On March 12, the SEC issued a 400-page rule proposal that, if adopted as proposed, would impose a multitude of new compliance requirements on The Options Clearing Corporation (“OCC”), The Depository Trust Company (“DTC”), National Securities Clearing Corporation (“NSCC”), Fixed Income Clearing Corporation (“FICC”) and ICE Clear Europe. Since these clearing agencies play a fundamental role in the options, stock, debt, U.S. Treasuries, mortgage-backed securities and credit default swaps markets, the proposed requirements have important implications for banks, broker-dealers and other U.S. securities market participants, as well as securities exchanges, alternative trading systems and other trading venues.
Posts Tagged ‘Recovery & resolution plans’
In a comment letter and supporting paper to the FDIC on its single-point-of-entry (SPOE) resolution concept release, Karen Shaw Petrou, managing partner of Federal Financial Analytics, argues that SPOE is conceptually sound and statutorily robust. However, progress to date on orderly liquidation has been so cautious as to cloud the credibility of assertions that the largest U.S. financial institutions, especially the biggest banks, are no longer too big to fail (“TBTF”). Crafting a new resolution regime is of course a complex undertaking that benefits from as much consensus as possible. However, if definitive action is not quickly taken on a policy construct for single-point-of-entry resolutions resolving high-level questions about its practicality and functionality under stress, markets will revert to TBTF expectations that renew market distortions, place undue competitive pressure on small firms, and stoke systemic risk. Even more dangerous, the FDIC may not be ready when systemic risk strikes again.
Questions addressed in detail in the paper and Ms. Petrou’s answers to them are summarized below:
On December 10, 2013, the Federal Deposit Insurance Corporation (the “FDIC”) proposed for public comment a notice (the “Notice”) describing its “Single Point of Entry” (“SPOE”) strategy for resolving systemically important financial institutions (“SIFIs”) in default or in danger of default under the orderly liquidation authority granted by Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  The Notice follows the FDIC’s endorsement of the SPOE model in its joint paper issued with the Bank of England last year.
The present article, Bank Recovery and Resolution Directive: Recovery Proceedings for Cross-Border Banking Groups, examines recovery proceedings for cross-border banking groups under European Union law. Recovery (or “early intervention”) includes measures intended to stabilize a bank (or banking group) and enable its recovery from financial stress. Recovery is targeted at a stage before resolution, when the bank (or group) in question has not breached the triggers for resolution, and therefore its economic recovery is still possible. The focus of this paper is primarily on three group recovery mechanisms under EU law: group recovery plans, intra-group financial assistance and coordination of early intervention measures regarding groups.
Chairman McHenry, Ranking Member Green, and members of the Subcommittee, thank you for the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) on Sections 165 and 121 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Our testimony will focus on the FDIC’s role and progress in implementing Section 165, including the resolution plan requirements and the requirements for stress testing by certain financial institutions.
Section 165 of the Dodd-Frank Act
Under the Dodd-Frank Act, bankruptcy is the preferred resolution framework in the event of a systemic financial company’s failure. To make this prospect achievable, Title I of the Dodd-Frank Act requires that all large, systemic financial companies prepare resolution plans, or “living wills”, to demonstrate how the company would be resolved in a rapid and orderly manner under the Bankruptcy Code in the event of the company’s material financial distress or failure. This requirement enables both the firm and the firm’s regulators to understand and address the parts of the business that could create systemic consequences in a bankruptcy.
The FDIC intends to make the living will process under Title I of the Dodd-Frank Act both timely and meaningful. The living will process is a necessary and significant tool in ensuring that large financial institutions can be resolved through the bankruptcy system.
On April 15, 2013, the Board of Governors of the Federal Reserve System (Federal Reserve) and the Federal Deposit Insurance Corporation (FDIC) issued additional guidance (Guidance) with respect to the 2013 resolution plan submissions of the U.S. and foreign banking organizations that filed their initial resolution plans on July 1, 2012 (First-Round Filers).
The Guidance shows that the Federal Reserve and FDIC are intensifying their credibility review of resolution plans, requiring analysis of the most challenging issues raised by a Covered Company’s failure. Responding to the Guidance will require First-Round Filers to address head-on difficult questions raised by their original submissions. In recognition of the amount of new information required to be supplied, the Guidance extends the 2013 submission date for First-Round Filers to October 1, 2013.
Although by its terms the Guidance is limited to the plans of the First-Round Filers, it suggests that banking organizations in the second and third filing rounds may be required to undertake more searching analysis in their submissions next year.
In this post, we discuss the most significant aspects of the Guidance:
As many of you know, I am now in my second term as an SEC Commissioner and this is my fifth time participating at SEC Speaks. During that time, I have served with three different SEC Chairmen, and a fourth is now in the works. It has been, and continues to be, a great privilege to serve at a time during which the SEC’s role as the capital markets regulator has never been more important. However, I must admit being frustrated that we haven’t done more to protect investors.
Clearly, my tenure as a Commissioner has been dramatically impacted by the financial crisis and the pressing need to address the many failings that were brought to light by that crisis. Throughout my tenure, I have worked to be a strong advocate for fulfilling the Commission’s mission to protect investors, facilitate capital formation, and promote a fair and orderly market. To that end, I want to talk to you today about the need to protect investors through robust and effective market oversight.
I am growing increasingly concerned about the stability of our market structure as we lurch from one crisis to another, be it the flash crash or the Knight trading fiasco. Today, I plan to focus on the dangers that investors face from a trading market structure that has shown too many signs of weakness and instability.
On December 17, 2012, the staff of the Federal Reserve issued a Supervision and Regulation (“SR”) letter describing the Federal Reserve’s new framework for consolidated supervision of large financial institutions. SR letters address significant policy and procedural matters related to the Federal Reserve’s supervisory responsibilities.
Under the new framework, the Federal Reserve’s primary supervisory objectives for large financial institutions will be (1) to enhance resiliency of an institution to lower the probability of its failure or its becoming unable to serve as a financial intermediary, and (2) to reduce the impact on the financial system and the broader economy of an institution’s failure or material weakness. These objectives are meant to conform to key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, such as enhanced prudential standards for large financial institutions. Although the Federal Reserve has not previously stated these objectives as its primary supervisory objectives, and the new framework formally integrates areas such as corporate governance and compensation that Federal Reserve staff has been focused on since the financial crisis, changes in specific supervisory expectations are limited. Changes include greater emphasis on recovery planning in the case of financial or operational weakness, and on orderly resolution planning, as required by the Dodd-Frank Act. The Federal Reserve will also engage in greater “macroprudential” supervision to detect systemic risks.
The new framework applies to the largest and most complex financial institutions subject to consolidated Federal Reserve supervision, including nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve; other domestic bank and savings and loan holding companies with consolidated assets of $50 billion or more; and other foreign banking organizations with combined assets of U.S. operations of $50 billion or more.
On December 10, 2012, the Federal Deposit Insurance Corporation (“FDIC”) and the Bank of England released a white paper, Resolving Globally Active, Systemically Important, Financial Institutions,  describing how each would resolve a materially distressed or failing financial institution that is globally active and systemically important (“G-SIFI”) in order to maintain the G-SIFI’s ongoing and viable operations, and contain any threats to financial stability. The paper reflects the work of U.S. and UK authorities  in developing resolution strategies for the failure of G-SIFIs in accordance with standards developed by the Financial Stability Board,  but does not go into detail on the strategic options that may be available.
The white paper warrants the close attention of G-SIFIs and their stakeholders, particularly their unsecured debtholders. The paper memorializes the consensus view of the FDIC and the Bank of England that a top-down or single-point-of-entry approach is the preferred (although not the sole) method of resolving a G-SIFI.  This approach could transform certain unsecured debt into equity or convertible debt and should cause G-SIFIs to review their organizational structure. Also of interest are the FDIC’s and Bank of England’s perspectives on the critical powers and preconditions for a successful resolution and what legislative or regulatory changes may be necessary.
It is hard to imagine a financial crisis that is not ultimately caused by creditors who had taken on too much debt. Debt is the root cause of most corporate financial failures and, if a snowball effect sets in, the root cause of financial system failure. Of course, debt also has advantages. Without debt, many privately and socially valuable projects could never be undertaken. Still, it is our current tax system that has pushed our economy to be too levered. Now is the time to address the problem—before it will again be too late.
From a creditor’s perspective, the two key advantages of debt are the tax deductibility of interest payments and the ability of lenders to foreclose on non-performing borrowers (which makes it in their interest to extend credit to begin with). Although both factors contribute greatly to the incentives of the borrower to take on debt, there is one important difference between them: the tax deductibility of debt is not socially valuable.
To explain this issue, let’s abstract away from the beneficial real effects of debt and consider only the tax component. In an ideal world, taxes should not change the decisions of borrowers and lenders. They would take exactly the same projects and the same financing that they would take on in the absence of taxes. At first glance, one might argue that the tax distortions of leverage are not so bad, because the interest deductibility of the borrower is offset by the interest taxation of the lender. But this “wash argument” is wrong. It ignores the fact that capitalist markets are really good at allocating goods to their best use. In this case, it means that the economy will develop in ways that many lenders end up being in low tax brackets (such as pension funds or foreign holders) ,while many borrowers end up being in high tax brackets (such as high-income households or corporations). The end result will be not only that the aggregate tax income is negative, but that debt is taken on by borrowed primarily to reduce income taxes and not because debt has a socially productive value.