor, type, exempt categories, treatment of set-off

● Complex issues where:

Foreign law debt is involved

Groups are involved

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Nationalisation

● Transfer of shares of bank to the state

● Constitutional limits on expropriation

● Bilateral Investment Treaty restrictions

● Compensation claims

● Change-in-control regulatory requirements and possible foreign law problems

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Key legal issues for resolution

● "No creditor worse off than in liquidation"/lowest cost principle

● Depositor preference

● Protected counterparties:

Secured creditors

Key financial system creditors

Derivatives treatment

Set-off, netting

● Events of default, stays, moratorium

● Overriding change in control provisions

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Triggering resolution

● Prompt Corrective Action

● Trigger point for resolution

● Legal safeguards

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Prompt Corrective Action

● Studies show that delaying closure/resolution of troubled bank tends to increase costs

● Prompt Corrective Action provisions introduced into US Federal Deposit Insurance Act after Savings & Loan crisis, to prevent forbearance

● They mandate intervention as capital position deteriorates, but in practice regulatory forbearance has continued

● "Gaming" of risk weightings and slow recognition of losses means that stated capital position is often unreliable

● Therefore other triggers for Prompt Corrective Action may need to be considered

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Defining the trigger point for resolution

● The bank cannot avoid insolvency

● Capital or liquidity requirements will not be met

● Non-financial regulatory requirements will not be met

● Any of these appears likely to occur?

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Trigger point - legal safeguards

● Definition of trigger point in the law

● Extent of regulatory discretion: striking a fair balance with legal certainty

● Procedures to be followed: administrative decision or judicial decision

● Recourse for wrongful exercise: judicial review and remedies

● Constitutional aspects, protection of property rights

● Immunity of authorities?

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Allocation of roles to the authorities

● Bank regulator has best information to assess bank's position

● However, choice of resolution option may affect deposit insurance fund and/or public finances

● In addition, emergency liquidity assistance may be required

● Resolution authority requires appropriate skills

● Allocation of roles between:

Finance Ministry

Central bank

Bank regulator

Deposit insurance fund

● Extent of judicial oversight

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Scope of the regime

● Banks, holding companies, key affiliates

● Non-bank institutions

● Key financial infrastructure (payment systems, exchanges, clearing houses, central counterparties)

● Broking firms (investment banks)

● Insurance companies

● Local subsidiaries/branches of foreign banks

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Cross-border aspects

● Universality, territoriality and ring-fencing

● Recognition of resolution measures under foreign law

Bail-in

Asset transfers

Events of default

Moratorium and stays on enforcement action

● Access to payment systems and other infrastructure

● Cross-border cooperation: Crisis Management Groups, colleges of supervisors, MoUs, institution-specific agreements

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Conclusion

● Resolution regimes and deposit insurance schemes may help to contain financial crises

● Normal insolvency proceedings are not sufficient

● Regime design should take account of national circumstances

● In addition to a range of resolution tools, information and planning are key

● Safeguards for creditors and shareholders are needed, to providestability and confidence in the rule of law

● Resolution authority needs access to the right skills

● Cross-border issues should be borne in mind

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Profile

Charles advises on corporate finance and publicsector work. In the field of restructuring financial institutions, he advised HM Treasury on a range of assignments arising from the credit crunch, including Northern Rock; Bradford & Bingley; the Icelandic banks; the recapitalisation of the UKbanking sector, including the investment of up to £45 billion in shares of RBS and £23 billion in shares of the merged Lloyds/HBOS; and the £280 billion Asset Protection Scheme.

Charles is included in the highest ranking for Corporate/M&A in Chambers Global, 2011.

He is a Visiting Fellow at Queen Mary University of London.

He speaks French and German.

CHARLES RANDELL+44 (0)20 7090 3243charles.randell@slaughterandmay.com

Joined firm1980

Partner since1989