Basel 3 December 2012

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Basel iii Compliance Professionals Association (BiiiCPA)
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Basel 3 December 2012

  1. 1. 1Basel iii Compliance ProfessionalsAssociation (BiiiCPA)1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750 Web: www.basel-iii-association.comDear Member,Today we will start with an interestingassessment:Basel III Expertsvs. RiskManagementExpertsIt is interesting to feel the market.Do you make more money as a riskmanager, or a risk manager with Basel iiiknowledge?What do you believe?Source: IT JobsWatch, that providesaunique perspectiveon todays information technology job market.http:// www.itjobswatch.co.uk/ jobs/ uk/ basel%20iii.doNote: Thisisnot anadvertisement. We have noaffiliationor anyother relationshipwithIT JobsWatch.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  2. 2. 2Basel III Top 30 RelatedIT Skills in UKBasel III Jobs, SalaryTrendin UKBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  3. 3. 3Risk ManagementJobs, SalaryTrendin UKBasel III SalaryHistogram in UKBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  4. 4. 4Risk ManagementSalaryHistogram in UKBasel III, Top 9 Job Locations inUKBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  5. 5. 5Risk Management, Top Job Locationsin UKBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  6. 6. 6Basel 3 –TheTimingDilemmaLast month the United States(US) regulatory authorities announced thatthey did not expect their rulesimplementing Basel 3 would becomeeffective on 1January 2013, although theyare working as ―expeditiouslyas possible‖ to complete their rulemaking process.Similarly in the European Union (EU), the trilogue between theEuropean Commission, the European Parliament and the Council ofMinisters to agree the text of Capital RequirementsDirective IV (CRDIV, the EU version of Basel 3 is still ongoing and, even if a politicalagreement can be reached by year-end (which still appearsto betheintention), it isrecognised in the EU that there will not be sufficient timefor CRD IV to be codified as legislation and put into effect on 1January2013.So, doesit necessarilyfollowthat weshould delayBasel 3implementationin H ong Kong because theUS and the EU cannot meet theinternationally agreed timeline?Or should we followthe timeline set by the Basel Committee on BankingSupervision and begin the first phaseof Basel 3 implementation from 1January 2013?Our Basel 3rules(the Banking (Capital) (Amendment) Rules2012) arecurrently tabled at LegCo and notwithstanding the expected delaysin theUSand the EU, the Basel Committee‘s timeline remains unchanged.Itsgradual phase-in of the new capital standardsover six years beginsfrom January2013 and extendsuntil 2019.In resolvingthe timing dilemma, it might first beinstructive to remindourselvesthat Basel 3 isbeing introduced to rectify weaknessesmade alltoo starkly apparent in the recent global financial crisis.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  7. 7. 7Or, put another way, Basel 3 isconsidered good for financial stability. TheBasel 3capital standardsaredesigned tostrengthen banks‘resilienceby requiring more and better quality capital and by addressing andcapturing risksnot adequatelyrecognised previously.The aim is to ensure that bankscan weather future financial stormswithout disruption to their lending.Thisshould in turn make them lesslikely tocreateor amplify problemsinother areas of the economy and facilitate their contribution to long-termsustainableeconomic growth.The roller-coasterof excessiveleveragepre-crisisand excessivedeleveraging post-crisisis not conducive to sustainablegrowth.Regulation isall about balance.If regulation is too lax, excessiverisk-taking may resultwith devastatingeffects.If regulation is too tight, it may suppressbeneficial financial activity andreducegrowth.In our view, Basel 3 representsan appropriate balancein bolsteringresilience whilst at the same time (with itsextended phase-in) not undulyhamperinglendingtobusinessand householdstodayand ensuringbankscan continue to lend in any downturn tomorrow.For thisreason we propose to begin implementing Basel 3 from 1January2013.We are not alonein this.Our regional peers, Mainland China, Japan, Singapore and Australia haveall published their final rulesfor Basel 3 implementation next year.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  8. 8. 8As hasSwitzerland, another important financial centre.But notwithstanding the intrinsic benefitsof Basel 3, shouldweneverthelessbe swayed by the argument put to usthat Asia istaking the―medicine‖ designed for the countries worst affected by the crisis, whilstthe intended ―patients‖ defer and thereby give their bankssignificant―competitive advantages‖ over our own?This competitive advantage argument would seem to be based on twoassumptions.First that USand EU global banks(i.e. those banksthat could realisticallycompete with our own) are currently holding much lower levels of capitalthan required by Basel 3 (and hencewill have a genuine cost advantage);and second that our bankswill, come 1January 2013, have to hold morecapital than they currentlyhold(and hence will incur additional cost).Are these assumptionscorrect?Well even though adoption of Basel 3 is delayed in the US and theEU, this certainly does not mean that banks in these regions remain attheir pre-crisiscapital levels.There hasbeen significant re-capitalisation.The Dodd Frank Wall Street Reform and Consumer Protection Act in theUSalreadyrequiresthe regulatory agencies to conduct stress-testingprogrammes to ensurebanksand other systemicallyimportant financialinstitutions have enough capital to weather severe financial conditionsand, even before the passage of the Dodd Frank Act, the USFederalReserveBoard put some of the largest US bank holding companiesthrough stress-tests, the resultsof which have led to significant increasesin capital.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  9. 9. 9By 2012, the 19 bank holding companies subject to the Fed‘sComprehensive Capital Analysisand Review had increased theiraggregatetier 1commoncapital toUS$803billion in thesecond quarter ofthe year from US$420 billion in the first quarter of 2009, with their tier 1common capital ratio (which compareshigh quality capital to assetsweighted according to their riskiness) doubling to a weighted average of10.9% from 5.4%.In the EU, under a recapitalisation exercise in 2011 that covered 71 of theEU‘smajor banks, the European Banking Authority (EBA) required mostto attain a ―core tier 1ratio‖ of not lessthan 9% by the end of June 2012.In October 2012, the EBA indicated that it will focuson capitalconservation to ―support a smooth convergence to the CRD IV…..regulatory requirements‖ and require the banksto maintain an absoluteamount of core tier 1capital corresponding to the level of the 9% core tier1ratio.So even absent formal adoption of Basel 3, the capital levelsof thelargestbanksin the US and the EU have increased significantly post-crisistolevels comparable with, or even in excessof, those required under Basel 3and sothe prospect of such banks―competing‖ by being allowed tomaintain much lower capital levelsthan Basel 3 bankswould seem moreapparent than real.Turning to the second ―competitive‖ assumption, will the first phase ofBasel 3, which startsnext year, require local banksto hold significantlymore capital than theydo at present, to the extent that they may becomeconstrained in their ability to lend and compelledto passon the costsofthe extra capital to borrowers?Well,the resultsof the H KMA‘s quantitative impact studiestell usthatour local banksare alreadyvery well-placedto meet the new Basel 3capital ratios.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  10. 10. 10Their capital levelsare alreadyin excessof the standard taking effect on 1January 2013 and the issuance of ordinary shares(common equity)alreadyaccountsfor a very significant proportion of their capitalbase, positioning them well for Basel 3‘snew focuson common equity asthehighest qualitycapital for the purpose of lossabsorption.In summary then, irrespective of any delay in formal implementation ofBasel 3, major banks in the US and EU are inexorably moving to higherlevelsof capital.This, together with the benefitsoffered by Basel 3 and the relative easewith which local bankscan comply, servesto underpin our view that weshouldproceed to implement the first phase of Basel 3 in line with theBasel Committee‘s timeline.Generallyspeaking, jurisdictions in Asia have in the past tended to adoptregulationsthat are in some respectshigher than the Basel Committee‘sminimum standards.This may have helpedAsia weather the global financial crisisrelativelyunscathed when compared with the jurisdictions worst affected.There would, therefore, seem littleto be gained from seeking to engagein, or indeed prompt, a ―race-to-the-bottom‖ in regulatory terms bydeliberatelydelaying the introduction of Basel 3 at this point in time.In implementing on 1January2013, we will be fulfillingour commitmentboth as an international financial centre which customarily adoptsbestinternational standardsand as a member of the Basel Committee onBanking Supervision.Karen KempExecutive Director (Banking Policy)Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  11. 11. 11Governor Daniel K. TarulloAt the Yale School of Management LeadersForum,New H aven, ConnecticutRegulationof ForeignBankingOrganizationsIn the aftermath of the financial crisis, regulatorsaround the world continue to implement reformsdesigned to limit theincidence and severity of future crises.My subject today pertainsto an area in which reforms have yet to bemade--the regulation of the U.S. operations of large foreign banks.Applicableregulation has changed relativelylittlein the lastdecade, despite a significant and rapid transformation of thoseoperations, asforeign banksmoved beyond their traditional lendingactivities to engage in substantial, and often complex, capital marketactivities.The crisisrevealed the resulting risks to U.S. financial stability.In taking afresh look at regulation of foreign banksin theUnited States, Iby no meanswant to imply that the United Statesshould revoke itswelcome to foreign banks.On the contrary, this reconsideration reflectsthe important role foreignbankshave played.The presenceof foreign bankscan bring particular competitive andcountercyclical benefits becauseforeign banksoften expand lending inthe United Stateswhen U.S. banking firms laborunder commondomestic strains.But just aswe are adapting our regulatory approach to U.S. banks, so weneed to incorporate important lessonslearned from the crisis into ouroversight program for foreign banks.The question of how best to regulate foreign banksis hardly a newone, either here or in other countries.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  12. 12. 12Debatesover the relative merits of territorial versusglobal or mutualrecognition approaches, the difficulties in achieving strictly equal termsof competition between bankswith different home regulatorysystems, and the degree to which harmonization of internationalstandardsand supervisory consultationscan mitigate the resultinginconsistencies and frictions are all familiar topics toacademics, banking lawyers, and supervisoryauthorities.WhileI do not aim to resolvethisafternoon the complicated interactionamong these perspectivesand considerations, I will try to outline apractical and reasonableway forward.Tobe effective, a new approach must addressthevulnerabilitiesthat havebeen created by the shift in foreign bank activities, in keeping with soundprudential policy and congressional mandates in the Dodd-Frank WallStreet Reform and Consumer Protection Act.At the same time, a modified regulatory system shouldmaintain theprinciple of national treatment and allowforeign banksto continue tooperate here on an equal competitive footing, to the benefit of the U.S.banking system and the U.S. economy generally.ForeignBank Regulationin the UnitedStatesRegulating the U.S. operationsof foreign bankspresentsuniquechallenges.Although U.S. supervisorshave full authority over the local operationsofforeign banks, we see onlya portion of a foreign banks worldwideactivities, and regular accessto information on itsglobal activitiescan belimited.Foreign banksoperate under a wide variety of businessmodelsandstructuresthat reflect the legal, regulatory, and businessclimatesin thehome and host jurisdictions in which they operate.Despite these difficulties, the United States hastraditionally accordedforeign banksthe same national treatment asdomestic banks, and U.S.regulatorsgenerallyhave allowedforeign banksto chooseamongBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  13. 13. 13structuresthat they believe promote maximum efficiency at theconsolidated level.Under the statutory scheme established by Congress, permissible U.S.structuresinclude cross-border branching and direct and indirectsubsidiaries, provided that they operate in a safe and sound manner.U.S. lawalsoallowswell-managed and well-capitalizedforeign bankstoconduct a wide range of bank and nonbank activities in the United Statesunder conditions comparable to those applied to U.S. bankingorganizations.Still, it isworth noting that even as there hasbeen continuity in thisbasicpolicy, U.S. regulation of foreign bankshas evolvedover the yearsinresponseto changesin the extent and nature of foreign bank activities.Let me mention two examples.Before1978, foreign bank branchesin the United Stateswerelicensed andregulated byindividual states, with littlein the way of federal regulationor restrictions.They were not subject to the full panoplyof limitations on interstatebanking, equity investments, or affiliations with securitiesfirmsthat wereapplicableto domestic banks.The rapid growth of foreign banking in the 1970s, particularlybranching, prompted an end to this lighter regulatory regime.The International Banking Act of 1978gave the Federal ReserveBoardregulatory authority over the domestic operationsof foreign banksandsignificantly equalized regulatory treatment of foreign and domesticfirms.Congressmaintained thisapproach of basic competitive equalityin the1999 Gramm-Leach-BlileyAct.That law substantiallyremoved restrictions on affiliations betweencommercial banksand other kindsof financial firms for both domesticand foreign institutions operating in the United States.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  14. 14. 14Moreover, in light of provisions in Gramm-Leach-Blileythat permitted aforeign bank to be a financial holding company (FH C), the FederalReserveannounced in 2001that a bank holdingcompany (BH C) in theUnited Statesthat was owned and controlledby a well-capitalizedandwell-managed foreign bank generallywould not berequired to meet theBoardscapital requirements normallyapplicableto BH Cs.My second example relatesto the massive fraud uncovered at the Bank ofCredit and Commerce International (BCCI) and its subsequentcollapsein 1991, which highlighted the need for more effective supervision ofbanksoperating in multiple countries.The Foreign Bank Supervision Enhancement Act of 1991(FBSEA)required foreign banksto receive approval from the Board beforeestablishing a branch or agency in the United States.The lawrequired the Federal Reserve, in turn, to determine that theforeign bank issubject to "comprehensive supervision or regulation on aconsolidated basis" in its home country before approving an applicationeither to open a branch or to acquire a U.S. subsidiary bank.It is further worth noting that changesin U.S. law and regulatory practiceaffecting foreign banking organizations have often corresponded tochangesin international regulatory agreements.For example, FBSEA was enacted at the same time as the BaselCommittee on Banking Supervision was working to addresstheproblemsrevealed by BCCI--an effort that bore fruit the next year in changesto theso-called Basel Concordat, which established minimum standardsfor thesupervision of international banking groups.Another instance was the substantial reduction or removal of remainingasset-pledge and asset-maintenance requirementsfor most U.S. branchesof foreign banks, prompted in part by implementation of the newinternational capital standardsincluded in the 1988 Basel Accord.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  15. 15. 15TheShift in ForeignBank ActivitiesAlthough foreign banksexpanded steadily in the United Statesduring the1970s, 1980s, and 1990s, their activities hereposed limited risksto overallU.S. financial stability.Throughout thisperiod, the U.S. operationsof foreign bankswere largelynet recipientsof funding from their parentsand generallyengaged intraditional lending to home-country and U.S. clients.U.S. branchesand agenciesof foreign banksheld large amounts of cashduring the 1980sand 90s, in part to meet asset-maintenance andasset-pledgerequirementsput in placeby regulators.Their cash-to-third-party liability ratio from the mid-1980s through thelate1990sgenerallyranged between 25 percent and 30 percent.The U.S. branchesand agencies of foreign banksthat borrowed fromtheir parentsand lent those fundsin the United States ("lendingbranches") held roughly 60percent of all foreign bank branch and agencyassetsin the United Statesduring the 1980sand 90s.Commercial and industrial lending continued to account for a large partof foreign bank branch and agency balance sheetsthrough the 1990s.This profile of foreign bank operationsin the United Stateschanged inthe run-up to the financial crisis.Reliance on lessstable, short-term wholesalefunding increasedsignificantly.Many foreign banksshifted from the "lendingbranch" model to a"funding branch" model, in which U.S. branchesof foreign bankswereborrowing large amounts of U.S. dollarsto upstream to their parents.These "funding branches" went from holding 40 percent of foreign bankbranch assetsin the mid-1990s to holding 75 percent of foreign bankbranch assetsby 2009.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  16. 16. 16Foreign banksas a group moved from a position of receiving fundingfrom their parentson a net basisin 1999 to providing significant fundingto non-U.S. affiliatesby the mid-2000s--more than $700 billion on a netbasisby 2008.A good bit of thisshort-term funding wasused to finance long-term, U.S.dollar-denominated project and trade finance around the world.There isalsoevidence that a significant portion of the dollarsraised byEuropean banksin the pre-crisisperiod ultimately returned to the UnitedStatesin the form of investments in U.S. securities.Indeed, the amount of U.S. dollar-denominated asset-backed securitiesand other securitiesheld by Europeansincreased significantly between2003 and 2007, much of it financed by the short-term, dollar-denominatedliabilitiesof European banks.Meanwhile, commercial and industrial lending originated by U.S.branches and agencies as a share of their third-party liabilities fellsignificantly after 2003.In contrast, U.S. broker-dealer assetsof the top-10 foreign banksincreased rapidlyduring the past 15 years, rising from 13 percent of allforeign bank third-party assetsin 1995 to 50percent in 2011.Lessonsfrom the RecentFinancialCrisisThe 2007–2008financial crisis and the continuing financial stressinEurope have revealedfinancial stability risksassociated with the foreignbanking model asit has evolvedin the United States.To some extent the concernsassociated with foreign banking operationstrack the more general shortcomings of pre-crisisfinancial regulation.Internationallyagreed minimum capital levelswere too low, the qualitystandardsfor required capital were too weak, the risk weightsassigned tocertain asset classesdid not reflect their actual risk, and the potential forliquidity strains was seriouslyunderappreciated.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  17. 17. 17But some risksare more closelytied to the specificallyinternationalcharacter of certain global banks, both here and in some other partsof theworld.The location of capital and liquidity proved critical in the resolution ofsome firms that failed during the financial crisis.Capital and liquidity were in some cases trapped at the home entity, as inthe case of the Icelandic banksand, in our own country, LehmanBrothers.Actionsbyhome-countryauthoritiesduring thisperiod showed that whilea foreign bank regulatory regime designed to accommodate centralizedmanagement of capital and liquidity can promote efficiency during goodtimes, it alsoincreasesthe chancesof ring-fencing by home and hostjurisdictions at the moment of a crisis, as local operations come underseverestrain and repayment of local creditors is calledinto question.Resolution regimes and powersremain nationallybased, complicatingthe resolution of firms with large cross-border operations.The large intra-firm, cross-border flowsthat grew rapidlyin the yearsleading up to the crisis alsocreated vulnerabilities.To be fair, the ability to move liquidity freelythroughout a banking groupmay have provided some financial stability benefitsduring the crisis byenabling banksto respond to localizedbalance-sheetshocksanddysfunctional markets in some areas (such as the interbank and foreignexchange swap markets) and by transferring resourcesfrom healthierpartsof the group.Nevertheless, thismodel alsocreated a degree of cross-currencyfundingrisk and heavy relianceon swap markets that proved destabilizing.Moreover, foreign banksthat relied heavily on short-term, U.S. dollarliabilitieswere forced to sell U.S. dollarassetsand reduce lending rapidlywhen that funding source evaporated, thereby compounding risksto U.S.financial stability.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  18. 18. 18Although the United Statesdid not suffer adestabilizing failure of foreignbanks, many rode out the crisis onlywith the helpof extraordinarysupport from home- and host-country regulators.Following national treatment practice, the Federal Reserve itself providedsubstantial discount window access to U.S. branches and the opportunityto participate in the Primary Dealer Credit Facility to U.S. primary-dealersubsidiariesof foreign banks.Moreover, thepotential for fundingdisruptionsdid not disappear with thewaning of the global financial crisis.In 2011, for example, as concernsabout the eurozone rose, U.S. moneymarket fundssuddenly pulled back their lending tolarge euroareabanks, reducing lendingto these firms by roughly $200 billion over justfour months.Whilethere has been some reduction in operations and some change infunding patternsby foreign banking organizations in the United Statessince the crisis, particularly by European firms reacting to euro zonefinancial stress, the basic circumstances havenot changed.The proportion of foreign banking assetsto total U.S. banking assetshasremained at about one-fifth since the end of the 1990s.But the concentration and complexity of those assetshave changednoticeably from earlier decades, and have not reversed in recent yearsdespite the global financial crisisand subsequent events.Ten foreign banksnow account for more than two-thirds of foreign bankthird-party assetsheld in the United States, up from 40 percent in 1995.And while the largest U.S. operationsof foreign banksdo not approachthe size of our largest domestic financial institutions, it isstriking thatthere are 23 foreign bankswith at least $50 billion in assetsin the UnitedStates--the thresholdestablished by the Dodd-Frank Act for specialprudential measuresfor domestic firms--compared with 25 U.S. firms.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  19. 19. 19Most notably, perhaps, fiveof thetop-10 U.S. broker-dealersareownedbyforeign banks.Like their U.S.-owned counterparts, large foreign-owned U.S.broker-dealerswere highly leveraged in the years leading up to thecrisis.Their reliance on short-term funding alsoincreased, with much of theexpansion of both U.S.-owned and foreign-owned U.S. broker-dealeractivities attributable to the growth in secured funding markets duringthe past 15 years.Finally, we should note that one of the fundamental elementsof thecurrent approach--our ability, ashost supervisors, to rely on the foreignbank to act asa source of strength to itsU.S. operations--has come intoquestion in the wake of the crisis.The likelihood that some home-country governments of significantinternational firmswill backstoptheir banks foreign operationsin a crisisappearsto have diminished.It alsoappearsthat constraints have been placed on the ability of thehome officesof some large international banksto provide support to theirforeign operations.The motivations behind these actions are not hard to understand andappreciate, but theydo affect the supervisoryterrain for host countriessuch as the United States.International andDomesticRegulatoryResponseSince the crisis, important changeshave been made to strengtheninternational regulatory standards.TheBasel III capital and liquidity frameworksare big improvements, andthe proposed capital surchargesfor systemicallyimportant firms will beanother important step forward.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  20. 20. 20But thesereforms are primarily directed at the consolidated level, withlittleattention to vulnerabilitiesposed by internationallyactive banksinhost markets.The risksassociated with large intra-group funding flowshave remainedlargelyunaddressed.Managing international regulatory initiatives alsohasbecome moredifficult, as the number of complex items on the agenda has increased.And despite continued work by the Financial Stability Board, challengesto cross-border resolution are likelyto remain significant.For the foreseeablefuture, then, our regulatory system must recognizethat while internationally active bankslive globally, they may well dielocally.Quite apart from the need to act pragmatically under thecircumstances, it isnot clear that we shouldaim toward extensiveharmonization of national regulatory practicesrelated to foreign bankingorganizations.The nature and extent of foreign banking activities vary substantiallyacrossnational markets, suggesting that regulatory responsesmight bestvary aswell.For instance, the importance of the U.S. dollar in many internationaltransactions can motivate foreign banksto use their U.S. operationstoraise dollar funding for their international operations, potentially creatingvulnerabilities.Such a model isunlikely to prevail in most other host financial marketsaround the world.Indeed, in responseto financial stability riskshighlighted during thecrisis, ongoing challengesassociated with the resolution of largecross-border firms, and thelimitationsof the international reformagenda, several national authorities have alreadyintroduced their ownpoliciestofortify the resourcesof internationally active bankswithin theirgeographic boundaries.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  21. 21. 21Regulatorsin the United Kingdom, for example, have recentlyincreasedrequirements for liquidity to cover local operations of domestic andforeign banks, set stricter rulesaround intra-group exposuresof U.K.banksto foreign subsidiaries, and moved to ring-fence home-countryretail operations.Meanwhile, Swiss authorities have explicitly prioritized the domesticsystemically important operations of their large, internationally activefirms in resolution.H ere in the United States, Congressincluded in the Dodd-Frank Act anumber of changesdirected at the financial stability risk posed byforeignbanks.Sections165 and 166 instruct the Federal Reserveto implement enhancedprudential standards for large foreign banksaswell asfor large domesticBH Csand nonbank systemicallyimportant financial institutions.Dodd-Frank alsobolstered capital requirements for FH Cs, includingforeign FH Cs, by extending the well-capitalizedand well-managedrequirements beyond U.S. bank subsidiaries to the top-tier holdingcompany.In addition, the so-calledCollinsAmendment in Dodd-Frank removedthe exemption from BH C capital requirements granted by the FederalReservesSupervision and Regulation Letter 01-01.The required phase-out of SR 01-01was clearlyintended tostrengthen thecapital regime applied to the U.S. operationsof foreign banks;however, theorganizational flexibility that the amendment gave to foreignbanksin the United Stateshas allowedsome large foreign bankstorestructuretheir U.S. operations to minimize the impact of thisregulatorychange.As a result, in the absenceof additional structural requirementsforforeign banksin the United States, the effectivenessof our capital regimefor large foreign bankswith both bank and nonbank operationsin theUnited Statesdependson the foreign banksown organizational choices.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  22. 22. 22ARebalancedApproachto ForeignBank RegulationAs hasbeen the casein the past, we need to adjust theregulatoryrequirements for foreign banksin responseto changesin the nature oftheir activities in the United States, the risksattendant to thosechanges, and instructionsfrom Congressin new statutory provisions.The modified regime should counteract the risks posed to U.S. financialstability by the activities of foreign banking organizations, as manifestedin the years leading up to, and through, the financial crisis.Special attention must be paid to the risk of runsassociated withsignificant relianceon short-term funding.In addition, the regime shouldreduce the difficultiesin resolution ofcross-border firms.Finally, it should take steps to diminish the potential need for ex-postring-fencing when losses mount or runs develop during a crisis, sincesuch actions may well be unhelpfullyprocyclical.At the same time, in modifying our regulatory regime for foreign bankingorganizations, we must remain mindful of the benefitsthat foreign bankscan bring to our economy and of the important policiesof nationaltreatment and comparable competitive opportunity.Thus, we shouldchart a middle course, not moving to a fullyterritorialmodel of foreign bank regulation, but instead making targetedadjustmentsto addressthe risksI have identified.In basic terms, three such adjustmentsare desirable.First, a more uniform structureshould berequired for the largest U.S.operations of foreign banks--specifically,that these firms establish atop-tier U.S. intermediate holding company (IH C) over all U.S. bank andnonbank subsidiaries.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  23. 23. 23An IH C would make application of enhanced prudential supervisionmore consistent acrossforeign banksand reduce theability of foreignbanksto avoid U.S. consolidated-capital regulations.BecauseU.S. branchesand agenciesare part of the foreign parentbank, they would not be included in the IH C.H owever, they would be subject to the activity restrictions applicabletobranchesand agencies today as well as to certain additional measuresdiscussed below.Second, the same capital rulesapplicableto U.S. BH Csshould also applyto U.S. IH Cs.These rules have been reshaped to counteract the risks to the U.S.financial system revealed by the crisis and should be implementedconsistentlyacrossall firms that engage in similar activities.Similarly, other enhanced prudential standardsrequired by theDodd-Frank Act--including stresstesting requirements, riskmanagement requirements, single counterparty credit limits, and earlyremediation requirements--should be applied to the U.S. operations oflarge foreign banksin a manner consistent with theBoards domesticproposal.Third, there should be liquidity standardsfor large U.S. operationsofforeign banks.Standardsare needed to increase the liquidity resiliency of theseoperationsduring timesof stressand to reducethe threat of destabilizingrunsas dollarfunding channelsdry up and short-term debt cannot berolledover.For IH Cs, the standards should be broadly consistent with the standardsthe Federal Reserve has proposed for large domestic BH Cs, pending finaladoption and phase-in of quantitative liquidity requirements by the BaselCommittee.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  24. 24. 24That is, they should be designed to ensurethat, in stressedcircumstances, the U.S. operations have enough high-quality liquidassetsto meet expected net outflowsin the short term.There should alsobe liquidity standardsfor foreign bank branch andagency networks in the United States, although they may be lessstringent, in recognition of the integration of branchesand agencies intothe global bank as a whole.By imposing a more standardized regulatory structure on the U.S.operations of foreign banks, we can ensurethat enhanced prudentialstandardsare applied consistently acrossforeign banksand incomparable waysbetween U.S. banking organizations and foreignbanking organizations.As with domestic firms subject to enhanced prudential standards, theFederal Reserve would work to ensurethat the new regime is minimallydisruptive, through transition periodsand other means.An IH C structure would alsoprovide the Federal Reserve, asumbrellasupervisor of the U.S. operations of foreign banks, with a uniformplatform to implement a consistent supervisory program acrosslargeforeign banks.In the caseof foreign bankswith thelargest U.S. operations, the IH Cwouldalsohelp mitigate resolution difficulties by providing U.S.regulatorswith one consolidated U.S. legal entity to placeintoreceivership under title II of the Dodd-Frank Act if the failure of theforeign bank would threaten U.S. financial stability.Branchesand agencies would remain separate, but all other entitieswould be included.Further, an IH C structure would facilitate a consistent U.S. capitalregime for bank and nonbank activities of foreign banksunder theIH C, similar to the approach taken in other jurisdictions, such as theUnited Kingdom and some continental European countries.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  25. 25. 25Some observerswill, I am sure, ask if it is necessary to depart from theprevailing firm-by-firm approach to foreign banking regulation and toadopt generallyapplicablerequirements in implementing theDodd-Frank enhanced prudential standardsfor foreign banks.It is difficult to seehow relianceon thisapproach can beeffective inaddressing risksto U.S. financial stability, at least in the absence ofextraterritorial application of our own standardsand supervision, andperhapsnot even then.We would, at a minimum, need to make regular and detailed assessmentsof each firms home-country regulatory and resolution regimes, thefinancial stability risk posed by each firm in the United States, and thefinancial condition of the consolidated banking organization.In fact, such an approach might result in the worst of both worlds--anongoing intrusivenessinto the consolidated supervision of foreign banksby their home-country regulatorswithout the ultimate ability to evaluatethose bankscomprehensivelyor to direct changesin a parent bankspracticesnecessaryto mitigate risksin the United States.Although the Federal Reservewill continue to cooperate with its foreigncounterpartsin overseeing large, multinational banking operations, thatsupervisorytool cannot provide complete protection against risksengendered by U.S operations asextensive asthose of many large U.S.institutions.It is alsoimportant to note that while the reformsI have described todaycontain some elementsthat are more territorial than our currentapproach, including requiring some additional capital and liquiditybuffersto be held in the United States, they do not represent a completedeparture from prior practice.This enhanced approach would allowforeign banksto continue tooperatebranchesin the United Statesand would generallyallowbranchesto meet comparable capital requirementsat the consolidated level.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  26. 26. 26Similarly, thisapproach would not impose a cap on intra-groupflows, thereby allowing foreign banksin sound financial condition tocontinuetoobtain U.S. dollar fundingfor their global operationsthroughtheir U.S. entities.It would instead provide an incentive to term out at least some of thisfunding in a way that reducesthe risk of runs.Requiring additional local capital and liquidity buffers, like anyprudential regulation, may incrementally increase cost and reduceflexibilityof internationally active banksthat manage their capital andliquidity on a centralized basis.H owever, managing liquidity and capital on a local basiscan havebenefitsnot just for financial stability generally, but alsofor firmsthemselves.During the crisis, the more decentralizedglobal banksrelied somewhatlesson cross-currencyfunding and were lessexposed to disruptions ininternational wholesalefunding and foreign exchange swap marketsthanthe more centralized banks.Indeed, asnoted earlier, in the wake of the crisisand of subsequentstresses, many foreign bankshave modified their funding practicesandbusinessmodels.In revamping our approach, we will both be guarding against a return topre-crisispracticesand, more generally, ensuring that foreign bankingoperations in the United Statesthat pose potential risksto U.S. financialstability are regulated similarly to domestic banking operations posingsimilar risks.ConclusionThe imperative for change in our foreign bank regulation isclearand, indeed, mandated by Dodd-Frank.Of course, I have provided only an outline of the threekey measuresthatwill best navigate the middle courseI have suggested.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  27. 27. 27The all-important detailsare under discussion at theBoard.I anticipatethat in thecoming weekswe will completeour work and issuea notice of proposed rulemaking that will elaboratethe basic approach Ihaveforeshadowed.I look forward to hearing your general reactionstoday and more specificfeedback after the Board has adopted a proposed rule.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  28. 28. 28OpportunitiesfacingIslamicfinanceandchallengesin managingcapitalflowsinAsiaOutline of special addressby Mr TharmanShanmugaratnam, Chairman of the MonetaryAuthority of Singapore, at the 8th World IslamicEconomic Forum, Johor Bahru, MalaysiaThe Prime Minister of Malaysia, H is ExcellencyDato‘ Sri Najib Tun Razak, The President ofComoros, H isExcellencyIkililou Dhoinine, ThePresident of the Islamic Development Bank, H isExcellencyAhmad Mohamed Ali, Chairman of the World IslamicEconomic Forum Foundation Tun Musa H itamMinisters and distinguished guests, Ladiesand gentlemenIntroductionIt is my pleasure to be here today and have the opportunity to share somethoughts.Let me first congratulate the WIEF on the progressit has made inestablishing itself asa leading international forum for economic leadersand opinion shapersfrom a broad range of countriesto discussissuesofinterest in Islamic Finance and related themes in global finance.The theme of the Forum, ―Changing Trends, New Opportunities‖ isparticularlyrelevant.Allow me to first offer a brief perspective on opportunities facing Islamicfinance.I will then go on to talk about the challengeswe face in Asia in managingcapital flowsin the aftermath of the Global Financial Crisis.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  29. 29. 29Islamicfinance:opportunitiesfor growthThe Islamic finance industry is estimated to have grown by some 19% peryear since 2006 – to record nearly US$1.3 trillion of total shariah compliantassetsin 2012.But there is still considerablescope for itsdevelopment:•Islamic finance presentlyformslessthan 1% the global financialindustry.•For a large number of countries, even in jurisdictions with substantialMuslim populations, Islamic finance currentlyconstituteslessthan 5% oftheir financial sector.•And despite a record level of sukuk issuance in 2012, the industry as awholeisstill largelyconcentrated on the banking sector.There is much ahead in the journey to developIslamic capital marketsand the takaful (Islamic insurance) industry.I believe thenext 10–15yearsoffer significant opportunitiesfor the growthand diversification of Islamic finance.Let me highlight thereasonsto be optimistic about itsprospects:•First, Islamic financial institutions have in the main escaped significantdamage in the global financial crisis.They are well-placedtogrow, at a time when many of the globalbanks, especiallythe European banks, are deleveraging or focusing onconsolidating their balancesheets.•Second, Islamic finance has much potential to diversify into new growthareas such as trade and infrastructure financing in Asia and the emergingmarkets.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  30. 30. 30These new areas will allow Islamic banks to reduce their exposure to thereal estate sector, and to take advantage of the stronger growth potentialof the emerging market economies.There are gapsto be filledin structured trade finance and in funding forinfrastructural projectsasthe emerging markets grow, and as globalfinance consolidates.•Third, Islamic finance can alsoseek to meet the increased demand forsimpler and more transparent productsand ‗back-to-basics‘finance.Investorsare now much more circumspect about complex productsandtheir risks.Thecrisistaught investorsworldwidenot only about thedamagetheycanface from the risksthat are known and unsurprising, but of the risksof‗what we do not know‘.Islamic finance, with itsfocuson transparency, price certainty andrisk-sharing, can ride this wave of demand for simpler and more basicinvestments.H owever, Islamic finance will have to overcome a few importantchallengesin order to grow itsshare in global finance and contribute tocross-border finance.These include the need to reducefragmentation in Islamic financemarkets due to differencesin accepted standardsof Shariah compliancebetween regions, jurisdictions, and in some caseseven domesticallywithin jurisdictions.This has hampered the flowof liquidity between jurisdictions, and isinpart why there is yet no Islamic equivalentsto the international moneyand bond markets.There isconsiderableprogressbeing made to addressthese challenges.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  31. 31. 31Bodiessuch as AAOIFI, IDB‘sIslamic Research & TrainingInstitute, and Malaysia‘sInternational Shariah Research Academy(ISRA) have made significant effortsto narrow the differencesinacceptability of Shariah compliance.The Islamic Financial ServicesBoard (IFSB), in conjunction withinternational standardssetting bodiessuch asthe Bank of InternationalSettlements(BIS), IOSCO and IAIS and various regulatorsfrom Islamicand conventional jurisdictions, are alsoformulating internationalstandardsand best practicesfor the industry.Islamic finance is alsoseeing increasing interest in Asia.We are seeing financial institutions leveraging on the strengthsandexpertise that have been developedin both Islamic and conventionalfinancial markets.This isexpanding the range of Shariah-compliant productsand allowingthe Islamic finance industry to tap on broad and deep investor poolsgloballyand in Asia.•Malaysia is widely recognised as a leader in Islamic finance, inparticular for the issuanceof sukuks.•Islamic finance is alsoseeing growing interest in other Asian financialcentressuch as Singapore, H ong Kong and Tokyo.•Just recentlyin mid-November 2012, institutional and private investorsin Singapore and H K were the largest investorsin the US$15.5 billionglobal sukuk issued by the Abu Dhabi Islamic Bank (ADIB).•Between our two countries, we are seeing Malaysian bankscollaboratingwith Singapore corporatesand financial players tostructureS$denominated corporate sukuk programmes.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  32. 32. 32And Singapore-listed companies are venturing out to tap the Ringgitsukuk market in Malaysia.These are trendsthat we are keen to encourage.To repeat therefore, I am optimistic that we can realisethe significantgrowth potential for Islamic finance in the next 10–15 years.Managingthe challengeof capital flowsin the post-crisiseraLet me move on now to say a few things about the challengesthat manyin the emerging world face in managing capital flows, particularly in theface of the extremelylow interest ratesbeing set in the advancedeconomies (AEs).We are in an unprecedented situation.Interest ratesare expected to stay extremelylow in the USand much ofthe advanced world for a few years, reflecting decisionsby their centralbanksto keep monetary conditions highly accommodative until theireconomies resume normal growth.There isdebate among economists on how effective these activistmonetary policies, such as the USFed‘sQE3 strategy, will be in revivingentrepreneurial spirits and rivate investments.If the strategy succeedsand the US economy recovers, it will be a plusfor Asia aswell.In themeantime, however, thereare significant implicationsfor emergingmarket economies, as global investorssearch for better returns – betterthan the near-zero ratesthey get on cash and treasury bills.With large amountsof liquidity now moving between markets, short-termshiftsin investor sentiment leadsto volatility in capital flows.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  33. 33. 33We have seen how a shock in the European periphery can send moneythat was invested in emerging markets rushing back to the US or othersafe havens.To be clear about it, there isa lot that is good about capitalflows, including even short term flows.They add liquidity to markets, by bringing more buyers and sellerstogether.H owever, weknowtoo that capital inflowscan alsobe toomuch of agoodthing.They can lead to asset prices, or exchange rates, becoming disconnectedfrom fundamentals.And the sudden withdrawal of capital from emerging economieswheninvestorsswitch from ‗risk on‘to ‗risk off‘ in their portfolios can bedestabilising.As I mentioned, the current global condition isunprecedented.The policy responsesin the advanced countries too are withoutprecedent.Globallytherefore, we need some humility in understanding the benefitsand costsof QE3 and easy monetary policiesin the advanced countries.But it will be wise to strengthen our policy toolkitsin Asia, so that we candeal with unpredictableand often excessivecapital flows.There are some lessonsthat come out of our experiencesin Asia andelsewhere, and policy responsesthat we can learn from each other.I will mention three setsof policy responsesthat will inevitably have tofigure in our toolkits.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  34. 34. 34First, there ismuch sense in curtailing volatility in the exchange rate overthe short-term.The costs of volatile and uncertain exchange rates are high in small openeconomies especially – which is what most of our ASEAN economies are.Accordingly, Malaysia, Singapore and several other Asian countries havenotfelt comfortableleaving their exchangeratesentirely to market forces.Their central banks, within each of their monetary policyframeworks, have sought to instil a focuson longer termfundamentals.There ismerit in allowing exchange ratesin Asia‘s emerging economiesto appreciate graduallyover the long term, reflecting their more rapidgrowth.If we resist these long term trends, we are likelyto see more inflation inour economies.But some stability in the short term is wise.Second, macro-prudential policiesare now an important part of thepolicytool kit.ManyAsian countrieshave introduced new macro-prudential measurestotry and avoid bubblesin their property markets over the last two years.Malaysia brought in stricter limits on loan-to-valueratios on housingloans.Singapore and H ong Kong have done similarly, and have introducedadditional stamp dutiesor transaction taxesto discourage speculativedemand for residential properties.These targeted administrative and prudential measuresare notconventional macro-economic tools.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  35. 35. 35But they are likelyto remain part of our policy toolkit, at least forthe foreseeablefuture, given the real risksto macro-economic stabilitythat an environment of very lowglobal interest ratesposes.A third and more fundamental strategy hasto focuson building greaterdepth in Asia‘s capital markets, while ensuring that our banking systemsremain sound.A good example of thisstrategy isin fact in Malaysia.Bank Negara‘sFinancial Sector Blueprint II (2012–2020), released aspartof the government‘s Economic Transformation Programme (ETP), willbuild on the solid foundations of Malaysia‘sfinancial system, includingdevelopinga deep and vibrant bond market.The banksin several leadingAsian countries, including Malaysia andSingapore, are generallywell-managed and well-capitalised.They were a sourceof strength for usduring the global financial crisis.H owever, Asia‘s capital markets, and especiallythe corporatebond markets, need much more depth.Broader and deeper capital markets will allowinvestorsto invest for thelong term while hedging against risks.They will helpusmeet the growing infrastructural and other long terminvestment needsof the region.Thisisthereforea very important priority in theregion, and thereisin factsignificant scope for futuredevelopment of Asian capital markets.Regulatorsare working to harmonise rulesand market practicesacrossthe region, such as issuance proceduresand settlement standards.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  36. 36. 36We alsoneed to develop the securitisation markets, with appropriatesafeguards, so that bankscan recycle their capital.More too is being done to boost linkagesbetween our markets andeconomies.We have to pool liquidity acrossour markets, soas to add depth to theAsian capital market.An exampleishow the Malaysian stock exchange, Bursa Malaysia, theSingapore Exchange and the Stock Exchange of Thailand recentlylaunchedan ASEAN Trading Link.Weare alsocooperating toencouragefinancing for infrastructureprojectsin the region.The ASEAN Infrastructure Fund (AIF), an initiative that was led byMalaysia, isa good example.It will pool resources, knowledge and experienceamong ASEANgovernments and the Asian Development Bank (ADB) for loanstosovereign or sovereign-guaranteed infrastructure projects.The Fund will alsoissue bonds, soas to bring in private sector andinstitutional investors.Another example of such cooperation in the region is the CreditGuarantee and Investment Facility (CGIF) amongst the ASEAN+3countries, which aims to help companiesin ASEAN+3 countriesraiselong term financing for infrastructure investment by providing thegovernments‘ guarantees on their corporate bonds, thereby reducing riskfor bond-holders.Projectssuch asIskandar Malaysia are alsoa prime example of howintra-regional investmentscan be encouraged, and how countriesin ourregion can developcompetitive strengthsjointly.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  37. 37. 37•Iskandar Malaysia‘sperformance has been impressive – poised to exceeditstargeted RM100billion investment mark bytheend of thisyear.•I am glad there is good progresson the joint ventureby TemasekH oldingsand Khazanah Nasional, Pulau Indah VenturesSdn Bhd toco-developtwo separate sitesin Medini.•Other significant projectsinclude a S$1.5 billion integrated eco-friendlytech-park byAscendas and Malaysia‘sUEM Land Berhad in Nusajaya(one of the five flagship zonesin Iskandar).Once completed, the park will accommodate a range ofindustriesincluding electronicsand precision engineering.•Just in the last month, we have seen other significant investmentcommitments in Iskandar reported by Singapore companies.Iskandar Malaysia will enhance the complementary space between ourtwo economies.It is a win-win.To ensure continued progressin Iskandar, Singapore and Malaysia willcontinue to take stepsto improve connectivity, cross-border tradefacilitation, and immigration processes.ConclusionI would like to conclude by emphasising once again that I am basicallyoptimistic about the prospectsin our bilateral and regional cooperation.We face many challengesin this post-Global Financial Crisis era.But theopportunitiesfor usin Asia are intact, and our ability tocooperatewith each other to achieve our full potential as a region isan asset for allour countries.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  38. 38. 38ResolvingGloballyActive, SystemicallyImportant, FinancialInstitutionsAjoint paper by theFederal Deposit InsuranceCorporationand theBankof EnglandResolving GloballyActive, SystemicallyImportant, Financial InstitutionsFederal Deposit InsuranceCorporation and the Bank of EnglandExecutivesummaryThe financial crisis that began in 2007 hasdriven home the importance ofan orderlyresolution processfor globallyactive, systemicallyimportant, financial institutions (G-SIFIs).Given that challenge, the authorities in the United States(U.S.) and theUnited Kingdom (U.K.) have been workingtogether todevelop resolutionstrategies that couldbe applied to their largest financial institutions.These strategies have been designed to enablelargeand complexcross-border firms to be resolvedwithout threatening financial stabilityand without putting public fundsat risk.This work has taken place in connection with the implementation of theG20 Financial Stability Board‘sKeyAttributes of Effective ResolutionRegimes for Financial Institutions.The joint planning has been productive and effective.It has enhanced the resolution planningprocessin bothjurisdictions, tackled key issuesin relation to cross-bordercoordination, and identified potential challengesthat will be addressedthrough further work.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  39. 39. 39This paper focuses on the application of ―top-down‖ resolution strategiesthat involve a single resolution authority applying its powers to the top ofa financial group, that is, at the parent company level.Thepaper discusseshowsuch a top-downstrategycould beimplementedfor a U.S. or a U.K. financial group in a cross-border context.In the U.S., thestrategy has been developed in the context of the powersprovided bythe Dodd-Frank Wall Street Reform and ConsumerProtection Act of 2010.Such a strategy would applya single receivership at the top-tier holdingcompany, assign lossesto shareholdersand unsecured creditors of theholding company, and transfer sound operating subsidiaries to a newsolvent entity or entities.In the U.K., the strategy has been developedon the basisof the powersprovided bythe U.K. Banking Act 2009 and in anticipation of the furtherpowersthat will be provided by the European Union Recovery andResolution Directive and the domestic reforms that implement therecommendations of the U.K.Independent Commission on Banking. Such a strategy would involve thebail-in (write-down or conversion) of creditors at the top of the group inorder to restore the wholegroup to solvency.Both the U.S. and U.K. approachesensure continuity of all criticalservicesperformed by the operating firm(s), thereby reducing risks tofinancial stability.Both approachesensure activities of the firm in the foreign jurisdictionsin which it operatesare unaffected, thereby minimizing riskstocross-border implementation.The unsecured debt holderscan expect that their claimswould be writtendown to reflect anylossesthat shareholderscannot cover, with someBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  40. 40. 40converted partly into equity in order to provide sufficient capital to returnthe sound businessesof the G-SIFI to private sector operation.Sound subsidiaries (domestic and foreign) would be kept open andoperating, thereby limiting contagion effectsand cross-bordercomplications.In both countries, whether during execution of the resolution orthereafter, restructuring measuresmay be taken, especially in the partsofthe businesscausing the distress, including shrinking those businesses,breaking them into smallerentities, and/ or liquidating or closing certainoperations.Both approacheswould be accompanied by the replacement of culpablesenior management.This paper outlinesseveral common considerationsthat affect theseparticular approachestoresolution in the U.S. and the U.K., including theneed to ensuresufficient lossabsorbencyat the top of the group.TheFederal Deposit InsuranceCorporationand theBank of England willcontinue to work together on these resolution strategies.ResolvingGloballyActive, SystemicallyImportant, FinancialInstitutions, FederalDeposit InsuranceCorporation and theBank of EnglandIntroduction1The Federal Deposit InsuranceCorporation (FDIC) and the Bank ofEngland—together with the Board of Governorsof the Federal ReserveSystem, the Federal ReserveBank of New York, and the FinancialServicesAuthority—have been working to develop resolution strategiesfor the failure of globallyactive, systemicallyimportant, financialinstitutions (SIFIsor G-SIFIs) with significant operationson both sidesof the Atlantic.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  41. 41. 41This work has taken placein connection with the implementation of theFinancial Stability Board‘s(FSB) KeyAttributes of Effective ResolutionRegimes for Financial Institutions (Key Attributes), as well asinconnection with thereforms to the legal arrangements for handling thefailure of financial institutions that were instituted in the United States(U.S.) and the United Kingdom (U.K.) in responseto the recent financialcrisis.2The goal isto produce resolution strategies that could be implementedfor the failure of oneor more of the largest financial institutions withextensiveactivities in our respective jurisdictions.These resolution strategies should maintain systemicallyimportantoperations and contain threatsto financial stability.Theyshould alsoassign lossestoshareholdersand unsecured creditorsinthe group, thereby avoiding the need for a bailout bytaxpayers.Thesestrategiesshould be sufficientlyrobust tomanagethechallengesofcross-border implementation and to the operational challengesofexecution.3As highlighted in the FSB‘srecentlypublished draft Guidance onRecovery and Resolution Planning, strategies for resolutionmay broadlybe categorized as either applying resolution powers to the top of a groupby a single national resolution authority (single point of entry), orapplying resolution toolsto different parts of the group by two or moreresolution authorities acting in a coordinated way (multiplepointsofentry).Which strategy ismost suitable to resolving the group will depend upon arange of factors.For example, a single point of entry strategy may offer the simplest andmost effectivechoice if thedebt issued at thetop of the group issufficientto absorb the group‘slosses.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  42. 42. 42Where thisis not the case, a multiplepointsof entry strategy will be moresuitable, particularlyif different partsof the group can continue on astandalonebasis.4The focusof thispaper ison a single point of entry resolution approach.It is hoped that thedetail it provides on the single point of entryapproach, when combined with the publishedFSB Guidance onRecovery and Resolution Planning, will give greater predictability formarket participants about how resolution authorities may approach aresolution.This predictability cannot, however, be absolute, asthe resolutionauthorities must not be constrained in exercising discretion in pursuit oftheir statutory objectivesin how best to resolvea firm.Post-crisisresolution strategy5The financial crisisthat began in late 2007 highlighted the shortcomingsof the arrangements for handling the failure of large financial institutionsthat were in placeon either side of the Atlantic.Large banking organizations in both the U.S. and the U.K. had becomehighly leveraged and complex, with numerousand dispersed financialoperations, extensiveoff-balance-sheet activities, and opaque financialstatements.These institutions were managed as single entities, despite theirsubsidiariesbeing structured as separate and distinct legal entities.They were highly interconnected through their capital marketsactivities, interbank lending, payments, and off-balance-sheetarrangements.6The legislative frameworks and resolution regimes at the time wereill-suited to dealing with financial institution failures of this scale andinterconnectedness.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  43. 43. 43In the U.S., theFDIC only had thepower to placean insured depositoryinstitution into receivership; it could not resolve failed or failing bankholding companies or other nonbank financial companies that posed asystemic risk.In theU.K., until 2009there wasnospecial resolution regime availableforbanksor other financial companies, whatever their size orcomplexity, and asa result the U.K. was reliant on standard insolvencyproceduressuch as administration.7As demonstrated by the Title I requirement of the Dodd-Frank WallStreet Reform and Consumer Protection Act of 2010 (Dodd-FrankAct), the U.S. would prefer that large financial organizations beresolvablethrough ordinary bankruptcy.H owever, the U.S. bankruptcy processmay not be ableto handlethefailure of a systemic financial institution without significant disruption tothe financial system.8Similarly, the U.K. administration processoften takestime and involvessignificant uncertainty regarding the outcome.Forcing large financial organizations through administration can createsignificant and systemic risksfor thereal economyby interruptingcriticalservices, disrupting key financial relationships, and freezing financialmarkets. In addition, it can destroy value, harming the real economy.9 Given theseproblemswith thebankruptcy process, the U.S. and theU.K. authoritiesresorted to providing large scalepublic support to failingfinancial companies during the 2007-09 crisisto prevent further systemicdisruption.This public support hasexposed taxpayersto lossand resulted in thebailout of multiple financial institutions and their creditors.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  44. 44. 4410Following the crisis, an overhaul of the framework for dealing withlarge and complex financial institution failureswas required.Whileit may be useful to strengthen the current bankruptcy code oradministration rulesto improve the handling of financial failures,systemic considerationswarrant having an alternative resolution strategy.11A resolution strategy for a failed or failing G-SIFI should assign lossesto shareholdersand unsecured creditors, and hold managementresponsiblefor the failure of the firm.The strategy shouldprovide continuity of the critical servicesthat theinstitution provides within the financial system and to the real economy,thereby minimizing systemic risk.The strategy should also enablea prompt transition of the firm‘songoingoperationsto full private ownership and control without taxpayer support.Given the cross-border nature of G-SIFIs, the resolution strategy shouldensurefinancial stabilityconcernsare addressed acrossall jurisdictionsinwhich the firm operates.To be successful,such an approach will require closecooperationbetween home and foreign authorities.12Under the strategies currentlybeing developedby the U.S. and theU.K., theresolution authority could intervene at the top of the group.Culpablesenior management of the parent and operating businesseswould be removed, and losseswould be apportioned to shareholdersandunsecured creditors.In all likelihood, shareholderswould lose all value and unsecuredcreditorsshould thusexpect that their claimswould be written down toreflect any lossesthat shareholdersdid not cover.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  45. 45. 45Under both the U.S. and U.K. approaches, legal safeguardsensure thatcreditorsrecover no lessthan they would under insolvency.13An efficient path for returning the sound operations of the G-SIFI tothe private sector would be provided by exchanging or converting asufficient amount of the unsecureddebt from the original creditorsof thefailed company into equity.In the U.S., thenew equity would become capital in one or more newlyformed operating entities.In the U.K., the same approach could be used, or the equity could be usedto recapitalize the failing financial company itself—thus, the highest layerof surviving bailed-in creditors would become the owners of the resolvedfirm.In either country, the new equity holderswould take on thecorresponding risk of being shareholdersin a financial institution.Throughout, subsidiaries (domestic and foreign) carrying out criticalactivities would be kept open and operating, therebylimiting contagioneffects.Such a resolution strategy wouldensure market discipline and maintainfinancial stability without cost to taxpayers.Legislativeframeworksfor implementingthe strategy14It should be stressed that the application of such a strategy can beachieved only within a legislative framework that provides authoritieswith key resolution powers.The FSB KeyAttributes have establisheda crucial framework for theimplementation of an effective set of resolution powersand practicesintonational regimes.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  46. 46. 46In the U.S., thesepowershad alreadybecome availableunder theDodd-Frank Act.In the U.K., the additional powersneeded to enhance the existingresolutionframework established under theBanking Act 2009 (theBanking Act) are expected to be fullyprovided by the EuropeanCommission‘s proposalsfor a European Union Recovery and ResolutionDirective (RRD) and through the domestic reforms that implement therecommendations of the U.K. Independent Commission on Banking(ICB), enhancing the existing resolution framework established underthe Banking Act.The development of effective resolution strategies isbeing carried out inanticipation of such legislation.U.S. regime15 The framework provided by the Dodd-Frank Act in the U.S. greatlyenhancesthe ability of regulatorsto addressthe problemsoflarge, complex financial institutions in any future crisis.TitleI of the Dodd-Frank Act requireseach G-SIFI toperiodically submitto the FDIC and the Federal Reservea resolution plan that must addressthe company‘splansfor itsrapid and orderlyresolution under the U.S.Bankruptcy Code.The FDIC and the Federal Reserveare required to review the planstodetermine jointly whether a company‘splan iscredible.If a plan is found to be deficient and adequate revisions are not made, theFDIC and the Federal Reserve may jointly impose more stringentcapital, leverage, or liquidity requirements, or restrictions ongrowth, activities, or operations of the company, including itssubsidiaries.Ultimately, the company could be ordered to divest assetsor operations tofacilitate an orderly resolution under bankruptcy in the event of failure.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  47. 47. 47Once submitted and accepted, the SIFIs‘ plansfor resolution underbankruptcy will support the FDIC‘splanningfor the exercise of itsresolutionpowers byproviding the FDIC with an understanding of eachSIFI‘sstructure, complexity, and processes.16 Title II of the Dodd-Frank Act provides the FDIC with new powerstoresolveSIFIs by establishing the orderlyliquidation authority (OLA).Under the OLA, the FDIC may beappointed receiver for any U.S.financial companythat meetsspecified criteria, including being in defaultor in danger of default, and whose resolution under theU.S. BankruptcyCode (or other relevant insolvencyprocess) would likely create systemicinstability.Title II requiresthat the lossesof any financial company placedintoreceivership will not be borneby taxpayers, but by common and preferredstockholders, debt holders, and other unsecured creditors, and thatmanagement responsible for the condition of the financial company willbe replaced.Once appointed receiver for a failed financial company, theFDIC wouldbe required to carry out a resolution of the company in a manner thatmitigates risk to financial stability and minimizes moral hazard.Any costsborneby the U.S. authorities in resolving theinstitution notpaid from proceedsof the resolution will berecovered from theindustry.U.K. regime17 In the U.K., the Banking Act providestheBank of England with toolsfor resolving failing deposit-taking banksand building societies.Powers similar to those of the FDIC are available, including powerstotransfer all or part of a failed bank‘sbusinessto a private sector purchaseror to a bridge bank until a private purchaser can be found.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  48. 48. 48The Banking Act alsoprovides the U.K. authorities with a bespokebankinsolvencyprocedure that fullyprotectsinsured depositorswhileliquidating a failed bank‘sassets.These powershave proved valuable;for example, during the crisistheyallowedthe authorities to transfer the retail and wholesaledeposits,branches, and a significant proportion of the residential mortgageportfolio of a failed building society to another building society.18The Banking Act powersdo not, however, provide a whollyeffectivesolutiontothefailure of a large, complex, and international financial firm.The critical economic functionsof a G-SIFI are currentlyintertwinedlegally, operationally, and financiallyacrossjurisdictions and legalentities.For U.K. firms, thesefunctions frequentlyreside in the same entities asthe firms‘ core unsecuredliabilities.Using the existing statutory transfer powerswould involve separating andtransferring large and complex businessesfrom within operating entitiesto a purchaser or bridge bank, whileleaving behind the remainingliabilitiesand bad assetsin the failed firm to be wound up throughinsolvency.These operating companiesmay have several thousand counterparties,customers, and contracts.Such a transfer would be almost impossible to achieve over a resolutionweekend without destroying valueand causing financial stabilityconcernsin multiple jurisdictions.19The introduction of a statutory bail-in resolution tool (the power towrite down or convert into equity theliabilitiesof a failing firm) under theRRD iscritical to implementing a wholegroup resolution of U.K. firmsina way that reducesthe risksto financial stability.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  49. 49. 49A bail-in tool would enablethe U.K. authorities to recapitalize aninstitution by allocatinglossesto itsshareholdersand unsecuredcreditors, thereby avoiding the need to split or transferoperating entities.The provisions in the RRD that enable the resolution authority to imposeatemporarystayon theexerciseof terminationrightsby counterpartiesinthe event of a firm‘sentry into resolution (in other words, preventingcounterparties from terminating their contractual arrangements with afirm solelyas a resultof the firm‘s entry into resolution) will be needed toensurethe bail-in is executed in an orderlymanner.20The existing Banking Act doesnot cover nondeposit-taking financialfirms, notablyinvestment banksand financial market infrastructures(clearing housesin particular), the failure of which, in many cases, wouldalsohave significant financial stability consequences.The Banking Act alsohas limitations with regard to the application ofresolution toolsto financial holding companies.The U.K. isin theprocessof expanding the scopeof the Banking Act toincludethese firms.This is expected to be achieved through the introduction of the U.K.Financial Services Bill, which is due to complete its passage throughParliament by the end of thisyear.21In addition to expanding the U.K. resolution regime, the FinancialServicesBill will significantly enhancethe U.K.‘sapproach to bankingsupervision.Going forward, the framework for prudential supervision in the U.K. willemphasize supervisory judgment, rather than supervision based solely onrules.Under thisframework, considerationsof resolvabilityor easeof resolutionwould become a core part of the supervisoryprocess.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  50. 50. 5022In conjunction with the Financial ServicesBill, the adoption of therecommendations of the ICB will alsosignificantly improve theresolvabilityof the U.K. domestic retail bank by ringfencing it from therest of the group.This will help to preserve core domestic intermediation servicesif agroup-wide resolution is not feasiblefor some reason.23To ensure that banksare resolvable,the Financial ServicesAuthority(and in the future, the Prudential Regulation Authority (PRA)) willrequire firms under the Financial ServicesAct 2010to produce Recoveryand Resolution Plans(RRPs).Firmswill submit the information that the authoritieswill need toprepareresolution plansand to assessresolvability.Where barriersto resolution are identified, firms will be required toremove them through changesto their structure and operations.The proposed RRD providesauthorities with the necessarypowerstoachieve this, including the ability to require changesto the legal oroperational structuresof institutions, and to require firms to ceasespecific activities.Descriptionof the resolution strategiesU.S. approachto singlepoint of entry resolution strategy24 Under the U.S. approach, the FDIC will be appointed receiver of thetop-tier parent holding company of the financial group followingthecompany‘sfailure and the completion of the appointment processsetforth under the Dodd-Frank Act.Immediately after theparent holding company isplaced intoreceivership, the FDIC will transfer assets(primarily the equity andBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  51. 51. 51investmentsin subsidiaries) from the receivership estate to a bridgefinancial holding company.By taking control of the SIFI at the top of the group, subsidiaries(domestic and foreign) carrying out critical servicescan remain open andoperating, limiting the need for destabilizing insolvencyproceedings atthe subsidiary level.Equity claimsof the shareholdersand the claimsof the subordinated andunsecured debt holderswill likelyremain in the receivership.25Initially, thebridge holding company will becontrolled by theFDIC asreceiver.Thenext stagein theresolution istotransferownership and control of thesurviving operations to private hands.Before thishappens, the FDIC must ensurethat the bridge has a strongcapital baseand must addresswhatever liquidity concernsremain.The FDIC would alsolikely require the restructuring of the firm—potentially into one or more smaller, non-systemic firmsthat could beresolvedunder bankruptcy.26Byleaving behind substantial unsecured liabilities and stockholderequity in the receivership, assetstransferred to the bridge holdingcompany will significantly exceed itsliabilities, resulting in awell-capitalizedholdingcompany.After the creation of the bridge financial company, but before anytransition to the private sector, a valuation processwould be undertakento estimate the extent of lossesin the receivership and apportion theselossesto the equity holdersand subordinated and unsecured creditorsaccording to their order of priority.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  52. 52. 52In all likelihood, the equity holderswould be wiped out and their claimswould have littleor no value.27To capitalize the new operations—one or more new private entities—the FDIC expectsthat it will have to look to subordinated debt or evensenior unsecured debt claimsas the immediate source of capital.The original debt holderscan thusexpect that their claimswill be writtendown to reflect anylossesin the receivership of the parent that theshareholderscannot cover and that, like those of the shareholders, theseclaimswill be left in the receivership.28At thispoint, the remaining claimsof the debt holderswill beconverted, in part, into equity claimsthat will serve to capitalize the newoperations.The debt holdersmay alsoreceiveconvertible subordinated debt in thenew operations.This debt would provide a cushion against further lossesin thefirm, asitcan be converted into equity if needed.Any remaining claimsof the debt holderscould be transferred to the newoperations in the form of new unsecured debt.29The transfer of equity and investments in operating subsidiaries to thebridge holding company shoulddo much to alleviate liquidity pressures.Ongoing operations and their attendant liabilitiesalsowill be supportedby assurancesfrom the FDIC, as receiver.As demonstrated by past bridge-bank operations, the assuranceofperformance should encourage market funding and stabilize the bridgefinancial company.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  53. 53. 53H owever, in the casewhere credit markets are impaired and marketfunding isnot availablein the short term, the Dodd-Frank Act providesfor FDIC accessto the Orderly Liquidation Fund (OLF), a fund withinthe U.S. Treasury.In addition to providing a back-up source of funding, the OLF may alsobe used to provide guarantees, within limits, on the debt of the newoperations.An expected goal of the strategy is to minimize or avoid use of the OLF.To the extent that the OLF is used, it must either berepaid fromrecoverieson the assetsof the failed financial company or fromassessmentsagainst the largest, most complex financial companies.The Dodd-Frank Act prohibits the lossof any taxpayer money in theorderlyliquidation process.U.K. approachto singlepoint of entry resolutionstrategy30The U.K.‘splanned approach to single point of entry alsoinvolvesatop-down resolution.On the basisthat the RRD will introduce a broad bail-in power, the U.K.authorities would seek to recapitalize the financial group through theimposition of losseson shareholdersand, as appropriate, creditorsof thefirm via the exercise of a statutory bail-in power.This U.K. group resolution approach need not employa bridge bank andadministration, although such powersare availablein theU.K. and maybe appropriate under certain circumstances.31Current proposalsfor implementing such a strategy incorporate aperiod in which equity and debt securitieswould be transferred from theshareholdersand debt holdersto an appointed trustee.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  54. 54. 54The trustee would hold the securitiesduring a valuation period in whichthe extent of the lossesexpected to be incurred by the firm would beestablishedand, in turn, the recapitalization requirement determined.During thisperiod, listing of the company‘sequity securities (andpotentiallydebt securities) would be suspended.Once the recapitalization requirement has been determined, anannouncement of the final terms of the bail-in would be made to theprevioussecurity holders.This announcement would include full detailsof the write-down and/ orconversion.32Debt securities would becancelledor written down in order to returnthe firm to solvencyby reducing the level of outstanding liabilities.The losseswould be applied up the firm‘scapital structure in a processthat respectsthe existing creditor hierarchy under insolvency law.The value of anyloans from the parent to itsoperating subsidiaries wouldbe written down in a manner that ensuresthat the subsidiaries remainsolvent and viable.33Completion of the exchange would see thetrustee transfer the equity(and potentiallysome of the existing debt securities written downaccordingly) back to the original creditorsof the firm.Those creditorsunableto hold equity securities(for example, for reasonsof investment mandate restrictions) would be ableto request that thetrustee sell the equity securitieson their behalf.The trust would then be dissolvedand the equity securities(andpotentiallydebt securities) of the firm would resume trading.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  55. 55. 55The firm would now be recapitalized and primarily owned by the(appropriate layer of) original creditors of theinstitution.As described later, the processwould be accompanied by restructuringmeasuresto addressthe causesof thefirm‘s failure and to restore thebusinessto viability.34TheU.K. hasalsogiven consideration to therecapitalizationprocessina scenario in which a G-SIFI‘sliabilitiesdo not include much debtissuance at the holding company or parent bank level but insteadcomprise insured retail depositsheld in the operating subsidiaries.Under such a scenario, deposit guarantee schemes may be required tocontribute to the recapitalization of the firm, as they may do under theBanking Act in the useof other resolution tools.The proposed RRD alsopermits such an approach becauseit allowsdeposit guarantee scheme fundsto be used to support the use ofresolution tools, including bail-in, provided that the amount contributeddoesnot exceed what the deposit guarantee scheme would have as aclaimant in liquidation if it had made a payout to the insured depositors.That is consistent with the contribution requirement that is alreadyimposed on the Financial ServicesCompensation Scheme in the U.K. intheexerciseof resolution powersand simulatesthelossesthat would havebeen incurred by those deposit guarantee schemesduring bankinsolvency.But insofar asa bail-in providesfor continuity in operationsand preservesvalue, lossesto a deposit guarantee scheme in a bail-in shouldbe muchlower than in liquidation.Insured depositors themselveswould remain unaffected.Uninsured deposits would be treated in line with other similarly rankedliabilities in the resolution process, with the expectation that they mightbe written down.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  56. 56. 5635Following the recapitalization process, thefirm would be restructuredto addressthe causesof itsfailure.It should then be solvent and viable, and asa result in a position to accessmarket funding.In recognition of the fact that it will take time for lossesto beassessed forpurposesof recapitalization, and that it will take time to executetherestructuring plan that will underpin the firm‘s viability, immediateaccessmay prove difficult.In certain circumstances, to reduce the immediate funding need and sofacilitate market access, illiquid assetsmight be removed from thebalancesheet of thefirm and transferred into an asset managementcompany to beworked out over a longer period.36If market funding were not immediately available, temporary fundingmay need to be provided by the authorities to meet the firms‘ liquidityneeds.The funding would onlybe provided on a fullycollateralizedbasiswithappropriate haircutsapplied to thecollateral to reduce further the risk ofloss.In the unlikelyevent that losseswere associated with the provision oftemporarypublic sectorsupport, such losseswould be recovered fromthefinancial sector.37It is important to note that the strategy described above would notnecessarilybeappropriate for all U.K. G-SIFIsin all circumstances.Other strategies may be more appropriate depending on the structure of agroup, the nature of its business, and the size and location of the group‘slosses.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  57. 57. 57For example, in caseswhere the losseson assetsin a particular operatingsubsidiary were potentiallyso great that theycould not be absorbed bybailing in at group level orwhere the businesshad incurred suchsignificant lossesand was so weighed down by toxic assetsthat thecapital needsin resolution were too difficult to estimatecredibly, resolution at the level of one or more operating subsidiaries maybe moreappropriate.In thissituation, the application of resolution toolsto operatingsubsidiarieswould be easier if the subsidiaries providing criticaleconomic serviceswere operationallyand financially ringfenced from therest of the group.38 This is one of the advantagesof the ringfence which is beingintroduced in the U.K. It will provide flexibility in the event of fatalproblemselsewherein the group to transfer the ringfenced entity to abridge bank or purchaser in its entirety.If losseswere concentrated in the ringfenced entity and capital in theringfenced entity was insufficient to absorb them, then lossescould beborne bycreditors of the ringfenced bank (including debt holderswherethe ringfenced bank had issued debt into the market).This could be achieved either by bail-in or by transferring the operationsof the ringfenced bank to a bridge bank, leaving uninsured creditorsbehind in administration.Draft legislation to establish thisringfence of the largest retaildeposit-takers is due to be introduced into Parliament earlyin 2013 and ifpassed will provide valuableadditional flexibility in implementingresolution strategies to preserve the provision of core servicesin the U.K.businessof U.K. G-SIFIs.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  58. 58. 58Keycommonconsiderationsfor U.S. andU.K. approaches39As outlined above, high-level transaction structureshave beendevelopedfor each jurisdiction.As discussed in the FSB Guidance on Recoveryand ResolutionPlanning, for any resolution to be effective, consideration needsto begiven in advanceto variouspreconditionsand operational requirements.Several of theseconsiderations in relation to a top-down resolutionstrategy are discussed in more detail below.Resolutionand restructuringmeasures40A top-down resolution by definition focuseson assigning lossesandestablishing new capital structuresat the top of the group.This approach keepsthe rest of the group, potentiallycomprised ofhundredsor thousandsof legal entities, intact.H owever, a top-down resolution would need to be accompanied, orshortlyfollowed, by significant restructuring measuresto addressthecausesof the firm‘s failure and to underpin the firm‘s viability.Such a restructuring may include shrinking the G-SIFI‘sbalancesheet, breaking the company up into smaller entities, and/ or sellingorclosing certain operations.The newlyrestructured companieswill all need to have strong corporategovernance and management oversight, which would likelynecessitatesignificant changesto management and board personnel and processes.In both countries, it islikelythat supervisory actionswill continue afterthe return to private ownership to ensurethat the firm ison a stable andBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  59. 59. 59sustainablefooting and the problemsthat caused the firm to fail in thefirst placehave been properly dealt with.41In the U.S., effective governance will be an important issue for both thetransitional bridge financial company and the newly capitalized entity orentities into which the bridge will transition.The FDIC, as receiver, will control the bridge financial company andwould immediately appoint a temporary board of directors and ChiefExecutive Officer (CEO) to run the bridge.The claimsof the failed G-SIFI‘sunsecured creditorswill be convertedintoequity and, asaresult, theformer creditorswill becomeownersof thenew private sectoroperations.They will thereafter be responsiblefor electing a new board ofdirectors, which will in turn appoint a new CEO.42During the period in which the FDIC controlsthe bridge financialcompany, decisionswill be made on how to on simplify and shrink theinstitution.It also would likely require restructuring of the firm—perhaps into one ormore smaller, non-systemic firms. Consideration will also be given to howto create a more stable, lesssystemicallyimportant institution.Required changes, including divestiture, may be influenced by the failedfirm‘s Title I resolution plan.Once determined, the required actions and relevant time frames for theirexecution will be specified in formal supervisory agreementswith the newownersof the private sector operations.43The required actionswould be executed in private marketsby the newowners.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  60. 60. 60For example, the new ownersmight be required to sell a portion of theirbranch structureto reducetheir footprint, divest their foreign operations,or separate their commercial and investment banking operations.The resulting new private sector operations would be smaller, moremanageable—and perhapsmore profitable.They would alsobe easier to examine and supervise. Importantly, all newoperations must be resolvableunder bankruptcy without public support.44 In the U.K., similar considerationswould enter into decisions on therestructuring process.Depending on the specific timeline for resolution, the restructuring mayoccur primarily either during the trusteestage (before the delivery ofequity securities to the creditors) or during the stage following thedissolution of the trust.The extent of the restructuring measures required would depend on thecause of failure, and the extent to which losses were contained within aparticular pool of assetsor legal entity.If lossesat the firm were localized,the restructuring measuresrequiredmay be limited.These would likelyrequire a saleor wind-down of relevant businesslinesand withdrawal from loss-making activities.The senior management that were responsiblefor bringing the firm intodistresswould alsobe replaced.On the other hand, if lossesat the firm were pervasive and spread acrossmultiplebusinesslines, a more fundamental restructuring of the firm‘sbusinesswould be required.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  61. 61. 61This would likelyinclude a complete governance overhaul and athorough reorganization of the activities of the institution.In the extreme case, much of the institution may enter managedwind-down over a prolonged period of time.In such a scenario, it islikely that a legal and operational ringfencing of abanking group‘s retail banking activities from the group‘sinvestmentbanking activities would prove particularlyvaluablein facilitating such arestructuring.Maintainingfinancialstability45 Both the U.S. and U.K. resolution proposalsare designed to maintainfinancial stability by ensuring that critical businessfunctions continue tobe performed.Critical businessfunctions are generallyperformed at the level of theoperating subsidiaries—assetsof the holding companiesof U.S. and U.K.G-SIFIstend to comprise littlemore than the equity stakesin theoperating subsidiaries.The newly resolved group would be solvent and viable, and should be in aposition therefore to access market funding or, if necessary, funding fromthe authorities as discussed above.Liquidity will be downstreamed in a ―businessasusual‖ manner to theoperating subsidiaries immediately following the resolution weekend.As described above, the balancesheetsof the operating subsidiariesshouldbe broadly unaffected bythe resolution action at the top of thegroup.To recapitalize the operating subsidiaries that had incurred losses, theequity or debt held by the parent in thosesubsidiaries would need to bewritten down.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  62. 62. 62The parent and, indirectly, the subsidiary operating companies may alsobe subject to change of control proceduresarising from a switch ofownership from the existing shareholdersto creditors.Provision of critical shared servicesacrossthe group shouldbeunaffected.46 Given minimal disruption to the balancesheet of the operatingcompanies, and given that the group shouldbe recapitalized followingthe assignment of lossesto shareholdersand creditors, counterpartiesshouldnot have strong incentivesto cease trading with the operatingcompanies during and following the resolution.The contingency plans are designed to minimize the triggering ofcross-defaults or closeout of netting arrangements at the operatingcompanies.In certain cases, a stay on termination rights may be applied to ensurethat termination of counterparty relationshipscannot be triggered solelyas a resultof entryinto resolution.A stay may assist in promoting the continuity of a variety of criticaleconomic functionsthat are dependent on maintaining counterpartyrelationships(for example, those functionsrelating to wholesalemarketactivities) and alsoavoiding the rapid, disorderly, and potentiallyvalue-destructivecloseout of financial contractsand liquidation ofsecurities.The stay couldalso minimize the closeout risk that may resultfromcross-defaultclauseswithin financial contracts.In the scenario in which the holding company isplaced intoreceivership, the stay would extend to certain subsidiary counterpartiessubject tofinancial contractsthat referencethe holding company.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  63. 63. 63Given cross-border considerations, it isimportant that staysontermination applyto both domestic and foreign operations of G-SIFIs.In certain cases, authorities cannot currentlyextend stayson terminationto foreign operations.Supporting actions by host authorities may be required (as included inthe KeyAttributes), or it may be necessaryto introduce clausesthatrecognize foreign resolution actions, including stayson termination, intocounterparty documentation.47Similarly, becausethe group remains solvent, retail or corporatedepositorsshould not have an incentive to ―run‖ from the firm underresolution insofar as their banking arrangements, transacted at theoperating company level, remain unaffected.In order to achieve this, the authorities recognize the need for effectivecommunication to depositors, making it clear that their depositswill beprotected.48If continuity of critical functions isto be achieved, the firm will needcontinuing accessto core servicesprovided by the financial marketinfrastructures(for example, payment systemsand centralcounterparties) during and followingresolution.To achieve this, authorities in both the U.S. and U.K. have begun aprocessof engaging with such infrastructuresto develop effectiveproceduresrelating to the treatment of members who have enteredresolution.Minimizationof cross-border coordinationrisk49It shouldbe stressed that a key advantage of a whole group, singlepoint of entry approach is that it avoidsthe need to commence separateterritorial and entity-focused insolvencyproceedings, which could bedisruptive, difficult to coordinate, and would depend on the satisfactionBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com

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