Introduction
After the financial crisis of 2007–09, the G20 and the Financial Stability Board (FSB) undertook to put in place a global framework for regulating and resolving global financial institutions (FSB 2010b). The development of common crisis management and resolution policies by authorities from the home and key host jurisdictions of globally active financial institutions was a sea change from the precrisis world.
In 2011, the FSB adopted an international minimum standard for resolution (“The Key Attributes of Effective Resolution Regimes for Financial Institutions,” hereinafter “Key Attributes”) that sets out the core elements of an effective resolution framework (FSB 2011a).1 It identifies the powers and tools that should be available to authorities to resolve failing financial institutions in a manner that maintains the continuity of the vital economic functions that those firms perform for the financial system and the economy as a whole. The underlying premise is that losses should be absorbed by the firm’s owners and creditors, not taxpayers.
In subsequent years, the FSB developed further guidance to assist jurisdictions and authorities in implementing the Key Attributes.2 A centerpiece is the requirement for minimum loss-absorbing capacity (FSB 2015e). All global systemically important banks (G-SIBs)3 should have in place at all times this minimum of financial resources so that a resolution can be implemented in a manner that ensures the continuity of critical functions and without exposing public funds to loss.
This chapter offers some reflections on the paradigm shift that occurred with the introduction of special resolution regimes and resolution planning for the largest financial institutions and on the progress made toward resolving the cross-jurisdictional challenges that arise when a globally systemic financial institution fails.
The first part of this chapter discusses the features of resolution regimes that distinguish them from ordinary court-based corporate bankruptcy. It focuses in particular on bail-in powers and the FSB’s total loss-absorbing capacity (TLAC) standard that seeks to ensure that a sufficient amount of resources remains available to be “bailed-in” in resolution.
The second part of this chapter focuses on the cross-border dimensions of resolution. It discusses how the Key Attributes and TLAC seek to reconcile the interests of both home and host jurisdictions in preserving financial stability and the continuity of critical functions in their respective jurisdictions and minimize the risk of costly defensive ring-fencing along jurisdictional borders.
The chapter concludes by discussing how the focus on resolvability and the introduction of resolution regimes with bail-in powers are leading to changes over time in firms’ legal and operational structures and business models and in the authorities’ approaches to their regulation and supervision.
Resolution: The Paradigm Shift
Financial institutions are special because they perform a number of vital economic functions.4 If the institution that performs such functions is large, even a temporary suspension of any of these functions could seriously disrupt economic activity. A primary objective of resolution is therefore to maintain the continuity of critical functions for the financial system, minimizing contagion and containing the social costs associated with financial panic.5 As a result, resolution differs fundamentally from standard bankruptcy processes.
Bankruptcy versus Resolution
Corporate bankruptcy procedures are primarily aimed at protecting individual stakeholders’ interests and seek to maximize value for individual creditors. These procedures are not designed to take account of externalities and the costs that the failure of a financial institution could impose on the broader economy. And they are not well suited for dealing with financial failures (Hüpkes 2005a, 2005b). Typical corporate bankruptcy procedures result in stays that block creditors’ access to funds. Financial institutions, if subject to stays, are not able to conduct financial transactions, and market participants are not able to make and receive payments or engage in hedging strategies. The lengthy process of initiating a bankruptcy process, negotiating a reorganization or liquidation plan, and obtaining court approval is lethal for a financial institution whose life or death depends on the trust of financial markets.
Just as regulation needs to have a macroprudential dimension,6 failure resolution needs to take into account systemic considerations. Ordinary bankruptcy actions may be optimal from the perspective of maximizing the residual value of the firm for all of the firm’s stakeholders. However, bankruptcy judges do not typically have a mandate to consider the structural economic effects of their decisions and any unintended and possibly adverse systemic consequences. They also cannot coordinate their actions with foreign regulatory authorities given their need to retain full independence.
Bail-In versus Bail-Out
Bail-in is core to the new resolution paradigm. The term “bail-in” is generally used to refer to shareholders and creditors bearing a bank’s losses, as opposed to “bail-out,” which refers to absorption of private creditors’ losses with public money. Under the FSB Key Attributes, bail-in is more narrowly defined and refers to the power to “write down equity or other instruments of ownership of the firm, unsecured and uninsured creditor claims to the extent necessary to absorb the losses; and to convert into equity or other instruments of ownership of the firm under resolution (or any successor in resolution or the parent company within the same jurisdiction), all or parts of unsecured and uninsured creditor claims in a manner that respects the hierarchy of claims in liquidation.”7
A debt-to-equity conversion can provide creditors with an upward potential if the bank survives and its value recovers. It also supports a recapitalization and reduces the need to find a new buyer or investor.
Operating Liabilities versus Capital Structure Liabilities
Resolution distinguishes between operating liabilities—demand deposits, client money, short-term funding, and financial contract liabilities that are directly linked to the bank’s provision of critical functions—and capital structure liabilities—liabilities linked to the bank’s capital structure, such as long-term unsecured debt.
The objective of resolution is to ensure to the extent possible that operating liabilities are not compromised and to rely on capital structure liabilities to achieve a creditor-financed recapitalization that supports the continued performance of critical functions.
A crucial consideration in resolution and resolution planning is therefore the availability of sufficient amounts of bail-inable capital structure liabilities. If upon failure of a G-SIB, resolution becomes inevitable, the firm’s equity and capital structure bailout should be first in line to absorb losses. They should be bailed-in before any of the operational liabilities are exposed to loss.8
A Comprehensive Resolution Toolkit
Key Attributes
The FSB’s Key Attributes set out a range of other powers that resolution authorities should have that may be applied in addition to or instead of bail-in. They distinguish between stabilization or continuity powers and wind-down powers. Stabilization powers are aimed at achieving continuity and include powers to:
Replace the senior management and directors and appoint an administrator to take control and operate the firm in resolution;
Establish a temporary bridge institution to take over and continue operating certain critical functions and viable operations of the failed firm or transfer the operations, including assets and liabilities, legal rights and obligations, deposit liabilities, and ownership in shares, to a solvent third party, notwithstanding any requirements for consent from shareholders or counterparties, or novation that would otherwise apply; and
Temporarily stay the exercise of contractual early termination rights that would otherwise be triggered upon entry of a firm into resolution in order to facilitate the implementation of resolution measures aimed at achieving continuity, such as the transfer of the contracts to another firm or bridge institution.9 Wind-down powers include, in particular, powers to:
Liquidate those parts of the firm’s business whose continued operation is no longer systemically important or critical;
Suspend payments to unsecured creditors and customers and stay creditor actions to attach assets or otherwise collect money or property from the firm (while protecting the enforceability of eligible netting and collateral agreements);10
Protect insured depositors, insurance policyholders, and other retail customers by facilitating a timely payout or the transfer of insured deposit and client assets.
The TLAC Standard
A Requirement for Loss-Absorbing Resources in Resolution
The FSB’s TLAC Standard implements the general premise that there must be sufficient resources for bail-in available on the firm’s balance sheet to achieve a recapitalization or orderly (solvent) wind-down of operations (FSB 2015e). The standard is composed of a set of principles and of a term sheet that elaborates the principles. The TLAC term sheet stipulates a minimum TLAC requirement for G-SIBs11 and specifies the types of instrument that are eligible to serve as TLAC as well as those that are not.12
TLAC-eligible instruments include common equity (that is, equity capital, retained earnings, reserves, subordinated debt, Tier 1 and Tier 2 securities, and certain senior unsecured debt). Short-term liabilities do not qualify as TLAC even though they may be bailed-in on entry into resolution. This is because they may not be renewed and may no longer be available once the firm approaches the point of entry into resolution. Liabilities that are directly linked to critical functions provided by the G-SIB, such as the deposit-taking or payment functions or derivatives, also do not qualify as TLAC because any write-down or conversion of such liabilities could interfere with the critical economic functions that the firm performs. To ensure that TLAC is likely to be available at the point of entry into resolution and fully loss-absorbing, eligible instruments must have a minimum remaining maturity of at least one year, be paid-in, unsecured, not be funded directly or indirectly by the resolution entity or a related party, and not be subject to any set-off or netting rights.
In the European Union, a similar concept is the minimum requirement for own funds and eligible liabilities (MREL).13 Though both TLAC and MREL share the same objectives, they differ in a number of important ways, such as their scope of application and the eligibility criteria, including the requirement of subordination as a criterion for eligibility.14
Subordination to Operational Liabilities
A critical feature of TLAC is that it should absorb losses ahead of operational liabilities. This means that TLAC needs to be subordinated to such liabilities in the creditor hierarchy or, conversely, that operational liabilities should rank senior to TLAC.15 If operational liabilities ranked pari passu with TLAC-eligible instruments and if the resolution authority had the ability to exclude certain of those operational liabilities from the bail-in scope, there could be a legal challenge based on the “no creditor worse off than in liquidation” (NCWOL) safeguard by those non-excluded creditors and TLAC holders.16 Those creditors could argue that they had to absorb more losses than they would have had to absorb had the bank been liquidated. They could claim that an insolvency court would have applied the pari passu principle and spread losses evenly across all creditors within the same class rather than exempting some creditors within that class from loss and shifting that loss on others.
The FSB standard is not prescriptive on the way to achieve subordination. Subordination can be achieved in one of three ways:
Incorporating a contractual subordination clause into the debt instrument (subordination by contract);
Providing in statute for a ranking of TLAC-eligible liabilities junior to operational liabilities (statutory subordination); or
Issuing TLAC out of a nonoperating holding company that funds and owns subsidiaries that hold operating liabilities (structural subordination). The nonoperating holding company would be expected to act as source of strength and downstream funds to its operational subsidiaries to absorb losses and recapitalize them as necessary. The mechanism for this is internal TLAC (see section titled “Internal TLAC—Distribution of TLAC within groups”). Losses will be absorbed by the TLAC issued out of the holding company before any liabilities of the operating subsidiaries will be exposed to loss.
A number of jurisdictions have amended the creditor hierarchy under their insolvency law:
In Germany, a new category of claims was created for unsecured, nonstructured debt instruments issued by banks. These instruments rank senior to subordinated debt instruments but junior to general creditors’ claims.17
In Switzerland, a new class for debt that is to be issued for the purpose of resolution measures (“bail-in bonds”) has been created by statute.18 Such bonds rank senior to subordinated debt but junior to other debt and all deposits (including nonpreferred deposits).
The European Union amended the European BRRD so that liabilities that have been issued for the purpose of complying with the TLAC requirements fall within a new class of senior nonpreferred debt.19 The amendment adopts a combination of a statutory and contractual approach. Instruments in this new class of senior nonpreferred debt would be junior to all senior liabilities but would be senior to subordinated debt. However, the subordination would only be effective if, when issued, the instruments explicitly refer to the “nonpreferred” senior ranking in their terms and conditions.
Location of TLAC: Resolution Entities and Resolution Groups
To provide the necessary loss-absorbing and recapitalization capacity and to achieve the continuity objective, TLAC must be not only of the right quality and quantity, it also must be available at the right locations within a group’s legal entity and capital structure. The appropriate issuance location will be determined by the preferred resolution strategy. G-SIBs have complex group structures with a large number of legal entities.20 The objective of resolution planning is to ensure—to the extent possible—that those material legal entities that operate critical functions have access to sufficient loss-absorbing and recapitalization capacity so that their operations can continue as usual and be insulated from disruptive resolution or bankruptcy processes.
The approach adopted by most G-SIB home authorities is to resolve the firm by applying resolution tools to a single entity, the ultimate parent entity (single point of entry into resolution, SPOE)21 For a majority of the G-SIBs, that parent entity is a nonoperating (“clean”) holding company. For others, the ultimate parent is a regulated bank. The entity to which the resolution powers would be applied and which is also expected to hold the minimum TLAC is referred to as “resolution entity.”22 Losses at operational subsidiaries that caused the distress would be passed up to the resolution entity and, on its entry into resolution, be absorbed by the holders of the resolution entity’s TLAC.
Alternatively, entry into resolution may occur at two or more resolution entities at the subholding level, for example, regional intermediate holding companies or operational subsidiaries (multiple points of entry into resolution [MPOE]).23 For G-SIBs that operate through subsidiaries with a high degree of autonomy, the preferred resolution strategy may be MPOE. Each resolution entity or subsidiary would be subjected to a separate resolution process, and be required to have sufficient loss-absorbing capacity at the individual level. For banks with more centralized operations, SPOE would be the more natural strategy.
The resolution entities to which resolution powers are presumed to be applied should be identified ex ante through the resolution planning process. This involves consultation and coordination by the home resolution authorities with key host authorities through institution-specific crisis management groups.24
The group consisting of the resolution entity and the subsidiaries that sit under it and that are not themselves resolution entities is referred to as “resolution group.”25 The TLAC requirement applies to the resolution entity and is determined by reference to the Basel III leverage ratio denominator and the RWAs of the resolution group.
Every entity within a G-SIB that is identified as resolution entity is expected to issue to external third parties a minimum amount of TLAC that could be bailed-in should the resolution entity enter resolution. It is also referred to as the “external TLAC.” Both the SPOE and MPOE resolution strategies involve maintaining a minimum amount of external TLAC at the resolution entity.
Internal TLAC: Distribution of TLAC within Groups
External TLAC at the resolution entity should provide loss-absorbing resources to the resolution group as a whole. Whereas in good times a firm can generally exercise central control over capital and liquidity and move resources from one group entity to another when needed, this flexibility evaporates in a crisis. In the absence of a statutory source of strength requirement that extends to subsidiaries in foreign jurisdictions, unconditional support of a parent (resolution) entity for its subsidiaries does not exist.26 The boards of the individual corporate entities within a group may be subject to fiduciary duties that constrain them in their ability to transfer funds to a troubled affiliate. Local regulators may seek to protect local operations, for example by imposing restrictions on fund transfers or asset maintenance requirements to secure local liabilities.
To provide assurances to host authorities that loss-absorbing resources will be effectively available to a material subsidiary of a foreign G-SIB in times of stress, the TLAC standard requires foreign subsidiaries or groups of subsidiaries that are deemed material to have on their balance sheet (“prepositioned”) capital instruments or liabilities issued to the parent (the “internal TLAC”). The bail-in of internal TLAC passes the losses to the parent’s equity holders and its unsecured creditors without necessitating the subsidiary’s entry into resolution.
When developing a resolution strategy the resolution authorities need to define the scope of the strategy and determine for each legal entity within the group whether it can be wound down or whether it should be recapitalized to support the continued performance of critical functions.
The TLAC standard defines a set of principles to identify subsidiaries that could be deemed material to the group as a whole. They are referred to as “material subgroups.”27 A material subgroup could be, for example, an intermediate holding company that consolidates a G-SIB’s operating subsidiaries in the host jurisdiction under a common holding, or it can be a single operating subsidiary or an operating subsidiary with one or more subsidiaries under its control. Such foreign material subgroups are expected to have prepositioned a minimum amount of internal TLAC that is issued to the resolution entity.28
Different internal TLAC issuance strategies may be adopted. For example, internal TLAC could be issued directly from the subsidiaries within the material subgroup to the resolution entity or indirectly through the ownership chain of multiple subsidiaries (“daisy chain”).29
If a material subsidiary or subgroup approaches the point of nonviability, the host authorities will expect the parent entity to recapitalize the distressed subsidiary. If parental support is not forthcoming or not sufficient, the bail-in of internal TLAC serves as a last resort resource to recapitalize the subsidiary or subgroup. It results in the write-down of the parent’s equity holdings in the subsidiary and conversion of the parent’s claims on the subsidiary into new equity. Under the “direct bail-in approach,” the failed holding company would retain ownership of the subsidiaries and have the claims of the holders of the holding company’s external TLAC written down and converted into new equity in the holding company. The new equity that is generated through the bail-in of internal TLAC is held by the recapitalized parent holding company in the case of a “direct” or “open bank bail-in” approach, or a newly established bridge or successor entity in the case of an “indirect bail-in” or “bridge-bail-in” approach.
Surplus TLAC
TLAC should be distributed within resolution groups as internal TLAC in a manner proportionate to the size and risk exposures of the material subgroups. However, not all external TLAC should be distributed and prepositioned. A proportion of the external TLAC should remain at the parent entity to cover risk on the resolution entity’s solo balance sheet, including exposures of domestic and foreign branches, and to be available so that it can be deployed flexibly to subsidiaries as needed (“surplus TLAC”).30 To ensure that surplus TLAC resources at the parent entity can be downstreamed to operating entities, including foreign subsidiaries, in a resolution scenario, some G-SIBs have adopted contractual arrangements in the form of secured support agreements to make intragroup transfers less vulnerable to legal challenge.31
Restrictions on TLAC Holdings
Limiting bail-in powers a priori to capital structure liabilities should reduce the risk of contagion effects. This aim needs to be supported by appropriate limits on holdings within the financial system and restrictions on interbank cross-holdings of TLAC (BCBS 2016). Investor protection considerations and the desire to enhance resolvability may also justify limitations of direct retail investments. Alternatively, high minimum denominations for TLAC instruments combined with strengthened disclosure requirements may also help address concerns with the investor base.
Disclosure of TLAC Holdings
G-SIBs will be expected to disclose the amount, maturity, and composition of their TLAC, as well as their position in the creditor hierarchy and the form of their subordination to operational liabilities and presence of any such liabilities that rank pari passu or junior to eligible TLAC.32 Disclosure should enhance market awareness of a resolution and the implications for shareholders and creditors of a bail-in and also help them to make investment decisions based on an informed understanding of the associated risks.33
Bail-In Execution
Unless a bail-in of TLAC resources can be effectively executed, resolution will not be credible. Bail-in requires advance planning and preparation for a series of actions to be undertaken in a short timeframe. For example, the recapitalization by the parent will take many steps and need multiple regulatory and board of director approvals. Authorities will need to prepare for carrying out a valuation of the assets and liabilities of the distressed firm to determine the write-down and conversion rates and to estimate the treatment that shareholders and creditors could have expected in ordinary insolvency proceedings so as to ensure that the potential resolution actions do not impose a disproportionate burden on them and violate the NCWOL safeguard.34 Execution of the bail-in will require coordinating the processes for suspending or canceling of affected securities and issuing new securities or tradable certificates following entry into resolution with relevant securities exchanges and central securities depositories, custodians, and regulatory authorities. Capital instruments and liabilities may be partially or fully written down or converted into new equity or other instruments of ownership. To the extent that equity is written down and the existing shares canceled, existing shareholders may be left with a residual financial claims at the bottom of the creditor hierarchy, but lose their control rights and associated rights.35 Control of the firm’s operations during the bail-in phase may be temporarily assumed by the authorities or an appointed administrator. Once the bail-in transaction is completed, ownership and control and the associated rights will be transferred to the bailed-in creditors as the new owners of the recapitalized firm or a newly established firm.36
G-SIBs are likely to have securities issued in multiple jurisdictions and be subject to different requirements from market integrity regulators, including regular reporting and ad hoc disclosure requirements.37 These are likely to arise already in the time period leading up to resolution. A successful bail-in resolution and reducing the risk of legal liability and investor suits also requires effective public communications that give confidence to market participants that a bail-in will be implemented in a predictable manner (FSB 2018c).
Other Resolvability Conditions
To achieve the resolution objective of maintaining the continuity of critical economic functions,38 a number of other conditions need to be met.
Operational Continuity
For example, the firm in resolution needs to be able to continue to rely on access to critical financial market infrastructure services, such as payment systems, central securities depositories, securities settlement systems, and central counterparties, as well as on the provision of an array of support functions, either in-house, by an affiliate entity, or by a third party. The FSB has issued guidance on arrangements and service delivery models that support the continuity of critical shared services (FSB 2016a). and on arrangements to support continuity of access to critical financial market infrastructure services (FSB 2017b).
Funding in Resolution
Another key resolvability condition is access to temporary liquidity in resolution. As a firm approaches and enters resolution, termination of contracts, depositor behavior, and increased collateral and margin requirements imposed by financial market infrastructures and other counterparties will likely give rise to substantially increased liquidity needs. Thus, there is a need to identify sources of private sector funding and public sector—liquidity back-stop mechanisms to address those funding requirements (FSB 2016b). Material subsidiaries that are not themselves in resolution should continue to have access to ordinary central bank facilities and central bank—and noncentral bank—operated payment and settlement systems, in home and host jurisdictions if the local requirements and conditions for access are met (FSB 2018b).
Cross-Border Effectiveness of Resolution Actions
Statutory versus Contractual Cross-Border Recognition
An effective domestic legal framework is a necessary but not sufficient condition for effective resolution. Global banks operate globally. SPOE and MPOE resolution strategies help minimize cross-border frictions by reducing the number of resolution proceedings to one or a few. However, they do not eliminate all potential conflicts that may arise between different jurisdictional legal frameworks and resolution regimes. For example, can a resolution authority effectively bail-in debt that is issued under the law of a different (“foreign”) jurisdiction? Will the courts in the jurisdiction where the debt was issued recognize the bail-in? The case National Bank of Greece v Metliss is often cited to show that this will not necessarily be the case.39 Creditors could argue that a foreign resolution authority cannot modify the parties’ obligations under a debt instrument governed by the law of another jurisdiction by writing down or converting the debt into equity.
In the absence of a binding treaty framework, such as within the European Union,40 there is no automatic cross-border recognition of bail-in or other resolution actions. In some jurisdictions, courts have the power to recognize foreign authorities’ resolution actions. Many jurisdictions rely on comity41 and judicial recognition processes for insolvency proceedings enacted in accordance with the United Nations Commission on International Trade Law “Model Law” on cross-border insolvency.42 Jurisdictions that recently introduced or modernized their resolution regimes conferred an administrative “recognition power” on the resolution authority.43 Such recognition power enables the resolution authority to recognize a foreign resolution proceeding and take local actions to support or give effect to foreign resolution actions.
The conditions for recognition (and grounds for refusal) typically relate to consistency with public policy objectives, the absence of adverse effects on domestic financial stability as a result of recognizing and enforcing a foreign resolution action, and the equitable treatment of creditors (FSB 2015c). Resolution authorities generally are afforded broad discretion in deciding on recognition of foreign resolution actions. Thus, for resolution planning purposes, there remains some uncertainty about the enforceability of a bail-in under the laws of a foreign jurisdiction. Authorities have responded to this in one of two ways. One way has required firms to issue TLAC instruments exclusively under domestic law to make sure that no cross-border recognition issues arise.44 The other way has required firms to include contractual recognition clauses in TLAC instruments whereby the holder of the instrument recognizes and agrees that the instrument may become subject to bail-in by the relevant home resolution authority.45
Contractual recognition can help ensure that financial contracts and instruments governed by third-country law can be subjected to resolution measures in the same way as contracts governed by domestic law. The aim is to ensure that all holders of TLAC, whether domestic or foreign, will be subject to bail-in to the same extent, regardless of the governing law of the agreement under which the liability arises.46
Cross-Border Stays on Early Termination Rights
A key challenge in resolution can arise from the effect of close-out rights and cross-default rights under the International Swaps and Derivatives Association (ISDA) Master Agreement. The FSB Key Attributes state that authorities should have the power to temporarily stay the exercise of such termination rights to support the implementation of measures aimed at achieving continuity and maintaining the risk management function of the financial contracts.47 Overriding cross-defaults should prevent termination and the associated liquidity runs in the case of failure of a parent entity of a direct counterparty that is still performing on the contract.
However, the cross-border enforceability of such temporary stay powers is not certain. ISDA member institutions in coordination with the FSB therefore developed a protocol that contractually opts adhering parties into provisions that limit the exercise of termination rights.48
Unless the protocols are adhered to by all market participants with significant derivatives and securities finance exposures, there is a risk that a fragmented adoption will further increase complexity and cost and give rise to level playing field issues, for instance, if some counterparties were to be stayed while others would be in a position to exercise their termination rights. The international community therefore agreed to promote, by way of regulation or other enforceable measures, the broad adherence to the protocol (FSB 2015a), for example, by issuing regulations that prohibit regulated institutions from entering into financial contracts unless the counterparty contractually opts into the home country’s resolution stay laws.49
Home-Host Cooperation
Cross-Border Crisis Management Groups and Cooperation Agreements
Crisis management groups have now been established for all firms identified as G-SIBs. They bring together the G-SIB home and key host authorities and include supervisory authorities, central banks, resolution authorities, and finance ministries.50 The regular engagement among home and key host authorities within the crisis management groups helps enhance preparedness for the management and resolution of a cross-border financial failure. Crisis management groups should be underpinned by firm-specific cooperation agreements that set out processes for coordination and information-sharing to support cooperation in resolution planning and in an actual crisis.
Allocating Costs across Borders
SPOE and MPOE resolution strategies and the TLAC standard have been designed with the view to facilitating cross-border cooperation by aligning more closely home and host authorities’ interests and mitigating the pressure on host authorities to ring-fence local assets or seize collateral as a preemptive measure in a crisis. The pre-positioning of internal TLAC should give confidence to host authorities that the material subgroups have sufficient loss-absorbing and recapitalization capacity available to maintain the continuity of local material operations and should reduce the incentives for imposing ex post ring-fencing in a crisis.51
To curb such incentives for host authorities, home and host authorities need to cooperate closely through the resolution planning and crisis management group process, and have a clear understanding of their respective roles and responsibilities, including in regard to their preferred resolution strategy (either MPOE or SPOE), the appropriate amount, composition, location, and triggers of internal TLAC.52 The FSB standard sets out an expectation that the host authority will not act without the consent of the home authority, except in exceptional circumstances where the conditions for initiating domestic resolution proceedings are met, and consent of the home authority is not forthcoming.53
However, in the absence of coordinated resolution planning, in particular those host authorities of global systemically important financial institutions (G-SIFIs), which are not part of the respective crisis management group, may look for increased self-sufficiency of local operations of G-SIFIs in their jurisdiction, which may negatively impact the efficiency of the global banking system and also cause increased uncertainty for investors.
Impact on Firms: Legal and Operational Structures and Business Models
The implementation of the resolution policies and of the FSB’s TLAC standard is affecting the ways firms operate and organize their legal entity structures. It is also affecting the way in which firms are regulated and supervised as it shifts the focus on ensuring that firms can be resolved without wider disruptions. Resolution planning has emerged as a new function that is distinct from supervision.
Firms search for a rationalization of their structures to meet the various resolvability requirements in the most efficient and cost-effective way, for example, by eliminating legal entities through merger or wind-down, aligning critical services with legal form, regrouping legal entities under a single subholding, insulating risky market activities with potential of contagion in a crisis from retail activities, and reducing intercompany transactions. Whether integrated global operations can be maintained or whether structures will increasingly be subsidiarized or compartmentalized with a holding structure composed of “independent” subsidiaries (Huertas 2015), will in part depend on how resolution strategies are implemented.
Building up loss-absorbing capacity within firms will take time and effort and require the restructuring of legal entities and creation and positioning of loss-absorbing resources. For the internal TLAC mechanism to work and effectively channel losses from the subsidiaries to the resolution entity, group operations need to be structured in such a way that they do not result in reverse financial linkages through intragroup exposures, such as uncollateralized exposures of a subsidiary on its resolution entity.
Structures and operations will need to conform to local rules that seek to make firms more resolvable so that corporate structures can be taken apart without disrupting the continuity of any vital economic functions. To ensure the continuity of critical services in resolution, banks need to map their network of critical services. Service contracts with internal service companies should be at arm’s length through the use of service-level agreements so that services can continue to be provided by the same operating company or an external alternative provider under a contract with similar terms. Terms for intercompany trades may need to be revised so that they are performed in the same manner as third-party trades and can be replaced in resolution.
Conclusion
The distress of a G-SIFI creates global problems that require a global solution. Significant progress has been made toward achieving a pragmatic and credible global solution in the form of a coherent international policy framework for resolution and resolution planning. Rather than calling for an international treaty and the global harmonization of bank resolution regimes, the framework relies on a combination of new resolution powers, ex ante resolution planning, that minimizes cross-border frictions and contractual approaches to address and mitigate cross-border challenges. Legislatures in a number of important jurisdictions have demonstrated their willingness to make significant changes in national laws and regulatory structures. The principal jurisdictions now have an alternative to relying on ordinary corporate insolvency procedures to address distress in financial firms. Cross-border cooperation and coordination have significantly intensified and strengthened.
However, sustained efforts are needed to make the framework and policies fully operational. G-SIBs need to build up their TLAC resources and fully implement changes in legal, operational, and funding structures to improve their resolvability. It will be possible to demonstrate the effectiveness of the framework only when it is used to address serious financial distress. Even now, however, there are signs that it has enhanced market discipline and made financial firms more aware of the risks they face.
Further work and analysis are needed to understand how the framework will operate in times of stress and what the impact of resolution actions might be in light of the interdependencies between major market participants and the concentration of essential financial system functions, in particular financial market infrastructure services, in a relative small number of firms. With mandatory central clearing, central counterparties now play a pivotal role in the financial system and must have in place robust recovery and resolution plans that ensure the continued performance of their critical functions in times of stress (FSB 2017a). Effective resolution planning by central counterparty members will support the success of resolution arrangements for those counterparties and vice versa. Work on these issues continues at the international level (FSB 2017d).
Cross-border resolution planning will need to evolve and adapt to changes arising from the use of new products and technologies, such as digital tokens and distributed ledger technology. The greater speed associated with the automation of business processes and services that support the provision of critical functions, combined with increased interlinkages through networks and systems, could transmit failure still more rapidly. Increasing reliance on third-party providers of information technology and data processes will need to be underpinned by robust arrangements that support the operational continuity of such services when a failure occurs. However, such arrangements may be more difficult to put in place when the provider is unregulated and located in a foreign jurisdiction. The use of new products and technologies may raise operational challenges and complex legal issues if the cause of the distress involves some combination of cyberattacks, fraud, and technological failure. Although new technologies involve risks, they may also offer new opportunities that can support the objectives of resilience and resolvability.
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European Union (EU). 2017. “Directive (EU) 2017/2399 of the European Parliament and of the Council of 12 December 2017 Amending Directive 2014/59/EU as Regards the Ranking of Unsecured Debt Instruments in Insolvency Hierarchy.” http://eur-lex.europa.eu/eli/dir/2017/2399/oj.
Financial Stability Board (FSB). 2010a. “Reducing the Moral Hazard Posed by Systemically Important Financial Institutions,” interim report to G20 Leaders, June 18. http://www.finan-cialstabilityboard.org/publications/r100627b.pdf.
Financial Stability Board (FSB). 2010b. “Reducing the Moral Hazard Posed by Systemically Important Financial Institutions,” November 11. http://www.fsb.org/2010/11/r101111a/.
Financial Stability Board (FSB). 2011a. “Key Attributes of Effective Resolution Regimes for Financial Institutions (as Updated with Sector-specific Annexes in November 2014).” http://www.fsb.org/wp-content/uploads/r141015.pdf.
Financial Stability Board (FSB). 2011b. “Policy Measures to Address Systemically Important Financial Institutions,” November. http://www.fsb.org/2011/11/r111104bb/.
Financial Stability Board (FSB). 2013a. “Guidance on Developing Effective Resolution Strategies,” July. http://www.fsb.org/2013/07/r130716b/.
Financial Stability Board (FSB). 2013b. “Guidance on Identification of Critical Functions and Critical Shared Services,” July. http://www.fsb.org/2013/07/r130716b/.
Financial Stability Board (FSB). 2013c. “Guidance on Recovery Triggers and Stress Scenarios,” July. http://www.fsb.org/2013/07/r130716c/.
Financial Stability Board (FSB). 2015a. “FSB Welcomes Extension of Industry Initiative to Promote Orderly Cross- Border Resolution of G-SIBs,” November 12.
Financial Stability Board (FSB). 2015b. “Guidance on Cooperation and Information Sharing with Host Authorities of Jurisdictions where a G-SIFI has a Systemic Presence that are Not Represented on its Crisis Management Group,” November. http://www.fsb.org/2015/11/guidance-on-cooperation-and-information-sharing-with-host-authorities-of-jurisdictions-where-a-g-sifi-has-a-system-ic-presence-that-are-not-represented-on-its-cmg/.
Financial Stability Board (FSB). 2015c. “Principles for Cross-border Effectiveness of Resolution Actions,” November. http://www.fsb.org/2015/11/guidance-on-cooperation-and-information-sharing-with-host-authorities-of-jurisdictions-where-a-g-sifi-has-a-systemic-presence-that-are-not-represented-on-its-cmg/.
Financial Stability Board (FSB). 2015d. “Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution and Total Loss-absorbing Capacity (TLAC) Term Sheet,” November. http://www.fsb.org/2015/11/total-loss-absorbing-capacity-tlac-principles-and-term-sheet/.
Financial Stability Board (FSB). 2015e. “Total Loss-Absorbing Capacity (TLAC) Principles and Term Sheet,” November 9.
Financial Stability Board (FSB). 2016a. “Guidance on Arrangements to Support Operational Continuity in Resolution,” August. http://www.fsb.org/2016/08/guidance-on-arrangements-to-support-operational-continuity-in-resolution/.
Financial Stability Board (FSB). 2016b. “Guiding Principles on the Temporary Funding Needed to Support the Orderly Resolution of a Global Systemically Important Bank,” August 16.
Financial Stability Board (FSB). 2017a. “Guidance on Central Counterparty Resolution and Resolution Planning,” July 5. http://www.fsb.org/2017/07/guidance-on-central-counterparty-resolution-and-resolution-planning-2/.
Financial Stability Board (FSB). 2017b. “Guidance on Continuity of Access to Financial Market Infrastructures (FMIs) for a Firm in Resolution,” July. http://www.fsb.org/2017/07/guidance-on-continuity-of-access-to-financial-market-infrastructures-fmis-for-a-firm-in-resolution-2/.
Financial Stability Board (FSB). 2017c. “List of Global Systemically Important Banks (G-SIBs),” November 21. http://www.fsb.org/2017/11/2017-list-of-global-systemically-important-banks-g-sibs/.
Financial Stability Board (FSB). 2017d. “Ten Years On—Taking Stock of Post Crisis Resolution Reforms,” Sixth Report on the Implementation of Resolution Reforms, July. http://www.fsb.org/2017/07/ten-years-on-taking-stock-of-post-crisis-resolution-reforms/.
Financial Stability Board (FSB). 2018a. “Funding Strategy Elements of an Implementable Resolution Plan.” https://www.fsb.org/2018/06/funding-strategy-elements-of-an-implementable-resolution-plan-2/.
Financial Stability Board (FSB). 2018b. “Guidance on Funding Strategy Elements of an Implementable Resolution Plan.”
Financial Stability Board (FSB). 2018c. “Principles on Bail-in Execution.” https://www.fsb.org/2018/06/principles-on-bail-in-execution-2/.
G20. 2010. “The G20 Toronto Summit Declaration,” June. http://www.fsb.org/wp-content/uploads/g20leadersdeclarationtoronto2010.pdf.
Gleeson, Simon, and Randall Guynn. 2016. Bank Resolution and Crisis Management: Law and Practice. Oxford: Oxford University Press.
Herring, Richard, and Jacopo Carmassi. 2012. “The Corporate Structure of International Financial Conglomerates: Complexity and its Implications for Safety and Soundness.” In The Oxford Handbook of Banking, edited by Allen N. Berger, Philip Molyneux, and John O. S. Wilson. Oxford: Oxford University Press, 2012.
Huertas, Thomas. December 15, 2015. “Global Banks: Good or Good-Bye?” The Future of Large, Internationally Active Banks.” Proceedings of the 18th Annual International Banking Conference, Federal Reserve Bank of Chicago 67–75.
Hüpkes, Eva H. G. 2005a. “Insolvency—Why a Special Regime for Banks?” Current Developments in Monetary and Financial Law 3.
Hüpkes, Eva H. G. 2005b. “Too Big to Save”—Towards a Functional Approach to Resolving Crises in Global Financial Institutions.” In Systemic Financial Crisis: Resolving Large Bank Insolvencies, edited by Douglas Evanoff and George Kaufman. Singapore: World Scientific Publishing.
International Swaps and Derivatives Association. 2015. “ISDA 2015 Universal Resolution Stay Protocol.” http://www2.isda.org/functional-areas/protocol-management/protocol/22.
International Swaps and Derivatives Association. 2016. “ISDA Resolution Stay Jurisdictional Modular Protocol.” https://www2.isda.org/functional-areas/protocol-management/protocol/24.
Spatt, Chester S. 2010. “Regulatory Conflict: Market Integrity vs. Financial Stability.” University of Pittsburgh Law Review 71: 625–39.
United Nations Commission on International Trade Law. 1997. “Model Law for Cross-Border Insolvency.” http://www.uncitral.org/uncitral/en/uncitraltexts/insolvency/1997Model.html.
Velasco, Julian. 2006. “The Fundamental Rights of the Shareholder.” University of California Davis Law Review 40 (2): 407.
Eva H. G. Hüpkes is Acting Head of Regulatory and Supervisory Policies at the Financial Stability Board (FSB). The views expressed are those of the author and do not necessarily reflect the views of the FSB or its members.
The 2014 document of the Key Attributes contains additional sector-specific guidance for insurers, financial market infrastructures, and the protection of client assets in resolution.
Including “Guidance on Recovery Triggers and Stress Scenarios,” July 2013; “Guidance on Identification of Critical Functions and Critical Shared Services,” July 2013; “Guidance on Developing Effective Resolution Strategies,” July 2013; “Guidance on Cooperation and Information Sharing with Host Authorities of Jurisdictions where a G-SIFI has a Systemic Presence that is Not Represented on its CMG,” November 2015; “Principles for Cross-border Effectiveness of Resolution Actions,” November 2015; “Guiding Principles on the Temporary Funding Needed to Support the Orderly Resolution of a Global Systemically Important Bank (“G-SIB”),” August 2016; “Guidance on Arrangements to Support Operational Continuity in Resolution,” August 2016; “Guiding Principles on the Internal Total Loss-Absorbing Capacity of G-SIBs (‘Internal TLAC’),” July 2017; “Guidance on Continuity of Access to Financial Market Infrastructures (FMIs) for a Firm in Resolution,” July 2017; “Principles on Bail-in Execution,” 2018; and “Funding Strategy Elements of an Implementable Resolution Plan,” 2018.
In November 2011, the FSB published an integrated set of policy measures to address the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs). See FSB 2011b. In that publication, the FSB identified as global systemically important financial institutions (G-SIFIs) an initial group of G-SIBs, using a methodology developed by the Basel Committee on Banking Supervision. The list is updated annually based on new data and published by the FSB each November. In 2016, 30 banks were identified as G-SIBs as part of the annual identification process of G-SIFIs. See FSB 2017c.
The FSB defines these functions as “critical functions,” that is, “activities performed for third parties where failure would lead to the disruption of services that are vital for the functioning of the real economy and for financial stability due to the banking group’s size or market share, external and internal interconnectedness, complexity and cross-border activities. Examples include payments, custody, certain lending and deposit-taking activities in the commercial or retail sector, clearing and settling, limited segments of wholesale markets, market-making in certain securities and highly concentrated specialist lending sectors.” See “Recovery and Resolution Planning for Systemically Important Financial Institutions: Guidance on Identification of Critical Functions and Critical Shared Services,” July 16, 2013. Functions that may be deemed critical include functions, such as credit extension, continued access to demand deposits, the provision of facilities for trading securities and for taking positions or hedging, and infrastructure-like functions, such as custody, clearing, settlement, and payment processing services.
At the Toronto Summit in June 2010, the G20 leaders agreed that resolution regimes should provide for “continuity of critical financial services, including uninterrupted service for insured depositors.” See also the FSB interim report: “All jurisdictions should have effective resolution tools that enable the authorities to resolve financial firms without systemic disruptions and without taxpayer losses. These should include powers that facilitate a “going concern” capital and liability restructuring as well as “gone concern” restructuring and wind-down measures, including the establishment of a temporary bridge bank to take over and continue operating certain essential functions.”
The G20 recommended that “national financial regulatory frameworks should be reinforced with a macro-prudential overlay that promotes a system-wide approach to financial regulation and oversight and mitigates the buildup of excess risks across the system.” “G20 Working Group on Enhancing Sound Regulation and Strengthening Transparency—Final Report,” March 6, 2009.
Key Attribute 3.5.
This requires capital structure liabilities to rank junior to operational liabilities in the creditor hierarchy (or conversely operating liabilities to be senior to the capital structure liabilities). See the section titled “Subordination requirement.”
Key Attributes 4.3 and Annex IV.
Key Attribute 3.
For G-SIBs headquartered in advanced economies, the FSB’s common minimum TLAC requirement has been set as follows: from January 1, 2019, resolution entities must hold TLAC instruments at least equivalent in value to 16 percent of the resolution group’s risk-weighted assets (RWAs) and 6 percent of unweighted exposures; from January 1, 2022, resolution entities must hold TLAC instruments of at least 18 percent of the resolution group’s RWAs and 6.75 percent of unweighted exposures. G-SIBs headquartered in emerging market economies, where capital markets are less well-developed, are expected to meet the lower requirement by January 1, 2025, and the higher requirement by January 1, 2028, at the latest. The FSB’s minimum TLAC requirement is set with reference to both RWAs and unweighted balance sheet assets, as defined by the Basel III leverage ratio exposure measure.
TLAC Term Sheet Section 9–10.
Article 45 of the Directive 2014/59/EU of the European Parliament and of the Council of May 15, 2014, establishing a framework for the recovery and resolution of credit institutions and investment firms (known as Bank Recovery and Resolution Directive [BRRD]).
The TLAC standard applies only to G-SIBs, whereas the MREL framework applies to a much broader set of institutions. MREL is set by the resolution authorities on a firm-specific basis, making it a more flexible tool in terms of the amount and eligibility of instruments to be held. A set of qualitative criteria, specified in the Regulatory Technical Standards of the European Banking Authority, are intended to guide the determination of the MREL and ensure a comparable approach and consistent interpretation of the BRRD provision across the European Union.
The TLAC standard provides for an exception to the subordination requirement and allows TLAC-eligible instruments to count toward the TLAC minimum requirement if they rank pari passu with excluded liabilities, as long as they do not exceed a minimum threshold.
Key Attribute 5.2. The NCWOL safeguard provides that shareholders and creditors should not incur greater losses than those which they would have incurred had the institution been wound up under normal insolvency proceedings. Shareholders and creditors that do suffer such greater losses should be entitled to compensation in an amount equivalent to the shortfall they have suffered.
Section 46f(5) to (8) of the Kreditwesengesetz, as amended by the Abwicklungsmechanismusgesetz (Resolution Mechanism Act) of November 2, 2015.
Article 30 b of the Swiss Banking Act of November 8, 1934 (as updated on January 1, 2016).
Directive (EU) 2017/2399 of the European Parliament and of the Council of 12 December 2017 amending Directive 2014/59/EU as regards the ranking of unsecured debt instruments in insolvency hierarchy.
FSB 2013a; “Resolution of Systemically Important Financial Institutions: The Single Point of Entry Strategy”, 78 Fed. Reg. 76614, December 18, 2013.
TLAC Term Sheet Section 3.
FSB, 2013, Strategies, July, Section 3.
The FSB Key Attributes (8.1) require “Home and key host authorities of all G-SIFIs should maintain CMGs with the objective of enhancing preparedness for, and facilitating the management and resolution of, a cross-border financial crisis affecting the firm. CMGs should include the supervisory authorities, central banks, resolution authorities, finance ministries, and the public authorities responsible for guarantee schemes of jurisdictions that are home or host to entities of the group that are material to its resolution, and should cooperate closely with authorities in other jurisdictions where firms have a systemic presence.” See the “Home Host Cooperation” section.
TLAC Term Sheet Section 3.
For example, US law provides for a requirement that the holding company owning an insured depository institution serves as a source of financial strength and provides financial assistance to such institution in the event of the financial distress. See Sec. 38A of the Federal Deposit Insurance Act (12 U.S.C. 1811 et seq.) as amended by the Dodd-Frank Act, which provides: “The appropriate Federal banking agency for a bank holding company or savings and loan holding company shall require the bank holding company or savings and loan holding company to serve as a source of financial strength for any subsidiary of the bank holding company or savings and loan holding company that is a depository institution.”
Pursuant to the TLAC term sheet Sections 16 and 17, a material subgroup consists of one or more direct or indirect subsidiaries of a resolution entity that: (1) are not themselves resolution entities; (2) do not form part of another material subgroup of the G-SIB; (3) are incorporated in the same jurisdiction outside of their resolution entity’s home jurisdiction unless the crisis management group agrees that including subsidiaries incorporated in multiple jurisdictions is necessary to support the agreed resolution strategy and ensure that internal TLAC is distributed appropriately within the material subgroup; and that (4) either on a solo or a subconsolidated basis meet at least one of the of the following criteria: (1) have more than 5 percent of the consolidated RWAs of the G-SIB group; (2) generate more than 5 percent of the total operating income of the G-SIB group; (3) have a total leverage exposure measure larger than 5 percent of the G-SIB group’s consolidated leverage exposure measure; or (4) have been identified by the firm’s crisis management group as material to the exercise of the firm’s critical functions (irrespective of whether any other criteria of this section are met).
The FSB TLAC term sheet stipulates that a material subgroup maintain internal TLAC of 75 percent to 90 percent of the external minimum TLAC requirement that would apply to the material subgroup if it were a resolution group, as calculated by the host authority and that the actual minimum internal TLAC requirement within that range be determined by the host authority of the material subgroup in consultation with the home authority of the resolution group. TLAC term sheet Sections 16 to 18.
Internal TLAC Guiding Principle 10.
Internal TLAC Guiding Principle 7.
Secured support agreements impose a legally binding, secured obligation on a parent holding to its material subgroups during periods of financial distress before it reaches its point of nonviability. The agreement requires the parent to use its assets to provide capital support to all of its material subsidiaries or subgroups, and the material subsidiaries would have a legal right to enforce the agreement and seize any collateral if the parent did not voluntarily honor its secured obligations. The triggers are defined by criteria based on ratios of the group’s capital and liquidity resources and are designed to occur before the top-tier parent would become balance-sheet insolvent or unable to pay its debts when due. See the public executive summaries of the 2015 resolution plans of Bank of America Corporation, Bank of New York Mellon Corporation, Citigroup Inc., Goldman Sachs Group, Inc., JPMorgan Chase & Co., Morgan Stanley, and State Street Corporation, as updated by their October 2016 submissions, at https://www.fdic.gov/regulations/reform/resplans/.
See Section 20 of the TLAC term sheet in relation to public disclosures by G-SIBs of their eligible TLAC. The Basel Committee specified the provisions in Section 20 of the TLAC term sheet and published a consultation document in 2016. See BCBS 2017.
The Basel Committee included disclosure requirements in the revised Pillar 3 framework.
For purposes of such a valuation, the question is what assumptions would need to be made about market conditions and the value of contracts, the applicable insolvency laws, and remedies available under such laws (for example, set-off or avoidance actions). For a list of questions that arise in connection with the valuation, see de Serière and van der Houwen 2016.
Shareholder rights fall into several categories, including economic rights (for example, the right to receive dividends and to sell the shares), control rights (for example, the right to vote on important matters relating to the business, such as mergers, acquisitions, and changes to the capital structure), the right to elect the directors who manage the business; information rights (for example, the right to receive the accounts and annual report); and legal rights (for example, the right to seek redress for breach of management’s fiduciary duties to the company and its shareholders). See Velasco 2006.
However, before any new qualified and controlling shareholders can exercise their control rights, they need to obtain the required “fit and proper” approvals in relevant applicable supervisory regimes.
These include ad hoc disclosure obligations that require a firm to disclose material nonpublic or inside information. There may be exemptions or an ability to delay disclosures, for example if the disclosure is likely to prejudice the legitimate interests of the issuer or if it risks undermining financial stability in some jurisdictions. See, for example, Article 17(5) of Regulation (EU) No 596/2014 of the European Parliament and of the European Council of April 16, 2014, on market abuse (market abuse regulation). For a discussion of the tension between financial stability and investor protection objectives, see Spatt 2010.
Defined as “the activities performed for third parties, the failure of which would lead to the disruption of services that are vital for the functioning of the real economy and for financial stability.” See FSB 2013b.
In National Bank of Greece v Metliss, the English courts decided that where a Greek bank owed money under bonds governed by English law, a Greek statute passed for the purpose of varying liability on the bonds would not be recognized by English courts, because English legal rights cannot be altered by Greek statute. See Gleeson and Guynn 2016, 213.
The European Union’s “Credit Institutions Winding Up Directives” (Article 3) provides that reorganization measures applied to an EU credit institution in one member-state will be effective throughout the European Union. In addition, the BRRD provides for the effectiveness of bail-in and transfer powers within the European Union.
Comity is a set of general principles governing when the courts and legal rules of a particular country pay deference to legal rules or proceedings of another country. See Bernstein and others 2013, “Recognition and Comity in Cross-Border Insolvency Proceedings,” The International Insolvency Review 1 (1). The Model Law is designed to assist states to equip their insolvency laws with a modern legal framework to more effectively address cross-border insolvency proceedings concerning debtors experiencing severe financial distress or insolvency. It focuses on authorizing and encouraging cooperation and coordination between jurisdictions, rather than attempting the unification of substantive insolvency law, and respects the differences among national procedural laws.
United Nations Commission on International Trade Law 1997.
For example, the EU jurisdictions and Hong Kong Special Administrative Region, Singapore, and Switzerland.
For example, under the Federal Reserve Board rule: In the summary of comments accompanying the release of the rule, it is noted that long-term debt subject to foreign law does not qualify as eligible external TLAC, because there is no guarantee that foreign courts defer to actions of US courts or US resolution authorities requiring the debt be converted into equity, for example, where the conversion negatively impacts foreign bondholders or foreign shareholders.
Article 55 of the BRRD requires the inclusion in agreements “creating” an unsecured liability that are “governed by the law of a third country,” a clause by which the “creditor or party to the agreement” recognizes that this liability may be subject to public authorities’ write-down and conversion powers.
See also TLAC term sheet, Section 13.
Key Attribute 4.3.
ISDA 2015. Twenty-one global banks had adhered to the protocol in November 2015. Whereas the Universal Stay Protocol is aimed at sell-side institutions, the ISDA Resolution Stay Jurisdictional Modular Protocol offers an approach tailored to jurisdiction-specific regulatory requirements and is aimed at buy-side firms. See ISDA 2016.
For example, for the United States, see “Restrictions on Qualified Financial Contracts of Systemically Important US Banking Organizations and the US Operations of Systemically Important Foreign Banking Organizations,” September 12, 2017; for the United Kingdom, see the “PRA Supervisory Statement Contractual stays in financial contracts governed by third-country law” at http://www .bankofengland.co.uk/pra/Pages/publications/ss/2015/ss4215.aspx. For Germany, see the “Act on the Reorganization and Liquidation of Credit Institutions as Amended September 2015” at https://www.gesetze-im-internet.de/bundesrecht/sag/gesamt.pdf.
Key Attribute 8.1.
The TLAC term sheet provides that, subject to conditions set out in the term sheet and agreement among home and relevant host authorities, on-balance-sheet internal TLAC may be replaced with internal TLAC in the form of collateralized guarantees.
The Federal Reserve Board issued a rule to implement the internal TLAC requirement in national law and defined the terms for the internal TLAC trigger that provides for an internal TLAC requirement for US intermediate holding companies that are controlled by a foreign G-SIB. Under the rule, the contractual trigger would enable the Federal Reserve Board to bail-in internal TLAC if the intermediate holding company is in default or in danger of default and if any of the following circumstances apply: (1) the parent or any subsidiary outside the United States is placed into resolution; (2) the home authority consents to the internal TLAC bail-in, or does not object following 24 hours’ prior notice from the Federal Reserve Board; or (3) the Federal Reserve Board has made a written recommendation to the secretary of the Treasury that the Orderly Liquidation Authority provisions of the Dodd—Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd—Frank”) are invoked. The contract terms would ensure that bail-in would be used only as measure of last resort in times of severe stress when the foreign parent enters resolution or the home resolution authority consents or does not object or when there is a threat to domestic financial stability as evidenced by an application for resolution under Orderly Liquidation Authority. See Federal Register, November 30, 2016, “Total Loss-Absorbing Capacity, Long-Term Debt, and Clean Holding Company Requirements for Systemically Important US Bank Holding Companies and Intermediate Holding Companies of Systemically Important Foreign Banking Organizations,” 12 CFR 252, https://www.federalregister.gov/documents/2015/11/30/2015-29740/total-loss-absorbing-capacity-long-term-debt-and-clean-holding-company-requirements-for-systemically.
TLAC Term Sheet Section 19.