WASHINGTON — Regulators had a litany of complaints about big banks' living wills in the assessments released last week, covering everything from cash flow to operational decision-making, but one that is flummoxing bankers is an item they say is out of their control: ring-fencing.

Several large banks were cited over concerns that they relied on liquidity from their subsidiaries in foreign countries in the event of a bankruptcy — funds that could be seized by overseas regulators in a crisis.

"No home or host regulator wants to be dependent on the good graces of their foreign counterparts," said John Simonson, a principal at PwC. The Federal Reserve Board and the Federal Deposit Insurance Corp. "want to make sure that the big eight U.S. firms are resolvable even if the host authorities chose to ring-fence."

But that isn't a problem that banks can fix, industry representatives claim — it's an issue that must be addressed by regulators. Some said it also contradicts regulatory statements about progress made in overseas cooperation on the resolution of megabanks, specifically with the United Kingdom.

Regulators' concerns over the possibility of ring-fencing "can only be seen as a vote of no confidence in the Bank of England," said one industry source, who spoke on condition of anonymity. "It is very difficult to reconcile the liquidity ring fencing required in some of the determinations with earlier claims by the regulators … that there was a good relationship with U.K. authorities."

FDIC Chairman Martin Gruenberg said last year that the two countries had made great strides in advancing international coordination.

"The bilateral relationship between the United States and the United Kingdom is of particular importance in cross-border resolution," he said, noting progress in "how the two jurisdictions would cooperate in the event of a cross-border resolution."

But these talks have mainly focused on how regulators would implement a government-directed resolution of a megabank under the FDIC's orderly liquidation authority. Under that scenario, the agency would have the authority to temporarily borrow money in order to wind down a failing financial institution — a powerful bargaining chip in international negotiations.

"The foreign regulators have some confidence that the U.S. will do what it says it's going to do," said Joseph Fellerman, a former top adviser at the FDIC. "We're not going to say, 'Too bad, so sad and good luck.' "

But banks' living wills cannot rely on the use of the FDIC's powers. Instead, they can only contemplate how to take apart the firm using the normal bankruptcy process. And under that process, the FDIC's help would be very limited.

In insolvency "there's no basis for cooperation" between international regulators, said Simon Johnson, a professor at the MIT Sloan School of Management. "Bankruptcy law is national, but these firms are very international."

International negotiations have yielded some results for bankruptcy planning. The International Swaps and Derivatives Association's Resolution Stay Protocol, for example, now contains limitations on cross-border defaults in cases where a holding company were to file for bankruptcy under U.S. law.

Bankruptcy has also been the subject of firm-specific resolution planning talks between international authorities during the so-called Crisis Management Group meetings. The institutions themselves have been encouraged to discuss the danger of ring-fencing with foreign authorities.

But some say these conversations are unlikely to warm foreign authorities to the prospects of bankruptcy.

"I have heard senior, very senior authorities in host jurisdictions say they would ring-fence in the event of a bankruptcy proceeding," said James Wigand, a partner at Millstein & Co. who served as first director of the FDIC's Office of Complex Financial Institutions.

There is also a cultural gap. European authorities don't see it as realistic that a megabank could go through bankruptcy without government assistance.

"In Europe, they don't believe or they don't plan for a civil resolution of one of these firms. It's regulatory," Fellerman said.

If a U.S. court were to decide how a large bank is to be wind down, "What assurances do they have that they'll continue to meet the demands of the U.K. counterparties or will they just cut them off?" Fellerman asked.

Instead, foreign regulators are likely to act swiftly during a failure to ensure that a bank's local assets stay put. Ring-fencing behavior could deliver a double blow to a failing megabank: first when the bank starts getting in trouble, and again as the bankruptcy is under way.

"When the institution is distressed," Wigand said, "the host supervisory authority will attempt to trap both liquidity and capital within its jurisdiction. ... Once there is an insolvency proceeding, what wasn't already ring-fenced, is."

That's why regulators have asked many of the systemically important banks, including JPMorgan, Morgan Stanley, Goldman Sachs and Bank of New York Mellon, to better account for the possibility of ring-fencing in their plans to move capital or cash across borders. That could mean banks will have to hold more reserves in their overseas operations.

"The skepticism that the regulators have is that the ring-fencing will likely occur. The question is how destructive will it be," Fellerman said. "If the funds can't flow around the world the way they normally have been, it actually increases the liquidity requirements of the firms, because then in each major jurisdiction they have to maintain a larger pool of liquidity" and capital.

Johnson said banks have to demonstrate "that they are resilient and the plan would not be jeopardized if the U.K. decided to freeze their U.K. operations."

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