REPORT TO THE CONGRESS ON SECURED CREDITOR HAIRCUTS

FINANCIAL STABILITY OVERSIGHT COUNCIL

Completed pursuant to Section 215 of the Dodd-Frank Wall Street Reform and Consumer Protection Act 

July 2011
Contents of the Financial Stability Oversight Council Secured Creditor Haircuts Study

I. Introduction and Executive Summary .................................................................................1

II. Key Questions .........................................................................................................................2

III. Secured Creditor Haircuts ....................................................................................................5

A. Mechanics of Secured Creditor Haircuts .......................................................................................... 5

B. Assessing the Impact of Secured Creditor Haircuts .......................................................................... 7

IV. Comparison of Treatment of Secured Creditors under Different Resolution 

Mechanisms ..................................................................................................................................12

A. Overview ......................................................................................................................................... 12

B. Bankruptcy Code ............................................................................................................................ 12

C. Federal Deposit Insurance Act ........................................................................................................ 17

D. Orderly Liquidation Authority ........................................................................................................ 23

E. Summary of Comparison of Resolution Mechanisms .................................................................... 27

V. Other Reforms that Protect Taxpayers from Loss and Promote Market Discipline .....29

A. Title I of the Dodd-Frank Act ......................................................................................................... 30

B. Basel III ........................................................................................................................................... 32

C. Increased Transparency of Funding Arrangements ........................................................................ 35

Appendix A: Overview of Certain Forms of Secured Lending ................................................39

I. Repurchase Agreements ......................................................................................................39

II. Stock Loan and Stock Borrow ............................................................................................42

III. Sell-Buyback Arrangements ................................................................................................43

 
1 

I. Introduction and Executive Summary

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (the “Dodd-Frank Act”).1

 Two of the goals of the Dodd-Frank Act are 

to promote market discipline and taxpayer protection. Section 215 of the Dodd-Frank Act calls 

on the Financial Stability Oversight Council (“Council”) to study whether allowing regulators in 

a resolution proceeding to treat a portion of fully secured creditors’ claims as unsecured 

(“secured creditor haircuts”) would promote these objectives.2

 While section 215 contemplates 

evaluating secured creditor haircuts in the utilization of the orderly liquidation authority 

(“Orderly Liquidation Authority” or “OLA”) authorized by Title II of the Dodd-Frank Act, OLA 

provides no authority to impose secured creditor haircuts.3

Proponents of secured creditor haircuts believe secured creditor haircuts would be an effective 

means of promoting market discipline and taxpayer protection. They argue that secured creditor 

haircuts would: (a) cause secured creditors to engage in more extensive credit analysis and 

monitoring, thereby limiting the ability of the largest, most interconnected financial firms to pose 

a risk to U.S. financial stability; (b) promote taxpayer protection by giving the United States 

priority over a portion of the secured claims of other creditors; and (c) reduce collateral demands 

on distressed firms and discourage secured creditors from taking value-destroying actions that 

would force borrowers into failure. 

Others have questioned the efficacy of secured creditor haircuts in promoting market discipline 

and taxpayer protection, and have argued that secured creditor haircuts may have significant 

drawbacks. They believe that secured creditor haircuts would: (1) reduce financial stability, 

including by limiting the availability of secured lending in a crisis; (2) have a negative impact on 

borrowers’ cost of funds, increasing the cost of funds for financial firms directly and for other 

 

1

 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010). 

2

 Section 215 of the Dodd-Frank Act requires the Council to: 

[C]onduct a study evaluating the importance of maximizing United States taxpayer protections 

and promoting market discipline with respect to the treatment of fully secured creditors in the 

utilization of the orderly liquidation authority authorized by this Act. In carrying out such study, 

the Council shall— (1) not be prejudicial to current or past laws or regulations with respect to 

secured creditor treatment in a resolution process; (2) study the similarities and differences 

between the resolution mechanisms authorized by the Bankruptcy Code, the Federal Deposit 

Insurance Corporation Improvement Act of 1991, and the orderly liquidation authority authorized 

by this Act; (3) determine how various secured creditors are treated in such resolution mechanisms 

and examine how a haircut (of various degrees) on secured creditors could improve market 

discipline and protect taxpayers; (4) compare the benefits and dynamics of prudent lending 

practices by depository institutions in secured loans for consumers and small businesses to the 

lending practices of secured creditors to large, interconnected financial firms; (5) consider 

whether credit differs according to different types of collateral and different terms and timing of 

the extension of credit; and (6) include an examination of stakeholders who were unsecured or 

under-collateralized and seek collateral when a firm is failing, and the impact that such behavior 

has on financial stability and an orderly resolution that protects taxpayers if the firm fails. 

3 See 12 U.S.C. §§ 5390(a)(3)(D), (b)(5). 
2 

firms indirectly; and (3) lead financial firms to rely more heavily on other forms of financing, 

which could reduce funds available for resolution should such firms fail. 

This report evaluates these and related topics. Section II (“Key Questions”) summarizes the 

Council’s evaluation of each of the issues the Council is required to assess under section 

215(a)(2)-(6) of the Dodd-Frank Act. Section III (“Secured Creditor Haircuts”) describes the 

mechanics of secured creditor haircuts, and evaluates their intended benefits and potential 

drawbacks. Section IV (“Comparison of Treatment of Secured Creditors under Different 

Resolution Mechanisms”) sets out aspects of the Bankruptcy Code, the Federal Deposit 

Insurance Act, and the Orderly Liquidation Authority that bear on the issue of secured creditor 

haircuts. Finally, Section V (“Other Reforms that Protect Taxpayers from Loss and Promote 

Market Discipline”) reviews other reforms that would help to achieve the same goals of market 

discipline and taxpayer protection as secured creditor haircuts would be intended to achieve. 

The report supports the view that the combination of the Orderly Liquidation Authority and the 

new supervisory framework provided by Title I of the Dodd-Frank Act4

 can be used to achieve 

the goals of market discipline and taxpayer protection effectively in the absence of secured 

creditor haircuts. 

II. Key Questions 

Consistent with its statutory mandate, the Council evaluated each of the questions posed below 

in preparing this report on secured creditor haircuts. 

 What are the similarities and differences between the resolution mechanisms 

authorized by the Bankruptcy Code, the Federal Deposit Insurance Corporation 

Improvement Act of 1991 (“FDICIA”) and the Orderly Liquidation Authority? 

The U.S. Bankruptcy Code, the Federal Deposit Insurance Act (as amended by FDICIA, 

“FDIA”), and OLA have different goals. The primary goal of the bankruptcy process is to 

maximize the value of a debtor’s assets for the benefit of its stakeholders and, if justified, 

provide the debtor with the ability to reorganize.5

 The Federal Deposit Insurance 

Corporation’s (“FDIC”) process for resolving and liquidating a failed insured depository 

institution (“IDI”) under the FDIA is driven by the FDIC’s mandate to maintain confidence 

in the banking system, including through the protection of insured depositors from losses, 

and to liquidate a failed IDI in the manner least costly to the Deposit Insurance Fund 

(“DIF”). The objective of OLA is to prevent serious adverse effects on U.S. financial 

stability, while prioritizing the goals of protecting taxpayers and maintaining market 

discipline above the goals of preserving the going-concern value of the debtor’s estate solely 

for the benefit of the failed firm’s stakeholders. The differing goals of the Bankruptcy Code, 

FDIA, and OLA give rise to other key distinctions, including the types of institutions subject 

 

4

 As discussed in Section V, the new supervisory framework provided by Title I of the Dodd-Frank Act is 

complemented by other recent reforms, including new “Basel III” capital, leverage and liquidity requirements. 

5

 THOMAS JACKSON, THE LOGIC AND LIMITS OF BANKRUPTCY LAW, 10-17, 20 (Beard Books 2001). 
3 

to each resolution mechanism, the manner in which each mechanism is initiated, and the 

scope and role of judicial review. 

 How are secured creditors treated in such resolution mechanisms, and how might a 

haircut (of various degrees) on secured creditors improve market discipline and protect 

taxpayers? 

The U.S. bankruptcy process generally allows a secured creditor to retain the benefit of its 

superior non-bankruptcy rights by granting the creditor’s secured claim full priority over 

other claims up to the value of its security interest, by providing the secured creditor 

“adequate protection” against a loss during the debtor’s retention of collateral, and by 

providing for judicial involvement at the time creditors’ rights are determined. The FDIC 

IDI resolution process under the FDIA is an administrative process designed to help the 

FDIC carry out its responsibility to maintain confidence in the banking system.6

 The FDIC 

as receiver has many of the same authorities under the FDIA that a bankruptcy trustee has 

under the Bankruptcy Code for recovery of the debtor’s property that was transferred prior to 

the point of bankruptcy or receivership to both secured and unsecured creditors (e.g., 

avoidance of preferential transfer and fraudulent conveyance in cases of actual fraud). As 

compared to the bankruptcy process, administrative processes by design have less 

contemporaneous judicial involvement. OLA continues to protect the contractual rights of 

secured creditors in many of the same ways as the Bankruptcy Code, while adopting many of 

the expanded authorities available to the FDIC for resolving IDIs.7 

As discussed in more detail below, proponents of secured creditor haircuts argue that secured 

creditor haircuts would promote market discipline and strengthen taxpayer protection by 

creating incentives for secured creditors to engage in more extensive credit analysis and 

monitoring, giving the United States priority over a portion of the secured claims of other 

creditors, and reducing collateral demands on distressed firms. However, others believe 

secured creditor haircuts could reduce financial stability by severely limiting the availability 

of credit in a crisis, raise the cost of funds for financial firms and other borrowers throughout 

the economy, and increase the use of other forms of financing that could reduce funds 

available for resolution. 

 How do the benefits and dynamics of prudent lending practices by depository 

institutions in secured loans for consumers and small businesses compare to the lending 

practices of secured creditors to large, interconnected financial firms? 

Prudent lending practices by depository institutions generally involve extensive credit 

analysis for each loan extended to a consumer or small business. Such loan-by-loan credit 

analysis is an important means of limiting risk when lenders do not already have substantial 

knowledge of borrowers, particularly when loans are long-duration, secured by illiquid 

collateral or would be subject to the automatic stay and avoidance provisions of the 

6

 The FDIC’s powers include: (1) the ability to transfer assets or liabilities quickly without counterparty or judicial 

consent to a bridge depository institution; (2) the ability to place failing IDIs into receivership prior to actual default, 

subject to ex post court review and other safeguards; and (3) the ability to place a temporary limitations on creditors’ 

rights to unwind financial contracts of the failed firm. 

7

 See 12 C.F.R. pt. 380 (2011). 
4 

Bankruptcy Code if the borrower were to enter a bankruptcy proceeding. Lenders to large, 

interconnected financial firms may have less need to engage in this type of credit analysis 

because, for example, they may have an understanding of the firms’ credit profile from 

repeated dealings and from publicly available sources, such as audited financial statements, 

material event disclosures, and market analyst reports. Further, secured lenders to major 

financial firms may manage risk by adjusting the duration of loans, obtaining high quality 

collateral, and entering into lending agreements that would allow them to obtain their 

collateral immediately if the borrower becomes insolvent or files for bankruptcy. 

Differences in the form of credit analysis do not necessarily indicate a lack of market 

discipline. 

 Does credit differ according to different types of collateral and different terms and 

timing of the extension of credit?

Extensions of credit differ along many dimensions, including loan duration, the nature of 

collateral, and the applicable legal structure. In the context of secured lending to consumers 

and small businesses, credit is often long-duration, secured by relatively illiquid collateral, 

and could be subject to the automatic stay, and to avoidance provisions of the Bankruptcy 

Code if the lender sought to obtain its collateral shortly before the borrower filed for 

bankruptcy. A significant portion of secured lending to large, interconnected financial firms 

is short-term, secured by highly liquid collateral, and qualifies for the “safe harbor” 

provisions of the Bankruptcy Code for “qualified financial contracts” (“QFCs” and “QFC 

Safe Harbors”).8 

 What was the impact, on both financial stability and on an orderly liquidation that 

protects taxpayers, of stakeholders who were unsecured or under-collateralized and 

sought collateral when a firm was failing? 

During the recent financial crisis, creditors of certain large, interconnected financial firms 

increasingly sought collateral from firms whose failure seemed imminent.9 Some have 

argued that these creditors, some of whom were initially unsecured or under-collateralized, 

precipitated the firms’ failures and, by removing or encumbering valuable assets of the firm 

while curtailing further credit extensions, reduced the amount available for distribution to 

creditors who did not have the benefit of the QFC Safe Harbors. Others have argued that 

preventing these creditors from limiting risk by seeking additional collateral might have 

either led them to terminate their lending arrangements earlier or increased the potential for 

broad contagion upon the borrower’s default. Thus, depending on the specific 

circumstances, preventing unsecured and under-collateralized creditors from limiting risk by 

seeking additional collateral could have had either a positive or a negative impact on the 

distressed firm’s survival, as well as on financial stability and taxpayer protection. 

 

8

 11 U.S.C. §§ 362(b)(6), (7), (17); 546(e), (f), (g); 555; 556; 559; 560. Under the QFC Safe Harbors, QFC 

counterparties can close out their contracts and obtain their collateral notwithstanding the automatic stay and 

avoidance provisions of the Bankruptcy Code. See infra Section III.A.6. at nn. 12–14 and accompanying text. 9 See, e.g., Darrell Duffie, “The Failure Mechanics of Dealer Banks” (Bank for Int’l Settlements, BIS Working 

Paper No. 301, 2010), available at http://www.bis.org/publ/work301.pdf. 
5 

III. Secured Creditor Haircuts 

A. Mechanics of Secured Creditor Haircuts 

Section 215 of the Dodd-Frank Act focuses on the treatment of fully secured creditors in the 

utilization of OLA. The following description of the mechanics of secured creditor haircuts 

therefore assumes that secured creditor haircuts, if authorized by statute, would only apply in 

OLA. However, as noted above, OLA provides no authority to impose secured creditor haircuts. 

Accordingly, the following discussion is solely for purposes of meeting the requirements of 

section 215 of the Dodd-Frank Act and is not a description of existing law or policy. 

1. Haircuts on the Value of the Secured Claim 

Secured creditor haircuts would be based on the value of a creditor’s secured claim. A claim is 

fully secured when the value of the collateral securing the claim is equal to or greater than the 

face value of the claim. When the collateral securing a claim is worth less than the face value of 

the claim, the claim is secured up to the value of the collateral and the remainder of the claim is 

unsecured. 

How secured creditor haircuts would work in practice can be clarified using three examples. In 

the first example, a creditor has a 100-dollar claim secured by 100 dollars of collateral. 

Assuming a haircut of 20 percent, this creditor would be left with a secured claim of 80 dollars 

and an unsecured claim of 20 dollars. In the second example, the creditor has a 100-dollar claim 

secured by 105 dollars of collateral. Because this creditor’s secured claim is limited to 100 

dollars, a 20 percent haircut would leave this creditor, like the creditor in the first example, with 

a secured claim of 80 dollars and an unsecured claim of 20 dollars. In the third example, the 

creditor has a 100-dollar claim secured by 80 dollars of collateral. Because this creditor’s 

secured claim is only 80 dollars, the creditor would be subject to a haircut of 16 dollars (i.e., 20 

percent of the 80 dollar secured claim), leaving the creditor with a secured claim of 64 dollars 

and an unsecured claim of 36 dollars. 

2. Determining the Haircut Amount 

Secured creditor haircuts could be structured such that the entity responsible for the resolution of 

the failed firm has discretion over the amount of the haircut up to a specified limit. If applied in 

the context of OLA, such an approach might allow the FDIC in its capacity as receiver (“FDICReceiver”) to impose secured creditor haircuts up to the specified limit on a case-by-case basis as 

necessary to repay amounts owed by a financial company in receivership (“covered financial 

company”) to the United States and to the fund (the “Orderly Liquidation Fund”) created by Title 

II of the Dodd-Frank Act. Such discretion would enable the FDIC-Receiver to retain more 

funding than otherwise would be available to satisfy the receivership’s obligations to the United 

States and the Orderly Liquidation Fund, while at the same time providing the FDIC with the 

flexibility to impose a haircut on some secured creditors but not others and only to the extent 

necessary. 
6 

3. Limitation on Orderly Liquidation Authority 

Under OLA, covered financial companies can include bank holding companies and nonbank 

financial companies, but only if it is determined that their failure and resolution under otherwise 

applicable federal or state law would have serious adverse effects on the financial stability of the 

United States.10 This is a significant limitation on the applicability of OLA and would 

correspondingly limit the applicability of secured creditor haircuts if authorized in the context of 

OLA. However, since creditors of financial firms would not know whether a given financial 

firm would be resolved under OLA, a secured creditor haircut provision that would only apply in 

OLA would likely affect decisions about lending to financial firms even if those financial firms 

were ultimately resolved under the Bankruptcy Code. 

4. Amounts Realized in Resolution 

If secured creditor haircuts were designed to serve the goal of taxpayer protection in the context 

of OLA, their application could be limited to situations in which the amounts realized in 

resolution are less than amounts owed to the United States or to the Orderly Liquidation Fund. 

Under the Orderly Liquidation Authority, unsecured claims of the United States generally rank 

second in priority of payment and are only exceeded in priority by payment of the receiver’s 

administrative expenses.11 The fact that amounts owed to the United States already have high 

priority under OLA might lessen the number of instances in which secured creditor haircuts 

would be invoked. 

5. Security Interests of the Federal Government 

Further, secured creditor haircuts could be structured not to apply to any security interest held by 

the federal government. Otherwise, under certain circumstances, secured creditor haircuts would 

simply transfer the costs of resolving a covered financial company from one federal entity to 

another. Security interests held by the federal government would likely include amounts owed 

to the U.S. Treasury and the FDIC arising from the resolution of a financial firm. 

6. Relationship to the QFC Safe Harbors 

Secured creditor haircuts could be structured to apply to secured claims arising from contracts 

that qualify for the QFC Safe Harbors.12 The QFC Safe Harbors provide a fairly extensive 

 

10 The Secretary of the Treasury must, for example, determine, in consultation with the President, that: (1) the 

financial company is in default or in danger of default; (2) the failure of the financial company and its resolution 

under otherwise applicable Federal or State law would have serious adverse effects on financial stability; and (3) any 

funding provided would avoid or mitigate such adverse effects. That determination generally may only be made 

after such a determination has been recommended by both the Federal Reserve Board and the appropriate federal 

regulator (either the FDIC or the U.S. Securities and Exchange Commission). Furthermore, those recommendations 

may only be made with the consent of two-thirds of the Federal Reserve Board and two-thirds of the board or 

commission of the applicable federal regulator. See Section 203(b) of the Dodd-Frank Act. 11 See Section 210(b)(1)(B) of the Dodd-Frank Act. See also 12 C.F.R. § 380.23. 12 QFCs include repurchase agreements, commodity contracts, forward contracts, securities contracts, swap 

agreements and master netting agreements. Subject to certain limitations, the QFC Safe Harbors in the Bankruptcy 

Code exempt most QFC counterparties from its automatic stay and from the effect of most of its avoidance action 

provisions. The legislative history states that the amendments that created the QFC Safe Harbors were intended to 

“minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy 
7 

exemption for QFC counterparties from the “automatic stay,” allowing such counterparties to 

terminate contracts and exercise setoff and netting rights without seeking bankruptcy court 

approval. In addition, the QFC Safe Harbors exempt QFC counterparties from the Bankruptcy 

Code’s rules governing preferential transfers, fraudulent conveyances absent actual fraud, and 

ipso facto clauses.13 QFC counterparties enjoy many of the same rights under OLA as they have 

under the QFC Safe Harbors of the Bankruptcy Code, with the exception of the one-day stay 

combined with the power to transfer the QFC intact to a bridge financial company.

14 

B. Assessing the Impact of Secured Creditor Haircuts 

1. Intended Benefits of Secured Creditor Haircuts 

(a) Market Discipline 

One of the principal arguments cited by supporters of secured creditor haircuts is that secured 

creditor haircuts would encourage greater due diligence and monitoring by secured creditors of 

large, interconnected financial firms. According to this argument, if those secured creditors were 

put at risk of losing a percentage of their secured claims, they would have greater incentives to 

investigate borrowers’ credit quality before entering into lending arrangements and to terminate 

such arrangements as borrowers’ credit quality decreases. Similarly, some believe that enacting 

a secured creditor haircut provision would cause secured creditors to shift their exposure to safer 

firms and thereby limit the ability of financial firms to use leverage to become large enough for 

their failures to pose a risk to U.S. financial stability. 

(b) Taxpayer Protection

Supporters of secured creditor haircuts that would apply in the context of OLA argue that such 

haircuts would provide taxpayers a measure of protection that they otherwise would not have. 

Such supporters advocate giving the United States and the Orderly Liquidation Fund priority 

over up to a specified percentage of the secured claims of other creditors. They argue that 

because secured lending is a significant funding source for large, interconnected financial firms, 

the resulting benefits in terms of taxpayer protection could arguably be substantial in some cases. 

 

 

affecting those industries” and to “prevent the insolvency of one commodity [or securities] firm from spreading to 

other brokers or clearing agencies and possibly threatening the collapse of the market.” H.R. REP. NO. 97-420 

(1982). 

13 Subject to exceptions, the Bankruptcy Code generally authorizes the trustee or debtor-in-possession to recover 

amounts paid by an insolvent debtor on pre-bankruptcy loans within 90 days of the commencement of bankruptcy 

(“preferential transfers”); allows the debtor to recover amounts lost through the pre-bankruptcy transfer of assets for 

less than fair value made while the debtor was insolvent (“fraudulent conveyances”); and renders unenforceable 

contractual provisions that would otherwise allow parties to an executory contract to terminate it or modify its terms 

based on the debtor’s bankruptcy or insolvency (“ipso facto clauses”). 14 There is currently a vigorous academic debate about amending the QFC Safe Harbors that raises many of the same 

issues as are raised by the issue of secured creditor haircuts. A full assessment of arguments for or against amending 

the QFC Safe Harbors is outside the scope of this study. However, such an assessment would likely involve many 

of the same considerations as are involved in assessing secured creditor haircuts. 
8 

(c) Collateral Demands on Distressed Firms

Some proponents of secured creditor haircuts claim that the demise of certain large, 

interconnected financial firms during the recent financial crisis was precipitated at least in part 

by increasing demands for collateral by their creditors. They argue that demands of creditors for 

increasing amounts of collateral during the period immediately preceding failure not only left 

fewer assets for distribution to other creditors, but also enabled some secured creditors to quickly 

obtain full payment of their claims before other creditors, regardless of the impact on the 

viability of the distressed firm. They argue that by exposing a fully secured creditor to a possible 

haircut on a percentage of its secured claim, secured creditor haircuts would create a disincentive 

for such creditors to take actions that would force a borrower into failure; and that a secured 

creditor haircut provision might thereby limit collateral demands on distressed firms, especially 

where the firm might have remained viable in the absence of such collateral demands. 

2. Qualifications Regarding the Intended Benefits of Secured Creditor 

Haircuts 

(a) Qualifications Regarding Market Discipline 

The extent to which secured creditors of large, interconnected financial firms already engage in 

due diligence and monitoring of their borrowers could arguably weaken the case for secured 

creditor haircuts. Even in the absence of the kind of loan-by-loan credit analysis typical in the 

consumer or small business contexts, decisions by lenders to large, interconnected financial firms 

are often based on knowledge of borrowers’ credit quality obtained in the course of repeated 

dealings and on analysis of information contained in publicly available sources, such as audited 

financials, material event disclosures, and market analyst reports. Further, secured lenders to 

large, interconnected financial firms may manage risk in other ways, such as by retaining the 

right not to roll over funding, requiring borrowers to post high-quality collateral, or obtaining 

other creditor control provisions that would be triggered by a decline in borrowers’ financial 

condition. These means of managing risk are also ways of imposing market discipline on 

borrowers and junior creditors. Differences in the form of credit analysis do not necessarily 

indicate a lack of market discipline. 

In addition, secured creditor haircuts might not increase due diligence or monitoring by those 

secured creditors of large, interconnected financial firms that are not well-positioned to engage in 

transactions with meaningful default risk. For example, some have argued that ultra-short term 

funding sources (e.g., cash-suppliers in 24-hour repurchase agreements (“repo agreements” or 

“repos”) or other overnight and intraday creditors) should be viewed as similar to individual 

bank depositors who are disinterested in performing extensive credit risk analysis or independent 

monitoring of the firms in which they “deposit” their funds. 15 The reason for this, it has been 

argued, is that the short duration of the credit extension, the fact that it qualifies for the QFC Safe 

Harbors, and the fact that it is often fully secured, make ultra-short term lenders relatively 

insensitive to the borrower’s fundamental condition. According to these arguments, increasing 

the risk of loss for such creditors might do less to promote market discipline than to promote 

rapid reduction in the availability of credit during times of severe economic distress. On the 

other hand, others have argued that ultra-short term creditors, because they regularly extend 

 

15 See, e.g., Morgan Ricks, “Regulating Money Creation after the Crisis,” 1 Harvard Business Law Rev. 75 (2011). 
9 

significant amounts of credit, could more cost-effectively conduct due diligence and monitoring 

than other creditors. 

As further described in Section IV and Section V, the Orderly Liquidation Authority, together 

with the new heightened prudential standards to be imposed on largest, most interconnected 

financial firms, will promote market discipline by helping to force such firms to internalize the 

full cost that their failure would impose on the financial system. 

(b) Qualifications Regarding Taxpayer Protection 

Secured creditor haircuts that would apply in the context of OLA have been promoted as a way 

to protect taxpayers by allowing a specified percentage of a creditor’s secured claim to be treated 

as unsecured. But in the absence of the other reforms contained in the Dodd-Frank Act, there 

could be cases in which the secured creditor haircut amount specified would be insufficient to 

protect taxpayers from loss. 

The Orderly Liquidation Authority and the supervisory framework for the largest, most 

interconnected firms set out in Title I of the Dodd-Frank Act may already provide a significant 

new measure of taxpayer protection. As described in more detail below, these reforms are 

designed to reduce the probability that a large, interconnected firm would fail, and in the event 

that such a firm does fail, allow regulators to wind it down, break it apart, and liquidate it 

without forcing taxpayers to bear any of the costs. If the proceeds from an orderly liquidation 

are insufficient to repay amounts owed to the U.S. Government, the FDIC ultimately has the 

authority to assess large financial companies to repay those amounts.16 These reforms therefore 

lessen the need for the potential taxpayer protection that the addition of the secured creditor 

haircuts might arguably afford. 

(c) Qualifications Regarding Collateral Demands on Distressed 

Firms 

In the case of secured creditor haircuts based on the value of creditors’ secured claims, creditors 

whose claims are less than fully secured would still have an incentive to seek collateral from 

distressed firms. Creditors who were initially fully secured would continue to have an incentive 

to seek additional collateral to compensate for any impairment to the value of collateral 

originally posted. Creditors who were initially unsecured or under-collateralized might continue 

to seek collateral based on “collateral-on-downgrade” or similar provisions in loans and other 

agreements that provide for collateral and other credit enhancements as the borrower’s financial 

condition weakens. Thus, secured creditor haircuts based on the value of creditors’ secured 

claims would have a limited ability to prevent the kind of liquidity shocks that may have resulted 

from collateral demands triggered by such provisions during the lead-up to the recent financial 

crisis.17 

Depending on their structure, secured creditor haircuts would not eliminate the incentive to 

obtain more collateral even in the case of fully-secured creditors. Secured creditor haircuts 

 

16 See Section 210(o) of the Dodd-Frank Act. 17 As discussed in more detail below, some argue that secured creditor haircuts could also contribute to liquidity 

shocks by causing creditors to withdraw funding from distressed firms. 
10 

might apply only if: (a) the borrower is resolved using the Orderly Liquidation Authority; (b) 

amounts realized from the resolution are insufficient to satisfy any amounts owed to the United 

States or to the Orderly Liquidation Fund; and (c) the FDIC exercises discretion to impose 

secured creditor haircuts. Given that creditors would not know in advance whether any of these 

conditions would be met, they may seek additional collateral to avoid being put at a disadvantage 

relative to other creditors even in cases where secured creditor haircuts would ultimately apply. 

3. Potential Drawbacks of Secured Creditor Haircuts 

(a) Financial Stability 

Critics of secured creditor haircuts argue that secured creditor haircuts could reduce the 

availability of secured lending in a crisis, transforming the “run on collateral” witnessed during 

the recent financial crisis into, at least, an equally disruptive flight from lending to financial 

firms.18 Creditors unable to protect themselves by securing their extensions of credit might 

withdraw credit more quickly, resulting in more sudden and intense liquidity shocks. Repo 

counterparties might structure their loans on a shorter-term basis in order to terminate funding 

arrangements at the first sign of distress. IDIs might also be more likely to pull out of the 

lending relationship with a weakened financial firm rather than continue to extend credit under 

circumstances requiring a loan loss reserve on account of a potential secured creditor haircut. 

Critics also argue that secured creditor haircuts could undermine financial stability by imposing 

losses on secured creditors. Secured creditors of large, interconnected firms might themselves be 

sufficiently large or interconnected that losses they would incur as a result of secured creditor 

haircuts could act as a vehicle for contagion throughout the financial system. In cases where 

creditors are investing funds of customers or investors, losses stemming from secured creditor 

haircuts could result in harm to those customers or investors (e.g., money market mutual funds). 

While appropriate forms of prudential regulation can reduce these risks to an extent, prudential 

regulation is unlikely to eliminate these risks completely. 

Further, critics argue that secured creditor haircuts could threaten financial stability by limiting 

the extension of credit to financial firms by the Federal Reserve Banks or the Federal Home 

Loan Banks. If lending by the Federal Reserve Banks or the Federal Home Loan Banks were 

made subject to secured creditor haircuts, the Federal Reserve Banks or Federal Home Loan 

Banks might be unable to lend to financial firms, either due to legal limitations or risk 

management practices. Other lenders, even if not legally prohibited from lending under 

circumstances that would render them partially unsecured, might nonetheless limit such lending 

on risk management grounds. In addition to increasing the cost of capital as a general matter, the 

absence of this liquidity could have negative implications for financial stability, particularly in 

circumstances where availability of credit is otherwise limited. 

 

18 See, e.g., Letter from the Comm. on Capital Mkts. Regulation to Christopher Dodd, Chairman, Richard Shelby 

Ranking Member, S. Comm. On Banking, Hous. & Urban Affairs and Blanche Lincoln, Chairman, Saxby 

Chambliss, Ranking Member, S. Comm. on Agric., Nutrition & Forestry 26 (Apr. 26, 2010), available at 

http://www.capmktsreg.org/pdfs/4.26.10_CCMR_Response_to_Senate_bills.pdf. 
11 

(b) Cost of Capital

Secured creditor haircuts could increase funding costs directly for financial firms and indirectly 

for other borrowers. 

Secured creditor haircuts that applied only in the context of OLA could increase the cost of 

borrowed funds for large, interconnected financial firms because lenders would demand higher 

rates of interest to compensate for the potential impact of secured creditor haircuts. These effects 

could be significant, since secured lending provides a major source of funding for financial 

firms.19 While the impact of secured creditor haircuts that applied only in the context of OLA 

would be somewhat reduced to the extent that those haircuts would only apply if further 

conditions were met,20 significant uncertainty about whether these conditions would be met in 

the case of any particular covered financial company could increase funding costs more broadly. 

Such uncertainties might not be easy to address given the importance of preserving the discretion 

of the FDIC-Receiver to administer the receivership of a covered financial company as 

effectively as possible in light of the particular facts and circumstances of each case. 

In addition, secured creditor haircuts could increase the cost of borrowed funds by making it 

more difficult for money market mutual funds, as well as other lenders, to participate in the repo 

market.21 Money market mutual funds are currently a major lender in the repo market, extending 

approximately $440 billion in credit through repo transactions in Q1 2011.22 However, Rule 2a7 under the Investment Company Act of 1940 limits money market mutual funds’ ability to 

participate in repo transactions unless they are “Collateralized Fully.”23 To the extent that 

secured creditor haircuts would prevent repo transactions from meeting the definition of 

“Collateralized Fully,” they could prevent institutions such as money market funds from 

participating in the repo market. 

While secured creditor haircut provisions that apply only in the context of OLA would affect 

large, interconnected financial firms’ borrowing costs directly, such provisions might affect 

borrowings costs for other firms indirectly. Securities prices reflect the cost of credit used to 

fund securities purchases. To the extent that credit becomes more expensive, securities prices 

will fall and securities issuers’ cost of capital will increase. 

 

19 For example, in 2010, bank holding companies with more than $500 billion in assets used secured federal funds 

borrowings, repos and other collateralized lending arrangements to fund, on average, approximately 14% of their 

assets. Federal Reserve Bank of Chicago, Bank Holding Company Data 2001-2011, 

http://www.chicagofed.org/webpages/banking/financial_institution_reports/bhc_data_2001_2011.cfm (last visited 

June 22, 2011). 

20 For example, secured creditor haircuts that applied in the context of OLA might only be triggered if amounts 

realized in resolution were less than amounts owed to the United States or to the Orderly Liquidation Fund and if the 

FDIC-Receiver exercised its discretion accordingly. 

21 As noted in Appendix A, large, interconnected financial firms use repos to obtain a substantial majority of onbalance sheet secured funding. 

22 Board of Governors of the Federal Reserve System, Flow of Funds Accounts, 

http://www.federalreserve.gov/releases/z1/Current/z1r-4.pdf (last visited June 22, 2011). 23 Specifically, Rule 2a-7 imposes a diversification requirement on money market mutual funds designed to prevent 

excessive exposure to any single issuer. A money market mutual fund cannot treat acquisition of a repo agreement 

as acquisition of the underlying collateral for purposes of the diversification requirement unless the repo agreement 

is deemed “Collateralized Fully.” 17 C.F.R. § 270.2a-7. 
12 

(c) Amounts Available to other Creditors 

If secured borrowing were to become significantly more costly as a result of secured creditors 

demanding increased interest rates to account for potential secured creditor haircuts, financial 

firms would opt for less expensive means of financing. These may include the issuance of assetbacked securities, shifting assets from their balance sheets to off-balance sheet vehicles or the 

outright sale of assets. As a general matter, a receiver would have greater flexibility when 

resolving a firm with secured debt rather than securitizations or an outright sale because secured 

borrowing allows unsecured creditors to benefit from any increase in the value of assets, while 

the creditors secured by those assets bear the cost of any decrease in the value of such assets.24 

Thus, if the secured borrowing is over-collateralized, then the receiver could determine to pay off 

the secured claim in cash up to the value of the pledged collateral, and retain the excess for 

distribution to other creditors. On the other hand, if the secured borrowing is undercollateralized, then the receiver could allow liquidation of the pledged collateral to pay off the 

secured portion of the claim and treat the remainder of the claim as unsecured. Accordingly, as 

compared with other means of financing, secured borrowing generally increases the receivership 

assets because the estate rather than a third-party receives the benefit of any overcollateralization.25 

IV. Comparison of Treatment of Secured Creditors under Different 

Resolution Mechanisms 

A. Overview 

The United States has several distinct resolution mechanisms for resolving a failed financial 

firm, including the Bankruptcy Code, the FDIA, and OLA. The statutory authority on which 

each of these mechanisms is based reflects the distinctive purposes of each mechanism. 

The following section describes each of the primary resolution mechanisms and their treatment 

of secured creditors, and in certain instances their perceived limitations or advantages for 

managing the resolution of a large, interconnected financial firm in a manner that preserves 

financial stability, and promotes taxpayer protection and market discipline. 

B. Bankruptcy Code 

1. Introduction 

The U.S. Bankruptcy Code generally permits corporate firms to liquidate under Chapter 7, or to 

reorganize under Chapter 11. Bankruptcy is a process with the primary goal of maximizing the 

 

24 This analysis assumes that the securitization would qualify as a true sale; thus, the financial firm would have to 

surrender the control necessary to achieve this result. It also assumes that the firm has put the proceeds from such 

sales to other uses or paid them out to shareholders. Securitizations that do not qualify for true sale treatment would 

likely not be issued as securitization investors would not want to take the risk of potential haircuts. 25 Further, since securitization standards have tightened through a combination of FAS 166/167 and the risk 

retention/disclosure requirements that increase the costs in structured finance, firms may not be able to issue 

securitizations at lower costs. As a consequence, they may opt for selling assets outright, thereby losing any 

increased value of the underlying assets. 
13 

value of a debtor’s assets for the benefit of its stakeholders and, if justified, providing the debtor 

with the ability to reorganize.26 At its most fundamental level, the U.S. bankruptcy process is a 

court-supervised forum for resolving conflicts among and between an insolvent debtor and other 

stakeholders regarding the allocation of the debtor’s assets. Ideally, the forum offers a collective 

proceeding in which stakeholders can negotiate the terms under which the firm will continue as a 

going concern, or if beyond the point of viability, liquidate it for the benefit of its creditors.27 

One leading attribute of the bankruptcy process is that it is seen as providing participants with a 

transparent, efficient, and equitable mechanism for enforcing non-bankruptcy rights. In doing 

so, it facilitates the extension of credit on terms and at prices that take into account predictable 

risks and consequences of a debtor’s insolvency. 

Certain provisions of the Bankruptcy Code have the effect of modifying or negating provisions 

in secured lending agreements that were entered into prior to a debtor’s entrance into a 

bankruptcy proceeding. These provisions include the automatic stay, the trustee’s avoidance and 

recovery powers as well as the ability to retain a secured creditor’s collateral (and surcharge a 

secured creditor for services that have benefitted such collateral). Some of the major allocative 

standards which affect secured creditors are discussed in detail below. 

2. Automatic Stay 

Upon the filing of a voluntary bankruptcy petition, all persons with claims against the debtor are 

subject to the “automatic stay,” which, among other things, forbids any action against the debtor 

or its property to collect debts, seize assets, or otherwise exercise control over property of the 

debtor.

The purpose of the automatic stay, particularly with respect to secured creditors, is three-fold. 

First, it leaves intact the assets of the debtor which might be needed to run the debtor’s business, 

whether it is the debtor’s premises, equipment, inventory or operating capital. Second, it leaves 

in place assets which might have equity beyond the amount needed to satisfy the secured 

creditor’s lien, thus giving the trustee or debtor in possession time to assess the scope of such 

equity and to realize on it for the benefit of unsecured creditors. Third, it reduces the amount the 

debtor might otherwise be required to spend to defend against disparate collection actions by 

bringing all such claims arising out of the various debtor-creditor relationships into a single 

forum where they can be addressed more comprehensively and cost-effectively. By shielding the 

debtor’s assets and preventing a free-for-all rush to seize assets, the automatic stay avoids the 

disorderly dismemberment of a potentially viable firm and facilitates a process in which the 

debtor and its creditors can negotiate the terms under which the firm will be rehabilitated or, 

failing rehabilitation, permits the assets to be divided according to established priority schemes.28 

While the automatic stay was intended to protect the interests of all creditors, it does not 

otherwise affect a secured creditor’s status as a secured creditor. Rather, the Bankruptcy Code 

provides that a secured creditor may seek relief from the automatic stay to pursue its rights 

against the collateral securing its claim if it can show that its collateral is not adequately 

 

26 THOMAS JACKSON, THE LOGIC AND LIMITS OF BANKRUPTCY LAW, 10-17, 20 (Beard Books 2001). 27 Franklin R. Edwards & Edward R. Morrison, “Derivatives and the Bankruptcy Code: Why the Special 

Treatment?,” 22 YALE J. ON REG. 101 (2005). 28 Id. at 105. 
14 

protected (e.g., if it is declining in value, is not insured, or is otherwise at risk), or if the debtor 

has no equity in the collateral and the collateral is not necessary to an effective reorganization. 

If, in the face of such a request, the trustee or debtor in possession wishes to keep the collateral 

for the reorganization of the business, or to market the collateral in an attempt to realize the 

equity, then the trustee or debtor in possession has the burden of establishing that the property is 

necessary to the debtor’s reorganization and that adequate protection for the collateral exists, 

often in the form of payments or additional security. Thus, the Bankruptcy Code attempts to 

strike a balance between the protection of secured creditors’ distributive rights and the 

preservation of assets to further the Code’s allocative goals. 

3. Avoidance and Recovery Powers 

A second allocative standard of the Bankruptcy Code is that secured creditors who follow 

ordinary and prudent business practices and who act in good faith are generally protected, while 

those who overreach or take other extraordinary measures generally are not. This principle has 

been incorporated into the Bankruptcy Code as the various “avoidance” powers, such as the 

preference, statutory lien, fraudulent transfer and post-petition transaction avoidance powers that 

the bankruptcy trustee may exercise. Any property inappropriately transferred (or its value) may 

be “recovered” for the benefit of the bankruptcy estate. These provisions have the effect of (1) 

instilling a more disciplined approach to secured creditors’ lending practices by incentivizing 

lenders to obtain adequate collateral at the outset of the lending relationship and to act promptly 

to perfect their security interest29; and (2) allowing the trustee to seek to enlarge the bankruptcy 

estate. The two most commonly invoked avoidance provisions, preference and fraudulent 

transfer, are described below. 

(a) Preference Avoidance 

Under normal circumstances, a prudent secured lender will enter into a security agreement with 

the borrower, or have the borrower execute a mortgage or deed of trust, at the time the loan is 

made, and will (in the case of personal property) promptly file a financing statement with the 

secretary of state’s office where the borrower is domiciled, or (in the case of real property) 

record the deed of trust or mortgage with the county recorder’s office where the property is 

located. Under non-bankruptcy law, these actions protect the secured creditor’s interest in the 

collateral against most later-filed liens. On occasion, the lender will act slowly in recording its 

initial security documents, or will later request additional security. If the lender obtains such 

additional security, or perfects its lien on the original security while the debtor was insolvent and 

within 90 days prior to the filing of the bankruptcy petition, then the trustee or debtor in 

possession can set aside (“avoid”) the new liens. If the secured creditor is an “insider” at the 

time of the transfer, any additional security acquired or late-perfected liens obtained within one 

year before the filing of the bankruptcy petition, can be avoided. The avoidance power also 

extends to judgment liens attached to property of the debtor within the 90-day or one-year 

periods described above.30 

 

29 The avoidance and recovery powers may also have the effect of incentivizing secured creditors to structure 

lending arrangements to take advantage of the QFC Safe Harbors. 

30 See 11 U.S.C. §§ 547, 550, 551.
15 

(b) Fraudulent (Constructive) Transfer Avoidance 

Secured creditors sometimes seek credit enhancements from persons other than their borrower. 

These often come in the form of guaranties or collateral from a parent, subsidiary or affiliate of 

the borrower. Under normal circumstances, the law honors such agreements and will enforce the 

third party’s obligations under the guaranty and will permit foreclosure of the collateral provided 

by the third party. However, different allocative principles are applied if the third party entered 

into the transaction with the intent to put its assets beyond the reach of its own creditors, or if, 

regardless of intent, the third party is left with too few assets to pay its own creditors. The 

Bankruptcy Code permits the trustee or debtor in possession to set aside such credit 

enhancements if they occurred within the two years prior to filing of the bankruptcy petition. 

The Bankruptcy Code also permits the trustee to apply state law, such as the state’s version of 

the Uniform Fraudulent Transfer Act, to avoid the third party’s guaranty or collateral pledge. 

This often allows a longer reach-back period than the two years provided for under the 

Bankruptcy Code.31 

In addition to the constructive fraudulent transfer powers, the Bankruptcy Code gives the 

bankruptcy trustee the power to avoid transfers which are made with actual intent to hinder, 

delay or defraud any entity to which the debtor was (or thereafter became) indebted. Such 

avoidance actions are less common, but they are carved out of the QFC Safe Harbors, leaving 

QFC counterparties subject to them. 

4. QFC Safe Harbors 

As described in Section III, the Bankruptcy Code exempts most activities relating to QFCs from 

the automatic stay and from the effect of most avoidance action provisions when those actions 

are carried out by QFC counterparties. Counterparties whose transactions qualify for the QFC 

Safe Harbors are free to exercise their contractual rights upon a debtor’s insolvency or 

bankruptcy filing, including rights that would allow the counterparty to liquidate, terminate, or 

accelerate the contract, and net any termination value, payment amount, or other transfer 

obligation arising under the contract when the debtor files for bankruptcy. 

The QFC Safe Harbors were adopted, and over time expanded, to promote financial stability by 

reducing both the ability of the trustee to unwind a transaction which occurred prior to the filing 

of the bankruptcy petition, and the power of the bankruptcy court to stay termination of financial 

contracts upon the filing of a bankruptcy petition. Proponents argue that the QFC Safe Harbors 

reduce the probability of default by limiting the risk to creditors involved in lending to a troubled 

company up to the date that the company files a bankruptcy petition and, thereby constraining 

the flight impulse of certain short-term creditors to immediately withdraw all funding. They 

believe that any reduction of those protections could increase the run risk of short-term lenders 

for all troubled firms; and, in the case of a large, interconnected financial firm on the brink of 

failure, could initiate, or hasten, a financial crisis. In addition, they argue that the QFC Safe 

Harbors limit loss-given-default by allowing QFC counterparties to engage in close-out netting, 

which limits losses to solvent counterparties. They suggest that the QFC Safe Harbors thereby 

 

31 See 11 U.S.C. §§ 544, 548, 550, 551. 
16 

limit the risk that any shock from the bankruptcy filing of a large, interconnected financial firm 

will spread to other firms, destabilizing the financial markets. 

Critics of the QFC Safe Harbors contend that the risk reduction that the QFC Safe Harbors were 

intended to provide comes at a high cost. 32 Such critics argue that in the recent financial crisis, 

the QFC Safe Harbors enabled certain creditors to demand large collateral posting on the eve of 

insolvency that they were permitted to keep, in circumstances under which traditional lenders 

would have been forced to return the collateral to the bankruptcy estate. They argue that, in 

addition to reducing the amount available for distribution under the Bankruptcy Code’s priority 

scheme, QFC counterparties’ ability to retain late-acquired collateral could decrease ex ante

market discipline and, by effectively subsidizing QFC counterparties in this manner, encourage 

over-use of unreliable ultra-short term credit. While the availability of close-out netting 

enhances market stability by limiting losses to solvent counterparties, critics also believe closeouts can create market instability when a large volume of simultaneous close-outs gives rise to 

collateral fire sales. 

5. Protections against Lien Stripping in Bankruptcy 

Courts have held that, in a Chapter 7 bankruptcy liquidation, the full amount of a secured 

creditor’s lien is protected even if, at the time of the bankruptcy, the collateral is worth less than 

the amount of the lien. In Dewsnup v. Timm, the U.S. Supreme Court refused to grant a Chapter 

7 debtor’s request to “strip down” the secured creditor’s lien on the debtor’s real property to the 

value of the property as determined by the court.33 

In reaching its conclusion, the Supreme Court cited to the long history of protecting secured 

creditors under U.S. bankruptcy law. 

Protections against lien stripping are also provided in Chapter 11 reorganization cases. Although 

the Bankruptcy Code permits non-consensual alteration of a secured creditor’s rights (“cramdown”), this can occur only within certain parameters: First, the debtor’s plan of reorganization 

must provide: (1) that the secured creditor retains its lien on the property and receives, on 

account of its claim, deferred cash payments totaling, as of the effective date of the plan, at least 

the value of its lien on the real property; (2) for the sale of the property, subject to the right of the 

secured creditor to credit bid the amount of its claim; or (3) for the realization by the secured 

creditor of the “indubitable equivalent” of its claim.34 

Second, unless the secured creditor elects otherwise or the real property is to be sold, a secured 

creditor is treated as having recourse against the debtor even if the creditor would not have had 

recourse under applicable non-bankruptcy law. In this way, the secured creditor obtains a 

secured claim to the extent of the value of the real property and an unsecured claim for the 

balance owed to it. The creditor must be paid in full (perhaps over time) for the full present 

value of its secured claim, and may be paid pro rata on its unsecured claim based on the rate 

paid to other unsecured creditors. If the secured creditor makes the election permitted under the 

 

32 Mark J. Roe, “The Derivatives Markets’ Payment Priorities as Financial Accelerator,” 63 STAN. LAW REV. 539, 

550-551 (2011). 

33 See Dewsnup v. Timm, 502 U.S. 410, 417 (1992). 34 See 11 U.S.C. § 1129(b)(2)(A). 
17 

Bankruptcy Code (commonly called an “1111(b) election”), then its entire claim is treated as a 

secured claim, even though the property may not at that time be worth enough to make the 

secured creditor whole. This allows the secured creditor to protect for itself the future increase 

in the value of the collateral—which may be undervalued in the confirmation process either 

because the market for the collateral is depressed at the time, or because the value as determined 

by the bankruptcy court in the confirmation process is less reliable than the value determined in 

an actual sale of the collateral—when the debtor wishes to retain the property for use in the 

reorganization.35 

6. Surcharge of Secured Creditor’s Collateral 

Another allocative standard under the Bankruptcy Code is the power to surcharge the secured 

creditor’s collateral. The Bankruptcy Code provides that the trustee or debtor in possession may 

recover, from property encumbered with a secured creditor’s lien, the reasonable and necessary 

costs and expenses of preserving, or disposing of, the collateral, to the extent of any benefit to 

the secured creditor. If the trustee or debtor in possession has paid ad valorem property taxes, 

the value of these payments may be recovered from the collateral as well. 

Typically, in the absence of a bankruptcy filing, the debtor is contractually obligated to the 

secured creditor to insure and maintain the value of the collateral. If the debtor fails to make 

such expenditures, the secured creditor normally has a right do so and to add the sums expended 

to the amount of its lien. Upon the filing of a bankruptcy petition, however, the task of caring for 

the collateral falls to the bankruptcy trustee or debtor in possession, who might choose to hold 

the collateral for a period of time while assessing whether it has equity or whether it will be 

needed in the reorganization. In cases where cash is scarce and unsecured creditors will not be 

paid in full, it is viewed as unfair for the trustee or debtor in possession to use its limited 

resources in a way that will not redound to the unsecured creditors’ benefit. 

In theory, the surcharge is limited to the benefit the secured creditor receives on account of the 

trustee’s expenditures. In practice, the timeframe during which the trustee administers the 

property may be far longer than the timeframe to foreclosure under applicable non-bankruptcy 

law. Despite the fact that the secured creditor might have been able to mitigate the costs of 

preserving the collateral and to dispose of it more quickly and efficiently in the absence of a 

bankruptcy, the Bankruptcy Code alters the secured creditor’s distributive rights in order to 

accomplish intertwined goals: to provide a breathing space to assess the potential benefit to other 

creditors of using or selling the collateral, while avoiding burdening the non-lien holder creditors 

with expenses that ultimately inure to the benefit of the secured creditor.36 

C. Federal Deposit Insurance Act 

The Federal Deposit Insurance Act provides a comprehensive scheme for the resolution and 

liquidation of a failed IDI. The FDIA confers on the FDIC, in its role as receiver of failed IDIs, 

extensive powers to resolve these institutions. The FDIC’s primary mission is to maintain 

stability and public confidence in the U.S. banking system, including through insuring deposits, 

and to minimize disruptive effects from the failures of banks. The FDIC is responsible for 

 

35 See 11 U.S.C. § 1111. 36 See 11 U.S.C. § 506(c). 
18 

effectively managing receivership operations and for making sure that failing institutions are 

resolved in the manner that will result in the least cost to the DIF. 

In many ways the powers of the FDIC as receiver of a failed institution are similar to those of a 

bankruptcy trustee. Like a bankruptcy trustee, a receiver steps into the shoes of an insolvent 

party. The receiver may liquidate the insolvent institution or transfer some or all of its assets to 

an acquiring institution. However, the FDIA grants the FDIC additional powers that lead to 

critical differences between bankruptcy and the FDIC receivership process. These additional 

powers allow the FDIC to both expedite the liquidation process for IDIs in order to maintain 

confidence in the nation’s banking system and to maximize the cost-effectiveness of the 

receivership process to preserve a strong insurance fund. The primary difference is that the 

FDIC, in administering the assets and liabilities of a failed institution as its receiver, is not 

subject to court supervision. 

The purpose of a receivership is to market the assets of a failed institution, liquidate them, and 

distribute the proceeds to the institution’s creditors. The FDIC as receiver succeeds to the rights, 

powers, and privileges of the institution and its stockholders, officers, and directors. The FDIC 

may collect the receivables owed to the institution, preserve or liquidate its assets, and perform 

any other function of the institution which is consistent with the appointment as receiver. 

A receiver also has the power to merge a failed institution with another IDI and to transfer the 

failed institution’s assets and liabilities without the consent or approval of any other agency, 

court, or party with contractual rights. Furthermore, a receiver may form a new institution, such 

as a bridge depository institution (“bridge bank” or “BDI”), to take over the assets and liabilities 

of the failed institution, or it may sell or pledge the assets of the failed institution to the FDIC in 

its corporate capacity. 

1. 90-Day Receivership Stay 

The FDIA provides the FDIC-Receiver with several procedural devices that help to conserve, 

and potentially increase, the receivership’s assets. After the FDIC is appointed as receiver of a 

failed IDI, the FDIC may request a 90-day stay of all pending litigation and the courts in which 

such litigation is pending are required to grant such stays.37 Although the courts must grant the 

FDIC-Receiver’s request, unlike in bankruptcy, the stay is not automatic. Additionally, the 

FDIC-Receiver is not subject to any court’s writ of attachment or execution on IDI assets that are 

in the FDIC-Receiver’s possession.38 The FDIC-Receiver is not required to post any bond in the 

event it desires to appeal a judgment,39 and may bring actions on many tort claims arising from 

fraud, intentional misconduct resulting in unjust enrichment, or intentional misconduct resulting 

in substantial loss to the failed IDI, notwithstanding the expiration of state statutes of 

limitations.40 A special statute of limitations exists for actions brought by a receiver. Under the 

FDIA, the receiver has up to six years to file a contract claim and up to three years to begin a tort 

suit. 

 

37 12 U.S.C. § 1821(d)(12). 

38 12 U.S.C. § 1821(d)(13)(C). 

39 12 U.S.C. § 1821(d)(13)(B). 

40 12 U.S.C. § 1821(d)(14)(C). 
19 

2. Avoidance and Recovery Powers 

The FDIA grants the FDIC-Receiver some of the avoidance powers under the Bankruptcy Code. 

A bankruptcy trustee can avoid fraudulent transfers and recover property for the bankruptcy 

estate in cases of actual or constructive fraud. Similarly, the FDIC-Receiver may avoid a 

transfer of any interest of an institution-affiliated party, or any person who the FDIC determines 

is a debtor of the IDI, in property, or any obligation incurred by such person that was made 

within five years of the date on which the FDIC was appointed receiver if such person or party 

voluntarily or involuntarily made such transfer or incurred such liability with the intent to hinder, 

delay or defraud the IDI or the FDIC-Receiver.41 

3. Mechanisms for Expanding and Administering the Estate 

(a) Power to Repudiate and Enforce Contracts 

In the critical area of contracting, the FDIA provides the FDIC-Receiver upon appointment with 

significant powers to affect contracts previously entered into by the failed IDI. The FDIA grants 

the FDIC-Receiver the power to repudiate contracts to which the failed IDI is a party that the 

FDIC finds to be burdensome or if doing so would promote the orderly administration of the 

receivership estate. 42 The power to disaffirm or repudiate a contract permits the receiver to 

terminate the contract, thereby ending any future obligations imposed by the contract, and limits 

the damages from repudiation to actual, direct, compensatory damages as of the date of the 

receiver’s appointment. The receiver must act to repudiate a contract within a “reasonable time” 

after appointment. 

In contracts involving the failed IDI and a landlord, the FDIA limits the FDIC-Receiver’s 

damages only to contractual rent that has accrued as of the date of the FDIC-Receiver’s 

repudiation of the contract.43 Moreover, the FDIA provides the FDIC-Receiver with the power 

to enforce the contracts entered into by the IDI, in spite of presence of ipso facto clauses in the 

contract that would otherwise terminate or accelerate the contract upon insolvency of the IDI or 

the appointment of a receiver.44 The power to enforce contracts under the FDIA allows the 

FDIC-Receiver to retain valuable contract rights and prevents improper preferences and allows 

for orderly resolution without disruption or loss of capital. 

Additionally, the FDIA precludes parties who had contracted with the failed IDI from exercising 

a right or power to terminate, accelerate or declare a default under any contract to which the IDI 

was a party, or obtain possession of or exercise control over any property of the IDI for 90 days 

from the date of appointment of the FDIC-Receiver.45 Although the FDIA grants the 

FDIC-Receiver broad powers to manage the failed IDI’s contracts, the FDIC-Receiver does not 

 

41 12 U.S.C. § 1821(d)(17). 

42 12 U.S.C. § 1821(e)(3)(A)(i). Damages against the FDIC-Receiver may not include punitive or exemplary 

damages, damages for lost profit or opportunity, or damages for pain and suffering. 12 U.S.C. § 1821(e)(3)(B). 

43 12 U.S.C. § 1821(e)(4). 

44 12 U.S.C. § 1821(e)(13)(A). However, this enforcement provision shall not apply to a director and officer 

liability insurance contract, a depository institution bond, or to the rights of parties to certain QFCs pursuant to 12 

U.S.C. § 1821(e)(8), or the rights of parties to netting contracts pursuant to 12 U.S.C. § 4401 et seq. 

45 12 U.S.C. § 1821(e)(13)(C). This provision does not apply to director or officer liability insurance contracts, 

fidelity bond contracts, and to the rights of parties of certain financial contracts. 
20 

have the ability to prevent a counterparty from exercising a contractual right to terminate under a 

QFC.46 However, the FDIA permits the FDIC-Receiver to transfer QFCs to another entity until 

5 pm on the business day following the date of appointment of the FDIC-Receiver.47 This 

authority limits the potential for settlement failures involving QFCs, thereby reducing the 

financial exposure of the FDIC-Receiver. 

(b) Bridge Depository Institution 

In situations where the FDIC has not been able to arrange for the sale or transfer of the assets and 

liabilities of the failing IDI prior to receivership, the FDIA permits the FDIC-Receiver to place 

the failed IDI into a BDI, and to transfer the assets and liabilities of the failed IDI into the BDI.48 

The BDI receives a charter from the Office of the Comptroller of the Currency (“OCC”),49 and 

the FDIC-Receiver is not required to capitalize the institution, though it may make available to 

the BDI funds for the operation of the BDI.50 A BDI is designed to bridge the gap between the 

failure of the IDI and the time when the FDIC can implement a satisfactory acquisition by third 

parties. The FDIA requires a BDI to terminate within two years following the date it was 

granted a charter, but that period may be extended for three additional one year periods at the 

discretion of the FDIC.51 An important part of the FDIC’s resolution process for large or 

complex failing IDI, a BDI provides the time the FDIC needs to take control of a failed IDI’s 

business, stabilize the situation, effectively market the failed IDI’s franchise, and determine an 

appropriate resolution. 

Upon taking over a failing IDI, the FDIC-Receiver possesses the authority to obtain an order 

from the appropriate federal district court to freeze the assets in the failed IDI of any person 

designated by the FDIC-Receiver, and to have the court appoint a trustee to hold such assets.52 

This authority provides significant assistance to the FDIC-Receiver in preserving sources of 

recovery in civil actions brought against the failed IDI’s directors and officers, who usually 

maintain accounts at the failed IDI. 

(c) Administration of the Receivership 

Unlike a bankruptcy proceeding, resolution by the FDIC-Receiver under the FDIA is an 

administrative proceeding. As receiver, the FDIC has broad discretion to manage the resolution 

of the failed IDI. As in most administrative proceedings, the FDIC administers the receivership 

without judicial supervision. A bankruptcy court typically rules on numerous intermediate 

matters (e.g., the choice of a trustee or disposition of assets). The parties may then choose to 

appeal these rulings, during which time the court may stay its own ruling until the appeals are 

resolved. Furthermore, once the FDIC-Receiver is appointed, there is no mechanism for 

creditors, management, or shareholders to participate in the decision-making process beyond the 

filing of claims and the provision of requested information. 

 

46 QFCs are included in the FDIA in 12 U.S.C. § 1821(e)(8) by list and include the following: (1) commodities 

contracts; (2) forward contracts; (3) swap agreements; (4) repurchase agreements; and (5) securities contracts. 47 12 U.S.C. § 1821(e)(9), (10). 

48 12 U.S.C. § 1821(n)(1), (3). 

49 12 U.S.C. § 1821(n)(2). 

50 12 U.S.C. § 1821(n)(5)(A), (B). 

51 12 U.S.C. § 1821(n)(9). 

52 12 U.S.C. § 1821(d)(18). 
21 

In effect, claimants have no standing and very limited rights to appeal decisions before they are 

executed. However, some decisions of the FDIC-Receiver are subject to ex post judicial review, 

although damages are the only available remedy. 

(d) Treatment of Secured Creditors 

Secured claims are satisfied in full up to the value of the collateral. 

Under the FDIA, secured claims are treated similarly to the way they are treated in the 

bankruptcy process. Under section 11(e)(12) of the FDIA, secured creditors are fully protected 

for the amount of their claim up to the value of the collateral. Secured creditors have a claim to 

the collateral, up to the full amount of their claim for payment at the time of any default. If a 

secured creditor’s claim exceeds the value of the collateral, the claim will be bifurcated and the 

deficiency will be treated as an unsecured claim. If the collateral is liquidated and the proceeds 

are in excess of the secured creditor’s claim, the surplus is returned and used to pay the claims of 

unsecured creditors to the receivership estate. 

The FDIC will generally recognize a security interest if: (1) the security agreement was entered 

into in the ordinary course of business; (2) the secured obligation represents a bona fide and 

arm’s length transaction; (3) the secured creditor is not an insider or affiliate of the depository 

institution; (4) the security interest was granted for adequate consideration; and (5) the security 

interest is evidenced in a writing that was approved by the board of directors of the depository 

institution or its loan committee, and remains an official record of the depository institution. 

4. Division of Assets among the Parties 

The National Depositor Preference Act (“NDPA”),53 codified in the FDIA, established a federal 

scheme of priority of payment for members of the different classes of a failed IDI’s receivership 

estate. Prior to the passage of the NDPA, the FDIC utilized the priority schemes of the different 

states in determining the order of payment among the different classes of creditors of a failed 

IDI. The FDIC’s reliance on state priority of payment schemes created conflicts in the resolution 

of failed banks, as some state schemes equated uninsured depositor claims with general creditor 

claims, while other states gave uninsured depositor claims a higher priority than general creditor 

claims. Congress resolved this tension in 1993 with the passage of the NDPA, which established 

that uninsured depositor claims are a higher priority than general creditor claims and must be 

paid in full before payment of any general creditor claims. The priority payment scheme of the 

NDPA is as follows: (1) administrative expenses; (2) depositor claims; (3) general creditor 

claims; (4) subordinated debt obligations; and (5) shareholders of the IDI. Secured creditors 

holding a legally enforceable or perfected security interest in any of the assets of any failed IDI 

receive their secured interest in the value of the collateral, except where the security interest was 

taken in contemplation of the institution’s insolvency or with intent to hinder, delay or defraud 

the institution or the creditors of the institution.54 

 

53 12 U.S.C. § 1821(d)(11). 

54 12 U.S.C. § 1821(e)(12). 
22 

5. The Systemic Risk Exception to the Least Cost Resolution 

Requirement 

Before 1991, Congress granted broad discretion to the FDIC to incur costs in resolving an IDI, 

requiring only that the cost of the FDIC resolution strategy be less than the cost of liquidating the 

IDI. In 1982, with the passage of the Garn—St. Germain Depository Institutions Act, the FDIC 

received broad authority from the U.S. Congress that allowed it to provide open bank assistance 

if the cost of such assistance was less than the cost of liquidating the bank. From that point until 

1991, the FDIC used “open bank assistance transactions”55 in 133 cases to resolve some larger 

banks, including Continental Illinois in 1984 and First City Bancorporation in 1988. Smaller 

community banks objected to FDIC open bank assistance practices, claiming that the FDIC 

assisted only those IDIs deemed by the agency to be too big to fail. In response, Congress 

passed the FDICIA, which, among other things, required the FDIC to use the resolution method 

that was the “least costly” to the DIF of all possible methods for meeting the FDIC’s obligations 

to resolve failing IDIs (“Least Cost Resolution”).56 This new statutory provision virtually 

eliminated the FDIC’s prior practice of using open bank assistance to help troubled banks. 

The only exception to the Least Cost Resolution requirement that allowed for use of FDIC open 

bank assistance is the “systemic risk exception” in the FDIA (“Systemic Risk Exception”).57 

Under the Systemic Risk Exception, if the Secretary of the Treasury, in consultation with the 

President and upon the written recommendations of not less than two thirds of the members of 

the Board of Directors of the FDIC and of the Board of Governors of the Federal Reserve 

System (the “Board”), determines that the FDIC’s compliance with Least Cost Resolution would 

have serious adverse effects on economic conditions or financial stability, then the FDIC may 

take such action as is necessary to avoid or mitigate these effects. Under a Systemic Risk 

Exception determination, the FDIC is not bound to implement the least cost resolution strategy 

and may provide assistance (such as debt or deposit guarantees) that protects uninsured 

depositors and creditors who otherwise might suffer losses under a least cost resolution.58 

Prior to the fall of 2008, the FDIC, the Board, and the Secretary of the Treasury had never 

invoked the Systemic Risk Exception. Between September 2008 and the date of enactment of 

the Dodd-Frank Act, the FDIC and the Board recommended that the Treasury make a Systemic 

Risk Exception determination on five separate occasions. The Treasury made the determination 

on three of those five occasions. The first Systemic Risk Exception determination, on September 

29, 2008, authorized the FDIC to provide assistance to arrange for the acquisition of Wachovia 

by Citigroup. The second determination, on October 14, 2008, allowed the FDIC to provide 

certain assistance to IDIs, their holding companies, and qualified affiliates under the Temporary 

 

55 In an open bank assistance transaction, the FDIC provided financial assistance to an operating IDI to restore 

deficit capital to a positive level. Open bank assistance was structured as cash contributions to, loans to, the 

purchase of assets of, or the placement of deposits in the troubled IDI. For large institutions, the FDIC used a note 

or a loan. In addition, the FDIC covered losses for a specific amount on a pool of assets over a specific period of 

time. Such assistance was frequently used to facilitate the acquisition of the failing IDI by a healthy institution. 56 See 12 U.S.C. § 1823(c)(4)(A)(ii). 57 12 U.S.C. § 1823(c)(4)(G). 

58 U.S. GEN. ACCOUNTING OFFICE, FEDERAL DEPOSIT INSURANCE ACT REGULATORS’ USE OF SYSTEMIC RISK 

EXCEPTION RAISES MORAL HAZARD CONCERNS AND OPPORTUNITIES EXIST TO CLARIFY THE PROVISION 12 (2010). 
23 

Liquidity Guaranty Program (“TLGP”).59 The third determination, on January 15, 2009, 

authorized the FDIC to provide assistance to Citigroup relating to a designated pool of troubled 

assets of Citigroup. The FDIC and the Board also made two other recommendations for 

Systemic Risk Exception determinations—to authorize the FDIC to provide assistance to Bank 

of America relating to a designated pool of troubled assets of Bank of America, and to support 

the Public-Private Investment Program’s proposed Legacy Loans Program—but neither resulted 

in the Treasury making such a determination. 

D. Orderly Liquidation Authority 

1. Introduction 

Title II of the Dodd-Frank Act authorizes a special resolution proceeding for certain financial 

companies.60 The Orderly Liquidation Authority may generally be invoked with respect to a 

particular financial company only upon a recommendation by the Board and the FDIC’s Board 

of Directors (both by a two-thirds vote); and a determination by the Secretary of the Treasury, in 

consultation with the President, that, among other things, the financial company is in default or 

in danger of default, and the company’s failure and resolution under the Bankruptcy Code would 

have serious adverse effects on U.S. financial stability, and resolution under OLA would avoid 

or mitigate these adverse effects. The U.S. Securities and Exchange Commission (the 

“Commission”) would substitute for the FDIC in this recommendation process if the firm, or its 

largest subsidiary, is a broker-dealer. The FDIC is then appointed as the FDIC-Receiver if, for 

example, the covered financial company consents or acquiesces to such appointment. 

The powers granted to the FDIC-Receiver under OLA to resolve a covered financial company 

are analogous to those the FDIC uses to resolve failed IDIs under the FDIA. Although many of 

these authorities differ from those available to a trustee or debtor in a bankruptcy proceeding, 

they are consistent with the FDIC-Receiver’s duties under OLA to preserve financial stability 

while minimizing moral hazard and maximizing market discipline. Five of the most important 

elements of those authorities are: (i) the ability to conduct advance resolution planning for bank 

holding companies with assets of $50 billion or more and nonbank financial companies 

designated by the Council (“Firms Subject to Heightened Prudential Standards”); (ii) an 

immediate source of liquidity for an orderly liquidation, which allows continuation of essential 

functions and maintains asset values; (iii) the ability to make advance dividends on creditor 

claims and prompt distributions to creditors based upon expected recoveries; (iv) the ability to 

continue key, systemically important operations, including through the formation of one or more 

bridge financial companies; and (v) the ability to transfer all qualified financial contracts with a 

given counterparty to another entity (such as a bridge financial company) and avoid their 

immediate termination and liquidation to preserve value and promote stability. 

 

59 Under TLGP, the FDIC had guaranteed newly issued senior unsecured debt up to prescribed limits for insured 

institutions, their holding companies, and qualified affiliates and provided temporary unlimited coverage for certain 

non-interest bearing transaction accounts at insured institutions. 60 Section 201(a)(11) of the Dodd-Frank Act defines a “financial company” as an entity organized under federal or 

state law that is (1) a bank holding company as defined in the Bank Holding Company Act of 1956 (as amended, 

BHC Act); (2) a nonbank financial company supervised by the Board; (3) any company that is predominantly 

engaged in activities that the Board has determined to be financial in nature or incidental thereto; or (4) any 

subsidiary (other than an IDI or an insurance company) of one of the three types of entities if the subsidiary is 

predominantly engaged in such financial activities. 
24 

Title II of the Dodd Frank Act provides that the distribution provisions of the FDIC-Receiver 

under OLA “shall not affect secured claims” except with respect to any unsecured portion of 

such claims resulting from the insufficiency of the security interest to satisfy the claim.61 The 

FDIC has initiated an on-going rulemaking effort to promulgate regulations that satisfy that 

statutory directive, and to harmonize the treatment of creditors in an OLA liquidation with such 

treatment under otherwise applicable insolvency laws, including, with relevant provisions of the 

Bankruptcy Code. Like the Bankruptcy Code, OLA alters certain distributive rights of secured 

creditors in order to meet the allocative goals of the Act. OLA is an administrative process, and 

therefore, unlike the bankruptcy process in which the negotiation among stakeholders is refereed 

by an impartial court, the FDIC-Receiver is given considerable authority to manage the orderly 

liquidation of a covered financial company without the contemporaneous involvement of a court. 

Generally, OLA seeks to adhere to the core rights and restrictions of the Bankruptcy Code, 

except where deviation is necessary to achieve the primary objectives of these reforms: financial 

stability, taxpayer protection and market discipline. However, in some ways, OLA’s alterations 

of distributive rights meaningfully deviate from similar provisions of the Bankruptcy Code. The 

analysis set forth below describes some of the ways OLA’s alterations of distributive rights 

deviate from similar provisions of the Bankruptcy Code, including comparisons between the 

ways a secured creditor’s rights are altered under OLA and the way they are altered under the 

Bankruptcy Code. 

2. Impact on Secured Creditors of the Orderly Liquidation Authority 

(a) Automatic Stay 

Like the FDIA, OLA provides for an automatic stay of a secured creditor’s right to foreclose on 

its collateral pursuant to ipso facto clauses for 90 days from the date of appointment of the 

FDIC-Receiver.62 The automatic stay imposed under the Bankruptcy Code remains in effect 

until either the time the case is closed or dismissed, or a discharge is granted or denied, unless 

relief from the automatic stay is granted upon motion by the secured creditor and approval of the 

Bankruptcy Court.63 If a motion for relief from the automatic stay is denied, the Bankruptcy 

Court may grant the secured creditor adequate protection to protect the creditor against 

diminutions in the value of the collateral securing the creditor’s claim.64 

Under OLA, except in very limited circumstances, there is no statutory right to adequate 

protection of claims in the receivership. However, by regulation the FDIC has provided a 

secured creditor under OLA with the ability to receive additional collateral or payments on its 

debt to compensate it for a decline in the value of its collateral.65 In addition, a secured creditor 

under OLA may request that its claim be determined on an expedited basis (i.e., within 90 days 

rather than the normal 180 days from the filing of the claim). In this process, the claimant must 

 

61 12 U.S.C. § 5390(b)(5). 

62 12 U.S.C. § 5390(c)(13)(C). Compare to 12 U.S.C. § 5390(a)(8), which provides for a 90-day stay of any pending 

litigation upon the FDIC-Receiver filing a request with the court. 63 11 U.S.C. § 362(a)-(d). 

64 11 U.S.C. § 361. 

65 12 C.F.R § 380.52. 
25 

show that irreparable injury will occur if the normal claims procedure is followed.66 A secured 

creditor that requests expedited determination of its claim may seek review of the 

FDIC-Receiver’s decision on its secured claim within 30 days after the earlier of the date the 

decision is rendered, or 90 days after the claim was filed.67 

Another source of protection available for all creditors under OLA is the ability of the 

FDIC-Receiver to make prompt interim distributions to creditors based on the FDIC-Receiver’s 

estimate of the amount on hand and/or the amount likely to be recovered from the liquidation of 

assets. Because this power is discretionary, however, a creditor cannot demand it as of right. 

(b) Avoidance and Recovery Actions 

Like a trustee under the Bankruptcy Code, OLA empowers the FDIC-Receiver to avoid certain 

transfers of assets made prior to the commencement of the receivership and recover their value 

for the benefit of the receivership estate.68 The exercise of this authority can have the effect of 

altering secured creditors’ distributive rights that would otherwise apply. The avoidance powers 

under OLA are generally analogous in scope to those under the Bankruptcy Code. They cover: 

(1) fraudulent transfers (actual and constructive), (2) preferences and (3) unauthorized postreceivership transactions.69 Similar to those under the Bankruptcy Code, Title II avoidance 

provisions have the dual effect of (1) incentivizing lenders to obtain adequate collateral at the 

outset of the lending relationship and to act promptly to perfect their security interests, and (2) 

permitting the FDIC-Receiver to seek to enlarge the estate. 

3. Advance Planning under the Dodd-Frank Act 

As discussed below, bankruptcy proceedings can be challenging in the case of a large, 

interconnected financial firm in part due to the lack of tools and discretion in the Bankruptcy 

Code to manage a bankruptcy process for the purpose of preserving financial stability, protecting 

taxpayers and promoting market discipline. A key feature of a disorderly, value-depleting, 

resolution of a large, interconnected financial firm is that the participants may have little notice 

or opportunity for advance preparation or coordination. An important tool for an effective 

resolution under OLA is advance planning, including the requirement that Firms Subject to 

 

66 12 U.S.C. § 5390(a)(5)(A). 

67 12 U.S.C. § 5390(a)(5)(C). Separate rules apply to QFCs. Under Title II, counterparties are stayed until 5:00 

p.m. on the business day following the date of appointment of a receiver from exercising termination, liquidation or 

netting rights under the QFC. 12 U.S.C. § 5390(c)(10)(B)(i)(I). If the QFCs are transferred to a solvent third party 

before the stay expires, the counterparty is permanently enjoined from exercising such rights based upon the 

appointment of the receiver, but is not stayed from exercising such rights based upon other events of default. See 12 

U.S.C. § 5390(c)(10)(B)(i)(II).

68 When the covered financial company subject to resolution under OLA is a SIPC-member broker-dealer, OLA 

reserves to SIPC, as trustee for the liquidation of the broker-dealer under the Securities Investor Protection Act 

(“SIPA”), all of the powers and duties provided by SIPA, “including, without limitation, all rights of action against 

third parties.” See 12 U.S.C. § 5385(b)(1). SIPA incorporates by reference the avoidance provisions of the 

Bankruptcy Code, inter alia, to the extent consistent with SIPA. See generally 15 U.S.C. § 78fff(b). The avoidance 

powers conferred through those provisions are comparable in scope to those enjoyed by the FDIC-Receiver under 

OLA. 

69 12 U.S.C. § 5390(a)(11). There is no right to avoid any transfer of money or other property in connection with a 

QFC absent actual intent to hinder, delay or defraud. 12 U.S.C. § 5390(c)(8)(C). 
26 

Heightened Prudential Standards maintain and submit to government regulators well-developed, 

firm-specific resolution plans and credit exposure reports. 

(a) Resolution Plans 

Under the resolution plan provisions of the Dodd-Frank Act, the Board and the FDIC are to 

jointly issue regulations that require Firms Subject to Heightened Prudential Standards to report 

periodically to the Board, the FDIC, and the Council their plans for rapid and orderly resolution 

in the event of material financial distress or failure. The Dodd-Frank Act requires that the 

resolution plans include information about the manner and extent to which any IDIs affiliated 

with a Firm Subject to Heightened Prudential Standards are adequately protected from risks 

arising from the activities of the nonbank subsidiaries of the Firm Subject to Heightened 

Prudential Standards. The resolution plan for any Firm Subject to Heightened Prudential 

Standards also must describe such firm’s ownership structure, assets, liabilities, and contractual 

obligations, identify cross guarantees tied to different securities, identify major counterparties 

and identify a process for determining to whom collateral of the company has been pledged. The 

Board and FDIC can require additional information as well.70 The elements contained in a 

resolution plan will not only help the FDIC and other domestic regulators to better understand a 

firm’s business and how that entity may be resolved, but will also enhance the FDIC’s ability to 

coordinate with foreign regulators in an effort to develop a comprehensive and coordinated 

resolution strategy for a cross-border firm. 

If, after reviewing a resolution plan of any Firm Subject to Heightened Prudential Standards, the 

Board and the FDIC jointly determine the plan is deficient,71 the agencies, together, must notify 

the company of the plan’s deficiencies. If a Firm Subject to Heightened Prudential Standards 

fails to effectively resubmit a plan that corrects identified deficiencies, the agencies may jointly 

impose more stringent capital, leverage, or liquidity requirements, or restrictions on the growth, 

activities or operations of the company. In some cases, the Board and the FDIC, in consultation 

with the Council, may jointly require a Firm Subject to Heightened Prudential Standards to 

divest certain assets or operations. Overall, under the resolution planning process, Firms Subject 

to Heightened Prudential Standards will be required to make a careful assessment of their 

structure and operations and determine, in conjunction with supervisory oversight, whether 

modifications should be made to facilitate resolution in times of financial stress. 

(b) Credit Exposure Reports 

The credit exposure reports required under section 165(d)(2) of the Dodd-Frank Act will also 

provide important information critical to the FDIC’s planning processes by identifying the 

company’s significant credit exposures, its component exposures, and other key information 

across the entity and its affiliates. 

On April 22, 2011, the Board and the FDIC issued for public comment a joint notice of proposed 

rulemaking that would implement the credit exposure report requirements of the Dodd-Frank 

 

70 On April 22, 2011, the Board and the FDIC issued a notice of proposed rulemaking to implement the resolution 

plan and credit exposure report requirements of section 165(d) of the Dodd-Frank Act. 76 Fed. Reg. 22,648. 

71 That is, the plan is not credible or would not facilitate an orderly resolution of the Firm Subject to Heightened 

Prudential Standards under the Bankruptcy Code. 
27 

Act.72 Section 165(d)(2) of the Dodd-Frank Act provides that the Board and the FDIC will 

jointly issue rules under which the Board shall require each Firm Subject to Heightened 

Prudential Standards to report periodically to the Board, the Council, and the FDIC on: (a) the 

nature and extent to which the company has credit exposure to other significant nonbank 

financial companies and significant bank holding companies; and (b) the nature and extent to 

which other significant nonbank financial companies and significant bank holding companies 

have credit exposure to that company. 

Under the proposal, a credit exposure report for a Firm Subject to Heightened Prudential 

Standards would be required to include information related to the aggregate credit exposure 

associated with a range of transactions with every large financial firm. In particular, under the 

proposal, each Firm Subject to Heightened Prudential Standards must report, on a quarterly basis 

(or more frequently if requested), its aggregate level of each of the following: extensions of 

credit, including loans, leases, and funded lines of credit, repo and reverse repo agreements 

(gross and net), securities borrowing and lending activities (gross and net), counterparty credit 

exposure (gross and net) in connection with all derivative transactions, and guarantees by the 

Firm Subject to Heightened Prudential Standards (including its subsidiaries) to each significant 

bank holding company or significant nonbank financial company (including their subsidiaries). 

The proposal also requires each Firm Subject to Heightened Prudential Standards to report which 

large financial firms have any of the same categories of credit exposure to it. 

E. Summary of Comparison of Resolution Mechanisms 

Corporate bankruptcy is the dominant process for liquidating (Chapter 7) or reorganizing 

(Chapter 11) a failing firm in the United States. Nearly all large firm bankruptcies in the U.S. 

are initiated under Chapter 11, a court supervised process with the primary goal of allowing 

stakeholders to negotiate the distribution of rights to the debtor’s assets in the manner that 

maximizes the value of such assets primarily for the benefit of the debtor’s creditors. In most 

cases, the bankruptcy process provides an appropriate framework for the resolution of nonbank 

financial firms. However, some argue that, in its current form, the bankruptcy process does not 

sufficiently protect the public interest in ensuring the orderly resolution of a nonbank financial 

firm whose failure would pose a substantial risk to U.S. financial stability.73 In the wake of the 

recent financial crisis, Congress concluded that the absence of a legal regime to address the 

unique challenges posed by the failure of such a firm left the government without an alternative 

to the unattractive options of value-depleting bankruptcy proceedings, on the one hand, or 

taxpayer “bailouts,” on the other. The creation of OLA was needed to enhance the government’s 

ability to mitigate the impact of the failure of a large, interconnected financial firm on U.S. 

financial stability; and, together with enhanced prudential supervision, to protect taxpayers and 

promote market discipline. 

 

72 76 Fed. Reg. 22,648 (Apr. 22, 2011). The comment period for the proposed rule ended on June 10, 2011. The 

Dodd-Frank Act requires a final rule to be in place no later than January 21, 2012. 73 Kenneth Scott, A Guide to the Resolution of Failed Financial Institutions: Dodd-Frank Title II and Proposed 

Chapter 14 (Apr. 21, 2011), available at http://media.hoover.org/sites/default/files/documents/ken-scott-guide-toresolution-project.pdf; see also Squam Lake Working Group on Financial Regulation, “Improving Resolution 

Options for Systemically Relevant Financial Institutions,” (October 2009), available at 

http://www.squamlakegroup.org. 
28 

The Orderly Liquidation Authority created by Title II of the Dodd-Frank Act authorizes the 

government to address the potential failure of a bank holding company or other nonbank 

financial firm when the stability of the U.S. financial system is at risk. The new resolution 

regime is thus an important component of the principal reform objectives of protecting taxpayers 

and promoting market discipline. 

The authority granted under OLA addresses several of the most perceived weaknesses of the 

existing Bankruptcy Code.74 OLA addresses the lack of tools or discretion in the Code by 

allowing government regulators to manage the resolution of a firm with the goal of preserving 

financial stability rather than maximizing the value of the firm’s assets for the benefit of its 

stakeholders. For example, the current Bankruptcy Code: (1) does not give government 

regulators the ability to force a nonbank financial firm on the eve of failure into a resolution 

proceeding; (2) is slower than some argue is necessary to manage the resolution of a large, 

interconnected financial firm during a financial emergency without first negotiating with the 

failed firm’s stakeholders; (3) does not provide an immediate source of funding to temporarily 

continue essential functions of the failed firm to minimize the cost of resolution (unless the 

conditions for debtor-in-possession financing are met); and (4) requires that similarly situated 

creditors be treated similarly. 

OLA thus fills an important regulatory gap. It provides that, to the extent possible, the FDIC 

shall seek to harmonize the rules and regulations applicable to OLA with the insolvency laws 

that would otherwise apply to a covered financial company,75 including the Bankruptcy Code. 

The bankruptcy process generally allows a secured creditor to retain the benefit of its superior 

rights by: granting creditors’ secured claims full priority over any unsecured or junior secured 

claims; providing “adequate protection” of the value of the secured claim if there is a loss due to 

the debtor’s use or detention of the collateral; and providing for judicial involvement at the time 

creditors’ rights are determined. Although the process is somewhat different, OLA’s protections 

of the contractual rights of secured creditors are substantively similar to those provided under the 

Bankruptcy Code.76 In addition, the FDIC has initiated an ongoing rulemaking process to further 

harmonize the treatment of secured creditors in an OLA liquidation with treatment under the 

relevant provisions of the Bankruptcy Code, including the ability of secured claimants to 

exercise rights against collateral and obtain adequate protection of their interests. In time, the 

FDIC will continue to issue policies, rules and regulations that help creditors to determine in 

advance how they will be treated in a proceeding under OLA. 

However, the process established by OLA differs from the bankruptcy process in that OLA gives 

the FDIC-Receiver authorities commensurate with the FDIC-Receiver’s duties to preserve U.S. 

financial stability while minimizing moral hazard and maximizing market discipline. These 

authorities are largely adapted from the FDIC’s IDI resolution authorities under the FDIA. As 

under FDIA, some of the FDIC-Receiver’s authorities under OLA with respect to treatment of 

secured creditors are more expansive than those available to a bankruptcy trustee. These 

 

74 See Randall D. Guynn, “Are Bailouts Inevitable?,” YALE J. ON REG (forthcoming Fall 2011). 75 12 U.S.C. § 5389. 

76 See, e.g., Douglas G. Baird and Edward R. Morrison, “Dodd-Frank for Bankruptcy Lawyers” (2011), available at

http://www.law.northwestern.edu/searlecenter/jep/symposia/documents/Baird_DoddFrank_for_Bankruptcy_Lawyers.pdf. 
29 

authorities include the ability to (1) treat unsecured creditors of the same class differently under 

certain circumstances, (2) transfer assets or liabilities to a solvent third-party, including a bridge 

financial company, without counterparty or judicial consent, (3) temporarily stay the right of a 

counterparty to a QFC to close out, net and liquidate collateral securing its claim and (4) 

promptly provide partial satisfaction of creditor claims – particularly claims of key 

counterparties – where doing so would mitigate risk to U.S. financial stability and protect 

taxpayers. 

The role of the court will also be different in an OLA claims determination process than it would 

in bankruptcy. In contrast to a case under the Bankruptcy Code, in which a debtor’s or trustee’s 

actions are subject to prior approval by a court, a receivership of a covered financial company is 

an administrative proceeding conducted by the FDIC-Receiver. Under OLA and FDIC 

implementing regulations, court jurisdiction is limited and subject to exhaustion of the 

receivership claims process.77 In the midst of a financial crisis, when time is of the essence, the 

existing bankruptcy process cannot always provide the speed and decisiveness afforded by an 

administrative process. Such speed and decisiveness is needed to manage the failure of a large, 

interconnected financial firm to preserve U.S. financial stability, protect taxpayers, and promote 

market discipline. While a claimant in an OLA process may have its day in court, judicial 

review of claims occurs after the FDIC-Receiver has first made a determination regarding the 

claim or the claimant’s rights. 

V. Other Reforms that Protect Taxpayers from Loss and Promote Market 

Discipline 

Title I of the Dodd-Frank Act provides a new regulatory framework under which Firms Subject 

to Heighted Prudential Standards are subject to consolidated supervision by the Board. Because 

the new supervisory framework is “macroprudential” in nature, prudential standards applicable 

to such firms will be more stringent than those applicable to other financial firms that do not 

present similar risks to financial stability, and must increase in stringency as the risk to financial 

stability posed by such firms increases. This is intended to compel Firms Subject to Heightened 

Prudential Standards to internalize the full range of risks associated with their failure, which will 

give those institutions an incentive to reduce those risks. 

Paralleling the new regulatory framework under Title I of the Dodd-Frank Act, the Basel 

Committee on Banking Supervision issued a package of reforms in December 2010 designed to 

strengthen global capital and liquidity rules with the goal of promoting a more resilient banking 

sector (“Basel III”).78 Similar to Title I of the Dodd-Frank Act, the broad objective of the 

reforms is to improve the banking sector’s ability to absorb shocks arising from financial and 

economic stress, thereby reducing the risk of spillover from the financial sector to the broader 

economy. 

 

77 See, e.g., 12 C.F.R. § 380.38. 78 See Basel Comm. on Banking Supervision (“Basel Comm.”), Basel III: A global regulatory framework for more 

resilient banks and banking systems (rev. June 2011) (2010); Basel Comm., Basel III: International framework for 

liquidity risk measurement, standards and monitoring (Dec. 2010); Basel Comm., Guidance for national authorities 

operating the countercyclical capital buffer (Dec. 2010). 
30 

Still other reforms will increase the transparency of certain broadly used funding arrangements. 

Ideally, increasing transparency would reduce creditors’ impulse to run while increasing cost of 

capital for firms that over-rely on short-term debt. 

Taken together, these reforms lessen the need for secured creditor haircuts to promote either 

taxpayer protection or market discipline. With respect to taxpayer protection, these reforms will 

help to avoid future taxpayer-funded bailouts by limiting the probability that a large, 

interconnected firm would fail and by reducing the knock-on effects of any such failure. These 

reforms will also promote more effective market discipline by forcing a firm’s creditors (and 

other stakeholders) to bear the costs of its failure.

A. Title I of the Dodd-Frank Act 

The recent financial crisis demonstrated that effective prudential regulation of Firms Subject to 

Heightened Prudential Standards requires regulators to have the ability to monitor and address 

risks across the entire organization. Title I of the Dodd-Frank Act achieves this result by 

subjecting Firms Subject to Heightened Prudential Standards to consolidated supervision by the 

Board, while maintaining oversight of certain subsidiaries by their primary federal financial 

regulator. 

In addition, Title I of the Dodd-Frank Act provides that Firms Subject to Heightened Prudential 

Standards will be subject to more stringent requirements covering, among other things, riskbased capital, leverage and liquidity requirements; stress testing; single counterparty credit 

exposure limits; and, as discussed in Section IV, the development of resolution plans and credit 

exposure reports. The Dodd-Frank Act requires the Board to establish an early remediation 

framework for Firms Subject to Heightened Prudential Standards to mitigate financial distress. 

1. Capital, Leverage and Liquidity 

Under Title I of the Dodd-Frank Act, capital, leverage and liquidity requirements applicable to 

Firms Subject to Heightened Prudential Standards must be more stringent than the standards 

applicable to other financial firms that do not present similar risks, and must increase in 

stringency relative to the risk posed. When calculating compliance with capital requirements, 

the Dodd-Frank Act requires off-balance sheet activities to be taken into account. The DoddFrank Act also directs the Board to require any Firm Subject to Heightened Prudential Standards 

that the Council determines poses a grave threat to the financial stability of the United States to 

maintain a debt-to-equity ratio of no more than 15-to-1 if necessary to mitigate such threat. 

2. Stress Testing 

Title I of the Dodd-Frank Act requires the Board to conduct annual analyses of Firms Subject to 

Heightened Prudential Standards to determine whether such companies have enough capital, on a 

total consolidated basis, to absorb losses as a result of adverse economic conditions. The Board 

must provide at least three different sets of conditions for the analyses – a baseline scenario, an 

adverse scenario, and a severely adverse scenario. The Board must require a Firm Subject to 

Heightened Prudential Standards to update its resolution plan, based on the results of those 

analyses. In addition, each Firm Subject to Heightened Prudential Standards must itself conduct 
31 

semi-annual stress tests. All other financial companies that have total consolidated assets of 

more than $10 billion and are regulated by a primary federal financial regulatory agency must 

conduct an annual stress test. The federal primary financial regulatory agencies must issue 

regulations to implement this requirement. The regulations must establish methodologies for the 

conduct of the stress tests under the same three sets of conditions described above (i.e., a 

baseline scenario, an adverse scenario, and a severely adverse scenario). 

The Board currently is working on a notice of proposed rulemaking to implement the enhanced 

prudential standard requirement of section 165 (a), (b), and (e)—(k). Under the Dodd-Frank Act, 

final rules must be in place no later than January 21, 2012. 

3. Single Counterparty Credit Exposure Limits 

Section 165(e) of the Dodd-Frank Act directs the Board to prescribe standards that limit Firms 

Subject to Heightened Prudential Standards from having credit exposure79 to any unaffiliated 

company that exceeds 25 percent of capital stock and surplus. The Board may lower the level as 

necessary to mitigate risks to financial stability. The single counterparty credit exposure limits 

required under the Dodd-Frank Act80 provide more broad-based restrictions on credit exposures 

of Firms Subject to Heightened Prudential Standards than the existing national bank legal 

lending limit. The Dodd-Frank Act requires the Board to impose credit exposure limits on the 

consolidated organization rather than the depository institution and imposes limits on a broad 

range of credit exposures, including counterparty credit exposures associated with securities 

financing and derivative exposures. By capping exposures of Firms Subject to Heightened 

Prudential Standards to any single counterparty, the credit exposure limits are intended to help 

limit interconnectedness among large financial firms going forward. 

The Board may exempt transactions in whole or in part from the definition of credit exposure if 

it is determined to be in the public interest or consistent with the purpose of the Dodd-Frank Act 

credit exposure limits. The standards do not become effective until three years after the 

enactment of the Dodd-Frank Act, and the Board may extend the transition period for two 

additional years. The Board may also, pursuant to a recommendation from the Council, establish 

an asset threshold above $50 billion for the application of the credit concentration limit standard 

to certain Firms Subject to Heightened Prudential Standards. 

The Board is currently working on a notice of proposed rulemaking to implement the credit 

exposure limit provisions of the Dodd-Frank Act. Under the Dodd-Frank Act, final rules must 

be in place no later than January 21, 2012. 

 

79 Credit exposure to a company is defined as: all extensions of credit to a company (including loans, deposits, and 

lines of credit); all repo and reverse repo agreements with the company (if credit exposure is created); all securities 

borrowing and lending transactions with the company (if credit exposure is created); all guarantees, acceptances, or 

letters of credit (including endorsement or standby letters of credit) issued on behalf of the company; all purchases 

of or investments in securities issued by the company; counterparty credit exposure to the company in connection 

with derivative transactions between the Firm Subject to Heightened Prudential Standards and that company; and 

any other similar transaction the Board determines to be a credit exposure. 

80 12 U.S.C. § 5365(e)(2). 
32 

4. Early Remediation 

Section 166 of the Dodd-Frank Act requires the Board, in consultation with the FDIC and the 

Council, to prescribe regulations that provide for the early remediation of financial distress of a 

Firm Subject to Heightened Prudential Standards. The purpose of this requirement is expressly 

identified as being to establish a series of specific remedial actions for Firms Subject to 

Heightened Prudential Standards to take in order to minimize (1) the probability that they will 

become insolvent, and (2) the potential harm of such insolvency to the financial stability of the 

United States. The Board has substantial discretion to implement this provision in a manner that 

it determines best achieves the objective, but the statute requires the Board to define measures of 

financial condition using regulatory capital, liquidity measures, and other forward-looking 

indicators. Further, the remediation provisions must increase in stringency as the financial 

condition of the company declines and remediation actions must include limits on capital 

distributions, acquisitions, and asset growth in the initial stages of financial decline and a capital 

restoration plan and capital raising requirements, limits on transactions with affiliates, 

management changes, and asset sales in later stages of financial decline. 

The Board currently is working on a notice of proposed rulemaking to implement section 166. 

Under the Dodd-Frank Act, final rules must be in place no later than January 21, 2012. 

B. Basel III 

Basel III imposes more stringent risk-based capital requirements; backstops those capital 

requirements with a new leverage standard; and requires relevant firms to increase their ability to 

withstand liquidity shocks. 

1. Capital and Leverage 

(a) The Definition of Capital 

Basel III increases the quality, consistency and transparency of the capital base. Deductions 

from capital currently applied at the tier 1 or total capital level will be harmonized internationally 

and applied at the common equity tier 1 level. The common equity tier 1 level includes common 

equity, and minority interests (subject to limits) in the form of common equity. Since credit 

losses and write-downs come out of retained earnings, a component of common equity, the new 

common equity tier 1 requirements are expected to help banking organizations better absorb 

losses on a going concern basis. Other regulatory deductions from capital, such as, for example, 

goodwill, deferred tax assets, and shortfalls in loss provisions, also will be made from common 

equity tier 1. Basel III imposes a minimum common equity tier 1 ratio (4.5 percent), raises the 

minimum tier 1 ratio (from 4 percent to 6 percent), establishes stricter criteria for tier 1 

eligibility, simplifies tier 2 capital requirements and eliminates tier 3 capital. The new capital 

requirements will be phased in over a period of time, with full implementation expected by 

January 2018. 

(b) Enhanced Risk Coverage 

A key lesson from the recent financial crisis is the importance of appropriately recognizing onand off-balance sheet risks, as well as derivative exposures. The Basel Committee has adopted 
33 

reforms that will raise capital requirements for the trading book and for complex securitization 

exposures. It also has implemented higher capital requirements for resecuritizations in both the 

banking and trading books. The Basel Committee also is conducting a fundamental review of 

the trading book, which has a target completion date of year-end 2011.81

Basel III strengthens the capital requirements for counterparty credit exposures arising from 

derivatives, repo agreements, and securities financing activities. These reforms will raise the 

capital charges for these exposures and provide incentives to move over-the-counter derivative 

contracts to central counterparties, helping to promote financial stability. Specifically, capital 

requirements for counterparty credit risk will be determined using stressed inputs, which will 

address concerns about capital charges becoming too low during periods of compressed market 

volatility and help address procyclicality.82 

(c) Other Mechanisms to Limit Procyclicality 

The Basel Committee also has introduced measures to promote the buildup of capital buffers in 

good times that can be drawn upon in periods of stress. The capital conservation buffer will be 

in addition to the capital minimums and will be composed solely of common equity. The capital 

conservation buffer has been set at 2.5 percent of risk-weighted assets. Banks will be able to 

draw on this additional capital during periods of financial stress; however, as a bank’s capital 

ratio gets closer to the minimum requirements, it will have greater constraints on earnings 

distributions. This new capital requirement will be phased in over several years. The 

countercyclical buffer will be implemented subject to national discretion. It represents an 

additional capital requirement ranging from zero percent to 2.5 percent of risk-weighted assets 

and will be applied to each bank in such a way that it reflects the banks’ geographic composition 

of its credit exposures. 

(d) The Leverage Ratio 

The Basel III leverage ratio is intended to serve as a supplementary measure, or backstop, to the 

risk-based ratios. It is a simple, transparent measure that reflects tier 1 capital relative to total 

exposure, both on- and off-balance sheet. The Basel Committee’s analysis shows that bank 

leverage was a key factor distinguishing between banks that ultimately failed during the crisis or 

required government capital injections, and those that did not.83 From a macro-prudential 

perspective, the leverage ratio will limit excessive leverage in the financial system. The Basel 

Committee intends to monitor bank data over a multi-year period to assess the proposed design 

and calibration of the 3 percent leverage ratio over a full credit cycle to increase the probability 

that identified objectives are ultimately realized. 

 

81 See BASEL COMMITTEE ON BANKING SUPERVISION, “ANALYSIS IN THE TRADING BOOK QUANTITATIVE IMPACT 

STUDY” (October 2009), available at http://www.bis.org/publ/bcbs163.htm. 82 In addition, the reforms will incorporate a capital charge add-on to better capture credit valuation adjustments 

based on “bond equivalent” measures used in a VaR framework, double the margin period for large netting sets for 

banks that use internal modeling methodologies for counterparty credit risk, and create a separate supervisory 

haircut category for repo-style transactions using securitization collateral and prohibiting resecuritizations as eligible 

financial collateral. 

83 See Stefan Walter, Sec’y Gen., Basel Comm. On Banking Supervision, Basel III: Stronger Banks and a More 

Resilient Financial System, Speech at the Conference on Basel III (April 6, 2011), available at

http://www.bis.org/speeches/sp110406.pdf. 
34 

Notably, the exposure measure used to calculate the Basel III leverage ratio is the same whether 

or not the exposure is secured. Assuming that more favorable treatment of secured lending under 

current capital rules artificially increases the supply of secured credit, the Basel III leverage ratio 

will serve to reduce the distortion. The shift to unsecured credit that could result from removing 

that distortion might promote market discipline to the extent that unsecured lenders have a 

greater incentive to impose market discipline. 

2. Liquidity Measures

An important part of the Basel III framework is a new framework for liquidity risk measurement, 

standards and monitoring. The objective of the liquidity reforms is to improve the banking 

sector’s ability to absorb shocks arising from financial and economic stress, thereby reducing the 

risk of spillover from the financial sector to the real economy. The Basel Committee developed 

two minimum standards for funding liquidity. They are designed to achieve two distinct but 

complementary objectives. The first standard, the Liquidity Coverage Ratio (“LCR”), is 

designed to promote short-term resilience of a bank’s liquidity risk profile by ensuring it has 

sufficient high-quality liquid assets to survive a significant stress scenario for one month. The 

second standard, the Net Stable Funding Ratio (“NSFR”), was developed to promote resilience 

over a longer time horizon – one year – by providing a sustainable maturity structure of assets 

and liabilities. Together, these two measures establish minimum levels of liquidity for 

internationally active banks. In addition, the Basel Committee has developed a set of monitoring 

tools to assist in assessing the liquidity risk exposures of banks, and in communicating these 

exposures among home and host supervisors. 

The LCR is the ratio of high-quality liquid assets to total net cash outflows in stressed conditions 

over 30 calendar days. This ratio must be equal to or greater than 100 percent on a continuous 

basis and must be satisfied with unencumbered, high-quality liquid assets. High quality liquid 

assets are those that can be easily and immediately converted into cash at little or no loss of 

value. In general, characteristics of such assets are low credit and market risk, an ease and 

certainty of valuation, low correlation with risky assets, and listing on a developed and 

recognized exchange market. In addition, certain market-related characteristics must be satisfied 

– there should be an active and sizable market, the presence of committed market makers, low 

market concentration, and historically, the market must have shown tendencies to move to these 

types of assets during times of financial instability. 

The NSFR is defined as the ratio of the available amount of stable funding to the required 

amount of stable funding, which must be greater than 100 percent. The NSFR is a longer term 

structural ratio to address liquidity mismatches and provide incentives for banks to use stable 

sources to fund their activities. Stable funding in this context means the portion of those types 

and amounts of equity and liability financing expected to be reliable sources of funds over a oneyear time horizon under conditions of extended stress. The NSFR aims to limit imbalances that 

occur when longer-term, illiquid assets are funded with shorter-term, less stable funding, and 

encourages better assessment of liquidity risk across all on- and off-balance sheet items. 

Additionally, the NSFR approach offsets incentives for institutions to fund their stock of liquid 

assets with short-term funds that mature just outside of the 30 day window used for the LCR 

standard. 
35 

The net effect of the new LCR and NSFR will be to increase the cost of relying on potentially 

unstable means of funding illiquid assets. At the same time, this approach, which would give 

firms greater flexibility to fund highly liquid assets with short-term borrowings, is consistent in 

spirit with secured creditor haircut proposals that would exempt secured borrowings 

collateralized by liquid instruments including U.S. Treasuries and government-sponsored 

enterprise debt. 

Currently, the Basel Committee is monitoring the implications of these standards for financial 

markets, credit extension and economic growth. Beginning in 2012, banking organizations 

would report the two ratios to their supervisors. The Basel Committee has noted it may make 

modifications to the standards if needed to address unintended consequences identified during 

the monitoring period. Under the current timetable, the LCR is expected to become applicable in 

2015 and the NSFR would become applicable beginning in 2018. 

C. Increased Transparency of Funding Arrangements 

Recent reforms that increase the transparency of funding arrangements would provide market 

participants with greater clarity in the context of tri-party repo and would require public 

companies to provide greater disclosure regarding short-term funding arrangements. 

1. Transparency in the Context of Tri-Party Repo 

In September 2009, the Payments Risk Committee of the Federal Reserve Bank of New York 

established a Task Force on Tri-Party Repo Infrastructure (“Task Force”).84 On May 10, 2010, 

the Task Force issued a report with specific recommendations directed to various participants in 

this market, several of which could significantly increase transparency in the tri-party repo 

market. 

One such recommendation – publication of monthly statistics provided by market participants on 

the Task Force’s website (hosted by the Federal Reserve Bank of New York) – already has been 

implemented. These statistics bring new transparency to investors, providing market 

participants, supervisors and the public with direct information concerning the composition, 

concentration, and quality of collateral in the tri-party repo market and the margins assessed by 

lenders to mitigate the credit risk of trades. Enhanced transparency around collateral and margin 

requirements could mitigate the risk of runs by repo lenders during times of financial distress. 

Similarly, the regular publication of margin levels in the tri-party repo market can aid market 

participants in setting appropriate margin levels and thereby reduce the probability of sudden 

margin level increases. 

A second Task Force recommendation is to reduce the use of intraday credit extended by 

clearing banks. To the extent that intraday credit continues to be provided by the two clearing 

banks, it will be done on a committed basis, which should bring greater clarity with respect to its 

availability. Numerous changes are required to the systems and processes of all tri-party market 

participants to achieve the goal of reducing reliance on intraday credit in accordance with the 

 

84 The Task Force includes representatives from institutions that play a significant role in the tri-party repo market, 

including lenders (notably money market funds), borrowers (broker-dealers), and the clearing banks. 
36 

Task Force’s timetable. Alongside the effort to reduce intra-day credit provided by clearing 

banks, the Task Force noted it is important to reinforce the understanding that cash investors are 

at risk if their repo counterparty defaults. When complete, these efforts should yield a more 

conservatively collateralized tri-party repo market in which repo lenders face stronger incentives 

to conduct appropriate counterparty risk management. 

Other Task Force recommendations focus on risk management practices of money market funds 

and broker-dealers. Recommendations directed at money market funds and other lenders include 

stress testing of exposures and contingency planning for management of collateral in the event of 

default by a tri-party counterparty. With respect to broker-dealers, including those affiliated with 

bank holding companies, the Board and other supervisors are focusing on the development of 

more robust contingency funding plans and better matching of the maturities of assets and 

liabilities. 

2. Transparency of Short-Term Funding Arrangements 

A company’s use of short-term financing arrangements can fluctuate significantly during a 

reporting period. As such, when a company reports at the end of a reporting period the amount 

of short-term borrowings outstanding, that amount is not always indicative of its funding needs 

or activities during the full period. Recent revelations85 have suggested that investors and other 

market participants could benefit from additional transparency about companies’ short-term 

borrowings, and, in particular, whether those borrowings vary materially during the reporting 

period as compared to period-end. 

On September 17, 2010, the Commission therefore issued a proposed rule designed to enhance 

disclosure of a company’s short-term borrowing practices.86 The proposed rule would apply to 

financial and non-financial companies, and would require disclosure of both quantitative data 

(including average and maximum amounts outstanding during the period) and qualitative 

information (including a discussion of the types of financing arrangements and the company’s 

reliance on those arrangements, and an explanation of variations in the levels of short-term 

borrowings during the period compared to period end). At its core, the rule’s aim is to enable 

better understanding of the use and impact of short-term borrowing arrangements throughout the 

reporting period. 

The proposed rule defines the phrase “short-term borrowings,” which would mean amounts 

payable for short-term obligations that are: (1) federal funds purchased and securities sold under 

agreements to repurchase; (2) commercial paper; (3) borrowings from banks; (4) borrowings 

from factors or other financial institutions; (5) any other short-term borrowings reflected on the 

registrant's balance sheet.87 The proposed requirement is designed to enhance disclosure about 

 

85 For example, the Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner’s Report found that Lehman 

characterized certain overcollateralized repurchase transactions as securities sales, thereby reducing Lehman’s stated 

financing transactions at the end of a reporting period. See 3 Lehman Brothers Holdings Inc. Chapter 11 

Proceedings Examiner’s Report 732 (March 11, 2010), available at

http://lehmanreport.jenner.com/VOLUME%203.pdf. 

86 Short-Term Borrowings Disclosure, Release Nos. 33-9143, 34-62932, 75 Fed. Reg. 59,866 (2010). 

87 Most repos are accounted for as financings on the balance sheet. As such, most repos would be covered by the 

proposed short-term borrowings disclosure requirements. If a repo is appropriately accounted for as a sale (and 
37 

the short-term borrowings items in a company's balance sheet, and does not cover “off-balance 

sheet” financing arrangements. The Commission’s existing disclosure rules cover off-balance 

sheet arrangements. 

In terms of the disclosure of quantitative data, a company would be required to provide 

quantitative information in the Management’s Discussion and Analysis (“MD&A”) section of 

Commission filings for each type of short-term borrowings a company uses, including: (1) the 

amount outstanding at the end of the reporting period and the weighted average interest rate on 

those borrowings; (2) the average amount outstanding during the period and the weighted 

average interest rate on those borrowings; and (3) the maximum amount outstanding during the 

period. To provide context for the quantitative data, companies would be required to disclose the 

following qualitative information: (1) a general description of the short-term borrowing 

arrangements included in each category and the business purpose of those arrangements; (2) the 

importance to the company of its short-term borrowing arrangements to its liquidity, capital 

resources, market-risk support, credit-risk support or other benefits; (3) the reasons for the 

maximum reported level for the reporting period; and (4) the reasons for any material differences 

between average short-term borrowings and period-end short-term borrowings. 

The proposed rule distinguishes between “financial companies” and all other companies for 

purposes of the quantitative disclosure requirements. A “financial company” would mean a 

company, during the applicable reporting period, that is: (a) engaged to a significant extent in the 

business of lending, deposit-taking, insurance underwriting or providing investment advice; (b) a 

broker or dealer as defined in section 3 of the Securities Exchange Act of 1934; or (c) an entity 

that is, or is the holding company of, a bank, a savings association, an insurance company, a 

broker, a dealer, a business development company, an investment adviser, a futures commission 

merchant, a commodity trading advisor, a commodity pool operator, or a mortgage real estate 

investment trust. Financial companies would be required to provide averages calculated on a 

daily average basis (which is consistent with existing Commission guidance applicable to bank 

holding companies), and to disclose the maximum amount outstanding on any day in the period. 

As proposed, a company that is engaged in both financial and non-financial businesses would be 

permitted to present the short-term borrowings information for its financial and non-financial 

businesses separately. It would be required to provide averages computed on a daily average 

basis and maximum daily amounts for the short-term borrowing arrangements of its financial 

operations, and it would be permitted to follow the requirements and instructions applicable to 

non-financial companies for purposes of the short-term borrowing arrangements of its nonfinancial operations. Non-financial companies would be permitted to calculate averages using an 

averaging period not to exceed a month and to disclose the maximum month-end amount during 

the period. 

 

therefore is not reflected on the balance sheet as a liability), it must be assessed under the Commission’s existing 

disclosure requirements for off-balance sheet arrangements. The Commission’s existing rules require disclosure 

where the repo is reasonably likely to have an effect on the company that is material. 
38 

The Commission has received numerous comments on the proposed rule. The Commission staff 

is currently reviewing and analyzing those comments, and is in the process of developing final 

rule recommendations for Commission consideration. 

Concurrently with the issuance of the proposed rule, the Commission issued interpretative 

guidance on existing requirements for liquidity and funding disclosure in MD&A, with a focus 

on addressing “window-dressing” or “debt masking” issues; this interpretive guidance was 

immediately effective. The interpretive release reflects the Commission’s expectation that 

MD&A disclosure keep pace with the increasingly diverse and complex financing alternatives 

available to companies. Among other things, the interpretive release makes clear that a registrant 

cannot use financing structures (whether on-balance sheet or off-balance sheet) designed to mask 

the registrant’s reported financial condition. Thus, if a company’s financial statements do not 

adequately convey its use of financing arrangements and the impact of those arrangements, 

disclosure in MD&A is needed to provide a clear picture of the company’s liquidity profile. 

Further, the interpretive release emphasizes that leverage ratios and other financial measures 

included in filings must be calculated and presented in a way that does not obscure the 

company’s leverage profile or reported results. Finally, the interpretive release addresses 

divergent practices in the preparation of the contractual obligations table, and provides guidance 

to focus companies on providing informative and meaningful disclosure about their future 

payment obligations. 
39 

Appendix A

Overview of Certain Forms of Secured Lending

This Appendix is intended to provide a basic overview of certain forms of secured lending that 

could be affected by secured creditor haircuts. This Appendix focuses on repurchase agreements 

(“repo agreements” or “repos”) because large, interconnected financial firms use repos to obtain 

a substantial majority of on-balance sheet secured funding. The Appendix also discusses two 

additional forms of secured lending – stock loan and stock borrow, and sell-buyback 

arrangements – that large, interconnected financial firms rely on to a lesser extent. 

I. Repurchase Agreements 

A. In General 

Repo agreements are securities lending transactions in which one party (the “repo seller”) agrees 

to sell securities to another party (the “repo buyer”) against the transfer of funds, with a 

simultaneous agreement by the repo seller to repurchase from the repo buyer the same or 

equivalent securities at a specific price at a later date.88 

Repos generally involve an interest component which is implicit in the pricing structure of the 

transaction. In repo transactions, securities are initially valued and sold at the current market 

price plus any accrued interest to date. At the termination of the repo transaction, the securities 

are resold at a predetermined price equal to the original sale price plus an agreed upon interest 

rate (the “repo rate”). 

When the repo transaction is driven by the repo sellers’ demand for cash (“cash-driven repo”), 

the repurchase price is typically set so that the repo buyer earns the equivalent of money market 

yields. Conversely, when the repo transaction is driven by the repo buyers’ desire to borrow the 

securities that collateralize the repo (“securities-driven repo”), the repo rate is usually less than 

current money market yields to account for the fact that the repo seller can invest the proceeds of 

the initial sale to earn the money market rate of return. 

Depending on whether the repo transaction is securities-driven or cash-driven, the transfer of the 

interest in securities from the repo seller to the repo buyer may more closely approximate an 

outright sale or a secured loan. Securities-driven repo transactions more closely approximate 

outright sales, since the repo seller’s interest in the purchased securities passes to the repo buyer, 

freeing the buyer to sell, transfer, pledge, or hypothecate the purchased securities. Cash-driven 

repo transactions more closely approximate secured loans, and repo sellers accordingly retain the 

ability to substitute new securities for the securities that serve to collateralize the transaction. 

 

88 A “reverse repo” is the same repurchase agreement from the buyer’s viewpoint, not the seller’s viewpoint. So a 

seller executing the transaction would describe it as a “repo” while the buyer in the same transaction would describe 

it as a “reverse repo.” Typically, the broker-dealer refers to the transaction as a “reverse repo” whereas the banking 

and investment company industries refer to the transaction as a “repo.” 
40 

In cash-driven repo transactions, the repo buyer obtains margin by pricing securities transferred 

as collateral at the market value minus a “haircut.” In securities-driven transactions, the lender 

of securities will typically receive margin by pricing securities higher than their market value. 

As noted above, repo is the dominant means by which most large, interconnected financial firms 

obtain on-balance sheet secured funding. To prepare this study, the Council gathered data on a 

sample of large, interconnected financial firms (“sample firms”). Since early 2009, the sample 

firms obtained aggregate repo financing in a range between $2 trillion and $2.5 trillion. This 

amount represents the bulk of the sample firms’ total on-balance sheet secured funding, and is 

nearly equivalent to the sample firms’ total on-balance sheet wholesale funding. 

Approximately two-thirds of sample firms’ currently outstanding repo transactions are secured 

by U.S. Treasuries, agency debt and agency mortgage-backed securities (“Treasury and Agency 

Collateral”). Approximately half of outstanding repo transactions for select firms are on an 

overnight basis, and roughly three-quarters mature in less than 30 days. 

A more detailed breakdown of the sample firms’ outstanding repo transactions by asset class of 

collateral and maturity is shown below. 

 Figure 1. 

 

B. Tri-Party Repos and Intraday Lending 

“Tri-party” repo agreements are a subset of repo transactions that settle on the books of one of 

the two clearing banks in the United States.89 The tri‐party repo structure developed in the 1980s 

in response to the desire to have collateral held by a third‐party agent. In addition to the 

favorable treatment of repurchase transactions in bankruptcy, the attractiveness of the tri‐party 

repo market is driven by the use of securities as collateral (including daily margining and 

haircuts), and the custodian services of the clearing banks which provide protections that do not 

exist for bilateral repo investors or unsecured creditors. The large U.S. securities firms and bank 

securities affiliates (collectively, “securities firms”) use the tri‐party repo market to finance the 

majority of their securities inventories. 

Typically in these transactions, a repo buyer, such as a money market fund, will lend cash to a 

securities firm at the end of the day; the securities firm collateralizes the borrowing with 

securities; and the clearing bank holds the collateral. In the morning, the clearing bank unwinds 

the repo transaction; cash is returned to the repo buyer; the securities held as collateral are 

 

89 The two clearing banks are J.P. Morgan Chase and Bank of New York Mellon. 
41 

returned to the securities firm; and the clearing bank extends intraday credit to the securities firm 

that is collateralized by the securities firm’s securities until new repo transactions are established. 

That evening, the repo buyer would then again lend cash by purchasing the securities of the firm, 

and the firm would use those proceeds to repay the clearing bank. 

Thus, the current structure of tri-party repo transactions entails an ongoing handoff of exposure 

between repo buyers, which bear the exposure overnight, and clearing banks, which bear the 

exposure during the day. As discussed above, the Tri-Party Repo Infrastructure Task Force 

made recommendations for reforming the tri-party repo market that include operational changes 

for significantly reducing the clearing banks’ intraday exposures. 

The current value of tri-party repo transactions outstanding is $1.6 trillion, down from $2.8 

trillion before the financial crisis. Funding is provided by money market funds, securities 

lenders and other large financial institutions with excess cash.

Figure 2. 
42 

Approximately 80% of collateral in the tri-party repo market is liquid, consisting of Treasury and 

Agency Collateral.

 

Figure 3. 

II. Stock Loan and Stock Borrow 

In a securities loan transaction, the owner of securities lends securities to a borrower who 

becomes contractually obligated to redeliver a like quantity of the same security. Borrowers 

generally provide collateral to assure the performance of their redelivery obligation. Collateral 

may take the form of cash, other securities, or a bank-issued letter of credit. Lenders of 

securities typically receive margin or collateral in excess of the market value of the loaned 

securities, to act as a buffer against an adverse change in the price of the loaned securities 

relative to collateral in the event the borrower defaults. The lender also receives a fee that is 

negotiated at the time of the transaction. Loans can be made on an overnight, open (terminable 

on demand) or term basis. 

The securities lender typically does not retain legal title to the securities that are loaned. The 

borrower obtains full title. The transaction would not be viable if the lender retained legal title to 

the securities it has loaned since the borrower may need legal title to the securities to transfer 

them to another party. Even if the borrower of the securities defaults on its redelivery obligation, 

the securities lender has no property interest in the original securities that could be asserted 

against any person to whom the securities purchaser may have transferred them. The securities 

lender’s protection is the right to foreclose on the collateral. 

While the securities lender does not retain legal title to the securities that are delivered to the 

borrower, it does retain contractual rights similar to beneficial ownership. Similarly, the 

securities borrower is entitled to receive all economic rights of beneficial ownership of the noncash collateral to the extent it would be so entitled if the collateral had not been transferred to the 

lender. Further, the securities borrower generally has the right to return the securities at any time 

(subject to settlement on the day following the trade), and a securities lender has the right to 

return collateral and recall securities loaned at any time (subject to settlement three days 

following the trade). 
43 

Stock loan and stock borrow transactions may be used when a securities firm needs a security to 

deliver against a settling transaction, such as a short sale. A securities firm may also be involved 

in a finder’s business, whereby securities are borrowed to relend to another broker-dealer, thus 

allowing the broker-dealer to earn a spread on the transaction. Broker-dealers may also engage 

in equity securities borrowed transactions solely to finance the positions of another broker-dealer 

where the equity securities are initially borrowed without a permitted purpose pursuant to 

Regulation T Section 220.10(a) and placed in a box location. 

III. Sell-Buyback Arrangements 

Market participants also effect securities lending transaction by entering into separate buy and 

sell trades. In a sell-buyback transaction, both the sell and buy trades are entered into at the same 

time, with the purchase transaction for settlement at a future date. An investment rate, typically 

the repo rate, is used to derive the forward contract price. In a sell-buyback, the purchaser of the 

securities (i.e., the borrower) receives legal title and beneficial ownership of the securities. The 

purchaser retains any accrued interest and coupon payments during the life of the transaction. 

The end price, however, reflects the economic benefits of a coupon being passed back to the 

seller. 

Sell-buyback transactions are financing trades and limited to fixed income securities. A cash 

borrower does not normally have the right to substitute collateral. Margin is not provided in 

these transactions. Trade confirmations are delivered showing the details of the trade and that 

there is the forward obligation to honor the agreement. Sell-buyback transactions have 

traditionally taken place outside a fully documented legal framework.