Making Bail-in Operational Charles Gray Financial Safety Net - - PowerPoint PPT Presentation

Making Bail-in Operational

Charles Gray Vice President Financial Institution Supervision Group Financial Safety Net Conference

May 2015

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The views expressed in this presentation do not necessarily reflect the views of the Federal Reserve Bank of New York, or any component of the Federal Reserve System.

Disclaimer

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G-SIB resolution – overarching goals and the basics

• Overarching goals
• Continuity of critical operations (market stability)
• Avoid exposing taxpayers (public funds) to loss
• Continuity of core business lines (preserving franchise value)
• Enable reorganization of the firm
• The basics
• Recovery actions have failed and firm has reached point of non-viability
• Top parent is either a holding company or an operating bank
• Under a single point of entry (SPOE) strategy, top parent is the entity placed

into a resolution proceeding

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Pre-conditions to make G-SIB bail-in operational

• To enhance the feasibility and credibility of the SPOE bail-in resolution strategy

for a global, systemically important bank (G-SIB), the following pre-conditions are essential:

• Adequate loss absorbing capacity at the top-tier entity of the firm (“Parent”)
• Adequate capacity of Parent to downstream capital to operating subsidiaries
• Parent Holding Company (if present) is “clean”

▫ No short-term debt issued out of Holding Company ▫ Limited derivatives exposures to third parties issued out of Holding Company ▫ No upstream guarantees by operating entities of Holding Company obligations

• Counterparties and foreign authorities understand the home jurisdiction’s preferred

resolution strategy and dual goals of preserving financial stability while preserving franchise value for creditors of Parent

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Overview of TLAC requirement

• The FSB’s proposed Total Loss Absorbing Capacity (“TLAC”) standard is

designed to ensure that G-SIBs maintain sufficient resources that can be exposed to loss (written down or converted into equity) during resolution.

• TLAC is the combination of existing regulatory capital instruments plus other

qualifying loss absorbing instruments.

• Under the FSB proposal, the quantitative minimum range of TLAC will be between

16% to 20% of risk-weighted assets (RWAs), and at least 2x the minimum leverage ratio requirement.

• While adequate TLAC is not by itself a sufficient condition for ensuring effective

resolution, adequate loss absorbing capacity is a necessary condition to implement resolution strategies that are aimed at maintaining the continuity of critical functions and promoting market confidence without exposing taxpayers to the risk of loss.

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• External TLAC. At the resolution entity level, the FSB has proposed external TLAC

minimums for all resolution entities (e.g., the top parent entity for an SPOE firm).

• Internal TLAC. Required for designated material subsidiaries (i.e., entities

incorporated in a national jurisdiction other than that in which the resolution entity is incorporated and that meet certain materiality thresholds).

• Pre-positioned on the balance sheet of material subsidiaries
• The proceeds of external TLAC committed to material subsidiaries can serve as internal

TLAC.

• Holding company should also maintain

unallocated internal TLAC that can be downstreamed to material subsidiaries in the event that significant losses in resolution exceed the pre-positioned internal TLAC at such entities.

• This allows the home country authority

to have flexibility in restoring solvency to material subsidiaries in foreign countries in resolution, and diminishes the possibility of disruptive ring-fencing by host jurisdictions.

Location of TLAC (External vs. Internal)

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SPOE: Group Structure Before Bail-in

Parent Only Balance Sheet Deposits / advances to subs 45 Unsecured long-term debt 55 Equity in subs 45 Unsecured short-term debt Other assets 10 Secured liabilities Total 100 Other liabilities Equity 45 Total 100 G-SIB Holding Company

Domestic Bank US Broker- Dealer Foreign Broker- Dealer

Foreign Branch Public shareholders

Deposits / Advances 25 Equity 25 Advances 10 Equity 10 Advances 10 Equity 10

Diagrams based on Bipartisan Policy Center, Too Big To Fail: The Path to a Solution (2013).

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SPOE: Hypothetical Losses

Parent Only Balance Sheet Deposits / advances to subs 45 Unsecured long-term debt 55 Equity in subs 9 Unsecured short-term debt Other assets 10 Secured liabilities Total 64 Other liabilities Equity 9 Total 64 G-SIB Holding Company

Domestic Bank US Broker- Dealer Foreign Broker- Dealer

Foreign Branch Public shareholders

Deposits / Advances 25 Equity 25 5 Advances 10 Equity 10 2 Advances 10 Equity 10 2

Diagrams based on Bipartisan Policy Center, Too Big To Fail: The Path to a Solution (2013).

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SPOE: Recapitalizing Operating Subsidiaries and Bridge

Bridge HoldCo Balance Sheet Deposits / advances to subs 9 Liabilities Equity in subs 45 Equity 64 Other assets 10 Total 64 Total 64 Bridge HoldCo

Domestic Bank US Broker- Dealer Foreign Broker- Dealer

Foreign Branch Failed G-SIB in receivership Claims left behind Long-term debt: 55 Equity: 9 Receivership Balance Sheet Equity of Bridge FHC 64 Unsecured long-term debt 55 Total 64 Equity 9 Total 64 Convert debt to equity at

• perating subsidiaries

Deposits / Advances 25 5 Equity 5 25 Advances 10 2 Equity 2 10 Advances 10 2 Equity 2 10

Assets of failed G-SIB and guarantees of subsidiary

• bligations

Diagrams based on Bipartisan Policy Center, Too Big To Fail: The Path to a Solution (2013).

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Process for operationalizing bail-in

• In the runway period leading up to the point of non-viability:
• Identify losses – amounts and locations/jurisdictions
• Identify funding sources to maintain liquidity in resolution
• Identify new management team
• Coordinate with Financial Market Infrastructure (FMIs) as needed to ensure continued

access to services

• Coordinate with affected domestic and foreign authorities (supervisory and resolution)

to develop communication strategy and prepare other necessary pre-arrangements

• At the point of non-viability:
• Holding company / bridge bail-in:

▫ Resolution authority converts the insolvent Holding Company’s unsecured debt into equity in a Bridge Company to which the original Holding Company’s assets are transferred. Holding Company fails and bail-inable debt is left behind. ▫ Creating the Bridge Company and effectuating the asset transfer is expected to occur over resolution weekend. ▫ Determining the ultimate value to be distributed to holders of bailed-in TLAC liabilities can

• ccur over a longer time.
• Operating bank / direct bail-in:

▫ Resolution authority converts TLAC liabilities of the parent operating bank into equity to recapitalize the operating bank.

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Challenges to operationalizing bail-in

• SPOE is untested. The theory is compelling, but execution in practice will raise

numerous issues of first impression.

• Requires sufficient external TLAC and internal instruments to absorb losses
• FSB currently conducting a Quantitative Impact Study with respect to the proposed

TLAC standard.

• Need to effectively balance certainty for host regulators associated with “pre-

positioned” internal TLAC instruments in material entities (i.e., reduce incentives to ring-fence) while retaining appropriate flexibility at the holding company to be able to move capital where it is needed in a particular situation

• Key areas of ongoing work to operationalize bail-in and each home jurisdiction's

preferred resolution strategy include:

• Funding in resolution
• ISDA protocol
• Operational Continuity

▫ Continuity of Critical Shared Services ▫ Continuity of FMI Access

• Valuation methodology