Making banks resolvable: the key to making resolution work
Speech given by
Andrew Gracie, Executive Director, Resolution Directorate
Risk Minds Conference, Amsterdam
4 December 2017
1
All speeches are available online at www.bankofengland.co.uk/speeches
Introduction
Resolution has come a long way since G20 Leaders put together the post-crisis financial reform agenda in
summits in London and Pittsburgh in 2009.1 In some ways, it represented the most notable gap, and
significant change in the pre-crisis regulatory architecture. Nearly ten years on, huge progress has been
made in establishing effective resolution arrangements and the commitment to ending too-big-to-fail (TBTF)
is undimmed.
The immediate priority in this effort was to put in place the necessary legal frameworks. Agreement in 2011
of Financial Stability Board (FSB) Key Attributes for Effective Resolution Regimes provided the international
standards to ensure a consistent approach to the design of resolution regimes across G20 jurisdictions.2
The UK now has in place a comprehensive bank resolution regime that is compliant with international
standards and will remain so after Brexit. Similarly, for all advanced economies, there are now resolution
regimes that are largely compliant with the Key Attributes in all the jurisdictions that are home to global
systemically important banks (G-SIBs).
But the Key Attributes were about effective resolution regimes rather than resolvable firms - they defined a
tool-kit but not how to use it; and a process for resolution planning for G-SIBs but not what would make a firm
resolvable. Powers without resolvability leaves resolution authorities vulnerable.
Indeed, the moral for me of recent failures and near-failures is not that resolution is misguided and will not
work, but that it will not work if firms are not regulated and supervised in a way that makes them resolvable.
This is the story of the last five years. We have focussed on organising firms in such a way that authorities'
resolution powers can be used without significant adverse consequences for the rest of the financial system
or the wider economy. This moves us progressively to where we want to be against risk appetite. And though
we are not yet where we finally need to be, what has been done has already yielded significant benefits. For
uplifts to bank' credit ratings.3
example rating agencies have largely removed government support Where UK
firms have come under stress, our resolution arrangements have been one factor that has helped secure
recovery.
Today I want to review where we are on the journey: what has been done and what is left to do. I want to
focus in particular on three topics:
1
'Declaration - (2009)
See FSB on Strengthening the Financial System London Summit'
FSB ' Leaders' (2009)
http://www.fsb.org/wpcontent/uploads/london_summit_declaration_on_str_financial_system.pdf and Statement the Pittsburgh Summit'
http://www.fsb.org/wp-content/uploads/g20_leaders_declaration_pittsburgh_2009.pdf
2
'Key (2014)
See FSB Attributes of Effective Resolution Regimes for Financial Institutions'
http://www.fsb.org/wpcontent/uploads/r_141015.pdf.
3
S&P Global Resolution' (2017)
See 'An Illustrative Rating Path for a Systemic Bank In A Bail-In
http://images.ratingsinfo.standardandpoors.com/Web/StandardPoorsRatings/Illustrative%20Rating%20Path.pdf.
(i) internal total loss-absorbing capacity (TLAC) or minimum requirements for eligible liabilities and
own funds (MREL) and the underpinning it provides for cross-border co-operation;
-
(ii) bail-in mechanics having required banks to maintain TLAC or MREL, we need, as resolution
authorities, to be clear how we would use it; and
-
(iii) disclosure resolution needs to be credible as well as feasible. With credibility comes market
discipline ex ante and less disruption in a resolution (lower probability of default and loss given
default in other words).
All three areas build on the core work of resolvability that has already been done, illustrating the point that
the process is incremental and resolvability is not binary but progressive.
Resolvability of firms
Let me start then by reviewing what has already been done.
I will focus on the standards and guidance coming from the FSB. It is true that they have been drawn up for
application to G-SIBs in Crisis Management Groups (CMGs). But in our view, they are equally applicable to
domestic systemically important banks (D-SIBs) or other firms where bail-in is the preferred resolution
strategy, especially where firms operate cross-border.
The convergence at international level on bail-in as the appropriate strategy for large banks is itself
significant. This transcends whether firms are single point of entry or multiple point of entry. And whether the
bail-in is effected by use of a bail-in tool in an operating bank or by application of a bridge bank tool at
holding company level. It represents the realisations that if we are to end TBTF we must have bail-ins
instead of bail-outs so losses can fall on investors not on taxpayers. And that the bail-in must enable
continuity in a firm's
operations to avoid interruption to critical functions and to buy time for an orderly
reorganisation of the firm to the extent necessary to deal with the problem that first caused the failure.
This shared understanding at FSB, and the desire to meet the goal set by G20 Leaders to end TBTF and the
risk of taxpayer bail-outs as soon as possible, has driven a focus on seeking changes at firms so that they
can be stabilised and enter resolution safely without disruption to critical functions. Hence the focus on two
dimensions:
-
Loss absorbency: firms need TLAC in the right amount (enough not only to absorb losses but to
provide for recapitalisation so firms can continue to meet requirements for authorisation); in the
right form (debt with residual maturity of a year and subordinated to operating liabilities to avoid
breaches of the 'no creditor worse off than insolvency' (NCWO) safeguard or other challenges to
the bail-in and at the same time to provide clarity to depositors that they are not likely to be
bailed in); and in the right location (ensuring that resources are positioned within a group so that
the key operating companies containing a firm's critical functions can be recapitalised
immediately in resolution).As such, international agreement of the FSB's TLAC
standard in 2015
represented a major milestone in moving towards ending TBTF.4
-
Continuity of critical functions: the second main dimension of stabilisation is to ensure continuity
in a firm's operations in resolution. Part of this is legal -
changing contractual arrangements so
that entry into resolution does not result in widespread, disorderly termination, close-out or
acceleration in financial contracts, provision of services or access to financial market
infrastructures (FMIs). It is true that under the Key Attributes, resolution regimes include
statutory powers to stay. But statutory stays may not be effective cross-border. And, anyway,
repapering contracts helps to convey to counterparties that there will be continuity in resolution
and so reduce incentives to break for the exit. FSB has published guidance in this space for
operational continuity in resolution and continuity of access to FMIs.5
Perhaps the most notable effort has been FSB's work with industry to agree a protocol to International
Swaps and Derivatives Association (ISDA) and other master netting agreements that addresses close-out
risk in over-the-counter (OTC), derivative and repo transactions.6 Agreement in 2014 of the universal
protocol amongst G-SIBs, and subsequently of jurisdictional modular protocols for individual jurisdictions to
bring in buy-side and non-G-SIB counterparties, is another major landmark in ensuring big international firms
are resolvable.7 The protocol is built around the premise that entry into resolution should not be classed as
an event of default as long as a firm continues to perform.
This underscores the importance of funding to making resolution credible. FSB set out principles on funding
in resolution in 2016 and just last week published for consultation guidance for use in CMGs on the liquid
resources and liquidity management capabilities firms require to be adequately resolvable and how liquidity
in firms might be bolstered in adverse cases by public backstops.8 CMGs will use the guidance to draw up
resolution funding plans setting out how, in order to achieve resolvability, liquidity and collateral should be
held in a group across legal entities, currencies and locations.
We have made good progress in regulating these various FSB standards in the UK, either through Bank of
England Policy statements or Prudential Regulation Authority (PRA) rules. UK banks have been given
indicative MREL requirement to meet by 2020; they will have operational continuity arrangements in place in
2019 (alongside the implementation of ring-fencing); and they are already trading on protocol terms with
4
See FSB 'Principles on Loss-Absorbing and Recapitalisation Capacity of G-SIBs in Resolution' (2015)
http://www.fsb.org/wpcontent/uploads/TLAC-Principles-and-Term-Sheet-for-publication-final.pdf.
5
See FSB 'Guidance on Arrangements to Support Operational Continuity in Resolution' (2015)
http://www.fsb.org/wpcontent/uploads/Guidance-on-Arrangements-to-Support-Operational-Continuity-in-Resolution.pdf and FSB 'Guidance on Continuity of
Access to Financial Market Infrastructures (FMIs) for a Firm in Resolution' (2016)
http://www.fsb.org/wp-content/uploads/Continuity-ofAccess-to-FMIs-Consultation-Document-FINAL.pdf.
6
FSB
See 'Cross-Border Recognition of Resolution Action' (2014) http://www.fsb.org/wp-content/uploads/c_140929.pdf.
7
(2014) '
See ISDA '2014 Resolution Stay Protocol' http://assets.isda.org/media/f253b540-25/958e4aed-pdf/, ISDA 2015 Universal
Resolution Stay Protocol' (2015) ' Resolution
http://assets.isda.org/media/ac6b533f-3/5a7c32f8-pdf/ and ISDA Stay Jurisdictional
Modular Protocol UK (PRA RULE) Jurisdictional Module' (2016) http://assets.isda.org/media/f253b540-94/cd991d70-pdf/.
8
See FSB 'Guiding Principles on the Temporary Funding Needed to Support the Orderly Resolution of a Global Systemically Important
(2016)
Bank ("G-SIB")'
' Funding
http://www.fsb.org/wp-content/uploads/Guiding-principles-on-the-temporary-funding-needed-to-support-theorderly-resolution-of-a-global-systemically-important-bank-"G-SIB".pdf and FSB Strategy Elements of an Implementable
Plan' (2017)
Resolution http://www.fsb.org/wp-content/uploads/301117-2.pdf.
buy-side firms as well as other G-SIBs. To the point that resolvability is progressive, the major UK banks on
average now have total loss absorbency of 23% measured against risk-weighted assets (RWAs) compared
to an average end-state requirement of 28% (including buffers).9
As described, there is more to do in some of these areas. But increasingly the emphasis is on
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implementation and, with it, assurance how we supervise firms against these regulatory requirements and
hold them to account that identified barriers to resolvability are removed and stay removed. In describing the
progress towards end-state resolvability, I want to pick out three areas that will be a focus in the period
ahead.
(a) Internal MREL
The first is internal MREL. One lesson that the crisis brought home is that the distribution of resources within
groups matters. While in life, firms might want to run themselves by business lines on a consolidated basis,
failure and resolution occurs at legal entity level.
It is understandable then that since the crisis that there has been a discernible tendency for host authorities
to hold onto more resources, capital and liquidity, or to force activity in branches into subsidiaries. The aim at
FSB level with TLAC was to lean against this tendency towards fragmentation of international groups by
providing comfort to authorities cross-border, not only that groups would have sufficient external TLAC to be
resolvable but also that resources would be prepositioned as internal TLAC in material subsidiaries in host
jurisdictions.
Previous international regulation of financial resources in groups has, like the Basel Accord, typically
focussed more on the consolidated level. Now applying TLAC regulation at legal entity level has brought with
it challenges.
One is timing: it is hard to roll out internal TLAC for a group until TLAC requirements are in place in all the
jurisdictions relevant for the material subsidiaries. The Bank is in the middle of consulting on its internal
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MREL policy10 but many other jurisdictions notably the Banking Union, Switzerland and Japan have still
not set policy.
Another challenge is arithmetic: to the extent that there are financial dependencies between legal entities
within a group the sum of solo RWAs is likely to be greater than consolidated RWAs. If a full TLAC
requirement were applied to each subsidiary then the sum of the internal TLAC would exceed the
consolidated TLAC requirement for the group as a whole.
9
The Bank of England published loss-absorbing capacity requirements for major UK banks in 2016 shortly after responding to the
Treasury Committee's inquiry into capital.
See
http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/treasury-committee/capital-andresolution/written/69208.pdf.
10
The Bank of England published a consultation paper on its approach to setting a minimum requirement for own funds and eligible
liabilities (MREL) within groups on 2 October 2017. See
https://www.bankofengland.co.uk/-/media/boe/files/financialstability/resolution/internal-mrel-consultation-october-2017.pdf?la=en&hash=33594C3FB3C7F1D129033AFE4E3A2BF20A4F9AA8 .
This was addressed in the TLAC term sheet in two ways:
-
by limiting internal TLAC only to subgroups and subsidiaries that are material to the group,
accounting for more than 5% of RWAs or income. The logic there was that at that level failure of
the material entity might trigger resolution of the group as a whole; problems for smaller entities,
even those that might house functions that are critical to the host jurisdiction, should be more of
a recovery matter.
- by including a provision that internal MREL for subgroups should be scaled in single point of
entry (SPE) groups to 75-90% of the requirement that would apply to the subgroup on a
standalone basis. The logic was that given the interdependence in the business models of SPE
firms, prepositioning in this range would be sufficient to secure cooperation and deter hosts from
ring-fencing, and home authorities from cutting off, foreign subsidiaries. Prepositioning of
resources in this way will provide concrete underpinning for cooperation that goes beyond the
paper commitments to cooperate in Memorandum of Understandings (MOUs), honoured in the
breach in previous cross-border failures.
Even with these restrictions there may still be a sum of the parts problem in which the sum of TLAC
requirements at solo level pushes up external requirements. If internal TLAC requirements are high they are
also likely to stand in the way of holding a surplus at the top of the group that could provide flexibility in
covering losses if they are concentrated in a particular part of a group.
Thus in our internal MREL policy our intention is first to consider setting internal MREL generally for the firm
at the bottom of the 75-90% range.11 But to set a higher requirement if we have doubts about: the home
resolution strategy, the availability of a surplus at the top of the group or a lack of reciprocity in MREL-setting
in other jurisdictions (that is others all set at the 90% end of the range). We expect to say more about surplus
MREL and the form it should be held in to be readily available when we come to finalise our internal MREL
policy next year.
Another important objective for us in setting policy on internal MREL is to avoid any distortion in the
sequence of loss absorption between operating companies (OpCo) and the group holding company
(HoldCo). We require UK banks to issue external MREL out of their HoldCos, structurally subordinated to
liabilities at the OpCo. The issuance proceeds are then onlent to the OpCo as internal MREL broadly
mirroring their external form, for example: Tier 2 could be onlent as Tier 2, AT1 as AT1 and senior debt out of
HoldCo would be downstreamed as an internal debt instrument sitting senior to capital instruments but junior
to operating liabilities in the OpCo.
We need to be sure that as losses are incurred in the operating company they are absorbed in an order that
follows the OpCo creditor hierarchy and does not bypass certain instruments. The aim with a single point of
11
Our starting point for calibrating internal MREL for ring-fenced bank sub-groups would be 90%, with the possibility that this could be
scaled down if there are sufficient readily deployable resources.
entry bail-in strategy, as the name suggests, is only to put one entity at the top of the group into resolution,
preferably a holding company which is only used for issuing capital instruments to the market and otherwise
has no or limited operating liabilities.
Write down or conversion of internal MREL instruments via contractual triggers will then allow operating
companies lower down the group to be recapitalised automatically without putting them into resolution. But
legacy non-equity capital instruments in OpCos without the requisite contractual triggers could cut across
this. We do not want these to be spared bearing losses for want of a trigger. And so, we are clear that such
instruments should not count as MREL beyond 31 December 2021 and if not matured by then we will work
with firms to remove them if they represent a barrier to the resolution strategy.
This is part of a larger effort to add to the credibility of resolution by being clear to debt investors and other
stakeholders how a bail-in will work in practice. We want debt investors to be able to price risk effectively by
being clear about where they rank in the creditor hierarchy and to give them confidence that we can stick to
the hierarchy in applying losses and that we will not be picking winners and losers within a class. Counting
as MREL senior debt issued out of operating companies without subordination looks like a recipe for
undermining that confidence.
(b) Bail-in execution
We also want to be clear as a resolution authority how we will conduct the resolution in a way that preserves
value and distributes it fairly, ensuring no creditor worse off protections are met. To that end, we have
thought hard about the valuation capabilities we need firms to have so that we can value losses and
recapitalisation needs in an effective and timely way. We have just consulted on a set of principle level
requirements and expect to finalise policy in this space in the next few months.12
We believe that the bail-in valuation for a large cross-border firm is not something that can be fixed over a
weekend. Valuation on that timetable will inevitably tend to overshoot on the estimation of losses, not least
because a significant driver of the valuation will be the reorganisation that follows the bail-in and the
restructuring costs and disposal valuations associated with that.
Rather, it is our intention to take several months for the bail-in valuation to ensure that through an
independent valuation process, losses as far as possible are bottomed out and tie back to the reorganisation
plan for the surviving business. It will be critical to determine the net asset value that had been generated in
the bail-in and the liability holders it should go to as compensation.
You may ask, what happens in the intervening period? From the perspective of the debt investor, our
intention on entry to resolution is to take control of the shares in issue and immobilise all the other external
12
The Bank of England published a consultation paper on valuation capabilities to support resolvability on 17 August 2017. See
https://www.bankofengland.co.uk/-/media/boe/files/financial-stability/resolution/boes-proposed-policy-on-valuation-capabilities-tosupport-resolvability.pdf?la=en&hash=4044F91DF1DDE7A131EA3186F66F304380553306 .
MREL instruments at the relevant international central securities depository (ICSDs) and central securities
depository (CSDs). We will at the same time issue onto the bondholders accounts at the ICSDs a tradeable
certificate of entitlement secured by the shares in issue. There will be as many classes of certificate as there
are classes of claim. Once the valuation is complete and we have announced the terms of exchange, holders
will present the certificates in exchange for whatever equity they are entitled to as compensation. The
resulting shareholders will then vote in a new board and the firm will return to private sector control.
Issuing certificates of entitlement in this way will provide a mechanism for debtholders that do not want to, or
due to their mandates, are not able to hold equity to trade out of their positions. And this will have an
ancillary benefit for us of providing some sort of shadow market valuation of the firm.
But what about other liability holders - depositors, market counterparties, trade creditors etc. - during this
interval?
Our aim with the announcement of the resolution is to send a strong signal to them that their claims are safe
and that the operating companies they are transacting with will continue to perform.
Full conversion of internal MREL in the key operating companies around the group and a strong sense that
the firm will have access to liquidity will contribute to that. To this end, the Bank has established new
arrangements to clarify, first, that a firm in resolution would continue to have access to the ordinary central
bank facilities in the Sterling Monetary Framework, subject to meeting the necessary eligibility criteria. And
second, those arrangements will be supplemented where necessary by a flexible Resolution Liquidity
Framework, designed to provide liquidity, in sterling or foreign currency, in the necessary scale, for a
sufficient period of time, and secured against a wide range of collateral to allow the firm to make the
transition to market-based funding.13 Sending a strong message in this way at the outset of the resolution will
maximise the chances of stabilising the firm and if liability holders know their claims will be refinanced,
reduce the risk of a further run.
This need for clarity is understood at international level. FSB has just published a consultation paper on
bail-in execution addressing a number of issues I have described including valuation and exchange
mechanics.14 Not least there are important home-host dependencies that need to be addressed. After all, in
a UK G-SIB resolution we will need to bail-in debt on both sides of the Atlantic, in the Depository Trust and
Clearing Corporation (DTCC) as well as Clearstream and Euroclear. This includes working through with
market regulators the securities law issues that will arise through a bail-in, ensuring that disclosure and
listing requirements continue to be satisfied.
13
- the Bank's approach to providing liquidity in resolution
See Box 2 in
https://www.bankofengland.co.uk/-/media/boe/files/financialstability/resolution/boes-approach-to-resolution.pdf?la=en&hash=8213BE00D67C4CADB948D51FEBD164E136A70BE6
14
' Principles on
See FSB Bail-In Execution' (2017) http://www.fsb.org/wp-content/uploads/P301117-1.pdf
(c) Disclosure
The third and final area I want to address is disclosure. A recurrent theme of my remarks has been the
importance of ex ante disclosure to making resolution credible and to realising the benefits of increased
market discipline. We want debt investors to have the information they need to price risk and so support the
proposals in the TLAC term sheet and Basel's Pillar 3 Framework that require
banks to disclose the rank
ordering of their liability structure at legal entity level.
As I have described, we want debtholders and other stakeholders to understand how we will use out
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resolution powers and so have published a document setting out our approach to resolution otherwise
known as the Purple Book.15 The latest edition in October indicates how far we have come since we first
published the Purple Book in 2014. But we have further to go.
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It is our intention which we indicated to the Treasury Select Committee in March to publish summaries of
the resolution plans for the major UK banks and our assessment of their resolvability. We will do this after the
start of 2019 when ring-fencing, the first level of TLAC requirements and operational continuity in resolution
arrangements are in place.
As an institution we want to be open and accountable. As a resolution authority we need to be for it to work.
There is a famous Chinese proverb that notes a journey of a thousand miles begins with a single step. On
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the resolution journey there have been a lot of steps in fact we could all be forgiven for feeling footsore
but the thousand mile marker is coming into view.
15
the Bank of England's approach to resolution
See
https://www.bankofengland.co.uk/-/media/boe/files/financialstability/resolution/boes-approach-to-resolution.pdf?la=en&hash=8213BE00D67C4CADB948D51FEBD164E136A70BE6 .