A Tale of Two Situations - Recovery & Resolution Planning - UK FSA


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Following the demise of some of the most prestigious financial institutions in recent history, due to the recent financial crisis, issues concerning the recovery and resolution of banks and other significant financial institutions in the UK have been highlighted. Due to the enormous cost, both financial and reputational, of the increased need for public money to be used to support the largest “too big to fail” banks and others, the UK authorities have decided that they need to have better control over any possible future institution that falls upon hard times.

Recovery & Resolution plans need a great deal of work in setting them up and there are greater implications by having them, requiring careful management.

Call 0800 689 9 689 to arrange an initial discussion.

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A Tale of Two Situations - Recovery & Resolution Planning - UK FSA

  1. 1. 2011 Due to the enormous cost, both financial and reputational, of the increased need for public money to be used to support the largest “too big to fail” banks and others, the UK authorities have decided that they need to have better control over any possible future institution that falls upon hard times. Lee Werrell CEI Compliance Limited
  2. 2. A Tale of Two Situations FSA Recovery & Resolution PlansContentsIntroduction ............................................................................................................................. 3So who will qualify as members of this elite club?................................................................ 5Where next?............................................................................................................................. 6Recovery Plans – what is needed? .................................................................................... 8Resolution Planning – what is needed? ........................................................................... 9Bailing In.............................................................................................................................. 11The Financial Services Authority invites comments on this Consultation Paper. Comments shouldbe sent by 9 November 2011.Full Text of the Consultation Paper CP 11/16 can be downloaded as a PDF document fromhereComments may be sent by electronic submission using the form on the FSA’s websiteat: www.fsa.gov.uk/Pages/Library/Policy/CP/2011/cp11_16_response.shtml. φ
  3. 3. A Tale of Two Situations FSA Recovery & Resolution PlansIntroductionFollowing the demise of some of the most prestigious financial institutions in recent history, due tothe recent financial crisis, issues concerning the recovery and resolution of banks and othersignificant financial institutions in the UK have been highlighted. Due to the enormous cost,both financial and reputational, of the increased need for public money to be used to supportthe largest “too big to fail” banks and others, the UK authorities have decided that they needto have better control over any possible future institution that falls upon hard times.On reviewing the level of control that the UK authorities hold, this then spawned therealisation that there was a further need, an obvious hole in previous planning. Clearly theyneeded more effective tools and information to enable the orderly resolution of financialinstitutions without needing to resort to taxpayer support. Not only were the authoritieskeen see the potential plans that firms would use on the rocky road to the summit ofbreakdown and insolvency (predicted by many pundits in the press) but they were keen tosee the firms identify and understand their own plans to recover from situations of severestress.Following the Turner Review Conference in 2009 the UK authorities started a pilot RRPproject initially involving four and ultimately involving six of the largest UK firms.RRPs have two aspects. The first, “Recovery” requires affected firms toidentify options to recover their financial strength and viability should afirm come under severe stress. This is work that should be conducted indetail, providing a menu of options under differing situations and thelikely solutions that may be available. Secondly, “Resolution planning”requires firms to submit detailed information about their business andoperational structure in the form of a Resolution Pack. The authorities will then write theirresolution plans for them, so that they know precisely what, how and when to instruct theInsolvency Practitioner (IP) to do if the time comes to wind down the firm.So essentially, the RRPs aim to ensure that financial institutions:  assess and document the recovery options which they believe would normally be available to them in a range of severe stress situations;  enable these recovery options to be identified and mobilised quickly and effectively; and  supply the regulatory authorities with information and analysis on their businesses, organisation and structures to enable the authorities to ensure that an orderly resolution could be carried out by the authorities should it become necessary.So who is this going to affect? This Consultation Paper (CP) should be read by:  all FSA-authorised banks and building societies;  significant investment firms; and  all firms subject to the FSA’s client asset custody rules and investment business client money rules.Although principally intended for policymakers and a wider range of authorised firms, such asinsurers, the minimal limit is a 730K CAD firm however it may well become extended to othercategories of firms over time, after consultation, as usual. χ
  4. 4. A Tale of Two Situations FSA Recovery & Resolution PlansAdditionally this is likely to be of interest to policymakers and practitioners involved in theresolution of failed firms, as it discusses the existence and removal of barriers to resolutionand the potential costs to taxpayers of a firm’s failure.New Legislation is planned to be enacted under which the FSA will be reformed into thePrudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). It is thereforeexpected that the bulk of the preparation of RRPs will have been implemented by the FSAbefore the PRA takes on responsibility for supervising the relevant firms.Although welcoming discussion, the formal consultation on rules for RRPs and for the CMAproposals found in the ‘CASS Resolution Pack’ (CASS RP). There are a number of documentswhich have been published alongside this paper:  The proposed Handbook text for RRPs  the CASS RP, (see Annex 4)  a guidance pack on how firms should complete their RRPs, and;  several other annexes including the cost benefit analysis and compatibility statement. So what makes a good recovery plan? The FSA state that a Recovery Plan must be developed and maintained by the firm and should have the following features:  sufficient number of credible options to cope with a range of scenarios, including both idiosyncratic and market-wide stress; (yes, there could well be overlap from the ICAAP document but remember an ICAAP stress test is an immediate and one off stress, whereas a recovery plan is more like a menu of options and mini-events may have to play out for further events to take place).  options that address capital shortfalls and liquidity pressures and which should aim to return the firm to a stable and sustainable position (this can include “bail in” which is explained further in Chapter 11 of the CP); and  appropriate governance processes, including intervention conditions and procedures, to ensure timely implementation of recovery options in a range of stress situations (which may involve multiple crisis team occurrences in series or parallel).It is very likely in the early iterations that cases are considered where the firm does notcurrently have credible options to enable it to recover from extreme stress situations. In suchcases the Recovery Plan should indicate the preparation measures (and a timetable for suchmeasures) that the firm will take to create such options.There are obviously going to be cases of globally significant financial institutions (G-SIFIs), andin these events the Recovery Plan will also assist discussions among international regulatorsled by the home authority using the Crisis Management Groups (CMGs), established underthe guidance of the Financial Stability Board (FSB). Recovery Plans will help to reassure host ψ
  5. 5. A Tale of Two Situations FSA Recovery & Resolution Plansregulators that the firm could deal effectively with difficult circumstances. This cooperationshould help to discourage host and home regulators from taking pre-emptive actions toprotect national interests which could be to the detriment of wider global interests.When things go awry - Resolution planningWithin the Resolution pack is a host of analysis and information identifiers that will help theUK authorities to prepare a resolution plan with their specific aims:  to ensure that resolution can be carried out without public financial support;  to seek to minimise the impact on financial stability;  to seek to minimise the effect on depositors and consumers;  to allow decisions and actions to be taken and executed in a short space of time (for example, over a ‘resolution weekend’);  to identify those economic functions for which continuity is critical to the economy or financial system;  to identify those economic functions which would need to be wound up in an orderly fashion;  to identify and consider ways of removing barriers which may prevent critical functions being resolved successfully;  to allow a resolution that separates the identified critical economic functions from non-critical activities which could be allowed to fail; and  to enhance international cooperation and crisis management planning between international regulators for G-SIFIs.With full analysis and the information supplied in the pack will allow the authorities to commitfirms that fail to meet threshold conditions into resolution smoothly and swiftly with minimalimpact on the financial system, regardless of the size or complexity of the firm.So who will qualify as members of thiselite club?The current basis is that the FSA’s RRP requirementswill apply to deposit takers in the first instance andalso significant investment firms, in particular, to fullscope BIPRU 730k investment firms with assetsexceeding at least £15 billion on its last accountingreference date.Be warned however, that investment firms that could present significant risks either to thestability of the financial system or to one or more other PRA-regulated entities within theirgroup should be subject to the same RRP requirements as deposit-takers, includingsupporting their orderly resolution under investment bank Special Administration Regime. Weexpect such firms will be designated as being subject to regulation by the PRA, but the exactscope of PRA regulation is still being determined.So for now, the current discussion is around the firms that are relating to CMA (CASS RP) apply toall firms subject to CASS 6 or 7 due to their holding of investment business client money orcustody assets. See Chapter 6 for more detail. ω
  6. 6. A Tale of Two Situations FSA Recovery & Resolution PlansAlso there is the likelihood of international impacts and given the financial and operationalinterdependencies often found in most financial services group, consideration will beexpected, when providing resolution analysis to the authorities, how all significant members ofthe group (both regulated and unregulated) could be resolved. Recovery Plans should similarlyaddress all significant parts of a group.Where next?On the 12 th September 2011 the Independent Commissions of Banking (ICB) published its finalreport recommending far-reaching changes to all banks headquartered in the U.K.In the wake of the global economic crisis of 2008, the 5-member ICB was charged with theresponsibility of understanding how stable and competitive the financial system is in the U.K., andfor suggesting how to handle banks that were “too big to fall”.In April this year, the ICB expressed the need to implement measures which would make bankscapable of absorbing losses while curbing their incentives for excessive risk-taking. The final reportjust builds on the draft proposal to achieve this. The ICB report itemises a set of reasons justifying the need to separate a bank’s retail and investment banking operations. The list includes reducing the risks on retail customers from volatile investment banking businesses, making it easier and less expensive to bail out banks in trouble and aiding the process of monitoring banks by introducing more transparency. The relief for U.K. banks is that the ICB report stops short of recommending a complete separation of investment banking and retail operations. It instead proposes steps to ring-fence various essential retail banking functions in banks, defining whatactivities should be or should not be permitted inside the ring-fence.And the ICB report acknowledges the impact of this ring-fencing on the banks. The direct operationalcosts for banks are expected to increase due to the proposed changes with additional increases tothe cost of capital and funding for banks.The increased capital requirements for banks would further push costs higher. Estimates peg theadditional costs to the country’s biggest banks to be £7 billion (U$11 billion) annually.With direct and far reaching consequences and a recommendation to ensure proposed changes arein place by 2019, the ICB has shaken up the U.K. banking sector. When the changes are called intolaw would determine how the banks respond – with drastic measures like shifting headquarters alsonot ruled out completely.The next development for RRPs is the G20 meeting in November. Then there will be furtherconsultation document in 1Q12 and final rules are expected in 2Q12 with earliestsubmissions around June 2012. RRPs complement existing policies with respect to capital,liquidity and stress testing. They are also consistent with the proposed PRA ProactiveIntervention Framework (PIF).As I mentioned earlier, the aim is for the RRP policy set out in the CP is to come into effect ϊ
  7. 7. A Tale of Two Situations FSA Recovery & Resolution Plansduring the first quarter of 2012. In due course, RRP policy as it relates to deposit-takers andsystemic investment firms will fall under the remit of the Prudential Regulation Authority(PRA).The CASS RP policy is expected to come into effect six months after the publication of therelevant PS. As stated firms in scope for the CASS RP will include some firms that are also inscope for the rest of the RRP policy and some that are not.The Bank of England and FSA set out in the joint paper, The Bank of England, PrudentialRegulation Authority: Our approach to banking supervision , the PRA’s role will be tocontribute to the promotion of the stability of the UK financial system. It will have a singleobjective – to promote the safety and soundness of regulated firms, including seeking tominimise any adverse effects of firm failure on the UK financial system and by ensuring thatfirms carry on their business in a way that avoids adverse effects on the system. As recognisedin its statutory objective, it will not be the PRA’s role to ensure that no PRA-authorised firmfails.RRP and existing capital stress-testing linksSo what’s wrong with the ICAAP/ILAS stress testing? There are obviously strong links between theRecovery Plan and the existing capital and liquidity stress testing requirements, given theircommon objective towards maintaining sufficient financial resources for a going-concern firm ina stressed environment. The FSA is keen for any firm not to try and re-invent the wheel.Firms may find that their existing capital and liquidity stress testing can serve as useful inputsin developing their Recovery Plans. However, the Recovery Plan will extend further by askingfirms to plan for additional actions when the impact or the speed of a crisis turns out to bemore severe than the scenarios they had projected in their stress tests. A menu of itemsincluding triggers and mitigating actions, set processes at certain times will be required toshow all avenues of recovery had been not only mapped and travelled down, but also whichof the kerbstones had been painted. ϋ
  8. 8. A Tale of Two Situations FSA Recovery & Resolution PlansRRP and reverse stress-testing linksThe FSA’s policy on reverse stress testing used as a risk tool, requires a firm to explicitly identifyand assess the scenarios that are most likely to cause its business model to fail, afterconsidering existing, realistic management actions. Where those tests reveal that business failurewill occur within the firm’s existing risk appetite or tolerance, the firm will be required toidentify and adopt effective arrangements, processes, systems or other measures to try toprevent those risks from crystallising.Given the roles of reverse stress testing in improving a firm’s contingency planning as well asin preventing it from failing, there are clear links between reverse stress testing and the RRPrequirements. In practice, the development of a firm’s RRP will inform its reverse stresstesting planning and vice-versa, providing the glue to connect all the risk reporting toolstogether.Recovery Plans – what is needed?Briefly, recovery plans;  are developed and maintained by the firms and the authorities will review their adequacy  should include a robust menu of options to deal with a range of stressed situations  should have unambiguous ‘triggers’ which, when breached, will create a strong presumption that the plan will be activated  should be reviewed at least annually and approved by the board.The purpose of a Recovery Plan is to enable a firm to plan how they would try to recoverfrom severely adverse conditions that could cause their failure. It will set out in advance afirm’s ‘menu of options’ for dealing with a range of severe stress events. These stresses may becaused by an idiosyncratic problem, a market-wide problem or a combination of both, andextend beyond the firm’s current regulatory stress testing scenarios and remedies.Firms will be required to produce a Recovery Plan that can be readily implemented whennecessary and that is integrated within its risk management framework and processes.Firms will need to ensure the necessary measures and preparations are in place in advance forthe plan to be effective.The recovery options need to be material in impact and capable of being executed withrelative ease and in a timely manner.The proposals cover the following key areas:  governance framework for the Recovery Plan;  key Recovery Plan options;  criteria for assessing recovery options; and  intervention conditions, i.e. a trigger framework. For a detailed explanation of the expected components of Recovery Plans, see modules 1 and 2 of the RRP Guide. ό
  9. 9. A Tale of Two Situations FSA Recovery & Resolution PlansDisposal optionsFor any Recovery Plan to be considered robust, it is likely to be necessary for firms toconsider radical choices which change the structure of their businesses. These choices arelikely to include, but are not limited to, disposal options for part of a firm’s business or evenselling the firm itself. Although it may be difficult accurately to assess the value of suchoptions, firms should be able to provide some broad estimates. Consideration of suchoptions and how they might be executed will form an important part of most RecoveryPlans, particularly those of the larger firms. When considering potential disposal options,consideration should be given to the long-term viability of the firm post-transaction.  The Resolution Plan is prepared by the authorities based on the Resolution Pack containing extensive information and analysis provided by the firms.  Modules 3 to 6 of the RRP Guide explain the work that firms must do. For the Handbook text on Resolution Packs see FINMAR 4.3.  A key part of the firms’ work is a separation or wind-down plan for deposit- taking and other critical economic functions.  Firms will be expected to identify barriers to resolution and propose changes to remove those barriers.  The Resolution Pack must be reviewed at least annually and the board will be responsible for ensuring there are processes in place to produce timely and accurate data.  The Resolution Pack must be updated on an ongoing basis to reflect any material developments in a firm’s business.Resolution Planning – what is needed?Alternatively, the aim of the Resolution Plan is to provide a clear and detailed strategyroadmap to resolve a failed firm or even a group in such a manner that minimises the impacton financial stability without needing to resort to public sector solvency support.The key element here is that the Resolution Plan is prepared by the UK authorities. However, itis vital that the authorities have the level of understanding necessary to make theappropriate decisions. They can only implement an effective action plan when resolution isimminent; which requires not only the provision of reasonably current information on thespecific business operations, structures and critical economic functions, but also a detailedresolution analysis prepared by firms.Effectively the authorities need to be able to form opinionson the resolvability of each firm. To enable this, firms willneed to provide a very significant level of detail and, inparticular, the authorities will be asking firms to undertakea ‘separability or wind-down’ analyses in relation to eachof its critical economic functions.The information and analysis to be supplied by firms iscalled the ‘Resolution Pack’.Economic functionsThese refer to the services delivered by a firm and will not always necessarily corresponddirectly to legal entities within a firm’s group structure. It may also not be clearly mapped to thebusiness units operated by the firm. What is required is that firms should explain how the ύ
  10. 10. A Tale of Two Situations FSA Recovery & Resolution Planseconomic functions they provide map to the business units through which the group mayorganise itself. Consequently a further mapping will be necessary to understand how thesebusiness units map to the legal entity structure of the group.Typical Economic Functions the financial services sector provides three high-level services tothe real economy:  payment services, to facilitate transactions between agents in the real economy;  intermediation of credit and capital, to allow agents in the real economy to save, invest and borrow efficiently; and  risk management products and services, to facilitate risk pooling and protect agents against adverse events.These high-level services can then be broken down into separate economic functions whichfirms perform. For example, (i) current accounts facilitate the provision of payment services;(ii) mortgage lending contributes to the intermediation of credit; and (iii) market-makingactivities contribute to the provision of risk management. Sometimes, an economic functionmay support the provision of more than one of the high-level services to the real economy.Examples of economic functions are as follows:  retail current accounts including overdrafts;  retail savings/time accounts;  retail lending: mortgages/other secured;  retail lending: unsecured personal loans;  retail lending: credit cards issuance and underwriting;  corporate deposits;  corporate lending;  long-term capital investment;  credit card merchant acquiring/services;  payment services;  clearing services;  cash services;  third-party services;  derivatives;  securities financing;  trading portfolio;  equity and debt capital markets;  asset management;  brokerage;  custody services;  prime brokerage and related securities services;  general insurance, re-insurance, underwriting and/or broking services;  life, pensions, investments and annuities υτ
  11. 11. A Tale of Two Situations FSA Recovery & Resolution Plans  corporate advisory services; and  research.Ongoing maintenance of data by firmsA clear signal and an obvious requirement is that it will be important that, while preparingthe initial RRPs, firms plan for their regular maintenance and update. This will surely be a lessonerous task than the initial preparation of the plans and, if systems for capturing andrecording data are properly established, particularly for resolution information, this shouldhelp the firm to provide updated information quickly and efficiently when required.A firm should review its Recovery Plan at least annually and when it has been through a majorreorganisation, especially when it involves an acquisition or disposal. The plans should also berefreshed whenever the firm looks likely to encounter a severe stress situation and on requestfrom the FSA.Bailing InWhat is bail-in?The term Bail-in is provided in this documentation and it usually refers to a process of internalrecapitalisation that is triggered once a firm has reached the point of non-viability. There is anautomatic Loss imposed on certain of a firm’s direct stakeholders of a firm by a process of‘bailing-in’, either by writing down their claims or by converting them to equity. As a result, thefirm is recapitalised from within and the need for new capital resources to be provided by thepublic sector (i.e. a bail-out) is avoided.Whilst it all seems a very straightforward arrangement, Bail-in will almost always need to beaccompanied by changes in the firm’s senior management. Coupled with this would be theadoption of a new business plan that addresses the causes of the firm’s failure. A vitalobjective of the bail-in process is to secure the continued existence of at least a part or eventhe entire firm on a going concern basis. If this can be done then disruption of services tocustomers of the firm should be minimised, while its shareholders and uninsured creditorsare subject to going concern losses rather than the much larger gone concern losses thatthey would suffer if the firm went into insolvency or liquidation.Full details of the Bail-In can be found in Chapter 11 of the CP11/16. υυ
  12. 12. A Tale of Two Situations FSA Recovery & Resolution Plans Companies that CEI have been involved with in the last 10 years; CEI Compliance can help provide a full compliance support service, reducing required management time, ensuring all areas are up to date and workingfor your firm’s long term benefit. Call 0800 689 9 689 today or go online at www.ceicompliance.co.uk This whitepaper was written by Lee Werrell FInstSMM Chartered MCSI Cert PFS, founder of CEI Compliance Limited. Avoid S166 Skilled Persons Reports – download our free guide here υφ
  13. 13. A Tale of Two Situations FSA Recovery & Resolution Plans How to Choose a Compliance Consultant(Acknowledgements to Alan Weiss, www.summitconsulting.com)Every financial services business occasionally needs outside help. Even well-run giants such as RBS, Lloyds,Aviva, Barclaycard, and many other firms deliberately choose to bring in compliance consultants on a regularbasis. For smaller businesses, an outside consultant can offer the following advantages:  Objective advice, not geared toward political advancement or promotion  Frame of reference and best practices from other clients  Models and methodology to gain results more quickly than internal trial and error  Permanent transfer of skills to internal people The problem, however, is that those external consultancies can create as many problems as they solve. (One definition of a consultant: someone who comes to fix a problem and remains to become a part of it.)These include:  Threatening employees by the mere presence of an “outsider”  Reliance on “off-the-shelf” fixed methods which don’t fit the current client very well  Lack of sensitivity to the client’s business, culture, and environment (a financial adviser practice is not run the same way as an accountancy practice)  Solutions that worked for large organisations cannot always be simply scaled down  “Ideal” solutions not really practical for the client’s business and have limited or no real valueI’ve been in consulting since 2000 and, to my astonishment, I find currently that about 50% of those callingthemselves “consultants” don’t really know what they’re doing, but what is worse is that almost 90% of thosebuying consulting services don’t know how to tell the difference! To remedy that, here is a primer on how tohire the best possible consultant for your needs:A good consultant frames an issue quickly but doesn’t suggest solutions too quickly, because they realise thatthey don’t know what they don’t know until they begin to gather more data.A good consultant will not promise the moon and the stars, and will never base an approach on tests orinstruments that are purchased for a few pounds from other companies. (You get what you pay for.)A good consultant is someone you’ll hate to see go when the project ends on time, and who you’ll want toinvite back at the first appropriate new challenge.CEI COMPLIANCE works on an alternative basis by collaboration and does not charge per hour, day or week. Call CEI on 0800 689 9 689 to make your first appointment. υχ