Paul Tucker: Solving too big to fail - where do things stand on
resolution?
Speech by Mr Paul Tucker, Deputy Governor for Financial Stability at the Bank of England,
Member of the Monetary Policy Committee, Member of the Financial Policy Committee and
Member of the Prudential Regulation Authority Board, at the Institute of International Finance
2013 Annual Membership meeting, Washington DC, 12 October 2013.
* * *
By way of setting the scene for this morning's discussion, I shall make five broad and big
points about where the international community has got to on addressing the Too Big To Fail
problem through planning for orderly resolution. Before continuing, I should stress that these
are my views and do not necessarily represent the views of any of the UK and international
bodies of which I have been a member.
(1) The US authorities could resolve most US SIFIs right now
First, I repeat what I said in London recently. I cannot see how the US Administration could
persuade Congress to provide taxpayer solvency support to - ie bailout - some of the
biggest US banks and dealers. In short, the US authorities have the technology - via Title II
of Dodd Frank; and, just as important, most US bank and dealer groups are, through an
accident of history,1 organised in way that lends them to top-down resolution on a group-wide
basis. I don't mean it would be completely smooth right now; it would be smoother in a year
or so as more progress is made. But in extremis, it could be done now. That surely is a
massive signal to bankers and markets.
Europe has not yet reached the same point, but contrary to some commentary is not far
behind. The necessary legislative regime is close to completion. In contrast to the US,
however, many of the largest European - including UK - banking groups will need to
reorganise in order to make themselves susceptible to either Single Point of Entry or Multiple
Point of Entry resolution.
That brings me to my second point.
(2) The Single Point of Entry versus Multiple Point of Entry resolution strategy
distinction may be the most important innovation in banking policy in decades
We will learn to speak of banks and dealers as either "SPE groups" or "MPE groups". Some
technical developments don't matter hugely. This one does. A lot will follow from it, as I will
sketch in a moment. But first I should recap the difference between SPE and MPE resolution
strategies.
A single-point-of-entry or SPE resolution works downwards from the group's top company -
most simply, a pure holding company (Holdco). Losses in subsidiaries are first transferred up
to Holdco. If Holdco is bankrupt as a result, the group needs resolving. The "bailin" tool is
applied to Holdco, with the equity being written off and bonds converted as necessary into
equity to recapitalise the group. Those bondholders become the new owners. The group
stays together.
Under multiple-point-of-entry or MPE resolutions, by contrast, a group would be split up into
some of its parts. Healthy parts might be sold or be maintained as a residual group shorn of
their distressed sister companies. The resolution of the distressed parts might be effected via
bailin of bonds that had been issued to the market by a regional intermediate holding
company.
This is, of course, no more than a brief sketch, but I hope it will suffice for me to draw out
some of the implications for the industry and regulators.2
For many financial groups, it is fairly obvious which broad resolution strategy (SPE or MPE)
they are currently most suited to. But few major groups will escape having to make significant
changes to their legal, organisational and financial structure to remove obstacles to effective
resolution under that preferred strategy.
For example, outside of the US, many "SPE groups" will need to establish holding companies
from which to issue bonds that can absorb losses and be converted into equity through a
resolution. And even in the US, nearly all "SPE groups" will need to ensure that there exists
intra-group debt, issued by key subsidiaries around the world to the holding company, that
can be written down when a distressed subsidiary would otherwise need to be resolved.
For "MPE groups", many will need to do more to organise themselves into well-defined
regional and functional subgroups, perhaps with regional or functional intermediate holding
companies, which could be subjected to SPE resolutions. And these groups will need to
ensure that common services, such as IT, are provided by stand-alone entities under
contracts that are robust enough to survive the break up of the group.
There will be implications for the regulatory regime too. As I see it, the amount of equity that
a host regulator requires to be held in a subsidiary over and above the Basel minimum may
vary according to whether it is part of an "SPE group" in which the parent/holding company is
a source of strength through resolution.
Where that is the case, it may be possible to shade the subsidiary's capital structure from
equity to subordinated debt issued to the HoldCo. Where the group as a whole is not a
source of strength in resolution, a subsidiary may need more equity than otherwise. What I
am describing would entail some recasting of the key pillars of international supervisory
cooperation: the Basel Concordat, Core Principles of Supervision, and Capital Accord.3
(3) There is no such thing as a "bailin bond". Bailin is a resolution tool. All
creditors can face having to absorb losses. What matters is the creditor
hierarchy
Notwithstanding the clarity in the Financial Stability Board's international standard on
resolution,4 and in the US and draft EU legislative regimes, it is still common for
commentators and industry participants to refer to "bailin bonds".5
As I have said before, "bailin" is a verb not a noun. It is a power, not a special kind of bond.
Like other resolution tools, it can be applied to any kind of debt obligation.
What is true is that if bonds are issued from a holding company and the resolution is
topdown (SPE), then those bonds will absorb losses before any creditors of the operating
subsidiaries; holdco creditors are structurally subordinated to opco creditors. But if the losses
are vast enough, then the haircuts imposed by the resolution authority can in principle
permeate to any level of the creditor stack.
In the case of insured deposits, that means Deposit Guarantee Schemes (DGS) suffering
losses, as they would in Purchase & Assumption-style resolutions of an operating bank. But,
due to less destruction of value, those losses under bailin would be smaller (and never
greater) than the losses the DGS would have suffered in a liquidation. Insured deposits
themselves do not get haircut under any resolution techniques; the losses of the DGS get
picked up by the rest of the industry standing behind it. Bailin is no different from other
resolution tools in that respect.
The point I have been labouring about all creditors being exposed to loss needs to be
distinguished from the quite separate issue of whether the authorities should mandate a
specified amount of bonded debt to act as required layer of gone-concern loss-absorbing
capacity (GCLAC). That may be issued from a holding company, or it might be subordinated
debt issued by an operating company. through such requirements, the authorities would in
effect be determining part of the creditor hierarchy - the order in which creditor classes take
losses - in order to reduce spillovers into the wider financial system when a distressed
financial group is resolved. The G20 Leaders' Summit have asked the FSB to develop such a
regime over the coming year.
(4) Some impediments to smooth cross-border resolution need to be removed
I said earlier that the resolution process will become smoother over time. A range of
impediments have been identified.6
Some of them require steps by policymakers. For example, I have said on behalf of the Bank
of England7 that in principle the Bank, as the UK's resolution authority, would be prepared to
step aside and allow UK subsidiaries of the big US financial groups to be resolved as part of
a group-wide resolution led by the US authorities.
To take this further, the Bank of England needs to set out the conditions that would need to
be met in practice for it to deliver on its "in principle policy". Second, the UK needs the US
authorities to make a reciprocal "in principle statement" about their being prepared to step
back to facilitate a UK-led top-down whole-group resolution of UK groups with a presence in
the US. That cannot, in my view, wait very long after the EU's Resolution Directive is passed.
And, third, similar commitments need to be made between other pairs of countries -
particularly the major jurisdictions in which the headquarters of global systemically important
financial institutions are domiciled. On that, I can tell you that progress in this field is not
limited to the US and UK.
Separately, some technical impediments need to be removed. Perhaps most obviously for
this audience, the standard market agreements for derivatives and repos need to be
amended so that putting a firm into resolution or the exercise of a resolution power is not an
event of default. If necessary, there will have to be regulatory changes to induce or require
this. That too is on the FSB's agenda for the next year.
(5) The resolution agenda is not just about banks and dealers. It is about central
counterparties too, for example
Banks became TBTF by accident. The G20 Leaders having mandated that standardised
OTC derivatives must be centrally cleared, there is a risk that central counterparties (CCPs)
will come to be seen as too important to fail as a matter of policy.
That makes it incredibly important that CCPs are robust, effectively managed, effectively
supervised, and have first rate recovery plans. And, beyond that, they absolutely must be
subject to a credible resolution regime.
I worry that CCPs are "for profit", or are typically part of "for profit" groups. If a CCP fails and
it turns out that its risk management was slack, this point is bound to come up in the public
response. Policymakers should think about that now in the context of the governance
structure they want for CCPs embedded in vertically integrated groups.
Meanwhile, work is underway in CPSS/ IOSCO8 on loss-allocation rules. Unlike banks, CCPs
are essentially rule-based machines for netting and allocating risks. Those rules need to be
enriched so that it is clear what happens when, due to a member's default , both the initial
margin and default fund are exhausted. The guidance which CPSS/ IOSCO produce
following the current consultation will need to be unambiguous.
That work can build a solid defence against failure. But one of the central lessons of the
crisis is that we must be able to cater for the worst, when all defences are breached. The
FSB has therefore been consulting on how resolution regimes can be applied to CCPs (and
other financial-infrastructure providers). I hope that G20 Ministers will keep the FSB's feet to
the fire on this.
If CCPs are probably the most important example of where resolution regimes need to be
extended, they are not the only one. Insurance is another. And you won't be surprised to
hear me say that, given the ubiquity of regulatory arbitrage, shadow banking and the world of
funds and special purpose vehicles could be another. That makes it important that resolution
is not the special preserve of the G20 jurisdictions. With many asset management vehicles
domiciled in offshore centres, we are going to need them to get on the resolution bandwagon
Conclusion
To conclude, let me say just this.
It is absolutely essential that the TBTF problem is cracked. Nothing is more important to the
success of the international reform agenda. Without it, global finance would remain fragile;
and to protect against that, the international financial system would balkanise as individual
countries sought to protect themselves. The stakes are high.
My final point, therefore, is that the authorities will have no excuse if they don't solve the
TBTF problem through resolution regimes and reforms. The necessary technology is clear.
The necessary restructuring of firms is clear. The necessary degrees and forms of
cross-border co-operation are clear. It is a matter of: just do it.