ADDRESSING PRIORITY ISSUES

IN CROSS-BORDER RESOLUTION

May 2011
ADDRESSING PRIORITY ISSUES
IN CROSS-BORDER RESOLUTION
May 2011
 THIS REPORT SETS OUT A GLOBAL FINANCIAL SERVICES INDUSTRY PERSPECTIVE ON A
NUMBER OF PRIORITY ISSUES IN CROSS-BORDER RESOLUTION. THE GLOBAL INDUSTRY
STRONGLY SUPPORTS THE DEVELOPMENT OF AN INTERNATIONAL FRAMEWORK FOR THE
RESOLUTION OF CROSS-BORDER FINANCIAL FIRMS. THIS IS KEY TO ENSURING DURABLE
financial stability consistent with sustainable growth of
ii the global economy. Achieving this will require both the will
to address this challenge as well as solutions to a number
|
of difficult technical questions. This report is designed to
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
contribute to both of these aspects. It articulates an industry
consensus on a number of key challenges and puts forward
proposals for approaching them.
The report builds on the Institute’s earlier submissions
to the Financial Stability Board on the subject: A Global
Approach to Resolving Failing Financial Firms: An Industry
Perspective (May 2010) and Preserving Value in Failing
Financial Firms (September 2010).
On preserving critical functions, the report advocates
a sharply focused approach to the identification of critical
functions, noting that the preservation of such functions
in the event of a failure is not a cost-free exercise. This
should be dealt with as part of resolution planning. Firms
have a responsibility to provide the information and
explanations that need to be available to supervisors to
achieve this. While the industry does not believe there is
a case for routine demands from supervisors for structural
changes such as modularization of businesses or required
subsidiarization, it is incumbent on firms to ensure that
properly identified critical functions can be maintained and
transferred in the event of a firm’s failure.
The report supports the use of bail-in techniques to
reduce loss of value in failing firms and avoid systemic
trauma. The primary focus of bail-in should be subordinated
debt, which could be expected, in a majority of cases, to
be sufficient to achieve the objectives. The bailing-in of
unsecured senior debt should occur only in the special
circumstances, that this is necessary as a last-resort
alternative to winding-down or liquidation, with certain
Josef Ackermann
Chairman of the Management Board
and the Group Executive Committee,
Deutsche Bank AG
Urs Rohner
Chairman of the Board of Directors
Credit Suisse Group AG
requirements imposed on authorities if they wish to use
these supplementary senior debt bail-in powers. Credit
liabilities arising from trading activities should be excluded
from the scope of bail-in, and the introduction of bail-in
should be on a prospective basis only.
An effective framework for the resolution of cross-
border firms requires both convergence of national regimes
and enhanced cooperation and coordination among
resolution authorities, based on legally effective crisis
management agreements. Such agreements have the
capacity to allow for approaches to resolution that are
consistent with the structural and organizational approaches
adopted by firms, and which avoid increased ring-fencing
of countries and fragmentation of the international
marketplace. There are significant benefits to the global
and local economies deriving from the diverse range of
approaches and structures that global firms deploy. Cross-
border resolution arrangements need to preserve these. To
be effective such crisis management agreements need to be
embedded in national resolution frameworks incorporating a
number of provisions designed to underpin and support the
international market in financial services.
The global industry is strongly committed to the
development of an effective international framework for
the resolution of cross-border financial firms. We consider
that, building on the work to date by the FSB and its
members as well as by industry representatives, this goal
is now potentially within our grasp. The IIF is pleased to
present this report as an industry contribution to the work
in this area. The industry stands ready to participate in
further work and dialogue in order to leverage the insights
and solutions of all parties toward the achievement of this
strongly shared objective.
Peter Sands
Group Chief Executive,
Standard Chartered, PLC
Charles H. Dallara
Managing Director
Institute of International Finance
CONTENTS

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii 1

|
IIF Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

INSTITUTE OF INTERNATIONAL FINANCE

IIF Special Committee on Effective Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

IIF Working Group on Cross-Border Resolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Section 1 - Effective resolution planning—Ensuring the continuance of critical functions . . . . . . 15

Section 2 - Avoiding systemic trauma—Making bail-in techniques operational . . . . . . . . . . . . . . . . 19

Section 3 - Resolving cross-border financial firms—Addressing key issues . . . . . . . . . . . . . . . . . . . . 26

Annex 1: Key components of an effective resolution framework as set out

in IIF Report, A Global Approach to Failing Financial Firms: An Industry Perspective . . . . . . . . . . . . 33

Annex 2: Critical functions—some putative examples to be considered . . . . . . . . . . . . . . . . . . . . . . . . 34

Annex 3: Summary of IIF Paper, Preserving Value in Failing Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Annex 4: Legal issues in group support and resolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

 IIF BOARD OF DIRECTORS

2 Chairman
Josef Ackermann*
|

Chairman of the Management Board and

ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION

the Group Executive Committee

Deutsche Bank AG

Vice Chairman Vice Chairman Vice Chairman

Roberto E. Setubal* Francisco González* Rick Waugh*
President and Chief Executive Officer, Chairman and Chief Executive Officer President and Chief Executive Officer
Itaú Unibanco S/A and BBVA Scotiabank
Vice Chairman of the Board of
Itaú Unibanco Holding S/A

Treasurer
Marcus Wallenberg*
Chairman of the Board
SEB

Ms. Suzan Sabanci Dincer Mr. Baudouin Prot*

Chairman and Executive Board Member Chief Executive Officer
Akbank T.A.S. BNP Paribas
Mr. Yannis S. Costopoulos* Mr. Robert P. Kelly*
Chairman of the Board of Directors Chairman and Chief Executive Officer
Alpha Bank A.E. BNY Mellon
Mr. Peter Wallison Mr. Vikram Pandit
Senior Fellow Chief Executive Officer
Financial Policy Studies Citigroup, Inc.
American Enterprise Institute
Mr. Martin Blessing
Mr. Hassan El Sayed Abdalla Chairman of the Board of Managing Directors
Vice Chairman and Managing Director Commerzbank AG
Arab African International Bank
Mr. Urs Rohner
Mr. Michael Smith Chairman of the Board of Directors
Chief Executive Officer Credit Suisse Group AG
Australia and New Zealand Banking Group Limited
Mr. Andreas Treichl
Mr. Walter Bayly Chairman of the Management Board and Chief Executive
Chief Executive Officer Officer
Banco de Crédito del Perú (BCP) Erste Group Bank AG
Mr. Gary D. Cohn
President and Chief Operating Officer
Mr. Yasuhiro Sato
President and Chief Executive Officer
3

|
Goldman, Sachs & Co. Mizuho Corporate Bank, Ltd.

INSTITUTE OF INTERNATIONAL FINANCE

Mr. Douglas Flint Mr. James Gorman
Group Chairman President and Chief Executive Officer
HSBC Holdings plc Morgan Stanley
Mr. K. Vaman Kamath Mr. Ibrahim S. Dabdoub
Chairman of the Board Group Chief Executive Officer
ICICI Bank Ltd. National Bank of Kuwait
Mr. Jiang Jianqing Mr. Frédéric Oudéa
Chairman of the Board of Directors and President Chairman and Chief Executive Officer
Industrial and Commercial Bank of China Société Générale
Mr. Jan Hommen Mr. Peter Sands
Chairman of the Executive Board Group Chief Executive
ING Group Standard Chartered, PLC
Mr. Charles H. Dallara (ex officio)* Mr. Walter B. Kielholz
Managing Director Chairman of the Board of Directors
Institute of International Finance Swiss Reinsurance Company Ltd.
Mr. Corrado Passera Mr. Nobuo Kuroyanagi*
Managing Director and Chief Executive Officer Chairman
Intesa Sanpaolo S.p.A. The Bank of Tokyo-Mitsubishi UFJ, Ltd.
Mr. Jes Staley Mr. Oswald Gruebel
Chief Executive Officer Group Chief Executive Officer
Investment Bank UBS AG
J.P. Morgan Chase & Co.
Mr. Martin Senn
Mr. Yoon-dae Euh Chief Executive Officer
Chairman Zurich Financial Services
KB Financial Group Inc.

*Member of the Administrative and Nominations Committee

 IIF SPECIAL COMMITTEE ON EFFECTIVE REGULATION

4 Chairman
Mr. Peter Sands
|

Group Chief Executive

ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION

Standard Chartered, PLC

Mr. David Hodnett Mr. Baudouin Prot

Group Financial Director Chief Executive Officer
ABSA Group Limited BNP Paribas Group
Mr. Bob Penn Mr. Christian Lajoie
Partner Head of Group Prudential Affairs / Co-head of Group
Allen & Overy LLP Prudential and Public Affairs
BNP Paribas Group
Ms. Alejandra Kindelán Oteyza
Head of Research and Public Policy Mr. Mark Musi
Communications, Group Marketing and Research Division EVP, Chief Compliance and Ethics Officer
Banco Santander BNY Mellon
Mr. Rob Everett Mr. Brian Rogan
European Chief Operating Officer Vice Chairman and Chief Risk Officer
Bank of America Merrill Lynch BNY Mellon
Mr. Robert Pitfield Ms. Jill Considine
Group Head, Chief Risk Officer Chairman
Bank of Nova Scotia Butterfield Fulcrum Group
Mr. Richard Quinn Mr. Michael Helfer
Director, Regulatory Affairs General Counsel and Corporate Secretary
Group Compliance Citigroup Inc.
Barclays
Mr. Simon Gleeson
Mr. Mark Harding Partner
Group General Counsel Clifford Chance LLP
Barclays PLC
Dr. Stefan Schmittmann
Mr. Gerd Häusler Chief Risk Officer and Member of the Board of Managing
Chief Executive Officer Directors
Bayern LB Commerzbank AG
Ms. Maria Abascal Rojo Mr. Jörg Erlebach
Chief Economist—Regulation and Public Policy Divisional Board Member
BBVA Research Group Risk Controlling & Capital Management
BBVA Commerzbank AG
The Honourable Kevin Lynch Dr. Rodney Maddock
Vice-Chair Executive General Manager
BMO Financial Group Group Strategy Development
Commonwealth Bank of Australia
Mr. Olivier Motte
Head of Public Affairs
Dr. Manfred Wimmer
Chief Financial Officer, Chief Performance Officer, and
5

|
Member of the Management Committee, CA-CIB Member of the Management Board

INSTITUTE OF INTERNATIONAL FINANCE

Credit Agricole CIB Erste Group Bank AG
Mr. Hubbert de Vauplane Mr. Barry Stander
Direction Juridique et Conformité Groupe Head of Banks Act Compliance
Crédit Agricole Regulatory Risk Management
FirstRand
Mr. Jérôme Brunel
Head of Public Affairs, Member of the Executive Committee Mr. Faryar Shirzad
Crédit Agricole SA. Managing Director, Global Head
Office of Government Affairs
Mr. Urs Rohner
Goldman Sachs
Chairman of the Board of Directors
Credit Suisse Group AG Mr. Gregory Wilson
President
Dr. René Buholzer
Gregory P. Wilson Consulting
Managing Director, Global Head Public Policy
Credit Suisse Ms. Lara de Mesa
Head of Public Policy
Mr. Robert Wagner
Research Department
Chief Analyst
Grupo Santander
Group Finance, Regulation
Danske Bank Mr. Nasser Al-Shaali
Chief Executive Officer
Dr. Hugo Banziger
Gulf Craft
Chief Risk Officer & Member of the Management Board
Deutsche Bank AG Mr. James Chew
Deputy Head, Strategy and Planning
Mr. Bjørn Erik Næss
GMO International
Group Executive Vice President
HSBC
Group Finance and Risk Management
DnB NOR ASA Mr. Koos Timmermans
Member of the Executive Board and CRO
Mr. Roar Hoff
ING Group
Executive Vice President, Head of Group Risk Analysis
DnB NOR ASA Mr. Carlo Messina
Chief Financial Officer
Mr. Wolfgang Kirsch
Intesa Sanpaolo Spa
Chief Executive Officer
DZ BANK AG Mr. Roberto Setubal
President and CEO of Itau Unibanco S/A and Vice Chairman
Dr. Florian Strassberger
of the Board of Itau Unibanco Holding S/A
General Manager
Itaú Unibanco S/A
Head of New York Branch
DZ Bank Dr. Jacob Frenkel
Chairman
JPMorgan Chase International
6 Dr. Mark Lawrence
Managing Director
Mr. John Drzik
President and Chief Executive Officer
|

Mark Lawrence Group Oliver Wyman

ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION

Mr. Philip Härle Mr. William Demchak

Director Vice Chairman
McKinsey and Co. PNC Financial Services Group
Mr. Masao Hasegawa Mr. John W. Campbell
Managing Director, CRO, and CCO Partner
Mitsubishi UFJ Financial Group, Inc Advisory Financial Services
PricewaterhouseCoopers LLP
Mr. Daisaku Abe
Managing Executive Officer, Chief Strategy Officer, Chief Mr. Eugene A. Ludwig
Information Officer, General Manager of Group Strategic Founder and Chief Executive Officer
Planning Promontory Financial Group, LLC
Mizuho Financial Group, Inc.
Mr. Fernando Barnuevo Sebastian de Erice
Mr. David Russo Managing Director
Chief Financial Officer RHJI Swiss Management
Institutional
Mr. Morten Friis
Morgan Stanley
Chief Risk Officer
Ms. Clare Woodman Royal Bank of Canada
Chief Operations Officer EMEA
Mr. Russell Gibson
Morgan Stanley
Director, Regulatory Affairs, Group Regulatory Affairs &
Mr. Ibrahim Dabdoub Compliance
Group Chief Executive Officer Royal Bank of Scotland Group
National Bank of Kuwait, S.A.K.
Mr. Nils-Fredrik Nyblaeus
Mr. Parkson Cheong Senior Advisor to the Chief Executive Officer
General Manager and Group Chief Risk Officer SEB Group
Group Risk Management
Mr. Pierre Mina
National Bank of Kuwait, S.A.K.
Head of Group Regulation Coordination
Mr. David Benson Société Générale
Vice Chairman, Nomura Holding
Mr. Rodgin Cohen
Nomura International plc
Senior Chairman
Mr. Samuel Hinton-Smith Sullivan & Cromwell LLP
Director, Public Affairs
Mr. Nobuaki Kurumatani
Corporate Communications
Managing Director
Nomura
Sumitomo Mitsui Banking Corporation
Mr. Ari Kaperi
Mrs. Kerstin af Jochnick
Executive Vice President, Chief Risk Officer
Managing Director
Group Risk Management
Swedish Bankers Association
Nordea Bank AB
Mr. Philippe Brahin
Director
Mr. Sergio Lugaresi
Senior Vice President Head of Regulatory Affairs
7

|
Risk Management Institutional and Regulatory Strategic Advisory

INSTITUTE OF INTERNATIONAL FINANCE

Swiss Reinsurance Company Ltd UniCredit Group
Mr. Donald F. Donahue Mr. Richard Yorke
Chairman and Chief Executive Officer EVP & Group Head
The Depository Trust & Clearing Corporation International Group
Wells Fargo & Company
Mr. Takashi Oyama
Counsellor on Global Strategy to President and the Board of Mr. Kevin Nixon
Directors Head of Regulatory Reform
The Norinchukin Bank Westpac
Dr. Steve Hottiger Dr. Peter Buomberger
Managing Director & Head Group Head of Government and Industry Affairs
Group Governmental Affairs Zurich Financial Services
UBS AG
Dr. Madelyn Antoncic
 IIF WORKING GROUP ON CROSS-BORDER RESOLUTION

8 Chairman
Mr. Urs Rohner
|

Chairman of the Board of Directors

ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION

Credit Suisse Group AG

Mr. Diederick van Mierlo Mr. Bradley Gans

Managing Director Corporate & Markets Risk Chief Legal Officer
Central Risk Management Europe, Middle East & Africa
ABN-AMRO Citi
Mr. Bob Penn Ms. Tina Locatelli
Partner Managing Director & General Counsel- Independent Risk
Allen & Overy LLP Citigroup Inc.
Ms. Suzanne Chomiczewski Mr. Seth Grosshandler
Director Partner
Corporate Treasury/GRRP Cleary Gottlieb Steen & Hamilton LLP
Bank of America
Mr. Simon Gleeson
Mr. Mark Lunn Partner
Senior Vice President Clifford Chance
Bank of America
Mr. Jérôme Brunel
Mr. Michael D’Souza Head of Public Affairs, Member of the Executive Committee
Managing Director Crédit Agricole SA.
Bank of America Merrill Lynch
Mr. Volker Bätz
Mr. Richard Quinn Director
Director, Regulatory Affairs Treasury
Group Compliance Credit Suisse
Barclays
Mr. D. Wilson Ervin
Mr. John Whittaker Senior Advisor to the CEO
Group Operational Risk Director Credit Suisse
Barclays Bank PLC
Mr. Andrew Procter
Ms. Maria Abascal Rojo Global Head of Government & Regulatory Affairs
Chief Economist—Regulation and Public Policy Government & Regulatory Affairs
BBVA Research Deutsche Bank AG
BBVA
Mr. Karl-Heinz von Oppenkowski
Mr. Christian Lajoie Director, Credit Restructuring
Head of Group Prudential Affairs / Co-head of Group Credit Department
Prudential and Public Affairs DZ Bank
BNP Paribas
Ms. Gerda Holzinger-Burgstaller
Head of Chairman’s Support
Ms. Karen Linney
Managing Director and EMEA Investment Bank General
9

|
Chairman’s Office Counsel

INSTITUTE OF INTERNATIONAL FINANCE

Erste Group Bank AG JP Morgan Chase & Co.
Dr. Oliver Schütz Mr. Michael Offen
Head of EU Legislative and Regulatory Affairs MD, Corporate Finance
Erste Group Bank AG JP Morgan Chase & Co.
Mr. Stephen Davies Ms. Sandra Boss
Managing Director Director
Finance McKinsey & Company
Goldman Sachs International
Mr. Akihiro Kitano
Ms. Lara de Mesa Senior Manager
Head of Public Policy Basel 2 Implementation Office
Research Department Mitsubishi UFJ Financial Group, Inc.
Grupo Santander
Mr. Hideyuki Toriumi
Ms. Sheryl Slater Senior Manager
Head of Asset and Liability Management Basel 2 Implementation Office
Asia Pacific Finance Mitsubishi UFJ Financial Group, Inc.
Hong Kong and Shanghai Banking Corporation Limited
Mr. Tetsuo Iimori
Mr. James Chew Executive Officer and General Manager of Corporate
Deputy Head, Strategy and Planning Planning
GMO International Mizuho Financial Group, Inc.
HSBC
Mr. Guy Clayton
Mr. Alain C. Stangroome Managing Director
Head of Group Capital Planning Legal and Compliance
Group Financial Planning and Tax Morgan Stanley
HSBC Holdings plc
Mr. Parkson Cheong
Mr. Henk Huisman General Manager and Group Chief Risk Officer
Deputy Director Credit & Risk Management Group
Public & Government Affairs National Bank of Kuwait S.A.K.
ING Group
Mr. John Bovenzi
Ms. Ellen Bish Partner
Legal Counsel—Regulatory Affairs Oliver Wyman
Corporate Legal Department
Ms. Sheryl Kennedy
ING Group
Chief Executive Officer
Mr. Luigi Ruggerone Promontory Financial Group, Canada ULC
Head of Country Risk
Risk Management Department
Intesa Sanpaolo S.p.A.
10 Mr. Ralph Ricks
Head, Group Regulatory Developments
Mr. Tetsuro Yoshino
Joint General Manager
|

Group Regulatory Affairs Corporate Planning

ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION

Royal Bank of Scotland Sumitomo Mitsui Banking Corporation

Mr. Sean McGuckin Mr. Philippe Brahin
Senior Vice President and Head, Risk Policy & Capital Director
Markets Risk Management
Scotiabank Swiss Reinsurance Company Ltd.
Dr. Byung-Chul Lim Mr. Thomas Pohl
Managing Director Executive Director, Head Executive & International Affairs
Shinhan FSB Research Institute Group Governmental Affairs
Shinhan Financial Group UBS AG
Mr. Denis Devers Mr. Sergio Lugaresi
Head of Financial Management Senior Vice President and Head of Regulatory Affairs
DEVL/FIN Institutional and Regulatory Strategic Advisory
Société Generale UniCredit Group
Ms. Frédérique Marchal Mr. Kevin Nixon
Capital Planning and Regulations Head of Regulatory Reform
Finance Department Westpac
Société Générale
Mr. Edmund Bosworth
Mr. Gareth Berney Head of Risk Reward
Head, Capital Optimisation Group Finance
Group Treasury Westpac Banking Corporation
Standard Chartered Bank
EXECUTIVE SUMMARY
1. This submission builds upon the Institute’s
previous submissions to the Financial Stability
Board (FSB): A Global Approach to Resolving
Failing Financial Firms: An Industry Perspective
(May 2010) and Preserving Value in Failing
Financial Firms (September 2010).
2. Effective resolution is essential in achieving long-
term resilience and financial stability. It plays a
key role in addressing moral hazard and issues
associated with systemically important firms.
3. This paper addresses three key components of an
effective framework for cross-border resolution:
(a) resolution planning for the maintenance of
critical functions, (b) bail-in mechanisms, and (c)
addressing key cross-border issues.
RESOLUTION PLANNING
FOR CRITICAL FUNCTIONS
4. High-quality recovery and resolution planning
is an essential component of effective resolution.
Such planning should take place on a group-
wide basis. There should be a single resolution
plan for the group as a whole, though this should
address the situation in the different parts of the
group and should be developed on the basis of
strong coordination between the authorities in the
different jurisdictions in the context of a well-
functioning firm-specific crisis management group.
5. Maintaining critical functions is not a cost-free
exercise. In addition to administrative costs—to the
extent that good assets are transferred to support
critical liabilities—there may be fewer such assets
available to cover losses in the failing firm. It is
important therefore to adopt a tight definition of
critical functions.
6. Resolution planning is the primary responsibility
of the authorities. Firms have a responsibility to
provide the information necessary to allow the
authorities to plan effectively.
7. Planning for the continuance of critical functions
should not involve requests to firms as a
matter of course to change their organizational
structures. In particular, forced modularization or
subsidiarization should not become the preferred
choice of authorities. It is important that a group’s
11
|
structure and organization reflect its business
INSTITUTE OF INTERNATIONAL FINANCE
model and strategy. A requirement to move away
from such an approach will give rise to significant
inefficiencies and economic costs.
8. Firms have the responsibility to provide the
information and explanation necessary to enable:
a) An assessment of the degree of the function’s
criticality to the economy;
b) Clear understanding of the function in
question, including its key features and the
scale of provision by the firm;
c) Identification of how that function is provided
by the firm;
d) Separation and transfer of the function in a
crisis; and
e) Understanding of how the function is financed,
and will continue to be financed in a transfer
situation.
9. In the context of cross-border groups, authorities
must cooperate and coordinate on the basis of
effective firm-specific agreements to carry out
resolution planning that avoids the imposition
of particular organizational structures and the
fragmentation of international markets.
BAIL-IN MECHANISMS
10. It is important to avoid that the failure of a financial
firm gives rise to losses of such a scale that systemic
trauma occurs. It is important that the failure of
such a firm does not, through its interconnectedness
with the broader system, give rise to a systemic
event that undermines financial stability.
11. In contrast with the situation involving a non-
financial firm, the simple fact of the declaration
of a firm’s insolvency and liquidation can cause
loss of business value sufficient to cause systemic
damage. In the case of Lehman, the loss to creditors
post-declaration of insolvency is expected to be a
number of times greater than the loss of asset value
incurred prior to the declaration of insolvency.
 12. Bail-in can forestall precipitous loss of value and
systemic shock by recapitalizing the firm and
allowing it to be restructured.
13. A set of principles is put forward as a suggested
basis for the development of bail-in regimes in
different jurisdictions.
14. While good progress has been made in developing
proposals to make the bail-in concept more
12 operational, there remain difficult questions
to be resolved and challenges to be overcome.
|
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
Accordingly, in a number of areas the need for
further work has been identified.
15. The views of investors will also be important
in arriving at final proposals for a bail-in
mechanism. In putting forward now the suggested
approach in Section 2, it is envisaged that this
approach can form the basis for a well-grounded
engagement with the investor community.
16. The objective of a bail-in is to preserve systemic
stability. Accordingly, all financial institutions
should potentially be able to be the subject of
a bail-in determination. In practice, only those
the failure of which would be systemic in the
circumstances as determined by the authorities
should actually be subject to bail-in.
17. The order of priority between classes of
shareholders and classes of creditors should be
maintained in all cases. Within a class, certain
creditors may be bailed-in while others are not.
However, no creditor should be left worse off as
the result of a bail-in than s/he would have been
in the liquidation of the firm.
18. It is proposed that the primary scope of a bail-
in mechanism should be limited to subordinated
debt. In many cases this is likely to be sufficient to
recapitalize the firm so as to achieve the objectives
set out. Such an approach can help address some
of the potential disadvantages of bail-in, including
enhanced uncertainty, increased pricing of debt,
and possible funding arbitrage. Moreover, such an
approach helps lock in tightly adherence to the
strict order of priorities in an insolvency.
19. However, it is acknowledged that it is not possible
to calibrate precisely ex ante the scale of the
potential need for fresh capital in a crisis situation.
Therefore it is envisaged that as a last resort, and
subject to clear requirements and criteria, it may
be necessary to bail-in a proportion of the senior
debt of the firm as an alternative to the winding-
down of the firm.
20. The Industry believes that obligations arising
from the trading activities of the firm should
be excluded ex ante from the scope of this
exceptional power of bail-in. Whether the scope of
this bail-in should be more precisely determined
ex ante—for example, by the exclusion of liabilities
with a maturity of less than 365 days, or of
uninsured deposits—is a key issue requiring further
consideration.
21. In all cases, the order of priority between different
classes of shareholder and debtholder must be
maintained. While this principle is immutable,
further work is needed to identify the best
technical options to achieve this.
22. Bail-in allows the firm to be restructured, weak
management to be replaced, and the recapitalized
firm to access sources of liquidity as being now
firmly capitalized.
23. In the case of cross-border firms, the preferred
approach is for the FSB to reach agreement on
the requirement for each country to adopt a
bail-in mechanism. This would avoid divergent
approaches. To the extent that this is not
achieved contractual solutions will be required.
KEY ASPECTS IN
RESOLVING CROSS-BORDER FIRMS
24. National resolution regimes must form consistent
and convergent components of an international
framework for the resolution of cross-border firms.
25. Firms adopt a variety of structural and
organizational approaches to the operation of
their cross-border businesses. Such approaches are
determined primarily by the nature of the business
of the firm and the business model adopted. As
such, material disbenefits would follow from
any attempt to require firms to adopt particular
structures or organizational approaches.
26. For certain types of business and under certain
business models, the ability of groups to run their
business so as to optimize the “group interest” can
result in enhanced outcomes for all parties and the
economy. However, there is a potential mismatch
between such a group-interest concept and the
legal entity–based nature of resolution regimes.
Moreover, in such cases the requirement for
authorities primarily to pursue outcomes defined
in national jurisdiction terms can also, depending
upon the nature of the business, produce negative
sum outcomes.
27. The work being carried out by the FSB on
firm-specific crisis management agreements
is important and has the potential to achieve
significant progress in this regard. To be
successful, however, these agreements should
establish legally effective resolution modalities
that reflect the organizational structure and
business model of the group. This in turn requires
that national resolution frameworks are adapted to
give effect to such agreements.
28. Among the components of such frameworks
should be:
• International mandates for authorities;
• A requirement of non-discrimination against
creditors of the group on the basis of their
location or nationality;
• An objective to optimize outcomes for creditors
of the group as a whole;
• A requirement for joint planning in the context
of crisis management and resolution colleges,
and clear cooperation and coordination
agreements led by the home authority;
• A requirement for authorities to share all
relevant information on the basis of strict
confidentiality; and
• Principles for the effective and fair
interoperation of funding arrangements in
respect of the additional costs of resolution.
29. Resolution and resolution planning in respect of
a host branch needs to take into account local
requirements, regulations, and depositor protection
arrangements. It should generally be led by the
home authority in close cooperation with the host
authority (though there may be exceptional cases
in which the particular configuration makes it
more appropriate for the resolution to be led by
the host authority).
30. In the development of firm-specific resolution
13
|
agreements between authorities, one of the issues
INSTITUTE OF INTERNATIONAL FINANCE
to address will be achieving fair outcomes among
creditors across the group. The development of
mechanisms that can achieve this—in particular
by addressing the distribution of resources in the
group during a resolution—remains a difficult and
challenging subject. Intensified work and close
dialogue between the official and private sectors is
needed to try and develop optimal solutions.
 INTRODUCTION
14 31. This paper has been prepared by the Institute’s
Cross-Border Resolution Working Group (CBRWG),
|
chaired by Urs Rohner, Chairman of the Board of
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
Directors, Credit Suisse Group AG, as a continuation
of the Industry’s contribution to the efforts aimed
at establishing an effective international framework
for the resolution of cross-border financial firms.
The work has been carried out under the auspices
of the Special Committee on Effective Regulation,
chaired by Peter Sands, Group Chief Executive,
Standard Chartered PLC.
BUILDING ON PREVIOUS WORK
32. In May 2010, the Institute published a report
developed by the CBRWG, A Global Approach to
Failing Financial Firms: An Industry Perspective1,
which outlined the key elements of a framework
that would make it possible for any firm, irrespective
of its size or interconnectedness, to exit the market
without causing systemic disruption and without any
expectation that taxpayers’ money will be used. Such
a framework is key to achieving a durably resilient
financial system. A summary of the key components
of an effective resolution framework as contained in
the May 2010 report are set out in Annex 1.
33. After the May 2010 report, the Institute submitted
to the FSB the paper, Preserving Value in Failing
Firms2 in September 2010, focused on the power
for authorities to convert some of the debt of the
firm to capital to bring about its recapitalization
(“creditor bail-in” or “bail-in”). The paper was
largely exploratory and did not seek to reach final
conclusions on several key issues; however, it
expressed considerable merit in examining bail-in
arrangements further.
IMPORTANCE OF RESOLVABILITY
34. The Institute believes that effective resolution is
essential to achieving long-term resilience and
financial stability. Such effective resolution plays
a key role in addressing moral hazard and issues
associated with systemically important firms.
35. As the Institute has said previously, we strongly
believe that addressing systemic risk requires
1
http://www.iif.com/download.php?id=Oq+9y23X4Us=
2
http://www.iif.com/download.php?id=ryVjoux4FSs=
an approach based on four mutually reinforcing
components:
(a) Enhanced regulation,
(b) Improved industry practices,
(c) Strengthened supervision, and
(d) Effectively functioning markets.
36. Not only is the balanced integration of these
four components necessary to achieve long-term
stability, failure to achieve such balance is likely
to have significant adverse consequences. There is
currently a real risk of disproportionate reliance
on the regulatory component at the expense of the
other three, and there is significant potential for
adverse consequences flowing from this.
37. An effective framework for the resolution of all
financial firms, including large, complex financial
institutions, is a key component in achieving
effectively functioning markets and finding a
balanced integration of the four components
outlined. Putting in place effectively functioning
resolution regimes is therefore a key priority.
STRUCTURE OF THE PAPER
38. This paper continues the Industry’s work in this
area. In particular, three broad priority areas
have been identified for further work. These are
reflected in the three sections of this paper:
39. Section 1 considers the need to ensure the
continuance of critical functions in the event of
the failure of a large, complex financial firm.
40. Section 2 continues the Institute’s work on
“bail-in.” It seeks to outline an effective and
economically viable mechanism whereby the
systemic shock potentially arising from the failure
of financial firm is significantly reduced. The
section develops a draft set of principles that might
be envisaged for the creation of a bail-in regime.
41. Section 3 develops an analysis of the key obstacles
to achieving the effective resolution of cross-border,
as opposed to purely domestic, financial firms and
proposes solutions to these obstacles.
SECTION 1 - EFFECTIVE RESOLUTION PLANNING—
ENSURING THE CONTINUANCE OF CRITICAL FUNCTIONS
42. For financial institutions to be able to exit the
market in an orderly manner, it is necessary that
their doing so does not cause a failure in essential
service provision within the financial system such
that the wider economy suffers a major disruption.
43. This section seeks to advance the analysis aimed
at achieving that objective. The issue is closely
tied to, indeed forms an integral part, of the
broader issue of resolution planning. Ensuring
the continuance of critical functions is a key
aspect of such planning. Accordingly, the analysis
in this section seeks to enhance the quality and
effectiveness of such planning.
THE MEANING OF “CRITICAL FUNCTION”
44. It is important to be clear about what is meant
by a “critical function.” This is necessary for
two reasons. First, different objectives may be
achieved by different tools. Being precise about
the particular objective in view—for example,
maintaining critical functions, as opposed to,
say, avoiding contagion, preserving value,
or minimizing costs to the deposit protection
scheme—can contribute significantly to the design
of an effective resolution framework.
Not a cost-free question
45. Second, the preservation of critical functions
may not be a cost-free exercise. To take a simple
stylized example: the transfer of the liabilities that
constitute the essence of the critical function to
a bridge bank will require the transfer of “good”
assets of at least the same value to support those
liabilities. This means—and indeed it depends for
its effectiveness on the fact—that the transferred
liabilities are protected from losses. On the other
hand, those liabilities left behind in the rump
institution are exposed to greater losses than they
would otherwise be, due to the removal of their
access to the transferred, good assets. Because of
the principle that no creditor should be worse off
than s/he would be in a liquidation, and assuming
that the value in the failing firm taken as a whole
is less than its liabilities, this would result in a
shortfall that needs to be somehow made good.
15
|
INSTITUTE OF INTERNATIONAL FINANCE
46. More realistically, it is likely that the decision
will be made to transfer a full business line
incorporating the critical function. This will
encompass both the liabilities and the assets that
constitute that business. Of course, if the assets
are impaired the purchaser will wish to see further
assets provided to ensure that what s/he is
receiving is at least a parity of asset value and
liabilities. In this case, it may be likely that the
franchise value of the business line will also
contribute materially to the value transferred so
that the “value gap” created in the rump firm
(to be borne by the residual creditors) might be
significantly reduced.
Systemic relevance necessary, but not sufficient
47. In the paper, Guidance to Assess the Systemic
Importance of Financial Institutions, Markets and
Instruments: Initial Considerations (October 2009),
the FSB, the International Monetary Fund (IMF), and
the Basel Committee on Banking Supervision (BCBS)
provided a broad definition of a systemic event:
The disruption to the flow of financial services
that is (i) caused by an impairment of all or
parts of the financial system; and (ii) has the
potential to have serious negative consequences
for the real economy.
48. The following key elements contribute to the
systemic relevance of the disruption:
a. non-substitutability: the disrupted services
cannot be substituted within a reasonable time
and at acceptable costs;
b. negative externalities: the failure of one
institution and the discontinuance of its critical
functions cause friction and spill over to other
market participants; and
c. real economy impact: the disruption—
both directly and through its negative
externalities—causes a significant spill-over
into the real economy.
 49. To an important extent, these three criteria are
relevant for the determination of what is a “critical
function” for current purposes. It is clear that it
is a necessary condition for a particular function
to meet the requirements of systemic relevance in
order to be considered a “critical function.”
Clarity as to mode of “systemicness”
16 50. However, some further specification may be
required to arrive at a practical definition of
|
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
critical functions for this purpose. For example,
the fact that a firm is connected to a large number
of counterparties because it operates a very large
derivatives business might mean that the firm is
systemic due to the counterparty contagion risk to
which it gives rise. However, it does not mean that
its derivatives business is a critical function.
51. There are a number of means by which the
“systemic relevance” of a firm will be addressed—
these include, for example, ensuring that creditors
are aware that they will be fixed with loss and
should therefore manage their risk more effectively
ex ante; ensuring that a continuum of effective
powers are available to authorities; enhancing the
resilience of market infrastructure; and putting in
place possible measures such as bail-in techniques
and contingent capital instruments to reduce risks
of contagion.
52. The concept of “critical function” is designed to
address just one aspect of systemic relevance: that
is where there is an essential function or service
performed by the institution and the only way that
it can reasonably be dealt with is to carve it out
and transfer it in the event of the failure of a firm.
53. One important aspect of this question therefore
is that a particular function should not be
deemed critical just because it will give rise to
some disruption if it fails. Rather, it should be
determined to be critical only if it is more or less
essential that the service not be disrupted, or at
least that the degree of disruption likely to result
is very great.
54. A further relevant consideration is the extent to
which users of the service might reasonably be
expected to take appropriate measures ex ante to
insulate themselves from the disruptive effects of
the firm’s failure. For example, large corporates
can be expected to ensure that they are not
exclusively dependent upon one financial firm
for their ongoing liquidity and should not be
incentivized not to do so by the treatment of such
liquidity provision as a critical function.
55. Accordingly, a service should be considered
critical when the following criteria are met:
a. the function represents a critical part of the
financial system infrastructure;
b. users of the service could not reasonably be
expected to have put alternative, fall-back
options in place ex ante;
c. the service cannot be substituted in a timely
manner; and
d. the service is essential to the financial system
and the economy and its failure would cause
severe trauma.
Considering critical functions
56. In general terms it is not possible to say in the
abstract whether a particular function is critical
or not without a specific assessment of the wider
context in which it is provided. For not only is the
nature of the function key to this determination, so
too is the scale upon which the service is provided
by the failing bank, and the prevailing financial
sector and economic circumstances. The market
share of the activity enjoyed by the firm in question
will be a key question in determining whether or
not a function should be deemed critical.
57. Criticality of function is therefore a matter which
falls to be determined on a firm-by-firm basis.
Nonetheless, it is useful to consider, by way of
example, a number of putative critical functions
to examine how the determination of whether
they may, in fact, be critical functions might be
approached. In Annex 2 we consider the potential
criticality of a number of functions.
58. Care is required in considering these examples as
a number of fine, if important, distinctions are
made. For example, it is said that deposit-taking
is unlikely to be a critical function. However this
means only that the provision of deposit taking
services per se by a particular firm is unlikely
to be critical. This does not mean that insured
depositors will not require to receive repayment
of their funds in a timely manner; nor that the
payment service aspect of such accounts may not
be critical. It simply means that, being precise
in our thinking, the approach to a failing firm’s
deposit taking activities should be determined
not by critical function considerations per se, but
rather by the need to avoid a loss of confidence
amongst consumers and outcomes considered
unfair. Accordingly the key means of addressing
the issue of insured depositors will be (a) by
 having in place an appropriate deposit protection
scheme; and (b) by making sure that arrangements
are in place to provide protected depositors with
timely access to their insured funds.
59. It is also important to take the time horizon into
consideration. The continuance of certain services
may be necessary only over a short timeframe to
allow other providers to step in and fill the gap.
60. The different circumstances prevailing in the
context of an idiosyncratic failure as compared
with an episode of wider systemic trauma should
also be taken into consideration. Sale to a third
party in the context of the latter may be more
challenging with greater resulting need for the use
of bridge-bank arrangements.
RESOLUTION PLANNING
61. As we said in our May 2010 report, resolution
planning is primarily the responsibility of
authorities. This is distinct from recovery
planning, the primary responsibility for which
falls on the firm. In the event of the need for
a resolution, it will be the authorities who
will be in control of the process, with the firm
playing an assistive role. The key purpose of
resolution planning is to ensure that both firms
and authorities are well positioned to handle the
situation if and when a firm fails.
No matter-of-course requests
for restructuring…
62. Firms have a responsibility to provide all of the
information necessary to allow authorities to
carry out resolution planning. It is legitimate
and appropriate for authorities to wish to be
satisfied that is practicable and feasible for critical
functions provided by the firm to be isolated and
transferred with all due speed in the event of the
imminent failure of the firm.
63. We do not believe that it is appropriate or
necessary for this to be sought to be achieved by
matter-of-course requests by authorities for firms
to restructure themselves so as to isolate particular
functions in dedicated legal entities or to require
a modularization of the firm along entity and
function lines.
64. It is important that a group’s structure and
organization reflect its business model and
strategy. A requirement to move away from
3
Section 2.
such an approach will give rise to significant
inefficiencies and economic costs.
65. Our May 2010 report considers this question at
some length.3 It sets out the Industry’s concern
“that if regulatory demands for changes to
organizational structure become a normal aspect
of recovery and resolution planning, that will lead
to a proliferation of requirements for change that
could result in a significant mismatch between
a firm’s organizational structure and its overall
17
|
business model. This is a real risk that could cause
INSTITUTE OF INTERNATIONAL FINANCE
significant harm over the long run.” There is also
considerable concern that such interventions
in how firms structure themselves will lead to
increased national ring-fencing.
66. Though firms should be able to demonstrate how
a critical function could otherwise be extricated
and transferred, a firm’s organizational and legal
structures should reflect and be determined by its
business model. There are many reasons why more
complex approaches may be necessary. Indeed,
such services often make most sense and add
the most value for clients when embedded in the
broader business of the firm.
67. What is essential is that it is made clear by a
firm how the separation and transfer of critical
functions can be achieved in a speedy manner.
Firms’ fulfillment of this requirement will obviate
any need for over-prescriptiveness by authorities
as to the manner in which this should be done.
…or separation
68. As to the desirability of requiring firms to
completely separate their retail and wholesale
banking activities, as discussed above, we do
not agree that all forms of retail activity are
necessarily to be deemed critical functions within
the strict meaning of that term as we have defined
it here. Moreover, for the reasons set out in the
preceding paragraphs, while it is the responsibility
of firms to explain and demonstrate how critical
functions can be maintained in the event of the
failure of the firm, this does not mean that such
functions are required to be separated ex ante and
subjected to modularization.
Firms’ responsibilities
69. There is, therefore, an important obligation
on firms to provide clear information and
explanations to the authorities as to how any
 critical function activities can be isolated and MAINTAINING CRITICAL FUNCTIONS
transferred in the event of failure. There is a need
for a clear and concrete description of how this
ON A CROSS-BORDER BASIS
can be done. 71. It is essential that resolution frameworks are
effective not just in the domestic but also
70. The Industry is of the view that the explanation
the international context. Indeed, given the
and information to be provided by firms for
international nature of many of the firms falling
critical functions should cover the following:
within the current moral hazard discussion, it is
a) A clear description of the function in question, in many ways even more important that such
18 including its key features and the scale of regimes are effective in a cross-border context.
provision by the firm.
|

72. The issue of achieving effective resolution of

ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION

b) Identification of how that function is provided specifically cross-border firms is considered in

by the firm. This should include: full detail in Section 3. We note here, however,
• Key aspects of the contractual basis upon the importance of being able to handle the
which the service provided rests; maintenance of critical functions on a cross-
border basis.
• Whether the service forms part of an
integrated suite of services provided to 73. Crucial to this will be coordination among
clients, or is a more stand-alone service; authorities in different jurisdictions. Determining
which functions are critical—be that locally or
• How to identify which clients use the service;
internationally—and how they should be dealt with
• Where and how the assets and liabilities in the event of the failure of a firm requires close
arising from the provision of the service are cooperation and coordination among authorities.
booked; This should be an important component of
• How the service is supported in terms of the work to establish firm-specific resolution
infrastructure and IT; and agreements among authorities currently underway
in the FSB and a key aspect for consideration in
• How the service is supported in terms of
the firm-specific crisis management groups.
funding.
c) Separating and transferring the function in an
event of failure:
• What contractual / legal issues arise?
• Is it needed to transfer a large part of
relevant clients’ business with the firm, or
just specific accounts? If specific accounts,
are these limited to the critical activity or
are they broader?
• What does it mean in practice to transfer this
business: Who will be the new legal parties?
By whom/how will the IT be provided?
What is the transfer mechanism? What
interdependencies need to be addressed?
d) Financing the function/financing the transfer:
• Assuming that the main moving parts of
the service to be transferred are liabilities
to clients, what assets will be transferred to
support those liabilities? How will these assets
be identified? How will they be transferred?
SECTION 2 - AVOIDING SYSTEMIC TRAUMA—
MAKING BAIL-IN TECHNIQUES OPERATIONAL
74. On the issue of bail-in, the Institute made a
submission to the FSB in September 2010:
“Preserving value in failing firms.4 Since that
time, the Institute—through its Working Group on
Cross-border Resolution (CBRWG)—has continued
to work on the topic, in particular to address a
number of the difficult issues that arise in making
bail-in techniques operational.
75. The FSB’s report, Reducing the moral hazard posed
by systemically important financial institutions,
of October 20, 2010, to the G20 leaders noted that
bail-in could potentially form part of the higher
loss absorbency required of systemically important
firms. The European Commission is also considering
the question of bail-in measures as part of its
recent consultative document, Technical details
of a possible EU framework for bank recovery and
resolution,published on January 6, 2011.
76. In the text below we set out a set of principles for
operationalizing bail-in techniques. It should be
noted, however, that this remains a challenging
area and in a number of places further work will
be required to arrive at final conclusions.
IIF’S PRESERVING VALUE PAPER
77. In our earlier Preserving Value paper, we expressed
the preliminary view that there was considerable
merit to examining the introduction of a bail-
in regime. We said that the technique offered a
promising means of forestalling the disorderly
liquidation of systemically important firms, with
the attendant instability that might result from
such an event. However, the paper also recognized
and cautioned on the need to address a number
of open issues and a range of technical matters
that needed further analysis in order to have a
clearer understanding of how such a regime could
operate. Key aspects of the analysis contained in
the Preserving Value paper are set out in Annex 3.
4
http://www.iif.com/download.php?id=ryVjoux4FSs=
Scope of liabilities subject to bail-in 19
78. A key issue in the Preserving Value paper, and one
|
INSTITUTE OF INTERNATIONAL FINANCE
that we return to below, is the scope of liabilities
that should be subject to a bail-in power, and the
extent to which this should be decided ex ante or
ex post.
79. Supporting a limited scope/ex ante approach
were the degree of clarity and certainty that this
would bring to the situation. This approach was
considered to have benefits in terms of making it
clear to certain categories of credit counterparties,
including trading counterparties, short-term
creditors and liquidity providers, and uninsured
depositors, that they would not be subject to bail-
in measures, thus minimizing the likelihood of
flight. By determining in advance which categories
of credit counterparty might be subject to bail-in
it was possible to increase the consensual nature
of the mechanism. Beyond this it was also the
view of a number of Members that by limiting
clearly the scope of bail-in it would be possible to
limit any potential increase in bank funding costs.
80. A number of disadvantages associated with
an ex ante limited scope approach also were
identified. This approach has the potential to
contribute to moral hazard in the system, as
those liabilities explicitly exempted from the
bail-in mechanism may be perceived as receiving
considerable additional protection against losses.
That significant distortions would be introduced
under an ex ante approach also was identified as
an important risk, with funding techniques being
arbitraged to avoid potential bail-in exposures.
On the cost of bank funding some argued that a
broad or “comprehensive” approach, by replicating
a “pre-packaged bankruptcy” by way of a residual
power vested in authorities, would minimize any
possible increase in funding.
81. In the text that follows we seek to resolve the
tension between these different approaches. In
 particular, it is envisaged that the primary scope
of bail-in powers will be limited to subordinated
debt. In proposing this approach we are influenced
by some research indicating that in many cases
adequate recapitalization of firms in difficulty
might be achieved on the basis of the conversion of
subordinated debt only. However, it is acknowledged
that it is not possible to calibrate precisely ex ante
the scale of the potential need for fresh capital in
20 a crisis situation. Therefore it is envisaged that as
a last resort, and subject to clear requirements and
|
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
criteria, it may be necessary to bail-in a proportion
of the unsecured senior debt of a firm as an
alternative to the winding-down of the firm.
OPERATIONALIZING BAIL-IN
82. Building upon the initial work in Preserving Value,
the objective in this subsequent contribution is to
make more operational the concept and in doing
so to address a number of the key challenges
identified in that earlier analysis. In particular, we
now seek to articulate a more concrete elaboration
of the concept and provide a more detailed
specification of the key building blocks.
83. To this end, this Section puts forward a draft set
of principles that might be envisaged to underpin
the development of a bail-in regime in different
jurisdictions. By putting forward this set of
principles, supported by appropriate commentary
and discussion, it is hoped to both provide a clear
path to the solution of outstanding difficulties and
promote an agreement on the subject among key
participants across the different jurisdictions.
TIMING
84. The general view among Industry participants is
that it would not be appropriate to retrospectively
subject existing debt to a new power of bail-in.
Moreover, it is considered desirable that there
should be—to the extent possible—a graduated,
rather than abrupt, adjustment of Loss Given
Default (LGD) estimates in respect to such debt.
Accordingly, it is proposed that bail-in techniques
should be prospective only.
BAIL-INS AND BRIDGE BANKS:
THE DODD-FRANK APPROACH
85. The discussion in the following text focuses on
the desirability of a mechanism that allows a
5
FDIC, April 2011
firm to be recapitalized by converting a certain
proportion of debt into equity so as to prevent a
precipitous loss of value and a resulting systemic
shock. It is argued by some that these outcomes
could also be achieved by the use of a bridge-bank
mechanism deployed in a particular way at the
point of insolvency. This question is of importance
as the approach enacted in the United States under
Dodd-Frank—while it requires the winding-up of
failing firms—also envisages the use of bridge-
bank mechanisms to optimize outcomes.
86. It may indeed be possible that bail-in outcomes
could, depending upon the legal context of
a particular jurisdiction, be achieved by such
alternative means. Whether this is the case requires
further study. In this regard see, for example,
the article, “The Orderly Liquidation of Lehman
Brothers Holdings Inc. under the Dodd-Frank Act.”5
THE KEY ELEMENTS
OF A BAIL-IN REGIME
87. Set out below is a set of suggested principles that
might form the basis for bail-in regimes to be
adopted in different jurisdictions. The principles
are accompanied by explanatory text.
GENERAL OBJECTIVES
AND GOVERNING PRINCIPLES
1.1 The general objectives of bail-in arrangements
are as follows:
• To create the conditions whereby every
financial firm may be restructured through
an orderly “failure” in the event that it is no
longer able to meet its obligations or becomes
otherwise not viable;
• To avoid the financial instability that may
result from the disorderly liquidation of a
systemically important firm;
• To reduce moral hazard and expectations that
risks and losses will be borne by taxpayers. Losses
should be borne by shareholders, providers of
other forms of capital, and creditors; and
• To forestall precipitous and major loss of
value in the firm, which could give rise to
traumatic effects on the financial system and
the broader economy.
1.2 These objectives should be pursued in
accordance with the following conditions:
 • Property rights must be respected. This
includes, in particular, full respect for security
and collateral rights. These should not be
abrogated.
• Creditors should not be worse off than they
would be in a normal bankruptcy.
• Bail-in should be seen as part of the
continuum of measures and tools necessary to
protect the financial system, and especially to
ensure that all firms can be resolved safely in the
event of their failure or imminent failure. Bail-in
measures should be deployed only after such
other measures and tools have been exhausted.
• Triggers should be clearly defined, avoiding
undue uncertainty. There should be consistency
across jurisdictions.
• When relevant, effective cross-border
coordination should be ensured and fragmented
national responses prevented.
• To the extent that additional costs are
incurred in resolving a firm in a manner that
avoids systemic damage, such costs should not
be imposed on creditors (or a particular group
of creditors).
COMMENTS ON GENERAL OBJECTIVES AND
GOVERNING PRINCIPLES
88. This set of principles sets out the central objectives
of a bail-in regime and the key conditions for such
a regime.
89. The key objectives of facilitating restructuring
or allowing an orderly failure while preserving
financial stability are broad enough to cover
in general terms a number of concerns often
highlighted by the official sector, for example,
protecting retail depositors and protecting
systemically important functions.
90. Allowing every financial firm to undergo an
orderly “failure” in the event that it is no longer
able to meet its obligations or becomes otherwise
not viable must be a key feature of any resolution
regime. Bail-in is a tool that contributes to
achieving this objective; it should be seen as a
form of restructuring for a firm that has failed.
91. The objective of any resolution tools should not
be the survival of a failing firm per se, but rather
allowing firms to fail in an orderly way without
any cost to taxpayers; however, a byproduct of
a bail-in mechanism is that firms, in some form,
survive legally at least ad interim, and if the
effort is fully successfully, in the longer term. In
this respect the outcomes can be seen as rather
similar to the potential outcome of a Chapter 11
bankruptcy in the United States.
SCOPE
2.1 Unless otherwise determined in accordance
with these provisions, a financial firm that fails
should exit the market in accordance with the 21
normal rules for the resolution of such firms.
|
INSTITUTE OF INTERNATIONAL FINANCE
2.2 All financial institutions may be potentially
subject to bail-in.
2.3 A financial institution should only be subject
to bail-in measures to the extent determined by the
designated authorities:
(a) that to allow the firm to be subject
to normal resolution rules would carry a
significant risk of causing significant financial
instability;
(b) that such risk would derive from a
precipitous loss of value affecting the assets
of the firm due to a declaration of insolvency
and/or affecting the wider financial system due
to the interconnectedness of the firm with the
wider market; and
(c) that there is a reasonable prospect of such
loss of value being averted or significantly
reduced if the measures in this set of principles
are deployed.
COMMENTS ON SCOPE
92. The effect of these “Scope” principles is to give
bail-in measures a broad potential scope in terms
of the firms to which they may potentially apply
and to clarify that, when a number of conditions
are met, any financial institution may be subject
to a bail-in.
93. This is consistent with IIF’s view that systemic
risk cannot be linked to any particular category
of firms. Moreover, any possible perception that a
regime directed only at some firms may lead to a
non-level playing field (and, specifically, might give
large firms some advantage) needs to be rejected.
The question of the systemic importance of a firm
needs to be made on a case-by-case basis against
the backdrop of the prevailing circumstances.
94. It is important that the purpose for which bail-in
powers can be exercised be clearly and tightly
drawn. Such powers significantly enhance the
administrative power of the State to intervene
 in private contracts. If the conditions for use are
drawn too broadly, there is material risk that
it could be exercised too early (see the “Bail-In
Triggers” principles below) or too broadly, giving
rise to undue interference with private contracts.
In short, unless the power is defined tightly there
is a risk of a disproportionate increase in financial
firm funding costs as creditors’ confidence and
certainty is undermined by the potential for
22 significant State administrative intervention.
|
95. The benefit of bail-in techniques as compared with
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
the application of general resolution provisions
is that a bail-in can forestall a precipitate loss of
value such as that seen in the Lehman’s case.6 It is
such loss of value that, either directly or indirectly
through the interconnectedness of the firm, can
give rise to systemic instability. Accordingly, only
where it is determined that there is a significant
risk of such loss of value should bail-in measures
be deployed.
BAIL-IN TRIGGERS
3.1 The decision to trigger the bail-in power
should be exercised by the designated authority(ies)
in consultation with relevant authorities who
are not the designated authority(ies), including,
as appropriate, the resolution authority, the
supervisory authorities, the central bank, and the
finance ministry.
3.2 The trigger for a bail-in should be the same
trigger that applies for a determination that a
financial firm’s activities require to be resolved or
wound down.
COMMENTS ON BAIL-IN TRIGGERS
96. We do not take a view at this stage as to which
authority(ies) should be the designated authority
for bail-in purposes. (More broadly, we have
not taken a view as to which authority should
have the power to determine that a firm should
be resolved.) Different modalities are possible.
However, in deciding which authority should have
this power, it will need to be ensured that risk of
authorities’ forbearance is avoided. Moreover, the
decision should be exercised in consultation with
relevant authorities who are not the designated
authorities, including, as appropriate, the
6
In our report, Preserving Value in Failing Financial Firms (September 2010), pp. 8–9, we estimate that a loss of asset value in the estimated range of $25
billion became, post-declaration of insolvency, a loss to creditors of possibly $150 billion. It its article, “The Orderly Liquidation of Lehman Brothers
Holdings Inc. under the Dodd-Frank Act,” (April 2011), the FDIC assumes for the purposes of illustration that the losses on assets prior to the declaration
of insolvency would have been $40 billion, representing a loss rate of 60 percent to 80 percent on $50 to $70 billion of assets identified by potential
acquirers as being impaired or of questionable value, representing a loss of value significantly less than currently expected under the bankruptcy.
resolution authority, the supervisory authorities,
the central bank, and the finance ministry.
97. It is desirable that bail-in measures are triggered
as close as possible to the time that the firm
would otherwise become insolvent and go into
bankruptcy. To avoid undue uncertainty or the
potential “bringing forward” of insolvency, the
relevant trigger must be tightly drawn, and the
judgment of the authority tightly constrained. For
this reason the trigger for a bail-in should be the
same as for a determination that a financial firm
requires to be resolved or wound down.
THE BAIL-IN POWER
4.1. The “bail-in” powers referred to here are:
• Power to dilute shareholders or write-off
shares of the firm, and
• Power to alter the terms and conditions of
subordinated debt of the firm, including the
conversion of such debt claims into equity.
4.2. In the exercise of such powers no category of
equity holder or creditor having priority over another
in the event of bankruptcy / insolvency, should be
treated other than in line with that priority.
4.3. Senior management
• The resolution authorities should have power
to replace any or all members of the senior
management and/or board.
• Over the period following the exercise of
the bail-in measures, steps should be taken
to investigate the reasons for the failure of
the firm and to identify those members of the
board and senior management considered to
be directly responsible for the decisions and/or
actions leading to the failure. Such individuals
should be replaced.
COMMENTS ON THE BAIL-IN POWER
98. As discussed in the introduction to this Section,
the question of the scope of liabilities falling
within the bail-in power is a difficult one upon
which the industry has had much discussion.
99. A crucial issue is whether any unsecured debt
might, at least in principle, be considered bail-
inable (with a number of selected exclusions
 determined ex post on a case-by-case basis by
the resolution authority), or whether a bail-
in mechanism should be built on an ex ante
determination as to which liabilities should
(potentially) be subject to bail-in.
100. The approach suggested above is to limit the
primary scope of application to subordinated
debt. On the basis of analysis carried out by some
Member firms, it is believed that in many cases
the availability of such debt is likely to provide
sufficient resources for effectively re-capitalizing
a firm. As indicated in principle 5 below, however,
it may be that in the particular circumstances of
the case the bail-in of subordinated debt will be
insufficient for the purpose. In this case authorities
should have the power to bail-in the necessary
proportion of senior debt.
101. Principle 4.2 aims to ensure that the order of
priorities in bankruptcy be respected. Once again,
different modalities are possible—for example, an
approach whereby all equity is fully written down
and extinguished before debt is converted or, if
this is not optimal, whereby remaining original
equity remains subordinated to converted debt.
Alternatively, another way to achieve this may
be to seek to ensure that the economic values of
the different instruments (including their relative
values), which reflect their ranking in the looming
resolution, are maintained. While being very clear
that it is essential that the order of priorities must
not be subverted, the Industry has not yet reached
a firm view as to whether this should be achieved
by means that are primarily legal in nature or
primarily economic.
102. Concerning principle 4.3, which deals with senior
management, the Industry believes that it is
important that those considered directly responsible
for the failure of the firm be held accountable.
ADDITIONAL POWER TO BAIL-IN SENIOR DEBT
5.1 In particular circumstances, it may be the case
that the bail-in of all subordinated debt will be
insufficient to recapitalize the firm sufficiently to
achieve the objectives set out above. In this case
where there is no other appropriate alternative to
achieve the objectives set out above, the designated
authorities should have the power to bail-in a
wider category of creditors as described below.
5.2 The supplementary nature of such power should
be recognized in the requirement for the authorities
to take a separate decision, clearly documented
and reasoned, and the subject of a report to be
made publicly available as to the basis upon which
their decision was reached. The report should inter
alia set out how the decision of the authorities
complies with the key principles of reasonableness,
proportionality, and final necessity.
5.3 The liabilities subject to this power of further
bail-in should be the unsecured senior obligations
of the firm except obligations of counterparties
arising from the trading activities of the failing
firm. [Whether the scope of principle 5.3
should be extended will be the subject of further
23
|
consideration—see comments below.]
INSTITUTE OF INTERNATIONAL FINANCE
5.4 The designated authorities should decide, in
compliance with the principles set out above, and
taking into account guidance to be published by
the authorities, whether to limit the types of senior
obligations to be subject to the power of further
bail-in and, if so, to which type of obligations.
5.5 In exercising this power, all of the principles
governing the bail-in of subordinated debt shall
apply.
COMMENTS ON ADDITIONAL POWER
TO BAIL-IN SENIOR DEBT
103. The approach described here is to make the bail-in
of any non-subordinated debt a last resort when a
conversion of subordinated debt is determined to
be insufficient to achieve the purposes sought.
104. The industry has reached the view that trading
obligations should not be subject to such final-
stage bail-in, as to do so would defeat one purpose
of the mechanism—to preserve the franchise
business of the firm. By including such obligations
in the potential scope of a bail-in, trading
counterparties’ confidence would be unlikely to
be maintained, with a resulting significant loss of
business value.
105. The industry has not yet reached a final view as
to whether other forms of senior obligation should
be excluded ex ante or left to be determined on
a case-by-case basis and in accordance with
administrative guidance to be published by the
authorities. The Industry will be working on this
issue further in the coming period.
SAFEGUARDS FOR CREDITORS
AND JUDICIAL REVIEW
6.1. Judicial review: Unless the board of directors
(or similar governing body) of the company has
acquiesced or consented to the activation of the
bail-in power, it should have the possibility to
file a petition for immediate judicial review.
 Such review should be limited to the legality and
legitimacy of the decision and ensure that the bail-
in mechanism is not activated arbitrarily, and any
judicial hearing should be strictly private.
6.2. Safeguards for creditors: No creditor of the
covered firm that has seen the amount that it is
owed written down or the terms and conditions of
the instrument it holds amended should be worse off
24 than it would have been under normal bankruptcy/
insolvency procedures. The determination as to
|
whether a creditor is worse off shall be made XX
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
year(s) after the exercise of the bail in powers.
6.3. Authorities should not be held liable for
negligence in the making of a determination to
exercise their bail-in powers.
COMMENTS ON SAFEGUARDS
FOR CREDITORS AND JUDICIAL REVIEW
106. It will be necessary to achieve an effective balance
between the need to ensure adequate judicial
safeguards and review and the need to ensure that
a bail-in mechanism can be deployed swiftly and
without creating undue uncertainties in the market.
CROSS-BORDER ASPECTS
7.1. These principles should apply to the liabilities
of the firm regardless of the jurisdiction in which
they are held and of the national law governing them.
7.2. Foreign creditors should have the right of
direct access to the resolution authorities and
to judicial authorities to obtain the safeguards
described in principle 6.
7.3. To the extent that the jurisdiction where the
liability holder is situated does not provide for
a recognition of the proceedings launched under
these principles, there should be incorporated in
the terms of all the relevant liabilities of the firm a
contractual provision rendering it subject to bail-in
measures as set out in these principles.
COMMENTS ON CROSS-BORDER ASPECTS
107. These principles seek to outline a response to the
coordination problems that arise when deploying
a bail-in mechanism in a cross-border context.
The main route to ensuring effective cross-border
coordination implies agreement among FSB
members committing:
• to undertake those legal changes needed
to achieve convergent and internationally
consistent resolution tools, and
• to recognize a foreign proceeding and ensure
the necessary cross-border cooperation and
communication among relevant resolution
authorities.
108. A supporting alternative approach is set out in
principle 7.3. This represents the hybrid approach
outlined in the Preserving Value paper: a bank
should, in its country of incorporation, be subject
to a statutory regime whose effect would be to
recognize the bail-in in national law; the bank
would then be required to ensure that for any
creditor eligible for a bail-in whose claims were
governed by any other law, the agreement with
that creditor would include a clause recognizing
the statutory power.
GROUP ISSUES
8. Where:
• the liabilities subject to the exercise of the
bail-in powers set out in these principles
represent liabilities of an entity that is a
subsidiary of another entity;
• the retention of the parent-subsidiary legal
relationship is determined by the resolution
authorities to be necessary to achieve the
objectives of these principles; and
• it is necessary to do so to preserve such
parent-subsidiary legal relationship
the equity interest received by those creditors of
the firm by virtue of the exercise of the powers
set out in these provisions shall be swapped for
equity of the parent of equivalent value.
COMMENTS ON GROUP ISSUES
109. Most large banks are members of groups, and it is
frequently the case that in a bank group there is
an unregulated bank holding company above the
bank. In the case below:
BANK HOLDING COMPANY
SENIOR OTHER GROUP
BANK
CREDITORS ENTITIES
if the bail-in were to be conducted at the bank
level, the effect could be to break the group
structure since, with the creditors becoming
 the shareholders, the bank would cease to be a
subsidiary of the holding company. The approach
proposed in principle 8 requires equity received
in the failing bank to be swapped for equity in
the parent entity/holding company when that is
necessary to achieve the bail-in objectives. This
issue should be identified and addressed as part of
the resolution planning in respect of the group.
NON-EFFECT OF DEFAULT
OR OTHER “TRIGGER” CLAUSES
9. The exercise of bail-in powers as described in
these provisions shall not be considered a default
for legal purposes. Any clause in any contract that
seeks to identify the exercise of bail-in powers
as an event similar to default for the purposes of
triggering legal consequences shall be invalid.
COMMENT ON “NON-EFFECT OF DEFAULT
OR OTHER TRIGGER CLAUSES” PRINCIPLES
110. Common practice in many derivatives, repo, bond
agreements, etc., is that forced resolution measures
by regulators are also deemed to be an event of
default, which would allow the counterparts to
terminate outstanding agreements. To achieve
the bail-in objective of avoiding the collapse
of the firm and a resulting major loss of value 25
and trauma to the system, measures are needed
|
INSTITUTE OF INTERNATIONAL FINANCE
to establish that the exercise of a bail-in power
would not be considered an event of default
among counterparties of the firm in question.
ISDA master agreements will be particularly
important in this regard. It is less clear that the
same would need to be achieved in respect of
credit derivative contracts referencing the firm.
This latter aspect requires further consideration.
 SECTION 3 - RESOLVING CROSS-BORDER
FINANCIAL FIRMS—ADDRESSING KEY ISSUES
26 INTRODUCTION
111. This section seeks to develop an analysis of the
|
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
key obstacles to achieving the effective resolution
of systemically important cross-border, as opposed
to domestic, financial firms and proposing
solutions to such obstacles. In the period since
the crisis, the conceptual and practical landscape
has changed quite significantly. This means that
the challenge now in achieving an effective
framework of cross-border resolution is somewhat
different than it was twelve months ago. There
has been important progress. It is important to
take stock of the developments that have occurred
in order to assess progress toward the ultimate
objective and to more accurately specify the
challenges that remain.
112. It is useful to remind ourselves what we mean by
“effective cross-border resolution.” What we mean
is that a large financial services group operating
in a number of jurisdictions—either by means of
subsidiaries or branches—is capable of exiting
the market in an orderly manner and without a
perception of unfairness in how the losses incurred
by the group are allocated among stakeholders.
To preserve the benefits of progress toward an
integrated international financial system, it is
important that this process be achieved without
requiring ring-fencing or the forcing of significant
structural/organizational change on financial
groups that have developed their organizational
structure to optimally reflect their business model
and the nature of their activities.
Less risk to taxpayers…
113. One of the major concerns of authorities is that,
in the event of the failure of a cross-border group,
the taxpayers in their jurisdiction will incur losses
and, further, that these losses will be unfair as
between jurisdictions. This is a central concern
that lies behind moves toward ring-fencing and
national self-sufficiency approaches.
114. Significant progress has been achieved, or can be
achieved, toward significantly reducing the extent
to which taxpayers are exposed to losses in the
event of failure. The work that is in train to ensure
that shareholders and creditors bear their losses in
the event of a failure should go a long way toward
achieving this.
115. The acceptance by the financial services industry
of its responsibility to fund the costs of effective
resolution mechanisms will also make a material
contribution toward protecting taxpayers from losses.
…but more to other stakeholders
116. It is not, however, simply disproportionate losses
to taxpayers that are of concern to national
authorities. They are also concerned about
disproportionate or unfair losses accruing to
stakeholders in their jurisdictions more generally.
For example, in the Lehman case, there were
no losses accruing to host country taxpayers.
Nonetheless, concern as to suboptimal outcomes
for creditors of host country subsidiaries was a
major factor in the reaction on the part of host
country authorities.
117. Given that an important objective of effective
resolution is to place shareholders and creditors
more at risk of loss than was the case in the past,
this aspect of the situation has become more
challenging than heretofore.
118. The protection of taxpayers is likely to be a
significantly greater imperative politically than
the protection of creditors (at least uninsured
creditors), who are better positioned to look after
themselves. Accordingly, the overall picture may
be one of a potential material easing of the extent
to which authorities feel at political risk if they do
not manage to ring-fence. However, the pressures
to ring-fence are likely to remain considerable as
things currently stand.
TYPOLOGIES AND APPROACHES
119. In general, cross-border financial institutions
can adopt a range of approaches to achieving a
physical presence in a host country. While they
can do so either by establishing a branch or by
establishing a subsidiary, it is important to think
 of cross-border groups not in binary terms but
rather as organizing themselves along a spectrum
of modalities as indicated by their particular
business model.
120. At one end of the spectrum are groups that
organize themselves on the basis of largely stand-
alone subsidiaries interacting with each other
on straightforward commercial terms (though
within the strong nexus of their intra-group
relationships). At the other end, there can be the
use of overseas branches that, both practically and
legally, operate more or less as the presence of the
home entity in the host jurisdiction. And between
these extremes, there are a range of hybrid
approaches: many groups utilize both branches
and subsidiaries, many make use of subsidiaries
in the context of an “integrated” group approach,7
and others make use of branches that operate to
a certain extent and in certain respects as stand-
alone entities.
GENERAL PROPOSALS
121. In our May 2010 report, A Global Approach to
Resolving Failing Financial Firms, we argued that
success in the area of cross-border resolution
required the establishment of an international
cross-border framework.
122. This did not require the establishment of an
international insolvency law. Rather, we called
on the G20/FSB to set up a high-level task force
with a view to establishing a roadmap toward the
creation of such an international framework for
the resolution of cross-border firms. This would
involve international agreement combined with
national jurisdiction measures.
123. Among the key components would be:
(a) convergence of national regimes to incorporate
agreed-upon key features of effective resolution
frameworks. The FSB report of October 20,
7
We would note that within the context of more integrated groups also, transactions between group entities are carried out on market-based commercial
terms. See further the question of “group interest” approaches discussed below.
8
See, for example, Restoring Confidence, Creating Resilience: An Industry Perspective on the Future of International Financial Regulation and the Search
for Stability (July 2009); Systemic Risk and Systemically Important Firms: An Integrated Approach (May 2010); and A Global Approach to Resolving
Failing Financial Firms: An Industry Perspective (May 2010).
2010, appears to indicate the potential for good
progress in this regard;
27
|
INSTITUTE OF INTERNATIONAL FINANCE
(b) enhanced coordination among resolution
authorities, including a lead authority
approach, possibly based on the modified
universalism approach suggested by some; and
(c) exploring methods for achieving equitable
cross-border outcomes.
124. In the following sections we consider in detail what is
needed to take these proposals successfully forward.
RESOLVING CROSS-BORDER
GROUPS: RESPECTING STRUCTURAL
ARRANGEMENTS DETERMINED BY
BUSINESS MODELS
125. As the Institute has discussed in a number of
places,8 it is important that financial groups
continue to be able to choose the mode of
organization and degree of integration of the
management of their group that most conforms to
the nature of their business model and the needs
of their business. A forced requirement that all
firms, regardless of their business model, adopt
a modular approach to their organization based
on the stand-alone self-sufficiency of each legal
entity or each national sub-group would dampen
economic performance.
126. As we said above, if regulatory demands for
changes to organizational structure become
a normal aspect of recovery and resolution
planning, this is likely to result in a significant
mismatch between a firm’s organizational
structure and its overall business model. There is
also considerable concern that such interventions
in how firms structure themselves will lead
to increased ring-fencing of countries and
fragmentation of the international marketplace.
 127. Depending upon the nature of the business being
carried on, amongst the benefits that can be
derived from group strength and strategy can be
the following:
• The ability to deploy capital and liquidity
efficiently for the group as a whole;
• The ability to support customers in cross-
border trade and investment to the benefit of
28 the economy in general;
|
• The ability to develop and implement
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
high-quality, strong governance and risk
management strategies at the group level for
the advantage of all entities;
• The development of a strong and reliable brand
that yields benefits both for the group and
its stakeholders and for consumers and the
economy in general; and
• The strength and resilience that can derive
from the ability to provide support from
one part of the group to another in times of
difficulty or stress.
Note: As well as political obstacles, there are
also a number of legal issues to be considered
in relation to the provision of group support
for entities that get into difficulty. These are
considered in Annex 4.
Avoiding negative-sum outcomes
128. Under current arrangements authorities in
different jurisdictions are in an invidious position.
Legislation requires the adoption of a legal
entity–based approach in the resolution and/or
insolvency phase. Such an approach means that
as the point of failure approaches, it becomes
increasingly critical as to where the assets of the
group are located.
129. Equally, the authority and legal mandate of
authorities to a significant extent relates to
the pursuit of certain outcomes within their
jurisdiction and to the promotion of the interests
of stakeholders—depositors, taxpayers, the
economy—within that jurisdiction. This means
that to the extent that there are informational
and first-mover advantages arising to some
authorities as compared with others, there is a
material risk of outcomes that are, when looked at
from the perspective of the group as a whole and
across all of the jurisdictions in which it operates,
suboptimal and potentially unfair.
9
Including, in many cases, an increased legal obligation to creditors.
130. Accordingly, it is important to address the
difficulties that arise from approaches to
resolution that are uncoordinated among national
authorities and based exclusively on the pursuit
of objectives defined in terms of jurisdictional
interests, which in relevant cases can produce
suboptimal outcomes.
Leveraging “group interest”
131. The concept of group interest is an important one
in this area. Different approaches have different
advantages depending upon the nature of the
business and the business model adopted. A
subsidiary model can, for example, encourage
the standalone strength of the different parts
of the group, limit intra-group contagion, and
simplify the insolvency procedures in some
cases. A more integrated model can, on the other
hand, and depending again on the nature of the
business, allow for a more efficient deployment of
capital and equity, integrated risk management,
etc. Depending upon the business of the group,
strategy and decisions taken to optimize the group
interest or outcomes for the group as a whole can
materially enhance the outcomes for all entities
comprising the group and their stakeholders in
certain cases. In other words, and again depending
upon the nature of the group’s business and in
certain cases, the adoption of a group perspective
in the running of the business across the
constellation of legal entities can result in better
outcomes for stakeholders and for the economy.
132. The difficulty arises when, as such a group enters
a period of crisis, with the potential need for
resolution looming increasingly large, the legal-
entity prism becomes dominant.9 At this point,
with the emphasis increasingly shifting to the
location of assets and the claims of the creditors
of the different legal entities, the group interest
perspective begins to become anomalous.
133. The issue therefore can be seen to be the tension
between the group interest perspective that can,
depending upon a firm’s business, add significant
value in the running of the business of the group,
and the legal-entity perspective that, under current
arrangements, dominates during the resolution
phase. Success in this area will come from
progress in reducing the tension between these
two different perspectives dominating different
phases of the life cycle of a group.
134. We note again, as identified throughout, that there
are a multiplicity of approaches adopted regarding
the structure and organization of cross-border
financial groups depending upon the nature of the
business and the business model adopted. Each of
these has its particular advantages in regard to the
business in question. What is essential is that these
benefits are not diminished by requiring a group
to adopt an approach that is not determined by
and aligned with its business model.
MAKING PROGRESS ON
RESOLVING CROSS-BORDER GROUPS
135. This is therefore a highly complex area. Progress
depends upon the implementation of a range of
measures and techniques designed on the one
hand to ensure that the degree of cooperation
and coordination among authorities is materially
enhanced and on the other that the legal
framework facilitates the adoption of approaches
to resolution that reflect more closely than is
currently the case the approach adopted by the
group to the running of its business.
136. An important area of focus for the FSB at present
is the issue of institution-specific cooperation
agreements between relevant home and host
authorities. The information available to date
on this work is limited; however, it is clear that
among the aspects to be addressed by such
agreements are the roles and responsibilities in
planning and managing resolutions, arranging
for cooperation in the assessment of recovery and
resolution plans, and setting out the legal basis
for and modalities of information sharing. It is
stated that “authorities should explore avenues to
formalize these agreements and over time make
them more binding.”10
137. In view of the complexity of this topic and the
importance of taking into account the specific
circumstances of individual groups, the Institute
believes there is considerable merit in an approach
based on firm-specific agreements. However,
we also note that to be effective in this area,
firm-specific agreements need to be effective
on the legal and not simply the operational
level. Accordingly, resolution frameworks in the
different jurisdictions will need to include those
provisions necessary to make such agreements
legally effective.
10
FSB, Reducing the moral hazard posed by systemically important financial institutions, October 20, 2010, p 5.
138. Among the steps that will be required to make
firm-specific resolution agreements between
authorities effective are the following:
International mandate: It should be part of the
legal mandate of each resolution authority to
coordinate effectively with the authorities of
other jurisdictions in the crisis management and
resolution of cross-border groups.
Non-discrimination: It should be required of each 29
authority that it adopts an approach that avoids
|
INSTITUTE OF INTERNATIONAL FINANCE
discrimination against creditors of the group on
the basis of their location or nationality.
Optimize outcomes for creditors as a whole: Each
authority should have, as part of its legal mandate,
a requirement to act to optimize outcomes for the
creditors of the group as a whole.
Joint planning/crisis management and resolution
colleges: The authorities responsible for the
resolution of a cross-border group should be
required to plan jointly in the context of dedicated
colleges for the crisis management and resolution
of the group under the leadership of the home
resolution authority.
Cooperation and coordination agreement: Based
on their joint planning, the authorities should
be required to enter into a cooperation and
coordination agreement in respect of the crisis
management and resolution of the group. While
requiring to be flexible and adaptive to changing
circumstances, this plan should nonetheless be in
its key components legally effective, including, in
particular, in crisis situations.
Information sharing: The relevant authorities
should share all relevant information with
each other on the basis of strict confidentiality
arrangements. This shall apply in both the
going concern and crisis situations. Detailed
consideration shall be given to the information to
be shared in both contexts.
Joint plan implementation: Authorities should have
an obligation, in the event of a crisis or resolution,
to act in accordance with the key principles and
components of the cooperation and coordination
agreement.
Early warning: Each authority should have an
obligation to alert other authorities without delay in
the event of information suggesting that the group
is at material risk of approaching a crisis situation.
 Burden sharing: It is the view of the Institute that
there should be no general expectation that losses
will be borne by taxpayers. Accordingly, we do
not think that it would be desirable to enshrine
burden-sharing principles as between governments
in such cooperation and coordination agreements.
To do so could send the wrong signals and
increase moral hazard.
30 Nonetheless, we note that there will be an
increased role for resolution funds (in the
|
majority Industry view, ex post funds11) to meet
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
any additional costs that arise in the resolution
of financial firms and that are not appropriately
absorbed by shareholders or creditors. We believe
that it will be desirable and important to develop
principles for the sharing of any such costs among
the different national resolution funds that might
be called upon in such a situation.
RESOLVING HOST BRANCHES
139. The fact that branches are legally part of the
home entity can help to achieve progress toward a
resolution approach that is in accordance with the
degree of integration of the group.
140. The FSB report, Reducing the moral hazard posed by
systemically important financial institutions, which
was presented to and endorsed by the G20 leaders
at their summit meeting in Seoul on November
11-12 2010 appears to go in this direction. It says
that resolution authorities should be required to
cooperate with each other and that national rules
that pose obstacles to fair cross-border resolution,
such as depositor priority rules that give preference
to domestic depositors over those of foreign
branches or certain automatic trigger rules, should
be eliminated where appropriate.
141. We support this direction of travel. Progress
should be made, based on the FSB report, to
remove national legal obstacles so that the
resolution of such a firm can be based on an
approach founded on close cooperation and
coordination between the home and host authority
led by the home authority.12
142. In our response to the Basel Committee Working
Group’s consultation of September 2009, we
expressed support for approaches such as the
Swiss, whereby, subject to the protection of
11
See IIF, A Global Approach to Resolving Failing Financial Firms: An Industry Perspective, May 2010, Section 6.
12
It is noted that there may be exceptional cases in which, due to the particular configuration of a group, it would make sense for the process to be
coordinated by a host authority. This is something that should be addressed in firm-specific resolution agreements between the relevant home and host
authorities.
secured and privileged creditors, to the need for
reciprocity, and to a requirement for the equal
treatment of domestic and foreign creditors, the
resolution of a firm and its overseas branches is
led by the home state administrator.
143. Ensuring the appropriate protection of local
depositors is likely to remain a key concern of
host authorities. The challenges arising from this
aspect can, however, be overcome on the basis of
well-coordinated, legally effective, firm-specific
crisis-management and resolution agreements
entered into between the respective authorities.
Clear agreements should be established, founded
in the resolution legislation in both jurisdictions,
enshrining principles of reciprocity, non-
discrimination, and equal treatment of creditors,
and incorporating recognition of the imperatives
of deposit protection arrangements.
144. Set out below are the features that it should
incorporated in such firm-specific agreements. (We
would note that many, though not all, of these
principles might apply equally in the context of
the resolution of host subsidiaries.)
(a) recognition that the home resolution regime
will be applied (except in exceptional
circumstances where it may be appropriate to
agree that a host regime should be applied);
(b) appropriate protection of depositors;
(c) equal treatment of creditors regardless of
location or governing law of their contract;
(d) in calculating liabilities, security, etc the
governing law of the contract in question to
be applied;
(e) elimination of asset maintenance requirements
in respect to branches;
(f) elimination of measures designed to ensure
that unencumbered assets are ear-marked for
certain categories of creditors;
(g) a requirement for close cooperation among
resolution authorities in the different
jurisdictions to ensure simultaneity of action,
effectiveness of measures, etc.; and
(h) no obstacle to the transfer of assets, collateral,
etc between jurisdictions in furtherance of the
resolution.
ACHIEVING CONSISTENCY BETWEEN
GOING CONCERN APPROACHES AND
RESOLUTION REQUIREMENTS
145. Under a “group interest” approach it is conceivable
that the distribution of assets and liabilities across
the entities in the group will be otherwise than
they would have been on a strictly legal entity-
based approach. As discussed above, depending
upon the nature of the business and associated
149. Such an approach would also need to be
embedded in the legal provisions establishing
national resolution regimes so that the firm-
specific resolution agreements are reliable and
enforceable at a time of difficulty.
150. Properly carried out and with appropriate ambition
to arrive at legally binding arrangements, the
approach to the development of institution-
specific agreements might have the potential to
make a significant contribution to the achievement
31

|
business model, in the context of a going-concern of an effective international framework of cross-

INSTITUTE OF INTERNATIONAL FINANCE

organization, not only is this not problematic, it border resolution.
is likely to be significantly to the benefit of the
stakeholders of the group taken as a whole and
to the wider economy. However, as the failure of
THE U.S. APPROACH:
the group begins to emerge as a possibility and a A NOTE ON DODD-FRANK
crisis begins to crystallize, the mismatch between 151. Title II of the Dodd-Frank Wall Street Reform
distributions under the group interest as against the and Consumer Protection Act is entitled “Orderly
legal entity approach becomes more significant. Liquidation Authority” and establishes a regime
146. We think that the work of the FSB on firm-specific for the resolution of systemically important firms.
crisis management and resolution agreements 152. Many of the principles and techniques embodied
has the potential to help address this problem. in this Title are in line with the proposals the
We would note, however, that this is one of the Institute put forth in its May 2010 report.
most difficult issues to be addressed, thinking
153. As we have discussed under Section 2 above, the
remains at a very early stage, and firms continue
Title takes a “winding up” approach. However, it
to have different views as to the best way forward.
also allows for the establishment of a bridge bank
The proposal under this heading is therefore for
and other techniques deemed useful to optimizing
intensified work and close dialogue between the
outcomes. Whether a bridge bank mechanism can
official sector and the Industry to seek to identify
be used to achieve bail-in outcomes is, as we have
optimal solutions.
seen, an open question.
147. To take an example of areas to be explored: if
154. However, Title II remains problematic in the
a group organizes itself so that resources are
limited attention that it pays to cross-border
distributed among entities in line with a group
issues. It remains an approach grounded in a
interest approach, and those entities are subject to
legal-entity philosophy of resolution and winding
integrated business and risk management, then it
up. The resolution framework created can apply
might be considered desirable, in order to forestall
to bank holding companies, non-bank financial
national restrictions being imposed on such an
holding companies supervised by the Federal
approach, for there to be entered into legally
Reserve Board (FRB), companies predominantly
binding agreements that permit the integrated
engaged in financial activities, and any subsidiary
nature of the group’s approach to be reflected in an
of any of the foregoing predominantly engaged in
integrated approach to the resolution of the group,
financial activities. However there is no remit over
including ensuring that creditors of the group have
foreign subsidiaries and no additional rights to
access to their fair share of the group’s assets.
consolidate parents and subsidiaries.
148. Such an approach would need to be voluntary
155. What this means is that the Title II approach
for the firm in question. To the extent that it
is strictly national jurisdictional in nature.
wished to include certain entities within such an
Subsidiaries of foreign groups that fall within the
arrangement, the firm would be free to do so, and
terms of the Title fall to be resolved independent
to the extent that it wished to exclude entities
of and separate from how the rest of the group
or, indeed, the whole of the group, it would be
might be dealt with. Similarly, foreign entities of
equally free to do so. There must be no question
U.S. groups do not fall to be resolved within the
of a firm’s business model and organizational
context of the group as a whole.
approach being undermined by the imposition of
group-support or similar requirements.
 156. In its recent article, “The Orderly Liquidation of
Lehman Brothers Holdings Inc. under the Dodd-
Frank Act,”13 the FDIC indicates that in the event
that Lehman Brothers had fallen to be resolved
under Title II of Dodd-Frank, the FDIC would
at an early stage have begun contacting key
foreign financial authorities “on a discrete basis
to discuss what legal or financial issues might
arise out of an FDIC receivership.” The article also
32 gives the example of effective cooperation with
the China Banking Regulatory Commission and
|
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
157. The FDIC is, however, required to coordinate
with any appropriate foreign financial authorities
regarding the orderly liquidation of a U.S.-covered
financial company that has any assets and
operations outside the United States.
158. In addition, the Governmental Accountability
Office is required to study and report to the
relevant House and Senate committees regarding
international coordination relating to the orderly
liquidation of financial companies.

the Hong Kong Monetary Authority concerning 159. Much, accordingly, remains to be done to
the acquisition by East-West Bank of United render the Dodd-Frank approach appropriate
Commercial Bank, San Francisco, with a wholly- for application in the context of cross-border
owned subsidiary in China and a branch in Hong financial groups.
Kong. Nonetheless it remains the case that such
cooperation and coordination is, under Dodd-
Frank, dependent upon the goodwill of the
different parties and perceived common interest in
the circumstances.

13
April 2011
ANNEX 1
KEY COMPONENTS OF AN EFFECTIVE RESOLUTION FRAMEWORK AS SET OUT IN
IIF REPORT: A GLOBAL APPROACH TO FAILING FINANCIAL FIRMS: AN INDUSTRY
PERSPECTIVE14
The following elements represent the cornerstones of
the approach set out in the above mentioned report:
– The overall objective is to advance the extent to
which it is possible for every financial firm to exit
the market in an orderly manner.
– There must be no expectation that losses will
be borne by the taxpayers—though a distinction
needs to be drawn between solvency and liquidity
support, and between normal expectations and
what might be necessary in a situation of systemic
crisis in which short-term support can yield
significant dividends.
– This means that:
a) It must be possible to extricate any part of the
firm that is an essential part of the general
financial infrastructure and maintain its
operations by transferring it to a third party or
a bridge bank.
b) There must not result a widespread “contagion”
effect whereby losses to stakeholders in the
firm result in knock-on losses (or the fear of
knock-on losses) to other participants in the
financial system to such an extent that the
system suffers material trauma and is put at
risk of ceasing to function effectively.
14
http://www.iif.com/download.php?id=Oq+9y23X4Us=
33
– Losses should be borne by shareholders, providers of
|
INSTITUTE OF INTERNATIONAL FINANCE
other forms of capital, and creditors in line with their
place in the bankruptcy/insolvency hierarchy laws.
– Property rights must be respected. This includes, in
particular, full respect for security and collateral
rights; these should not be abrogated.
– To the extent that additional costs are incurred in
resolving a firm in a manner that avoids systemic
damage, such costs should not be imposed on
creditors (or a particular group of creditors);
rather, they should be borne by the financial
industry generally (in line with the principles
of resolution funding set out in the May 2010
report). This report indicated that there was a clear
majority within the industry in favor of ex post
mechanisms for meeting such additional costs of
failure rather than the creation of an ex ante fund.
– Authorities should have a full range of powers
necessary to achieve the above.
 ANNEX 2
CRITICAL FUNCTIONS: SOME PUTATIVE EXAMPLES TO BE CONSIDERED
34 Payment and settlement systems: Depending upon the
scale of its involvement, the activities of a failing firm
|
in respect of payment or settlement systems can be
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
potentially critical and thus need to be preserved. A
failure to do so could, depending upon the scale of
the firm’s activities, lead to significant disruption both
as a result of the failed settlement of items currently
making their way through the system and as a result of
the disruption to real economy activity that can arise
from customers being shut out of payment or settlement
systems for a material period of time.
Deposit taking: The Institute considers that in
general, deposit taking should not be considered a
critical function per se. Unless there are very specific
prevailing circumstances, we think that it is unlikely to
be the case that a competitor could not quickly step in
to provide a replacement service.
It is important to be clear, however, that this does
not mean that insured depositors will not require to
receive repayment of their funds in a timely manner,
nor that the most effective way of achieving this may
not be to transfer the deposit accounts to a bridge bank
or third party, nor that the payment service aspect of
such accounts may not be critical (see above). What
it does mean is that maintenance of deposit-taking
services by a particular bank is not, per se and under
normal circumstances, a critical function the cost of
preserving of which needs to be met.
Clearly, robust and reliable deposit protection
schemes are essential to the maintenance of financial
stability. However, it should be recognized that
the systemic feature that is being addressed is the
avoidance of financial shock and loss of confidence
rather than the continuance of a critical function.
Credit availability: In general, it is considered that
the provision of credit by any particular firm is unlikely
to be a function critical to the financial system or to
the economy. There can generally be expected to be
competitors ready and able to step in to fill the gap left
by any individual failing firm. A possible exception to
this is in respect to the availability of credit facilities
to small businesses. Such facilities may be important
to customers for cash management purposes and may
therefore, where the scale of the provision of such
facilities by the financial firm in question constitutes
a material factor in the smooth functioning of the
economy, represent a critical function.
Derivatives activities: A firm’s engagement in
derivatives activities can be very significant; however,
such activities should not be considered a critical
function. They do of course have the potential to
cause significant losses to counterparties and, through
contagion or fear of similar outcomes elsewhere, to
participants in the wider economy. Such activities
should not, however, be considered critical functions.
These are activities that can be quickly taken up by
other participants, and the exit of the firm in question
does not undermine the continuance of the functions
per se. The issue of major loss and contagion is, of
course, a very significant one. It is considered in
extensive detail in the Section 2 of this paper. The
key point here, however, is that such activities do not
represent a critical function to be preserved on the
basis that the cost of doing so should be met from some
source external to the firm.
In all of the cases discussed above in which there
is a potential for a critical function to be present,
it is important that the individual circumstances be
closely examined. There are potentially significant
costs associated with the preservation of particular
business activities of failing firms. These are costs that
will not, given the principle that no creditor should be
worse off than they would have been in a liquidation,
have a natural “home.” They will, accordingly, need
to be externalized outside the firm and so should be
kept to an absolute minimum. The question therefore
is not whether discontinuance would be disruptive or
regrettable, but whether it would cause major disruption
to the real economy.
ANNEX 3
SUMMARY OF IIF PAPER, PRESERVING VALUE IN FAILING FIRMS
In September 2010,15 the CBRWG made a submission
to the FSB on the issue of bail-ins: Preserving Value
in Failing Firms. Set out here is a summary of the key
points of the analysis contained in that document.
Part of a continuum
The paper noted the importance of recognizing a bail-
in measure as one in a continuum of measures and
powers, running from those deployed by supervisors in
the business-as-usual phase, through those used during
crisis management and emerging risks of insolvency to,
at the other end of the spectrum, resolution and wind-
down mechanisms, including, potentially, bail-in.
Need for clarity
The distinction between contingent convertible
capital instruments (CoCos) and bail-in measures was
considered, with the central difference being thought to
lie in the contractual nature of CoCos combined with
the strictly defined nature of their triggers as compared
with the more statutory nature of a bail-in regime and
the role given to authorities in invoking bail-in powers.
Avoiding precipitous loss of value
It was noted that the central effect that could be
achieved by bail-in measures was likely to be the
avoidance of the precipitous loss of value in the failing
firm giving rise to a systemic event. Such loss can occur
when a financial firm enters bankruptcy or liquidation.
It is this sharp and significant evaporation of value—
arising from a combination of impact on franchise,
customer, and workforce value; the unwinding of
financial contracts, including a move to mid-market
from bid/ask pricing; and fire-sale effects— that is at the
heart of the systemic trauma associated with contagion
and fear of further failures and that is a key reason why
the failure of a large, complex financial institution can
be so problematic.
The interconnectedness of such firms and the wider
financial services market can give rise to a systemic
shock that needs to be forestalled.
15
September 9, 2010
The bail-in of credit counterparties, combined with
restructuring and a change of senior management,
35
|
allows the firm to be recapitalized, returned to solvency,
INSTITUTE OF INTERNATIONAL FINANCE
and put back into a position whereby liquidity is once
more available to it. While losses will occur, these will
be absorbed by equity holders, providers of other forms
of capital, and, to a limited extent, by senior credit
counterparties. And, indeed, to the extent that the
recapitalization is successful, some of even these losses
may be reversed.
To be used for securing systemic stability
It was the view of the Preserving Value paper that,
while bail-in would be likely to operate to the benefit
of the creditors of the failing firm, the grounds for the
exercise of the bail-in power should be limited to that
of securing systemic stability through the preservation
of value and avoidance of traumatic losses.
Respecting priorities between classes
The order of priority between equity, other forms of
capital, subordinated debt, and senior debt needed to
be preserved. To the extent that the bail-in mechanism
might eventually turn out to be unsuccessful, it was
identified as a key principle that no creditors should
emerge worse off than they would have done in a
normal liquidation.
Determination ex ante or ex post
An important question considered in the Preserving
Value paper was the extent to which those liabilities
to be made subject to the bail-in decision should be
decided ex ante or ex post. It was also noted that the
question of the extent to which bail-in should rest
on a contractual versus a statutory basis would be
determined by the answer to this prior question. A
number of advantages and disadvantages of both the ex
ante and the ex post approaches were identified.
Supporting a limited scope/ex ante approach were
the degree of clarity and certainty that this would
bring to the situation. This approach was considered
 to have benefits in terms of making it clear to certain
categories of credit counterparties – such as trading
counterparties, short-term creditors and liquidity
providers, and uninsured depositors - that they would
not be subject to bail-in measures, thus minimizing the
likelihood of flight. By determining in advance which
categories of credit counterparties might be subject to
bail-in, it would be possible to increase the consensual
nature of the mechanism. Beyond this it was also the
36 view of a number of Members that by limiting clearly
the scope of bail-in, it is possible to limit any potential
|
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION
increase in bank funding costs.
Counter to this, it was identified that there were
also a number of disadvantages associated with an
ex ante limited-scope approach. This approach had
the potential to contribute materially to moral hazard
in the system as those liabilities explicitly exempted
from the bail-in mechanism would be perceived as
receiving considerable additional protection. There
was also identified to be considerable risk that under
an ex ante approach significant distortions would be
introduced, with funding techniques being arbitraged
to avoid potential bail-in exposures. On the cost-
of-bank-funding issue, some argued that a broad or
“comprehensive” approach, by replicating a “pre-
packaged bankruptcy” by way of a residual power,
would minimize any possible increase in funding.
Triggers
Preserving Value noted the importance of effective
trigger design. While bail-ins required a determination
by the authorities, the judgment of the authorities
should be appropriately constrained so as to maximize
predictability. It would also be crucial to minimize
the extent to which the development of a bail-in
mechanism could have the effect of bringing-forward
the point of failure of financial firms.
Termination and close-out rights
The paper noted that for bail-in measures to be effective
it would be important to incorporate in the legislation
establishing bail-in mechanisms, provisions which
would have the effect of suspending automatic default,
cross-default, and close-out clauses.
Group issues
To deal with the common situation whereby a failing
financial firm is part of a wider group, it was identified
in the Preserving Value paper that it would be necessary
to introduce measures capable of addressing the
complexities arising in such a context. It would be
important that a group-level approach be adopted,
including notably in the context of recovery and
resolution planning. Concerning the mechanics of a
bail-in in such a context, it was envisaged that there
would be a potential need for provisions enabling the
swap of equity in the bailed-in entity for that in the
group parent.
Cross-border aspects
Because they have the potential to significantly reduce
the losses arising from failure of a cross-border group,
bail-in mechanisms were seen as having considerable
potential to alleviate the difficulties that have arisen
previously in dealing with the failure of cross-
border financial firms. It also, however, gives rise
to complexities of implementation of the technique
itself. The paper identified that this was effectively
a coordination problem that should be addressed by
the FSB achieving agreement among its members that
they would introduce bail-in mechanisms in their own
jurisdictions. Failing this, it might be necessary to
supplement the statutory approach with contractual
techniques in particular jurisdictions.
ANNEX 4
LEGAL ISSUES IN GROUP SUPPORT AND RESOLUTION
Obstacles to group support
Where a group is entering resolution, there are a
number of issues that arise out of the nature of the
group that may cause difficulty for the effective
resolution of the situation.
Limitations on the ability of group members
to transfer assets inter se.
The basis of a group structure is that each group member
is a separate entity subject to the relevant company
law regime. Company law regimes generally restrict or
prohibit directors from dealing with company assets
in a way that is not of some benefit to the company
concerned. Thus, for example, directors of a solvent
subsidiary of a troubled parent bank might be prohibited
from transferring assets to the parent in order to ensure
its liquidity, and will almost invariably be prohibited
from subscribing for new capital in the parent.
These issues can vary depending upon the
configuration of the group concerned:
(1) Transfers from a parent to a subsidiary are
generally straightforward, in that the parent will
generally subscribe new capital into the subsidiary.
However, even loans from a parent to a subsidiary
can, in extreme cases, be prohibited when the loan
is almost certain not to be repaid.
(2) Transfers from subsidiaries to parents are
considerably more restricted, and they cannot
be used to create new capital at the level of the
parent. In addition, any transfer of assets from a
subsidiary to a parent is likely to be characterized
as a dividend, and company law frequently
restricts or prohibits the payment of dividends in
certain circumstances.
(3) Direct transfers between subsidiaries are in general
subject to many of the restrictions imposed on
transfers from subsidiaries to parents.
It is important to note that these issues constitute
a separate set of legal issues from those involved in
37
|
designing a resolution regime. Where a bank parent
INSTITUTE OF INTERNATIONAL FINANCE
in country A has a solvent non-bank subsidiary in
country B, it is likely to be the case that the solvent
subsidiary in country B will not be (or possibly cannot
be) placed in a bank resolution regime. Thus the legal
measures necessary to deal with the issues above must
be approached through the company law regime in
country B.
Resolution of groups
One of the most difficult issues in the construction
of resolution regimes arises out of the resolution of
cross-border groups containing multiple banks. If bank
A in country A is the parent of bank B in country B,
the making of a resolution order in respect of B will
not, without some sort of mutual recognition regime,
result in the making of a resolution order in respect
of A. Furthermore, if B is in financial difficulty but A
(considered as a freestanding entity) is solvent, there
may be difficulties for supervisors and resolution
authorities in country A in placing a solvent institution
into resolution to assist in the resolution of country B.
However, if this is not done then the resolution of bank
B may be seriously hindered.
When both bank A and bank B are in financial
trouble and are placed in resolution, there are still
considerable difficulties to overcome. Most important,
any transfer of assets between the two will advantage
the one at the cost of disadvantaging the other. If
the objective of the resolution authorities is to work
together for the benefit of creditors as a whole, it may
be necessary for one resolution authority to make a
transfer whose effect is to reduce the claims of the
creditors of the institution in respect of which he is
appointed, and this is clearly politically unpopular.
ADDRESSING PRIORITY ISSUES IN CROSS-BORDER RESOLUTION |

38
Design by www.katetallentdesign.com
INSTITUTE OF INTERNATIONAL FINANCE
1333 H Street, NW, Suite 800 East
Washington DC 20005-4770
Tel: 202-857-3600 Fax: 202-775-1430
www.iif.com