WASHINGTON U.S. regulators are set to require formal compliance with an international deal calling on large banks to wait before terminating derivatives contracts in a failure, Federal Deposit Insurance Corp. Chairman Martin Gruenberg said Tuesday.
In a speech touting the FDIC's steps preparing for big-bank wind-downs, Gruenberg said the Federal Reserve Board is expected to draft a rule "to codify" the International Swaps and Derivatives Association's protocol on termination stays. The ISDA framework, which 18 of the largest banks agreed to follow last year, is meant to aid government resolution regimes.
The Fed's "efforts are essential to avoid gaming and to provide a level playing field for those institutions included in the rulemaking," Gruenberg said in remarks before the Peterson Institute of International Economics. "The rulemaking and the adoption of the protocol will reduce the legal uncertainty regarding the termination of derivative contracts in the context of cross-border resolutions."
Gruenberg used the speech to give a status report on U.S. regulators' progress establishing a credible wind-down scheme, the lack of which was a gaping hole in policymakers' handling of the 2008 crisis. But while he praised the steps taken so far, a long list of work still must be completed before such resolutions are feasible, including rules requiring banks parents to hold minimum amounts of long-term debt.
"There has been a transformational change in the United States and internationally since the financial crisis in regard to the resolution of systemically important financial institutions that perhaps has been underappreciated," Gruenberg said. "Prior to the crisis, the major jurisdictions of the world, including the United States, lacked the basic statutory authorities to address this issue. In the United States, all of those issues have been or are in the process of being addressed."
The FDIC, which was given new resolution powers under the Dodd-Frank Act, has favored a wind-down approach known as "single point of entry," which would involve the closure of a firm's holding company and the transfer of what Gruenberg called "critical" subsidiaries into a bridge institution. The wiping out of shareholders and equity conversions for long-term creditors would be used to recapitalize the subsidiaries operating under the bridge. Public financing paid back by recoveries on assets from the failed firm or, if that is insufficient, assessments on the largest banks would also be available.
Taking questions from the audience after giving his prepared remarks, Gruenberg said a key goal of the resolution regime is to remove the belief that failing firms will get a government lifeline in the future.
"I don't think any firm that is subjected to orderly liquidation authority would view the FDIC as riding to the rescue," he said. "That firm will fail, the shareholders would be wiped out, the creditors will take losses according to the losses of the firms, culpable management would be replaced and then we will undertake an orderly process for the wind-down."
But regulators say their first preference is for the new scheme to never be needed, and for complex institutions to be resolved through traditional bankruptcy. Under Dodd-Frank, big banks must draft "living wills" proving they could be unwound through bankruptcy. But the Fed and FDIC last year criticized 11 of the largest institutions for flaws in their resolution plans, requiring them to make adjustments this year.
"The agencies found that the firms failed to make, or even identify, the kinds of changes in firm structure and practices that would be necessary to enhance the prospects for orderly failure under bankruptcy," Gruenberg said.
Yet he spent most of the speech hailing how far the FDIC and other policymakers have come in making the orderly failure of a big bank rather than the bailouts and upheaval that defined the last crisis a more realistic scenario.
"While there is still a lot of work to do, looking at where we were and where we are today, in my view the progress has been impressive," he said.
Still, regulators' process to implement a resolution regime carries a host of unanswered questions and doubts. U.S. and international regulators have not completed rules requiring behemoths to hold sufficient long term debt and capital that could be used to prop up successor firms. There is also skepticism about how well global regulators would work together in a cross-border resolution and whether authorities would have the political will to pull the trigger on a failure someday.
Gruenberg said other countries have made progress building their own resolution regimes and noted efforts between the U.S. and other foreign jurisdictions particularly the United Kingdom to improve communication and coordination.
"It is fair to say, all the major jurisdictions of the world are focused on this," Gruenberg said.