WASHINGTON — Regulators from the U.S. and the United Kingdom took a major step Monday toward proving that they could dismantle a large globally active financial institution, outlining how the two sides would cooperate in the event of a cross-border resolution.
The Federal Deposit Insurance Corp. and the Bank of England, which have been in close talks about resolution planning since the financial crisis, released a paper revealing that both regimes favor "single point of entry" resolutions for international behemoths.
Under such a method, a single resolution agency would wind down the parent company in its home country, and preserve the firm's solvent subsidiaries both domestically and internationally.
"A top-down resolution by definition focuses on assigning losses and establishing new capital structures at the top of the group," the paper said. "This approach keeps the rest of the group, potentially comprised of hundreds of thousands of legal entities, intact."
The FDIC — given new powers under Dodd-Frank to unwind systemically important firms — has endorsed the strategy publicly for months. But the white paper confirms that the FDIC is not alone and may bolster how far other countries go in adopting the idea.
"People have been chatting about this informally, but to have the Bank of England come out with a joint paper with the FDIC saying this approach will work is a strong signal to other regulators around the world," Margaret Tahyar, a partner at Davis Polk & Wardwell, said in an interview.
In the clearest sign yet of how cooperative the two regimes have become, Bank of England Deputy Governor Paul Tucker told FDIC officials in a public meeting that his country would allow the FDIC to operate freely in resolving U.S. firms that have significant U.K. operations.
"I genuinely believe that the United Kingdom authorities are prepared in principle to stand back and let you execute a resolution of the massive U.S. groups which have massive operations in the U.K., and to leave it to you to do it, without our stepping in and interfering or grabbing the subsidiaries or the branches [or] the assets of the businesses that are domiciled in the U.K," Tucker said in a meeting of the FDIC's Systemic Resolution Advisory Committee.
But he said further collaboration is needed with other host countries "to effect this on a global scale."
"This is a journey that involves trust, but trust that is based on the … foundations that we will continue to need to build. … We're going to need to build those foundations with countries around the world," he said.
In addition to the U.K., the FDIC has completed bilateral memoranda of understanding on coordinating resolution regimes with three other jurisdictions, has talks underway for agreements with 20 others and plans to engage seven additional jurisdictions in future discussions.
But the U.S.-U.K. collaboration is clearly the most developed, which reflects the high level of financial services activity that flows between the two nations.
The U.K.'s resolution approach, as outlined by the paper, relies in part on policymakers in the country and the European Union authorizing new powers for British regulators. U.K. officials have focused on developing what is commonly called a bail-in, where creditors of the holding company either receive haircuts or are converted into equity holders in order to recapitalize the company as a whole.
"Debt securities would be cancelled or written down in order to return the firm to solvency by reducing the level of outstanding liabilities," the paper said.
The basic concept is largely identical to what the FDIC — which has clearer legislative authority — has discussed for its regime. The agency would be appointed the receiver for the parent company, transfer its assets in its healthy subsidiaries to a bridge institution, wipe out the claims of shareholders, and similarly write down or convert subordinated debt claims into equity. (The U.K. proposal envisions transferring healthy assets to a "trust" entity, instead of a bridge.)
"The reason why the single point of entry strategy has such an appeal is because the companies typically operate as single enterprises. They don't operate as multiple enterprises," James Wigand, the head of the FDIC's Office of Complex Financial Institutions, said at the advisory meeting. "The creditors of the single holding company at the top are the ones who have benefited from the operations of the company as an integrated whole."
The paper said the approach also allows for smoother coordination that would need to take place between the various countries in which a firm operates.
"A key advantage of a whole group, single point of entry approach is that it avoids the need to commence separate territorial and entity-focused insolvency proceedings, which could be disruptive, difficult to coordinate, and would depend on the satisfaction of a large number of pre-conditions in terms of structure and operations of the group for successful execution," the paper said. "Because the whole group resolution strategies maintain continuity of business at the subsidiary level, foreign subsidiaries and branches should be broadly unaffected by the resolution action taken at the home holding company level."
But whereas Tucker indicated significant latitude for the FDIC to operate a resolution of a U.S. firm with UK offices, it is unclear if the U.S. would allow as much free reign for the U.K. or other nations.
"Is the United States willing to stand back if it's the U.K. or some other country's home institution?" former Federal Reserve Board Chairman Paul Volcker, a member of the committee, said at the meeting.
Tahyar said more guidance is needed from Washington about a foreign resolution authority's leeway in dealing with global firms that have a U.S. presence.
"Imagine it is a U.K. or a German bank, and we are presumed to have confidence in those governments," she said. "Eventually the U.S. is going to have to answer that question."
Others remain skeptical that resolution regimes — no matter how well developed — can work, given the size and complexity of the organizations involved.
"I'm sorry but I'm increasingly convinced that global" systemically important financial institutions "that we are talking about today domiciled in the United States are ultimately not resolvable under this authority," said Simon Johnson, former chief economist of the International Monetary Fund and now a professor at the Massachusetts Institute of Technology.
Wigand said developing agreements with other countries will be pivotal toward proving that regulators can take that step.
"We are thinking through the best mechanisms to address what clearly is a very difficult challenge. The outreach component of international coordination … is extraordinarily important," he said.