FDIC Chair Gruenberg Speaks on SIFI Resolution Progress
Peterson Institute for International Economics
“Progress Report on the Resolution of
Systemically Important Financial Institutions”
Tuesday, May 12, 2015
Key Topics & Takeaways
- Orderly Liquidation Authority: Gruenberg stated that future situations in which bankruptcy proceedings would result in severe economic stress cannot be ruled out and that it is for this type of scenario that OLA gives the FDIC authority to establish bridge financial companies, to stay the termination of certain financial contracts, to provide temporary liquidity that may not otherwise be available, to convert debt to equity, and to coordinate with domestic and foreign authorities in advance of a resolution to better address any cross-border impediments.
- Qualified Financial Contracts: Gruenberg noted that the International Swaps and Derivatives Association issued a protocol last year that ends the automatic termination of covered derivatives contracts, and said the Federal Reserve is expected to engage in a rulemaking to codify compliance with this protocol.
- Cross-Border Cooperation: Gruenberg stated that other major jurisdictions have followed the U.S. in enacting systemic resolution authorities that are comparable to those in the Dodd-Frank Act, and that the FDIC has worked closely with many jurisdictions and European entities including the new Single Resolution Board and the Single Supervisory Mechanism.
Speakers
- Martin Gruenberg, Chairman, Federal Deposit Insurance Corporation
Gruenberg Remarks
In his speech, Federal Deposit Insurance Corporation (FDIC) Chairman Martin Gruenberg said progress towards a framework for the orderly failure of systemically important financial institutions (SIFIs) has been “impressive and somewhat underappreciated.” He commented that prior to the crisis, major jurisdictions did not envision that global SIFIs could fail and little thought was devoted to their resolution. He said resolution authorities in the U.S. had not kept pace with changes in the financial system and no agency had the authority to manage the resolution of complex financial institutions until the passage of the Dodd-Frank Act.
Gruenberg stressed that bankruptcy remains the statutory first option under the current framework and pointed out that the largest bank-holding companies are required to prepare resolution plans known as living wills that demonstrate that they could be resolved under bankruptcy without severe consequences to the financial system. It is only in the event that an orderly bankruptcy is not possible that Title II of Dodd-Frank allows the FDIC to exercise its Orderly Liquidation Authority (OLA). He explained that the framework helps to ensure that financial markets can weather the failure of a SIFI as shareholders creditors and culpable management of the firm are held accountable without cost to taxpayers.
Overall, Gruenberg said there has been a “transformational change” in the U.S. and internationally since the financial crisis in regard to the resolution of SIFIs. He said it is clear that without these new authorities, regulators would “be back in the same position as 2008, with the same set of bad choices.”
Living Will Process
Gruenberg explained the living will process as a way of strengthening bankruptcy. He said the FDIC and Federal Reserve are charged with reviewing and assessing each firm’s plan, and that if the regulators jointly agree that a plan is not credible and fails to demonstrate resolvability, they can issue a notice of deficiencies. Ultimately, he said, the agencies can jointly impose requirements on the firm and its subsidiaries, such as more stringent capital, leverage or liquidity requirements, or restrict the firm’s growth, activities and operations. If after two years the firm still fails to submit an acceptable plan, Gruenberg, said the agencies can order the divestiture of assets or operations.
Interconnectedness
Gruenberg stated that the actions required of SIFIs are focused in particular on reducing interconnectedness between legal entities within the firms, and that the firms must show their legal entities can be separated from the parent company and affiliates. He said actions that promote separability will lessen the problem of “knock-on” effects created by interconnectedness.
Despite progress on the living wills, Gruenberg stated that future situations in which bankruptcy proceedings would result in severe economic stress cannot be ruled out. He said it is for this type of scenario that OLA gives the FDIC authority to establish bridge financial companies, to stay the termination of certain financial contracts, to provide temporary liquidity that may not otherwise be available, to convert debt to equity, and to coordinate with domestic and foreign authorities in advance of a resolution to better address any cross-border impediments.
Bridge Financial Companies
Gruenberg said the FDIC focused on the single point of entry strategy, given the challenges presented in the resolution of complex institutions, in which the FDIC would place the top-tier parent company of the firm into receivership while establishing a temporary bridge financial company to hold and manage its critical operating subsidiaries for a limited period. He commented that this bridge company would have a strong balance sheet because the unsecured debt obligations of the failed firm would be left as claims in the receivership while assets would be transferred to the bridge company.
Under the law, Gruenberg explained, taxpayers cannot bear losses. He said losses would be first borne by the failed company through its shareholders and creditors. He said sufficient debt at the parent company could be converted into equity to absorb losses in the failed firm to allow for the recapitalization of any critical subsidiaries. He added that at the international level, the FDIC and Federal Reserve have been working through the Basel Committee and the Financial Stability Board to finalize an international proposal to establish a minimum total loss-absorbing capacity requirement (TLAC).
Gruenberg said another major impediment to the orderly resolution of a financial firm during the crisis was the inability of the bankruptcy process to stay the early termination of certain financial contracts. He said OLA gives the FDIC the ability to impose temporary stays to address risks posed by such contracts written under U.S. law, but that questions remain regarding contracts not subject to U.S. law. He noted that the International Swaps and Derivatives Association issued a protocol last year that ends the automatic termination of covered derivatives contracts, and said the Federal Reserve is expected to engage in a rulemaking to codify compliance with this protocol.
Gruenberg stated that other major jurisdictions have followed the U.S. in enacting systemic resolution authorities that are comparable to those in the Dodd-Frank Act, and that the FDIC has worked closely with many jurisdictions and European entities including the new Single Resolution Board and the Single Supervisory Mechanism. He said the bilateral relationship between the U.S. and the United Kingdom is of particular importance, and that the FDIC last year hosted a meeting of the heads of the Treasuries, central banks and leading financial regulatory bodies.
Question and Answer:
Asked about capital regulations coming from the Basel Committee since the crisis, Gruenberg said U.S. regulators have gone “well beyond” leverage ratios from Basel because they wanted stronger cushions to give more time in a resolution process. He commented generally that stronger prudential standards are significant changes since the crisis that reduce the probability of a firm’s failure.
Asked about the living will process, Gruenberg stated that prior to the crisis, institutions did not have to absorb the costs of making themselves resolvable, but that the living will process today is a way to make firms internalize the costs of putting themselves in a position to be resolved in an orderly way. He said the ability to require such real-time structural changes is an enormously important tool in facilitating resolution in bankruptcy, and that the Fed and FDIC have been working “quite cooperatively” with each other and with firms submitting resolution plans.
For more information on this event and to view an archived webcast, please click here.
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Peterson Institute for International Economics
“Progress Report on the Resolution of
Systemically Important Financial Institutions”
Tuesday, May 12, 2015
Key Topics & Takeaways
- Orderly Liquidation Authority: Gruenberg stated that future situations in which bankruptcy proceedings would result in severe economic stress cannot be ruled out and that it is for this type of scenario that OLA gives the FDIC authority to establish bridge financial companies, to stay the termination of certain financial contracts, to provide temporary liquidity that may not otherwise be available, to convert debt to equity, and to coordinate with domestic and foreign authorities in advance of a resolution to better address any cross-border impediments.
- Qualified Financial Contracts: Gruenberg noted that the International Swaps and Derivatives Association issued a protocol last year that ends the automatic termination of covered derivatives contracts, and said the Federal Reserve is expected to engage in a rulemaking to codify compliance with this protocol.
- Cross-Border Cooperation: Gruenberg stated that other major jurisdictions have followed the U.S. in enacting systemic resolution authorities that are comparable to those in the Dodd-Frank Act, and that the FDIC has worked closely with many jurisdictions and European entities including the new Single Resolution Board and the Single Supervisory Mechanism.
Speakers
- Martin Gruenberg, Chairman, Federal Deposit Insurance Corporation
Gruenberg Remarks
In his speech, Federal Deposit Insurance Corporation (FDIC) Chairman Martin Gruenberg said progress towards a framework for the orderly failure of systemically important financial institutions (SIFIs) has been “impressive and somewhat underappreciated.” He commented that prior to the crisis, major jurisdictions did not envision that global SIFIs could fail and little thought was devoted to their resolution. He said resolution authorities in the U.S. had not kept pace with changes in the financial system and no agency had the authority to manage the resolution of complex financial institutions until the passage of the Dodd-Frank Act.
Gruenberg stressed that bankruptcy remains the statutory first option under the current framework and pointed out that the largest bank-holding companies are required to prepare resolution plans known as living wills that demonstrate that they could be resolved under bankruptcy without severe consequences to the financial system. It is only in the event that an orderly bankruptcy is not possible that Title II of Dodd-Frank allows the FDIC to exercise its Orderly Liquidation Authority (OLA). He explained that the framework helps to ensure that financial markets can weather the failure of a SIFI as shareholders creditors and culpable management of the firm are held accountable without cost to taxpayers.
Overall, Gruenberg said there has been a “transformational change” in the U.S. and internationally since the financial crisis in regard to the resolution of SIFIs. He said it is clear that without these new authorities, regulators would “be back in the same position as 2008, with the same set of bad choices.”
Living Will Process
Gruenberg explained the living will process as a way of strengthening bankruptcy. He said the FDIC and Federal Reserve are charged with reviewing and assessing each firm’s plan, and that if the regulators jointly agree that a plan is not credible and fails to demonstrate resolvability, they can issue a notice of deficiencies. Ultimately, he said, the agencies can jointly impose requirements on the firm and its subsidiaries, such as more stringent capital, leverage or liquidity requirements, or restrict the firm’s growth, activities and operations. If after two years the firm still fails to submit an acceptable plan, Gruenberg, said the agencies can order the divestiture of assets or operations.
Interconnectedness
Gruenberg stated that the actions required of SIFIs are focused in particular on reducing interconnectedness between legal entities within the firms, and that the firms must show their legal entities can be separated from the parent company and affiliates. He said actions that promote separability will lessen the problem of “knock-on” effects created by interconnectedness.
Despite progress on the living wills, Gruenberg stated that future situations in which bankruptcy proceedings would result in severe economic stress cannot be ruled out. He said it is for this type of scenario that OLA gives the FDIC authority to establish bridge financial companies, to stay the termination of certain financial contracts, to provide temporary liquidity that may not otherwise be available, to convert debt to equity, and to coordinate with domestic and foreign authorities in advance of a resolution to better address any cross-border impediments.
Bridge Financial Companies
Gruenberg said the FDIC focused on the single point of entry strategy, given the challenges presented in the resolution of complex institutions, in which the FDIC would place the top-tier parent company of the firm into receivership while establishing a temporary bridge financial company to hold and manage its critical operating subsidiaries for a limited period. He commented that this bridge company would have a strong balance sheet because the unsecured debt obligations of the failed firm would be left as claims in the receivership while assets would be transferred to the bridge company.
Under the law, Gruenberg explained, taxpayers cannot bear losses. He said losses would be first borne by the failed company through its shareholders and creditors. He said sufficient debt at the parent company could be converted into equity to absorb losses in the failed firm to allow for the recapitalization of any critical subsidiaries. He added that at the international level, the FDIC and Federal Reserve have been working through the Basel Committee and the Financial Stability Board to finalize an international proposal to establish a minimum total loss-absorbing capacity requirement (TLAC).
Gruenberg said another major impediment to the orderly resolution of a financial firm during the crisis was the inability of the bankruptcy process to stay the early termination of certain financial contracts. He said OLA gives the FDIC the ability to impose temporary stays to address risks posed by such contracts written under U.S. law, but that questions remain regarding contracts not subject to U.S. law. He noted that the International Swaps and Derivatives Association issued a protocol last year that ends the automatic termination of covered derivatives contracts, and said the Federal Reserve is expected to engage in a rulemaking to codify compliance with this protocol.
Gruenberg stated that other major jurisdictions have followed the U.S. in enacting systemic resolution authorities that are comparable to those in the Dodd-Frank Act, and that the FDIC has worked closely with many jurisdictions and European entities including the new Single Resolution Board and the Single Supervisory Mechanism. He said the bilateral relationship between the U.S. and the United Kingdom is of particular importance, and that the FDIC last year hosted a meeting of the heads of the Treasuries, central banks and leading financial regulatory bodies.
Question and Answer:
Asked about capital regulations coming from the Basel Committee since the crisis, Gruenberg said U.S. regulators have gone “well beyond” leverage ratios from Basel because they wanted stronger cushions to give more time in a resolution process. He commented generally that stronger prudential standards are significant changes since the crisis that reduce the probability of a firm’s failure.
Asked about the living will process, Gruenberg stated that prior to the crisis, institutions did not have to absorb the costs of making themselves resolvable, but that the living will process today is a way to make firms internalize the costs of putting themselves in a position to be resolved in an orderly way. He said the ability to require such real-time structural changes is an enormously important tool in facilitating resolution in bankruptcy, and that the Fed and FDIC have been working “quite cooperatively” with each other and with firms submitting resolution plans.
For more information on this event and to view an archived webcast, please click here.