Description
The purpose of this paper is to analyze whether and how “living wills” and public
disclosure of such resolution plans contribute to market discipline and the effective resolution of too
big and too complex to fail banks.
Journal of Financial Economic Policy
Living wills and cross-border resolution of systemically important banks
J acopo Carmassi Richard J ohn Herring
Article information:
To cite this document:
J acopo Carmassi Richard J ohn Herring , (2013),"Living wills and cross-border resolution of systemically
important banks", J ournal of Financial Economic Policy, Vol. 5 Iss 4 pp. 361 - 387
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Living wills and cross-border
resolution of systemically
important banks
Jacopo Carmassi
Assonime, Rome, Italy and
Wharton Financial Institutions Center, University of Pennsylvania,
Philadelphia, Pennsylvania, USA, and
Richard John Herring
The Wharton School, Wharton Financial Institutions Center,
University of Pennsylvania, Philadelphia, Pennsylvania, USA
Abstract
Purpose – The purpose of this paper is to analyze whether and how “living wills” and public
disclosure of such resolution plans contribute to market discipline and the effective resolution of too
big and too complex to fail banks.
Design/methodology/approach – The disorderly collapse of Lehman Brothers is analyzed. Large,
systemically important banks are now required to prepare resolution plans (living wills). In the USA,
parts of the living wills must be disclosed to the public. The public component is analyzed with respect
to contribution to market discipline and effective resolution of banks considered too big and complex
to fail. In a statistical analysis of the publicly available section of living wills, this information is
contrasted with legislative requirements.
Findings – The analysis of public disclosures of resolution plans shows that they are insuf?cient to
facilitate market discipline and, in some instances, fail to enhance public understanding of the ?nancial
institution and its business. When coupled with the uncertainty over how an internationally active
?nancial institution will be resolved, the paper concludes that these reforms will do little to reduce
market expectations that some ?nancial ?rms are simply too big or too complex to fail.
Research limitations/implications – A very small data set and the necessity of cross-checking the
authors’ observations with all publicly available sources. The authors have also tried to infer a purpose
for public disclosure of parts of resolution plans. The authorities are remarkably vague on the issue and
so the authors have assumed they actually did have a speci?c intent that would strengthen the system.
Practical implications – The inference from the publicly available portion of living wills is that the
authorities are a very long way from abolishing too-big-to-fail.
Originality/value – So far as the authors know, this is the ?rst in-depth analysis of the information
available in the public sections of living wills.
Keywords Financial crisis, Government policy and regulation, Living wills,
Systematically important banks
Paper type Research paper
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – G01, G21, G28
The support for this project was provided by the Systemic Risk Council, an independent and
non-partisan council formed by CFA Institute and The Pew Charitable Trusts to monitor and
encourage regulatory reform of US capital markets focused on systemic risk. The views
expressed herein are those of the authors and do not necessarily re?ect the views of the Systemic
Risk Council, its members, The Pew Charitable Trusts or CFA Institute.
Journal of Financial Economic Policy
Vol. 5 No. 4, 2013
pp. 361-387
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-07-2013-0030
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1. Introduction: the peculiar absence of resolution policy from the
pre-crisis Basel agenda
Although international efforts to enhance the safety and soundness of the banking
system date back to the mid-seventies, the focus has been on harmonizing international
banking supervision (e.g. the Basel concordat and successive efforts to delineate best
practices in supervision) or on negotiating increasingly complex, risk-based prudential
capital requirements (e.g. Basel I, II, and III). These efforts aimed to prevent banks from
failing – without, however, considering what might need to be done if a bank should fail.
The inadequacy of these efforts can be seen in the record of failures from 1989
through 2009. Ranking the top 100 banks by assets each year and counting the number
of this group that failed[1], the implied failure rate was 1.3 percent (Kuritzkes, 2010) –
a failure rate roughly equivalent to that of BB-rated corporate bonds. Worse still, the
lack of an effective framework for unwinding the affairs of a large international
?nancial institution meant that of?cial interventions were usually improvised over
sleepless weekends and often involved a substantial public subsidy to facilitate the
merger of the faltering institution with another larger institution in a desperate and
costly attempt to avert damaging spillovers.
This contributed to the rapid growth of increasingly large, ever more complex
?nancial institutions. The outcome has been an expanding number of ?nancial
institutions that are each too large and/or too complicated to be resolved without
jeopardizing ?nancial stability[2]. Indeed, quite apart from these subsidized mergers,
the absence of a credible resolution mechanism has given banks an incentive to become
bigger and more complex to bene?t from an implicit subsidy (in the form of a lower
cost of funds) based on the beliefs of creditors that they would be protected from loss in
the event of trouble. This weakening of market discipline may also have led to
increased risk taking by these institutions.
Nonetheless, resolution policy was simply absent from the international
supervisory and regulatory agenda – until 2008. A series of hastily improvised
rescues of large ?nancial institutions preceded the failure of a relatively large
investment bank despite the attempt by the authorities to devise a rescue package over
a frantic weekend in mid-September 2008[3].
We review in Section 2 how the Lehman Brothers cross border organization
contributed to value destruction under existing bankruptcy laws in the USAand abroad.
Lessons and policy consequences from the Lehman Brothers collapse are discussed in
Section 3. These consequences include the rise in policy makers’ interest in living wills.
The US policy with respect to living wills is described and discussed in Section 4.
Thereafter in Section 5 we ask how informative the public portions of living wills are.
We emphasize the ambiguity and divergence in banks’ interpretation of “material
entities” in their disclosures. The lack of clarity with respect to the de?nition of a
material entity undermines information value of the resolution plans. Section 6
concludes that much uncertainty remains with respect to resolution of large, complex
international banking groups.
2. The Lehman Brothers collapse
When Lehman Brothers collapsed in September 2008 it was the 4th largest investment
bank in the USA, nearly twice as large and complex as Bear Stearns, which had agreed
to a subsidized, shot-gun merger with JPMorgan Chase in March of 2008 when it was
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unable to meet calls for additional collateral. The Lehman Brothers group, with more
than 25,000 employees, consisted of over 6,000 subsidiaries in more than 40 countries
(Miller and Horwitz, 2013), many of which were subject to host country national
regulation as well as supervision by the Securities and Exchange Commission[4].
In 2006 Lehman made a deliberate decision to embark on an aggressive growth
strategy and to take on greater risk by substantially increasing its leverage[5] and
making concentrated bets on commercial real estate, leveraged lending and
private-equity-like investments. These were far riskier than its usual line of business
because rather thanbrokeringrisk, theywere holdingsubstantial amounts of riskontheir
balance sheet, ?nanced largely by short-termrepurchase agreements often amounting to
hundreds of billions of dollars per day. In the words of one Lehman employee, they had
shifted from the “moving business” to the “storage business” (Valukas, 2010). They had,
in essence, taken on the risk pro?le of a commercial bank without the protection of the
bank safety net. When the subprime crisis erupted, they saw it as an opportunity to
double-down on their bets rather than a threat and consistently violated their declared
risk appetite and risk limits to position themselves for a market rebound[6].
Just after the acquisition of Bear Stearns by JPMorgan Chase, Lehman announced
its ?rst loss since going public in 1994. Nonetheless, it was able to raise $6 billion in
new capital. Secretary of the Treasury Paulson, in a private communication to the CEO
of Lehman, warned that this was not enough and that if Lehman were to announce a
loss in the third quarter without having a buyer or a de?nitive survival plan in place,
its existence was in jeopardy (Valukas, 2010, p. 5). Unfortunately, the administration
did not prepare a plan of action for such a contingency either.
Lehman Brothers did not succeed in ?nding a merger partner nor did the ?rmdevelop
a survival plan. Instead it resorted to window dressing its public disclosures and
regulatory ?lings by arbitraging accounting requirements[7] and it overstated its
liquiditypool byincluding “comfort deposits” that it held withits clearing banks inorder
to continue clearing operations with them[8]. It is noteworthy that so many market
participants expressed surprise when Lehman failed. It seems likely that the surprise
was more due to the perceptionof anabrupt change inthe USpolicy of providing support
for any large ?nancial institution rather than to con?dence in Lehman’s strength. Many
market participants believed that if the authorities managed to ?nd $29 billion to
arrange a merger for Bear Stearns, an investment bank little more than half the size of
Lehman, they should be willing to advance at least $60 billion for Lehman. Analysis of
market prices indicates that many market participants knewthat Lehman was insolvent
and had been so at several times during the summer. Figure 1 shows the implied market
value of Lehman’s assets relative to its total liabilities.
Nonetheless, the collapse seemed to catch of?cials and some market participants
unawares. Over the weekend of September 12-14, 2008, US authorities met with CEOs of
leading ?nancial institutions from around the world to try to broker a merger or at least
raise a fund to subsidize a merger for Lehman (much as they had accomplished for Long
Term Capital Management in 1998). At one point on Sunday afternoon they believed
they had struck a deal with Barclays Capital Management that would be subsidized by
many of Barclays’ competitors, but the Financial Services Authority in the UKrefused to
waive the requirement for shareholder approval. Thus, with no buyer and
(the authorities claimed) no way of funding a Lehman rescue[9], the head of the SEC
encouraged Lehman’s board to ?le for bankruptcy immediately, before it would be
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unable to meet its cash obligations when markets opened in Asia. On September 15,
2008, at 1:45 a.m. Lehman Brothers Holdings Inc. (LBHI) ?led for protection under
Chapter 11 of the Bankruptcy Act, becoming the largest bankruptcy in US history.
The administrators of the Lehman bankruptcy in the USA have estimated that at least
$75 billion have been wasted because of the complete lack of preparation for bankruptcy
(Cairns, 2009).
While the US authorities refused to support LBHI, they did support Lehman Brothers
Inc. (LBI), the US broker-dealer subsidiary, for another ?ve days until it could enter the
Securities Investor Protection Act trusteeship on September 19. At this point its prime
brokerage activities and a substantial portion of its clients’ assets and obligations were
sold to Barclays Capital Inc. and others. This removed one of chief systemic concerns in
the USA. The other concern, Lehman’s leading role in the opaque OTC derivatives
market, turned out not to be a major problem. Most derivatives were closed-out and
netted under ISDA agreements. Although counterparties were not necessarily happy
with the prices they received, no knock-on effects could be attributed to the unwinding of
the derivatives book[10].
The only domestic impact that could be labeled systemic was due to a “moral hazard”
play by managers of the $62 billion Reserve Primary Fund, a wholesale money market
fund that was forced to break the buck because of its outsized holdings of Lehman’s
commercial paper. News that one of the oldest money market mutual funds had broken
the buck started a run on other money market mutual funds, which led to large sales of
corporate commercial paper to meet the demand for cash withdrawals. The collapse of
prices in the secondary market caused the primary market for commercial paper to shut
down. Because commercial paper is the primary means of ?nance for much of corporate
Figure 1.
The implied market
value of Lehman’s
assets relative to
its total liabilities
20.0
10.0
-
(10.00)
(20.00)
(30.00)
(40.00)
May 31, 2008 June 30, 2008
July 31, 2008 August 31, 2008
$6 BN capital raised on 6/9,
including $4 billion in common equity
and $2 billion in preferred equity
Lehman-implied MV of Assets Relative to Total Liabilities
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Note: The implied market value of assets is equal to the market value of equity
plus the market value of its liabilities
Source: Valukas (2010, p. 1580)
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America, the Treasury hastily provided insurance for money market mutual funds.
Later the Federal Deposit Insurance Corporation (FDIC) increased the deposit insurance
ceiling for banks from $100,000 to $250,000 and provided an unlimited guarantee for all
non-interest transactions accounts to reassure depositors and attempt to level the
playing ?eld between money market mutual funds and banks.
Still many observers interpreted this as a successful application of bankruptcy rules
to a large, complex ?nancial institution (Ayotte and Skeel, 2010). Apart from the
unanticipated spillover to the wholesale money market and knock-on effect on the
commercial paper market, the USA had shown that the economy could get on perfectly
well without Lehman Brothers.
This relatively orderly outcome contrasted with the chaos created abroad.
The immediacy of the impact was largely due to the tight integration of the lines of
business of the Lehman Group. The operational structure bore little resemblance to its
legal corporate structure. Like many other global ?rms Lehman managed substantially
all of the cash resources centrally at the holding company. Since LBHI declared
bankruptcy before cash could be swept out again to the subsidiaries, they found
themselves suddenly illiquid and unable to continue operation. Uncoordinated
bankruptcy proceedings were initiated in a variety of jurisdictions including Australia,
Japan, Korea, and the UK. Ultimately, the LBHI Chapter 11 case precipitated insolvency
actions throughout the world and the appointment of receivers or administrators in over
80 insolvency proceedings.
Because London was Lehman’s largest center of activity outside the USA, many of
the most complex problems emerged there. The London subsidiaries, including
Lehman Brothers International Europe, its largest broker-dealer in Europe, ?led for
bankruptcy and turned to PwC for administration. Because British law made no
provision for debtor in possession ?nancing, the administrators had to struggle to ?nd
money to keep minimal functions such as security, housekeeping, or the canteen going.
PwC was confronted with forty-three thousand trades that were still “live” and would
need to be negotiated with each individual counterparty.
The integration of the group was such that a trade performed in one af?liate could
be booked in another, without the client necessarily being aware that the location of the
asset had shifted. Record keeping fell into disarray when LBHI ?led for bankruptcy.
At the time of ?ling, Lehman maintained a patchwork of over 2,600 software systems
and applications, many of which were outdated or arcane. These systems were highly
interdependent, but dif?cult to decipher and not well documented. Moreover, most
systems to cover operating functions, trading, valuation, ?nancial accounting and
other data had been transferred to Barclays in the sale and Barclays had integrated its
own proprietary and con?dential data into some of the systems. Thus, other Lehman
af?liates experienced enormous dif?culties even in determining what their balance
sheets were and who owed what to whom.
Although arrangements were ultimately negotiated with Barclays for access to some
essential information, the delay made it almost impossible to salvage much going-concern
value out of the rest of the group (with the exception of the sale of the foreign equity
business to Nomura). In London, where much of the prime brokerage business had
shifted, it was permissible to mingle clients’ funds with the ?rm’s own funds and so
several hedge funds suddenly became illiquid and faced close-out netting procedures
that added further downward pressure on prices in some already illiquid markets.
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The fragmented data system impeded the salvaging of going-concern value fromthe
remainder of the Lehman Group. Different parts of any particular line of business were
lodged in different subsidiaries in various parts of the world with no way of
reintegrating themeven if they had been viable. Clearly, signi?cant value was destroyed
by the lack of cooperation in the unwinding of the Lehman Group. The process
(and costs) may continue for a decade[11].
3. Lessons and policy consequences from the Lehman collapse
The Lehman collapse focused the attention of world leaders on the lack of preparedness
of regulators and supervisors to manage ?nancial crises. First, Lehman provided yet
another example of the inadequacy of the Basel II capital ratios[12]. Although Lehman
had not technically violated its capital requirements, the denominator failed to capture
the risks to which Lehman was exposed and the numerator clearly was inadequate to
absorb Lehman’s losses and permit it to remain as a going concern.
Second, it showed the ineffectiveness of supervisors in constraining the risk-taking
of a ?rm determined to take greater risks. Lehman violated its own internal risk
constraints and it managed to engage in accounting arbitrage to overstate its balance
sheet strength without detection. When warned by the Secretary of the Treasury, the
senior most ?nancial authority in the US government, to raise more capital or prepare a
recovery plan, it simply ignored the warning. Lehman did not formulate a resolution
plan, but, even more remarkably, neither did the regulatory authorities. This and the
inadequacy of capital adequacy measures were indications that despite roughly thirty
years of effort, the international supervisory authorities had failed to implement
effective prudential measures.
Third, the Lehman collapse also highlighted the complete absence of any
international attention to the resolution of internationally active ?nancial institutions
even though even a casual analysis of insolvencies of international institutions since
the mid-70s foreshadowed all of the problems revealed in the Lehman collapse
(Herring, 2002).
Since neither Lehman nor the regulatory authorities had made any plans for the
resolution of the group, the last-minute ?ling for bankruptcy was chaotic. Even though
Lehman was active in at least 40 countries, this action was taken without consultation or
cooperation with any foreign government. Moreover, it demonstrated the ?rst-mover
advantage in seizing assets. In this case, the USA gained control over all of Lehman’s
liquid assets because of the timing of the bankruptcy ?ling. 80 uncoordinated insolvency
proceedings quickly followed.
Fourth, the lack of congruence between Lehman’s lines of business and its legal
corporate structure made it virtually impossible to salvage going-concern value in most
of the rest of the world. This problem was exacerbated by the fact that Lehman’s
management information systems for valuation, accounting, risk management and even
the location of assets were centralized and quickly sold to Barclays Capital Management
and this meant that other resolution authorities could gain access to vital information
only with a substantial lag. In addition, Lehman had engaged in regulatory arbitrage to
mingle clients’ funds with the ?rm’s own funds so that many clients were surprised to
?nd themselves general creditors of the ?rm.
The disorderly collapse of Lehman Brothers focused international attention on the
lack of a coherent framework for dealing with the insolvency of a ?nancial institution
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with substantial international operations. The Group of Twenty (G20) heads of State
met in Washington just after the Lehman bankruptcy. In the Communique´ issued after
meeting, they agreed that as a matter of priority (White House, 2008, p. 6):
National and regional authorities should review resolution regimes and bankruptcy laws in
light of recent experience to ensure that they permit an orderly wind-down of large complex
cross-border ?nancial institutions.
Thus, the issue of cross-border resolution of large complex ?nancial institutions rose
from obscurity to a prominent place on the policy agenda.
At the same meeting the leaders of the G20 expanded the membership in the
Financial Stability Forum (FSF) to include the members of the G20 and in the follow-up
meeting in London in 2009 rechristened the FSF as the Financial Stability Board (FSB).
This was the ?rst international institutional innovation of the G20 since the crisis.
The FSB was given broad responsibility to help implement the G20 recommendations
on strengthening the safety and soundness of the international ?nancial system. At the
request of the G20 during their meeting in Seoul in November 2010, the FSB (2011) set
out an agreement on “key attributes of effective resolution regimes for ?nancial
institutions”, which attempted to ?ll the obvious gap in the international prudential
framework highlighted by the crisis.
The FSB identi?ed eight essential features that should be part of an effective
resolution regime for banks (FSB, 2011, p. 3):
(1) ensure continuity of systemically important ?nancial services and payment,
clearing and settlement functions;
(2) allocate losses to ?rm owners and unsecured and uninsured creditors in a
manner that respects the hierarchy of claims;
(3) not rely on public solvency support and not create an expectation that such
support will be available;
(4) avoid unnecessary destruction of value, and therefore seek to minimize the
overall costs of resolution in home and host jurisdictions and, where consistent
with the other objectives, losses for creditors;
(5) provide for speed and transparency and as much predictability as possible
throughlegal andprocedural clarityandadvancedplanningfor orderlyresolution;
(6) provide a mandate in law for cooperation, information exchange and
coordination domestically and with relevant foreign resolution authorities
before and during a resolution;
(7) ensure that non-viable ?rms can exit the market in an orderly way; and
(8) be credible, and thereby enhance market discipline and provide incentives for
market-based solutions.
Many of these features can be read as attempts to establish a new regime that would
prevent another disorderly, Lehman-like bankruptcy. The emphasis is on planning,
sharing of information, cross-border cooperation, the protection of systemically
important functions and avoiding the unnecessary destruction of value. All of these
goals will be dif?cult to achieve, especially because many of the G20 countries have not
established special resolution regimes for complex, international ?nancial institutions.
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Perhaps the greatest challenge, however, is to achieve credibility. The authorities tend
to be judged by what they do, not what they say, and most of the interventions and
resolutions that occurred during the crisis were too late to plan for an orderly
liquidation or restructuring process, failed to allocate losses to unsecured and
uninsured creditors, involved major commitments of public funds, and showed little
evidence of substantial cross-border cooperation. None of these interventions could be
described as speedy, transparent or predictable.
The effort to establish credibility, however, is not advanced by the vague way in
which the FSB (2011, p. 7) describes the point at which resolution should take place:
“resolution should be initiated when a ?rm is no longer viable or likely to be no longer
viable, and has no reasonable prospect of becoming so”. Although the clear intent is for
the authorities to intervene before equity is wiped out, the clause “has no reasonable
prospect of becoming so” can be very permissive. Given the demonstrated tendency of
managers, accountants and supervisors to take an overly-optimistic view of a ?rm’s
prospects for recovery, this clause seems to provide scope for delaying intervention
until long after a ?rm’s equity has been destroyed, which will mean more or less
business as usual in ad hoc resolution improvisations.
One of the most signi?cant new requirements was that each jurisdiction ensure that
every systemically important ?nancial institution ?les a “robust” recovery and
resolution plan. The resolution plan should include:
.
identi?cation of ?nancial and economic functions for which continuity is critical;
.
suitable resolution options to preserve those functions or wind them down in an
orderly manner;
.
data describing the ?rm’s business operations, structures, and systemically
important functions;
.
potential barriers to effective resolution and actions to mitigate those barriers;
.
actions to protect insured depositors and ensure the rapid return of segregated
client assets;
.
clear options or principles for the exit from the resolution process; and
.
assurance that key service level agreements can be maintained in crisis situation
and in resolution, and that underlying contracts include a provision that prevents
terminations triggered by recovery or resolution events and facilitates transfer of
contracts to a bridge institution or a third party acquirer.
Although the key attributes proclaim the intent to enhance market discipline and to
provide incentives for market-based solutions, no mention is made of public disclosure
of recovery or resolution plans. Howmarket discipline is to be enhanced is far fromclear.
4. Resolution plans in the US response
At more or less the same time that the FSB key attributes were being negotiated the
Dodd-Frank (D-F) reforms were being implemented in the USA[13]. A key provision
under Title I of the D-F Act requires that all large, systemically important ?nancial
companies submit resolution plans[14] to demonstrate how they would be resolved
under the Bankruptcy Code. This is particularly noteworthy because the USA has
long had an administrative procedure for the FDIC to resolve a failing bank and,
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when appropriate, establish a bridge bank to continue systemically important
functions. The key attributes advocate that other countries adopt a similar set of
powers, but Congress wanted to make clear than an institution should not count on
intervention from the FDIC. Although the FDIC would continue to resolve all insured
depository institutions, it would manage the resolution of the group only under Title II
of the D-F Act (orderly liquidation authority). They emphasized this point by insisting,
in Title I of the D-F Act, that groups prepare for a resolution under Chapter 11 of the
Bankruptcy Code in their resolution plans.
Section 165(d) of the D-F Act requires that each non-bank ?nancial company
supervised by the Federal Reserve Board (FRB) and each bank holding company with
at least $50 billion in assets (which together are termed “covered companies”) present a
plan for rapid and orderly resolution to the FRB and the FDIC. Foreign banking groups
with US operations must also comply with this requirement. The plan must include
(US Congress, 2010):
(A) information regarding the manner and extent to which any insured depository institution
af?liated with the company is adequately protected from risks arising from the activities of
any nonbank subsidiaries; (B) full descriptions of the ownership structure, assets, liabilities,
and contractual obligations of the company; (C) identi?cation of the cross-guarantees tied to
different securities, identi?cation of major counterparties, and a process for determining to
whom the collateral of the company is pledged.
This resolution plan is to be accompanied by a credit exposure report.
The implementation details were left to the FRB and FDIC. They published the
implementing regulation on November 1, 2011 (FDIC and FRB, 2011b), that
emphasized living wills should indicate how the covered company can be sold, broken
up, or wound down quickly and effectively without jeopardizing US ?nancial stability.
Living wills must include:
.
an executive summary with a strategic analysis describing the ?rm’s plan for a
rapid and orderly resolution (without, however, de?ning what period of time
quali?es as “rapid”);
.
a description of how resolution planning is incorporated in the ?rm’s corporate
governance structure;
.
a description of the group’s overall organizational structure that includes a
hierarchical list of all material entities, as well as jurisdictional and ownership
information and mapping of core business lines and critical operations into
corporate entities;
.
a description of management information systems that support the covered
company and its material entities, including a detailed inventory and description
of key applications along with identi?cation of the legal owner or licensor and
related service level agreements;
.
a description of interconnections and interdependencies among a covered
company and its material entities and the covered company’s critical operations
and core business lines along with a description of how service levels would be
sustained during a material ?nancial distress or insolvency; and
.
identi?cation of supervisory authorities and regulators that oversee the covered
company.
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For the largest andmost complicatedbankinggroups that have thousands of subsidiaries,
the third requirement has been onerous. It demands not only a mapping of lines of
business into corporate entities, but also details regarding material entities, critical
operations andcore business that, at a minimum, describe types andamounts of liabilities.
It alsorequires details about the bookingof tradingandderivatives activities, as well as an
identi?cation of major counterparties including descriptions of any interconnections or
interdependencies among them. Finally, it requires that covered companies list all
material trading, payment, clearing and settlement systems in which they participate.
Most of these requirements can be seen as attempts to minimize the prospect of a
Lehman-Brothers-like disorderly bankruptcy by ensuring that both covered companies
and regulators have thought through the end game in advance.
The compliance costs for both covered companies and the regulatory authorities
have been very heavy[15]. 11 ?rms submitted living wills in 2012. Several of the
submissions were reported to be thousands of pages in length. Based on an early
evaluation of these submissions, William Dudley, President of the Federal Reserve
Bank of New York, concluded that:
[. . .] this initial exercise has con?rmed that we are a long way from the desired situation in
which large complex ?rms could be allowed to go bankrupt without major disruptions to the
?nancial system and large costs to society. Signi?cant changes in structure and organization
will ultimately be required for this to be achieved.
While the D-F Act generally supports greater market discipline, it does not address the
issue of public disclosure of resolution plans. The FRB and FDIC, however, have
required disclosure of a public section of the plan containing an executive summary
that describes the business of the covered company including: “(i) the names of
material entities; (ii) a description of core business lines; (iii) consolidated or segment
?nancial information regarding assets, liabilities, capital and major funding sources”.
During the comment period following the Advance Notice of Proposed Rulemaking
(ANPR), the FRB and FDIC received many expressions of concern from the industry
regarding the possibility that details of the resolution plan might be made public through
the Freedom of Information Act (FDIC and FRB, 2011b, p. 67326). The ANPR dealt
with the issue by requiring that any covered company that desired con?dential treatment
of the information must ?le a request for con?dential treatment under the general rules of
the FDICand FRB(2011a, p. 22660). This was essentially an opt-out approach that left the
institutionwiththe burdenof justifyingwhether some informationshouldbe con?dential.
In the commentary preceding the ?nal proposal, the FDIC and FRB (2011b, p. 67322)
tried to ease these fears and added their own concern that:
[. . .] release of this information would impede the quality and extent of information provided
by covered companies and could signi?cantly impact the efforts of the Board and the
Corporation to encourage effective and orderly unwinding of the covered companies in a
crisis.
The upshot was a disclosure requirement observing that FDIC and FRB (2011b,
p. 67332):
While information in the public section of a resolution plan should be suf?ciently detailed to
allow the public to understand the business of the covered company, such information can be
high level in nature and based on publicly available information.
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In effect, this creates a safe harbor for an institution that does not wish to disclose any
information that is not already publicly available.
If the information is already publicly disclosed, it is not clear what value this
disclosure requirement adds. This timid approach represents a signi?cant lost
opportunity. If the authorities had been serious about enhancing market discipline, they
should have required disclosure of information that would enable potential creditors of
the covered company to understand the statutory hierarchy of claims on the various
entities in resolution, and precisely how the authorities propose to conduct a resolution.
In the absence of such information, creditors cannot be expected to price claims
ef?ciently. Moreover, some of the information in the ?rst round of disclosures falls short
of the more modest goal of helping the public understand the business of the covered
company because it is dif?cult to reconcile with other publicly available information.
The next section summarizes and analyzes the data provided by the 11 banking groups
that submitted resolution plans during 2012. The ?nal section argues that the lack of
agreement on howcross-border ?rms will be resolved casts a huge uncertainty over how
an international insolvency would be dealt with.
5. How informative are public sections of living wills?
The 11 banking groups that submitted their living wills in 2012 include seven US
institutions – Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs,
JPMorgan Chase, Morgan Stanley, State Street Corporation – and four foreign banking
groups – Barclays, Credit Suisse, Deutsche Banks, UBS[16]. In their implementing
regulation, the FRB and FDIC speci?ed the format that each resolution plan should
follow. We focus on aspects of the public section of the living will that might have
improved market discipline if they had been more rigorously speci?ed and carefully
implemented[17].
A major weakness of the disclosure format is the vague way in which the
authorities have de?ned material entities: “material entity means a subsidiary or
foreign of?ce of the covered company that is signi?cant to the activities of a critical
operation or core business line” (FDIC and FRB, 2011b, p. 67335). Critical operations, in
turn, are de?ned as:
[. . .] those operations of the covered company, including associated services, functions and
support, the failure or discontinuance of which, in the view of the covered company or as
jointly directed by the Board and the Corporation, would pose a threat to the ?nancial
stability of the USA (FDIC and FRB, 2011b, p. 67335).
No speci?c asset or income threshold has been set for identifying material entities that
may be either branches or subsidiaries[18]. This may be appropriate in cases in which
a key entity that services the group, such as providers of information technology or
risk management services, has been set up as a separate entity. In fact, such entities are
material even though they have negligible income or balance sheets.
Although we have no way of identifying material entities that have negligible income
statements or balance sheets, it is possible to check whether the material entities that the
banking groups chose to list include all of the entities that have a balance sheet size
exceeding the $50 billion threshold – the same threshold which at the consolidated level
would require bank holding companies to ?le a resolution plan under the D-F Act.
To determine whether entities that exceed the $50 billion threshold have been omitted,
Living wills
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we have used Bankscope data fromMay 2013, data fromSEC ?lings as of yearend 2011,
Federal Reserve/National Information Center data as of June 2012, information available
in the banks’ annual reports and other information published on their web sites[19].
The results (Table I) indicate that eight of the 11 banking groups did not identify a few
large subsidiaries withassets greater than$50 billionas material entities. Table I displays
the number of material entities reported byeach of the 11 bankinggroups andthe number
and name of subsidiaries with more than $50 billion that were not identi?ed as material
entities in the public section of the resolution plan. Most “missing” material entities are
intermediate holdingcompanies, but inthe absence of additional informationabout where
suchholdingcompanies sit inthe legal organizationstructure of the group, it is impossible
to tell whether such information might be redundant because all of the material entities
that are subsidiaries of anholding company – or its parent holdingcompany – have been
reported. Of course, even if all of the main subsidiaries, or controlling entities, of the
holding company are reported, information about an omitted holding company may be
important as well, especially if it issues debt or makes guarantees to other af?liates.
The FDIC/FRB implementing rule requires that each group provide a hierarchical
list of material entities. Oddly, these appear to have been omitted from the public
section. No organization or corporate structure tree chart is provided[20], much less
information about the percentage of ownership in each subsidiary. Presumably, the
con?dential section of the plan contains such information, but no clear case has been
made about why such information should be excluded from the public portion of the
plan. With considerable effort some of this information can be gleaned from other
public documents, but it is not readily available in a format that is easy to compare
across institutions.
At least some of these “missing” material entities might be regarded as material.
For example, both Bank of America and Citigroup have disclosed high level
organizational structure trees on their web sites. These are purported to include the
material holding companies of each group, but some of these holding companies are
not included in the public sections of their resolution plans. In Figures 2 and 3, we have
circled the large subsidiaries (all holding companies) that are missing from the relevant
public section of each living will[21]. In some cases it is clear from information
outside the living wills that such entities could have important interactions with other
af?liates in the group. For example, Citigroup Global Markets Holdings Inc. may have
signi?cant liabilities to af?liated depository institutions[22].
One can only speculate about why such entities are omitted from the public sections
of living wills, but this does raise troubling questions about the criteria that have been
employed to select the reported entities.
Surely investors would gain a better understanding of the groups’ business and
structure if they were required to provide detailed explanations about their decision
criteria and an organizational chart including, at a minimum, the type of business, the
legal form, the location, total assets and the percentages of ownership for each of the
displayed entities. Without more quantitative and qualitative details on material
entities and the methodology to select them, the public sections of the living wills are
less informative than they should be. Moreover, it is dif?cult to imagine that a strong
rationale could be advanced that this sort of information should be proprietary.
Although it is crucial to have better information about the reported material entities,
the other entities that are implicitly deemed “non-material” should not be ignored
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Material entities
in resolution plans
Living wills
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altogether, if only because of their magnitude. For example, Citigroup listed seventeen
material entities, but in fact it had 2,319 subsidiaries according to the Federal
Reserve/National Information Center data as of June 30, 2012. While many of these
subsidiaries may be irrelevant for understanding how an institution would be resolved,
the living will should at least categorize these subsidiaries and explain why they are
not relevant to the orderly resolution of the group.
More broadly, much of the other information contained in the public section of
the living wills seems far more general than it should be if the objective is to
enhance public understanding of the group’s business or enhance market discipline.
Figure 2.
The corporate structure
of Bank of America
Notes: Red circles indicate the large subsidiaries not included in the material entities list in the
public section of Bank of America resolution plan submitted in 2012;
a
this chart includes only
select major operating subsidiaries and asssociated material holding companies of Bank of
America Corporation. Not all subsidiaries of Bank of America are represented;
b
reflects a
majority-owned subsidiary
Source: Bank of America web site, own elaborations
Living wills
375
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Table II summarizes the information provided regarding the number of core business
lines, the number of entities with balance sheet or income statement data reported, the
number of material payment, clearing and settlement systems in which the group
participates and the number of supervisory authorities that oversee the ?rm.
In virtually every case, the lack of speci?city in the “material entity” concept
undermines the usefulness of the other information disclosed and the resulting
differences across institutions can be very large. For example, the number of core lines of
business varies from State Street Corporation, which lists 2, to JPMorgan Chase, which
identi?es 30. The average for the 11 institutions is eight. While business models across
Figure 3.
The corporate
structure of Citigroup
Notes: Red circles indicate the large subsidiaries not included in the material entities list in the
public section of Citigroup resolution plan submitted in 2012;
a
for a list of ratings for
Citigroup Investor Relations website:http://www.citigroup.com/citi/investor/rate.htm
Source: Citigroup web site, own elaborations
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the 11 banking groups do differ signi?cantly in many respects, one is left with the
uncomfortable feeling that differing de?nitions of “core business lines” may also play a
role[23]. Although the groups report basic information about the business conducted by
each material entity, it is generally left to the reader to map lines of business into material
entities and, even then, it is not clear how these might be preserved in the bankruptcy
process.
Financial data about material entities are very sparse, usually including only the
assets and liabilities (and sometimes income data) of the largest depository institution,
which must disclose its balance sheets periodically in any event[24]. While this is
consistent with the FRB/FDIC requirement, it leaves huge gaps in a reader’s
understanding of the material entities and how they operate.
The systemicallyimportant ?nancial institutions were requiredto indicate the number
of “material” payment, clearing and settlement systems in which they participate, as well
as the number of “material” supervisors and regulators with whom they must interact.
This information is often used as a proxy for the complexity and interconnectedness of a
?nancial institution that are believed to be two aspects of systemic risk.
Number of
core business
lines
Number of entities with
individual balance
sheet/income data
reported
Number of material
payment, clearing and
settlement systems
Number of material
supervisory
authorities
a
Bank of
America
5 2 (depository
institutions)
15 8
Bank of
New York
Mellon
4 1 (depository
institution)
15 11
Barclays
(USA)
b
4 2 (1 depository branch,
1 broker-dealer)
18 19
Citigroup 12 1 (depository
institution)
16 10
Credit
Suisse
11 0 11 18
Deutsche
Bank
(USA)
b
10 0 16 10
Goldman
Sachs
4 1 (depository
institution)
c
19 45
JPMorgan
Chase
30 2 (depository
institutions)
18 11
Morgan
Stanley
3 1 (depository
institution)
19 19
State Street
Corporation
2 0 10 13
UBS (USA)
b
7 0 na 14
Notes:
a
Italics indicates that the bank reports only supervisory authorities of material entities;
we have included in our calculations only supervisors explicitly named;
b
information largely related to
US operations;
c
included in the resolution plan for the depository institution submitted as a separate
document
Source: Public section of banks’ 2012 resolution plans
Table II.
Overview of selected
information provided
by banking groups
in the public portion
of resolution plans
Living wills
377
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Clearly the groups have taken the materiality guideline quite rigorously in reporting
these two dimensions of proxies for systemic risk. Citigroup is reported to be
a participant in 550 clearing and settlements systems in another source (Herring, 2013).
While many of these may not be material, it is crucial to understand what standard of
“materiality” is being applied. Similarly, the largest number of material supervisory
authorities, 45, is reported by Goldman Sachs, which is by no means the largest or most
complicated group. Indeed, most of these groups are active in more than 45 countries
and so it is dif?cult to infer what standard of materiality has been employed and what
the information implies about the dif?culty of resolving the ?rm.
In short, the FDIC/FRB regulation set up guidelines for the public section of living
wills that permitted groups to avoid providing any new information even if it was
critical to understanding how dif?cult it would be to resolve an institution. Our
examination of the actual public sections of the reports indicates that most groups took
full advantage of their discretion to maintain con?dentiality of information that is
crucial to understanding how easily they could be resolved without, in many cases, any
plausible rationale for holding such details in con?dence. Nonetheless, even if the groups
had been more forthcoming with information, investors and creditors would still be
unable to price claims ef?ciently because of?cials have not yet agreed on how to handle
cross-border resolutions.
6. Why resolution policy remains uncertain
The crisis revealedthe US lacked a coherent regime for resolving systemicallyimportant
global ?nancial institutions. In this it was not alone. The Basel Committee on Banking
Supervision (2010) concluded that no country had a framework for adequately
addressing the problems that arise in the resolution of a purely domestic banking
conglomerate, much less a cross-border or global systemically important institution.
The D-F reforms were intended to enhance the ability of the authorities to resolve a
purely domestic institution. Since the new regime remains untested, it is too early to
judge whether it is suf?cient to resolve a large institution without cost to taxpayers
and without threatening ?nancial stability. The cross-border aspects of resolution
policy remain a challenge and the obstacles are formidable.
A cross-border resolution is bound to involve multiple supervisory authorities with
differing statutory powers and responsibilities. Some may be charged with taking
?nancial stability into account, others may simply be responsible for taking whatever
measures they can to protect the customers of the part of the group they oversee.
In addition to these differences in objectives, bankruptcy and administrative processes
differ markedly, as do the competencies and powers of individual supervisory and
regulatory authorities. The sheer number of authorities whose actions must be
coordinated is mind boggling. One moderately large foreign bank, not large enough to
be included on the FSB list of Global Systemically Important Banks (G-SIBs), held a
meeting of its key national and international regulators to discuss its resolution plan
and was obliged to convene the meeting in a large hotel ballroom.
Since November 2010, the members of the FSB have been developing resolution
strategies, operational resolution plans and ?rm-speci?c cross-border cooperation
agreements that establish a process for cooperation and information sharing. In its
April 2013 progress report, however, the FSB (2013, p. 1) concluded that:
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[P]rogress has been relatively slow both because the issue is complex and because in many
jurisdictions the powers necessary for implementing a preferred resolution strategy have not
yet been provided.
This is particularly worrisome with regard to the European Union because it is home to
a large number of G-SIBs and several of these institutions hold more assets outside
their home country than within.
Table III lists 11 European banking groups and one US banking group (Citigroup)
that have less than half of their assets in the home country. In order for the market to
function properly, it needs to understand not only living wills, but also what the
authorities will do in a crisis. In the absence of ?rm, credible and binding cooperation
agreements, it must remain a matter of speculation.
The problem is complicated by the fact that the authorities have not achieved a
consensus on the appropriate model for cross-border resolution. Idealists favor a
universalist approach in which insolvency laws are harmonized and an insolvent ?rm’s
assets are pooled in one proceeding and shared equitably across claimants without regard
to where they reside or which part of the group they have dealt with. Cynics consider this
approachtobe the Esperanto of resolutionpolicies andbelieve that no matter what of?cials
saythey will ringfence those parts of the failing institution that they cancontrol inthe end.
Banking groups
Total assets
in US$
billion
World
assets
rank
Home country as
% of total assets
Rest of region as
% of total assets
Rest of world as
% of total assets
1. Deutsche bank
(Germany) 2,800 1 34 32 34
2. HSBC (UK) 2,556 3 35 11 54
3. BNP Paribas
(France) 2,543 4 49 34 17
4. Barclays (UK) 2,417 7 34 27 39
5. Citigroup
(USA) 1,874 14 36 21 43
6. Banco
Santander
(Spain) 1,619 17 27 41 32
7. UBS
(Switzerland) 1,508 19 36 20 44
8. ING bank (The
Netherlands) 1,244 23 40 38 22
9. UniCredit
(Italy) 1,199 24 42 56 2
10. Credit Suisse
Group
(Switzerland) 1,115 25 21 26 53
11. Nordea group
(Sweden) 927 27 21 74 5
12. Standard
Chartered (UK) 599 41 15 4 81
Source: Schoenmaker (2013, p. 62)
Table III.
Large international
banking groups
with . 50 percent of
assets outside home
country, yearend 2011
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These extremes are re?ected to some extent in two approaches that are widely
discussed: a single point of entry strategy (SPE) and a multiple point of entry strategy
(MPE). The Bank of England and the FDIC (2012) have developed a SPE strategy. This
approach attempts to leapfrog the seemingly hopeless task of harmonizing national
bankruptcy laws and resolution procedures by vesting resolution powers in a single
resolution authority that is responsible for overseeing the top holding company or
parent company in a G-SIB. The responsibility of the single resolution authority would
be to ensure that the top level institution would be restructured in such a way that it
would serve as a source of strength by recapitalizing subsidiaries and down-streaming
liquidity as necessary. The hope is that this would ?nesse most cross-border problems
by preserving the assets and operations of subsidiaries on a going concern basis.
This presumes that the top level entity will be required to be suf?ciently
well-capitalized to absorb losses throughout the group – and, indeed, that the group is
structuredinsucha waythat there is a clear top-level entity. Of course, this canonlywork
if the single resolution authority has access to suf?cient resources to maintain the
subsidiaries in the group while the restructuring of the top level institution takes place,
whichmaybe anissue inseveral countries that are host to institutions withliabilities that
are a substantial multiple of domestic GDP. Moreover, in the case of the USAit appears to
assume that resolution will take place under the administrative procedures of Title II of
the D-F Act rather than the bankruptcy resolution plans required in the livings wills.
This approach raises tricky issues in a scenario in which a foreign subsidiary is the
major source of losses and should be liquidated. The authorities, of course, do not want
to be in the position of propping up an institution that has no going-concern value. But
once they admit the possibility that some foreign subsidiaries may not be protected,
creditors have reason to be concerned about all of the foreign subsidiaries and it may
not be possible to implement the resolution without creating unwanted spillovers as
creditors engage in a ?ight to quality.
In addition to the hope that foreign authorities can be convinced to forbear and leave
the resolution to the headquarters authority, the laws underlying many ?nancial
contracts will need to be changed or the single resolution authority will need to have the
ability to impose a stay. Otherwise the initiation of resolution proceedings with regard to
the top-level entity can be interpreted as an event of default that permits counterparties
to terminate their ?nancial contracts. This could destabilize markets and frustrate the
attempt of the single resolution authority to ensure the continuity of operations.
A MPE strategy involves the application of resolution powers by multiple
authorities to multiple parts of the group and the break-up of the group into separate
parts along national, regional or functional lines. Unless the multiple authorities have
?rm agreements about how to coordinate their actions and allocate losses, this
approach amounts to ring fencing[25]. This approach is opposed by most G-SIBs
because they believe it would reduce the ef?ciency with which they can allocate capital
and liquidity within the group.
It is dif?cult to imagine both approaches operating simultaneously without causing
enormous uncertainty – not unlike the current situation. The key point, however, is that
how the cross-border resolution will be conducted is a critical factor that must be taken
into account in valuing the claims on any entity within the group. When this uncertainty
is considered in conjunction with the meager public disclosures in living wills, market
discipline cannot be expected to reinforce and support regulatory discipline.
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Despite an enormous amount of effort, one must conclude that we do not yet have
the framework to undertake the orderly resolution of a G-SIB. This means that these
institutions are likely to enjoy an implicit subsidy that is completely unrelated to their
ef?ciency or the quality of their services. Too-big-to-fail may be too-costly-to-continue,
but a solution to the problem remains elusive.
Notes
1. Failures were counted as direct bankruptcies, conservatorships, or substantial government
interventions. They numbered 26 over these two decades.
2. For example, Dudley (2012), in the mid-1990s, the top ?ve banks in the USA had total assets
of $1 trillion or about 14 percent of GDP. By the end of 2007, the top ?ve banks had assets of
$6.8 trillion or 49 percent of GDP. Similarly, in the mid-1990s, the top securities ?rms had
total asset equal to about 9 percent of GDP. By the end of 2007, these had grown to
$3.8 trillion, about 27 percent of GDP.
3. The resolution process was much more orderly for smaller banks that were entirely subject
to FDIC administrative procedures.
4. This is an unusually clear example of the law of unintended consequences. The EU
threatened to force the large American investment banks to form holding companies in
Europe if they did not submit to consolidated supervision by a competent authority.
Although it had no prior experience, the SEC somehow convinced the EU that it was a
competent supervisory authority and in 2004 the ?ve largest investment banks became
voluntary Consolidated Supervised Entities (CSEs) subject to Basel II-like capital regulation.
When they measured their required capital under Basel-like rules that had been extended to
the net capital computation for the broker-dealer, the ?ve CSEs discovered that they had
considerable excess regulatory capital and quickly increased their leverage, which was
surely not what the EU intended. See Lo (2012, p. 34) for an analysis of the regulatory
change, emphasizing that before 2004, the holding companies of the broker/dealers had not
been subject to any oversight or leverage constraint. Lo also raises doubts about the
magnitude of the impact of the change in rules on leverage. Kwak (2012), however, notes that
Lo’s analysis fails to emphasize a key point: the SEC’s intent was to permit the large
broker/dealers to substitute mathematical models for traditional risk weights so that the
net-capital calculation would “probably will be lower”.
5. Lehman’s debt to equity ratios often exceeded 40:1, and during the middle of any reporting
period might go up to 60:1 (Miller and Horwitz, 2013).
6. Lehman exceeded its risk limits by margins of 70 percent with regard to commercial real
estate and 100 percent with regard to leveraged loans (Valukas, 2010, p. 50).
7. Valukas (2010) gives a full account of the so-called 105 repo transactions that could be
reported as sales rather than borrowings.
8. By September 12, 2008, two days after reporting $41 billion in its liquidity pool, Lehman had
less than $2 billion of readily monetizable assets (Valukas, 2010, p. 10).
9. The authorities claimed that they lacked legal authority to make a direct investment in
Lehman and that Lehman’s assets were insuf?cient to support a loan large enough to avoid
collapse.
10. It should be noted that this relatively benign result was unlikely to have happened if not for
the substantial liquidity provided to the broker/dealer by the Federal Reserve while it was
being prepared for a SIPC resolution.
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11. Desmos (2010) reported that the total fees paid to lawyers, administrators and other advisers
in the Lehman bankruptcy through October 2010 totalled nearly $2 billion. At least 1,300
people have been working on the Lehman bankruptcy since it began. This, of course, was
merely an interim report.
12. Luckily, many of the world’s largest banks had not yet made a full transition from Basel I to
Basel II, so that when the crisis hit these banks had a somewhat greater ability to absorb
losses than if they had been fully authorized to operate under the Basel II advanced internal
models approach.
13. See the Appendix 1 for a summary of the EU proposal on bank recovery and resolution
plans, contained in the directive harmonizing bank crisis resolution tools and procedures
proposed by the European Commission in 2012 and currently under discussion.
14. Although “resolution plan” is the of?cial name for such documents, they are commonly
referred to as a “living will” or, more sardonically, a “funeral plan”. In the remainder of the
text we will generally use the terms “resolution plans” and “living wills” interchangeably.
15. The ANPR (FDIC and FRB, 2011b) estimated that averaged over the 124 covered companies,
the initial burden of compliance would be 12,400 hours. For the largest institutions, the
number of hours required to comply with the regulation was surely a substantial multiple of
this amount. The burden on the supervisory agencies to analyze and evaluate the data has
undoubtedly been quite substantial as well.
16. The resolution plans ?led by foreign banking groups mainly focused on US operations and
entities.
17. We will not, for example, comment on the institution’s responsibility to provide a high-level
resolution plan because in most instances the information was so high-level as to be
uninformative. In addition, we have sympathy with the reluctance of institutions to specify
to whom they might sell various lines of business because the grounds for maintaining
con?dentiality about this sort of information seem self-evident on competitive grounds.
18. Luciano and Wihlborg (2013) emphasize that the practical distinction between a subsidiary
and a branch in cross-border banking is often quite blurred. Some countries oblige foreign
branches to meet liquidity and capital requirements within the host country as if they were
separately incorporated subsidiaries.
19. See the Appendix 2 for details regarding the statistical benchmarks.
20. With the partial exception of Morgan Stanley’s (2012, p. 24) submission for the depository
institution.
21. Three “missing” material entities of Citigroup are not shown in Figure 3: Citigroup Funding
Inc., Citigroup Korea Inc. and Citigroup Overseas Holdings GK.
22. “Some of Citigroup’s non-bank subsidiaries have credit facilities with Citigroup’s subsidiary
depository institutions, including Citibank, N.A. Borrowings under these facilities are
secured in accordance with Section 23A of the Federal Reserve Act. Citigroup Global
Markets Holdings Inc. (CGMHI) has borrowing agreements consisting of facilities that
CGMHI has been advised are available, but where no contractual lending obligation exists.
These arrangements are reviewed on an ongoing basis to ensure ?exibility in meeting
CGMHI’s short-term requirements”. (Citigroup, 2012a, p. 217).
23. The FDIC/FRB regulation de?nes core business lines as “those business lines, including
associated operations, services, functions and support that, in the ?rm’s view, upon failure
would result in a material loss of revenue, pro?t, or franchise value” (FDIC and FRB, 2011a,
p. 67334).
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24. Moreover, banking groups also have to submit to the FDIC a resolution plan for their
depository institutions with at least $50 billion in total assets, as required by a January 2012
FDIC rule. In most cases this plan was incorporated in the same public document with the
resolution plan for the banking group.
25. New Zealand has taken this position and attempted to apply it more rigorously than any
other national authority. It has tried to ensure that even if the foreign parents of their four
largest banks should fail, the New Zealand subsidiaries could continue to operate. See the
contribution of Mayes (2013) in this issue.
26. These groups were required to submit their resolution plans by July 1, 2012 as their nonbank
assets (US nonbank assets for foreign covered companies) were at least equal to $ 250 billion.
A second group of banks, with total nonbank assets between $ 100 billion and $ 250 billion,
had to submit their plans by July 1, 2013; ?nally, covered companies with less than
$100 billion in total nonbank assets must submit their plans by December 31, 2013. BNP
Paribas, HSBC, Royal Bank of Scotland and Wells Fargo submitted their plans in the second
round and the public sections were released by regulators on July 2, 2013. In our analysis we
have focused on the resolution plans submitted in the ?rst round in 2012.
References
Ayotte, K. and Skeel, D. (2010), “Bankruptcy or bailouts?”, Journal of Corporate Law, Vol. 35.
Bank of England and FDIC (2012), “Resolving globally active, systemically important, ?nancial
institutions”, A Joint Paper by the Federal Deposit Insurance Corporation and the Bank of
England, December 10.
Basel Committee on Banking Supervision (2010), Report and Recommendations of the
Cross-border Bank Resolution Group, Basel Committee on Banking Supervision, Basel,
March.
Cairns, A. (2009), “Breaking the insolvency mould”, International Corporate Rescue,
Vol. 6 No. 2, p. 115.
Citigroup (2012a), Annual Report on Form 10K, Citigroup, New York, NY.
Desmos, T. (2010), “Lehman’s US bankruptcy costs top $1 bn”, Financial Times, November 23,
available at: www.ft.com/intl/cms/s/0/39d642a0-f699-11df-b434-00144feab49a.html
Dudley, W. (2012), “Solving the too big to fail problem”, Remarks at the Clearing House’s Second
Annual Business Meeting and Conference, November 15.
European Commission (2012), Proposal for a Directive of the European Parliament and of the
Council Establishing a Framework for the Recovery and Resolution of Credit Institutions
and Investment Firms and Amending Council Directives 77/91/EEC and 82/891/EC,
Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC and 2011/35/EC
and Regulation (EU) No. 1093/2010, COM(2012) 280 Final, European Commission,
Brussels, June 6.
FDIC and FRB (2011a), “Resolution plans and credit exposure reports required, proposed rule;
request for public comment”, Federal Register, Vol. 76 No. 78, pp. 22648-22662.
FDIC and FRB (2011b), “Resolution plans required, ?nal rule”, Federal Register, Vol. 76 No. 211,
pp. 67323-67340.
FSB (2011), Key Attributes of Effective Resolution Regimes for Financial Institutions, Financial
Stability Board, Basel, October.
FSB (2013), “Implementing the FSB key attributes of effective resolution regimes – how far have
we come?”, Report to the G20 Finance Ministers and Central Bank Governors, April 15.
Living wills
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Herring, R. (2002), “International ?nancial conglomerates: implications for bank insolvency
regimes”, Policy Challenges for the Financial Sector in the Context of Globalization,
Proceedings of the Second Annual Policy Seminar for Deputy Central Bank Governors,
Federal Reserve Bank/IMF/World Bank.
Herring, R. (2013), “The case for rapid resolution plans”, Review of Economics & Finance, Vol. 3,
pp. 1-7.
Kuritzkes, A. (2010), “A safer world ?nancial system – improving the resolution of systemic
institutions, Geneva report: discussion”, overhead presentation at the Geneva Conference,
May 7.
Kwak, J. (2012), “What didthe SECreally do in2004?”, The Baseline Scenario, January 30, available
at:http://baselinescenario.com/2012/01/30/what-did-the-sec-really-do-in-2004/
Lo, A. (2012), “Reading about the ?nancial crisis: a 21-book review”, Journal of Economic
Literature, Vol. 50 No. 1, pp. 151-178.
Luciano, E. and Wihlborg, C. (2013), “The organization of bank af?liates: a theoretical
perspective on risk and ef?ciency”, International Centre for Economic Research,
Working Paper No. 6/2013, May.
Mayes, D. (2013), “Achieving plausible separability for the resolution of cross-border banks”,
Journal of Financial Economic Policy, Vol. 5.
Miller, H.R. and Horwitz, M. (2013), Resolution Authority: Lessons from the Lehman Experience,
Weil, New York, NY.
Morgan Stanley (2012), Resolution Plan, Morgan Stanley, New York, NY, June 29.
Schoenmaker, D. (2013), Governance of International Banking – The Financial Trilemma, Oxford
University Press, New York, NY.
US Congress (2010), “The Dodd-frank wall street reform and Consumer Protection
Act”, 111th Congress of the United States of America, January 5.
Valukas, A. (2010), Report of Anton R. Valukas, Examiner, on Lehman Brothers Holdings Inc.,
United States Bankruptcy Court, Southern District of New York, New York, NY, March.
White House (2008), Declaration of the Summit on Financial Markets and the World Economy,
Of?ce of the Press Secretary, Washington, DC, November 15.
Further reading
Bank of America (2012), Bank of America Corporation Resolution Plan, Bank of America, N.A.
Resolution Plan, FIA Card Services, N.A. Resolution Plan, Public Executive Summary,
Bank of America, Charlotte, NC.
Bank of NewYork Mellon (2012), BNYMellon Resolution Plan, Public Section, Bank of NewYork
Mellon, New York, NY, October 1.
Barclays (2012), Resolution Plan, Section 1: US Public Section, Barclays, London, July.
Citigroup (2012b), Resolution Plan for Citigroup Inc. & Citibank, N.A., Section 1: Public Section,
Citigroup, New York, NY, June 29.
Credit Suisse (2012), Credit Suisse Global Recovery and Resolution Plan, Chapter 1 – Public
Section, Credit Suisse, Zu¨rich, June 29.
Deutsche Bank (2012), Deutsche Bank Resolution Plan, Section 1 – Public Section, Deutsche
Bank, Frankfurt, June 29.
Goldman Sachs (2012), Summary of Resolution Plan, Goldman Sachs, New York, NY, June 29.
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JPMorgan Chase & Co. (2012), Resolution Plan, Public Filing, JPMorgan Chase & Co., New York,
NY, July 1.
State Street Corporation(2012), ResolutionPlanfor State Street Corporation&State Street Bankand
Trust Company, Section 1: Public Section, State Street Corporation, Boston, MA, October 1.
Taylor, J. (2008), “The ?nancial crisis and the policy responses: an empirical analysis of what
went wrong”, A Festschrift in Honor of David Doge’s Contributions to Canadian Public
Policy, Bank of Canada, November, pp. 1-18.
UBS (2012), Resolution Plan, Section 1 – Public Section, UBS, Zu¨rich.
Appendix 1. The EU approach to bank recovery and resolution plans
In the European Union, the European Commission presented in June 2012 a proposal for a directive
on bank recovery and resolution, with the goal of introducing new bank crisis management and
resolution tools to facilitate orderly resolution and avoid bailouts (European Commission, 2012).
Negotiations with the European Parliament and the Council of the European Union to adopt the
?nal legislation are still in progress (the most recent compromise has been reached at the end of
June 2013, with a ?nal approval expected by the end of 2013).
The directive aims to harmonize policy instruments and procedures to deal with banking crises
across EU countries and to improve the ability to manage the crisis and failure of cross-border
banks. The proposal included provisions on preparation and prevention, early intervention and
resolution tools and powers. Preparation and prevention measures include the requirement for
banking groups and individual institutions within a group to prepare recovery plans, and for
authorities to draw up resolution plans for them. Colleges of resolution authorities are also
introduced, in which home and host countries resolution authorities participate under the lead of
the group (home) resolution authority; the European Banking Authority would participate too,
facilitating joint actions and acting as binding mediator in case of need. Finally, the proposed
directive also requires the creation of national resolution funds to bear the costs related to
resolution procedures (e.g. provide capital for a bridge bank), but never to bail out banks: these
funds would have to be ?nanced to a large extent by risk-based fees paid ex-ante by banks.
The directive introduces a requirement for banking groups to prepare and submit a recovery
plan to their consolidating supervisor, which will transmit it to resolution authorities. The plan
should include measures for the stabilization of the group as a whole in case of distress, indicating
also arrangements for intra-group ?nancial support. The preparation and submission of the
recovery plans shall have at least an annual frequency, and an updated version should be
presented in case of changes to the legal or organizational structure of the institution, its business
or its ?nancial situation. The plans must include a wide range of information, including:
a communication and disclosure plan outlining how the ?rm intends to manage any potentially
negative market reactions; a range of capital and liquidity actions required to restore the
institution’s ?nancial position; the identi?cation of critical functions; a detailed description of the
processes for determining the value and marketability of the core business lines, operations and
assets of the institution; arrangements and measures to reduce risk and leverage, to restructure
liabilities andbusiness lines, to maintainthe continuous functioningof the institution’s operational
processes, including infrastructure and ITservices; preparatory arrangements to facilitate the sale
of assets or business lines in a timeframe appropriate for the restoration of ?nancial soundness.
Competent authorities, after consultation with relevant foreign authorities, must assess the
effectiveness of the measures proposed in the recovery plan to rapidly restore viability without
producing adverse effects on the ?nancial system; the European Banking Authority will develop
guidelines specifying minimum criteria to be followed for such assessment. If competent
authorities are not satis?ed with the plan, they may request the institution to revise the plan: if it
fails to submit the revised plan or changes are not considered satisfactory, then authorities may
direct the institution to take corrective measures, such as a reduction of the risk pro?le of the
bank, timely recapitalization, changes to the funding strategy or to the governance structures.
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While banks are required to draw up recovery plans, resolution authorities are entrusted with
the preparation of resolution plans, outlining the resolution measures that will be adopted if the
bank is taken through resolution. Resolution authorities, however, may require the banks to assist
theminthe preparationandupdatingof the resolutionplan, and their requests mayconcern, among
other issues, the following information: a detailed description of the institution’s organizational
structure includinga list of all legal entities; the identi?cationof the direct holder andthe percentage
of voting and non-voting rights of each legal entity; the location, jurisdiction of incorporation,
licensing and key management associated with each legal entity; a mapping of the institution’s
critical operations and core business lines by reference to legal entities; a detailed description of the
components of the institution’s andall its legal entities’ liabilities, separatingat a minimumbytypes
and amounts of short term and long term debt, secured, unsecured and subordinated liabilities;
a description of the off-balance sheet exposures of the institution and its legal entities, including
a mapping to its critical operations and core business lines; the identi?cation of the major or most
critical counterparties of the institution as well as an analysis of the impact of the failure of major
counterparties on the institution’s ?nancial situation; each payment, clearing or settlement system
of which the institution is directly or indirectly a member, including a mapping to the institution’s
legal entities, critical operations and core business lines; an identi?cation and mapping of the legal
entities and the interconnections and interdependencies among the different legal entities
(e.g. capital, funding and liquidity arrangements, cross-guarantee arrangements).
As for recovery plans, resolution plans must be updated at least annually or in case of changes
to the legal or organizational structure of the institution, its business or its ?nancial position that
might have an impact on the plan. The latter shall include a demonstration of how critical
functions andcore business lines could be legally andeconomically separated fromother functions
so as to ensure continuity upon the failure of the institution; a description of the processes for
determining the value and marketability of the critical functions, core business lines and assets of
the institution; an explanation by the resolution authority on how the resolution options could be
?nanced without any extraordinary public ?nancial support; a detailed description of the different
resolution strategies that could be applied according to the different possible scenarios;
a description of critical interdependencies; a description of essential operations and systems for
maintaining the continuous functioning of the institution’s operational processes.
If resolution authorities identify signi?cant impediments to the resolvability of a group, they
may require the institution to take measures in order to facilitate its resolvability. Such measures
might include a reduction of complexity through changes to legal or operational structures in
order to ensure that critical functions can be legally and economically separated from other
functions; the drawing up of service agreements to cover the provision of critical functions; limits
to maximum individual and aggregate exposures; imposition of reporting requirements;
restrictions of activities and new business lines or products; requirement to issue additional
convertible capital instruments.
Appendix 2. Methodology for the identi?cation of large subsidiaries not listed by
banking groups as “material entities” in the public section of resolution plans
Table I displays the number of material entities listed by the 11 banking groups[26] in the public
portion of their resolution plans as well as the number, name and location of large subsidiaries
which have not been included in the list of material entities. To identify these “missing” material
entities we have ?rst collected information on large subsidiaries provided by the Bankscope
database (as of May 2013): we have chosen $ 50 billion of total assets as the size threshold to select
large entities and selected all subsidiaries that Bankscope reported to have surpassed such
threshold, based on the latest ?nancial data indicated by Bankscope in the list of subsidiaries.
To obtain the Bankscope list of subsidiaries we have used the 50 percent majority-ownership ?lter
made available by the database: companies included in the list of subsidiaries are only those that
the banking group owns with at least a 50.01 percent stake in every single piece of the
ownership chain.
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Second, we have excluded some large subsidiaries included by Bankscope but not active any
longer (e.g. due to bankruptcy or merger): for this purpose, we have used information provided
by Bankscope in other sections of their database and by the Orbis database (which follows the
same criteria and format of Bankscope but has a wider coverage with regard to details on
subsidiaries).
Third, we have checked whether any large subsidiary included by Bankscope was not in the
material entities list provided by banking groups in the resolution plan, ?nding a few “missing”
entities for eight out of the 11 banking groups of our sample.
Fourth, in order to double-check our results with of?cial regulatory sources and to make sure
that large subsidiaries identi?ed by Bankscope as of May 2013 were existing at the time of
submission of the resolution plans, we have veri?ed whether the missing entities were included
by banking groups in the list of subsidiaries displayed in the SEC 10-K form for US groups and
in the SEC 20-F form for foreign groups; we used data for year-end 2011 as this is the most recent
date before the submission of the resolution plans for which SEC data were available. For a
couple of foreign banking groups we were not able to ?nd the list of subsidiaries in the SEC 20-F
form and performed the double-check with 2011 annual reports or other of?cial documents
published by the banks.
Moreover, we have performed this double check also with Federal Reserve data on banks’
organization hierarchy made publicly available through the National Information Center
database. Since these data can be retrieved for any point in time, we have used the end of June
2012 data, corresponding to the timing of submission of resolution plans.
Our missing entities were included in both the SEC and the Federal Reserve data, or in
documents published by the banks (only in one case a subsidiary was included in the Fed data
as of June 2012, but not in the SEC list as of yearend 2011, while being included in the SEC list
for yearend 2010).
Corresponding author
Prof. Richard John Herring can be contacted at: [email protected]
Living wills
387
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doc_525178987.pdf
The purpose of this paper is to analyze whether and how “living wills” and public
disclosure of such resolution plans contribute to market discipline and the effective resolution of too
big and too complex to fail banks.
Journal of Financial Economic Policy
Living wills and cross-border resolution of systemically important banks
J acopo Carmassi Richard J ohn Herring
Article information:
To cite this document:
J acopo Carmassi Richard J ohn Herring , (2013),"Living wills and cross-border resolution of systemically
important banks", J ournal of Financial Economic Policy, Vol. 5 Iss 4 pp. 361 - 387
Permanent link to this document:http://dx.doi.org/10.1108/J FEP-07-2013-0030
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Living wills and cross-border
resolution of systemically
important banks
Jacopo Carmassi
Assonime, Rome, Italy and
Wharton Financial Institutions Center, University of Pennsylvania,
Philadelphia, Pennsylvania, USA, and
Richard John Herring
The Wharton School, Wharton Financial Institutions Center,
University of Pennsylvania, Philadelphia, Pennsylvania, USA
Abstract
Purpose – The purpose of this paper is to analyze whether and how “living wills” and public
disclosure of such resolution plans contribute to market discipline and the effective resolution of too
big and too complex to fail banks.
Design/methodology/approach – The disorderly collapse of Lehman Brothers is analyzed. Large,
systemically important banks are now required to prepare resolution plans (living wills). In the USA,
parts of the living wills must be disclosed to the public. The public component is analyzed with respect
to contribution to market discipline and effective resolution of banks considered too big and complex
to fail. In a statistical analysis of the publicly available section of living wills, this information is
contrasted with legislative requirements.
Findings – The analysis of public disclosures of resolution plans shows that they are insuf?cient to
facilitate market discipline and, in some instances, fail to enhance public understanding of the ?nancial
institution and its business. When coupled with the uncertainty over how an internationally active
?nancial institution will be resolved, the paper concludes that these reforms will do little to reduce
market expectations that some ?nancial ?rms are simply too big or too complex to fail.
Research limitations/implications – A very small data set and the necessity of cross-checking the
authors’ observations with all publicly available sources. The authors have also tried to infer a purpose
for public disclosure of parts of resolution plans. The authorities are remarkably vague on the issue and
so the authors have assumed they actually did have a speci?c intent that would strengthen the system.
Practical implications – The inference from the publicly available portion of living wills is that the
authorities are a very long way from abolishing too-big-to-fail.
Originality/value – So far as the authors know, this is the ?rst in-depth analysis of the information
available in the public sections of living wills.
Keywords Financial crisis, Government policy and regulation, Living wills,
Systematically important banks
Paper type Research paper
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – G01, G21, G28
The support for this project was provided by the Systemic Risk Council, an independent and
non-partisan council formed by CFA Institute and The Pew Charitable Trusts to monitor and
encourage regulatory reform of US capital markets focused on systemic risk. The views
expressed herein are those of the authors and do not necessarily re?ect the views of the Systemic
Risk Council, its members, The Pew Charitable Trusts or CFA Institute.
Journal of Financial Economic Policy
Vol. 5 No. 4, 2013
pp. 361-387
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-07-2013-0030
Living wills
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1. Introduction: the peculiar absence of resolution policy from the
pre-crisis Basel agenda
Although international efforts to enhance the safety and soundness of the banking
system date back to the mid-seventies, the focus has been on harmonizing international
banking supervision (e.g. the Basel concordat and successive efforts to delineate best
practices in supervision) or on negotiating increasingly complex, risk-based prudential
capital requirements (e.g. Basel I, II, and III). These efforts aimed to prevent banks from
failing – without, however, considering what might need to be done if a bank should fail.
The inadequacy of these efforts can be seen in the record of failures from 1989
through 2009. Ranking the top 100 banks by assets each year and counting the number
of this group that failed[1], the implied failure rate was 1.3 percent (Kuritzkes, 2010) –
a failure rate roughly equivalent to that of BB-rated corporate bonds. Worse still, the
lack of an effective framework for unwinding the affairs of a large international
?nancial institution meant that of?cial interventions were usually improvised over
sleepless weekends and often involved a substantial public subsidy to facilitate the
merger of the faltering institution with another larger institution in a desperate and
costly attempt to avert damaging spillovers.
This contributed to the rapid growth of increasingly large, ever more complex
?nancial institutions. The outcome has been an expanding number of ?nancial
institutions that are each too large and/or too complicated to be resolved without
jeopardizing ?nancial stability[2]. Indeed, quite apart from these subsidized mergers,
the absence of a credible resolution mechanism has given banks an incentive to become
bigger and more complex to bene?t from an implicit subsidy (in the form of a lower
cost of funds) based on the beliefs of creditors that they would be protected from loss in
the event of trouble. This weakening of market discipline may also have led to
increased risk taking by these institutions.
Nonetheless, resolution policy was simply absent from the international
supervisory and regulatory agenda – until 2008. A series of hastily improvised
rescues of large ?nancial institutions preceded the failure of a relatively large
investment bank despite the attempt by the authorities to devise a rescue package over
a frantic weekend in mid-September 2008[3].
We review in Section 2 how the Lehman Brothers cross border organization
contributed to value destruction under existing bankruptcy laws in the USAand abroad.
Lessons and policy consequences from the Lehman Brothers collapse are discussed in
Section 3. These consequences include the rise in policy makers’ interest in living wills.
The US policy with respect to living wills is described and discussed in Section 4.
Thereafter in Section 5 we ask how informative the public portions of living wills are.
We emphasize the ambiguity and divergence in banks’ interpretation of “material
entities” in their disclosures. The lack of clarity with respect to the de?nition of a
material entity undermines information value of the resolution plans. Section 6
concludes that much uncertainty remains with respect to resolution of large, complex
international banking groups.
2. The Lehman Brothers collapse
When Lehman Brothers collapsed in September 2008 it was the 4th largest investment
bank in the USA, nearly twice as large and complex as Bear Stearns, which had agreed
to a subsidized, shot-gun merger with JPMorgan Chase in March of 2008 when it was
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unable to meet calls for additional collateral. The Lehman Brothers group, with more
than 25,000 employees, consisted of over 6,000 subsidiaries in more than 40 countries
(Miller and Horwitz, 2013), many of which were subject to host country national
regulation as well as supervision by the Securities and Exchange Commission[4].
In 2006 Lehman made a deliberate decision to embark on an aggressive growth
strategy and to take on greater risk by substantially increasing its leverage[5] and
making concentrated bets on commercial real estate, leveraged lending and
private-equity-like investments. These were far riskier than its usual line of business
because rather thanbrokeringrisk, theywere holdingsubstantial amounts of riskontheir
balance sheet, ?nanced largely by short-termrepurchase agreements often amounting to
hundreds of billions of dollars per day. In the words of one Lehman employee, they had
shifted from the “moving business” to the “storage business” (Valukas, 2010). They had,
in essence, taken on the risk pro?le of a commercial bank without the protection of the
bank safety net. When the subprime crisis erupted, they saw it as an opportunity to
double-down on their bets rather than a threat and consistently violated their declared
risk appetite and risk limits to position themselves for a market rebound[6].
Just after the acquisition of Bear Stearns by JPMorgan Chase, Lehman announced
its ?rst loss since going public in 1994. Nonetheless, it was able to raise $6 billion in
new capital. Secretary of the Treasury Paulson, in a private communication to the CEO
of Lehman, warned that this was not enough and that if Lehman were to announce a
loss in the third quarter without having a buyer or a de?nitive survival plan in place,
its existence was in jeopardy (Valukas, 2010, p. 5). Unfortunately, the administration
did not prepare a plan of action for such a contingency either.
Lehman Brothers did not succeed in ?nding a merger partner nor did the ?rmdevelop
a survival plan. Instead it resorted to window dressing its public disclosures and
regulatory ?lings by arbitraging accounting requirements[7] and it overstated its
liquiditypool byincluding “comfort deposits” that it held withits clearing banks inorder
to continue clearing operations with them[8]. It is noteworthy that so many market
participants expressed surprise when Lehman failed. It seems likely that the surprise
was more due to the perceptionof anabrupt change inthe USpolicy of providing support
for any large ?nancial institution rather than to con?dence in Lehman’s strength. Many
market participants believed that if the authorities managed to ?nd $29 billion to
arrange a merger for Bear Stearns, an investment bank little more than half the size of
Lehman, they should be willing to advance at least $60 billion for Lehman. Analysis of
market prices indicates that many market participants knewthat Lehman was insolvent
and had been so at several times during the summer. Figure 1 shows the implied market
value of Lehman’s assets relative to its total liabilities.
Nonetheless, the collapse seemed to catch of?cials and some market participants
unawares. Over the weekend of September 12-14, 2008, US authorities met with CEOs of
leading ?nancial institutions from around the world to try to broker a merger or at least
raise a fund to subsidize a merger for Lehman (much as they had accomplished for Long
Term Capital Management in 1998). At one point on Sunday afternoon they believed
they had struck a deal with Barclays Capital Management that would be subsidized by
many of Barclays’ competitors, but the Financial Services Authority in the UKrefused to
waive the requirement for shareholder approval. Thus, with no buyer and
(the authorities claimed) no way of funding a Lehman rescue[9], the head of the SEC
encouraged Lehman’s board to ?le for bankruptcy immediately, before it would be
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unable to meet its cash obligations when markets opened in Asia. On September 15,
2008, at 1:45 a.m. Lehman Brothers Holdings Inc. (LBHI) ?led for protection under
Chapter 11 of the Bankruptcy Act, becoming the largest bankruptcy in US history.
The administrators of the Lehman bankruptcy in the USA have estimated that at least
$75 billion have been wasted because of the complete lack of preparation for bankruptcy
(Cairns, 2009).
While the US authorities refused to support LBHI, they did support Lehman Brothers
Inc. (LBI), the US broker-dealer subsidiary, for another ?ve days until it could enter the
Securities Investor Protection Act trusteeship on September 19. At this point its prime
brokerage activities and a substantial portion of its clients’ assets and obligations were
sold to Barclays Capital Inc. and others. This removed one of chief systemic concerns in
the USA. The other concern, Lehman’s leading role in the opaque OTC derivatives
market, turned out not to be a major problem. Most derivatives were closed-out and
netted under ISDA agreements. Although counterparties were not necessarily happy
with the prices they received, no knock-on effects could be attributed to the unwinding of
the derivatives book[10].
The only domestic impact that could be labeled systemic was due to a “moral hazard”
play by managers of the $62 billion Reserve Primary Fund, a wholesale money market
fund that was forced to break the buck because of its outsized holdings of Lehman’s
commercial paper. News that one of the oldest money market mutual funds had broken
the buck started a run on other money market mutual funds, which led to large sales of
corporate commercial paper to meet the demand for cash withdrawals. The collapse of
prices in the secondary market caused the primary market for commercial paper to shut
down. Because commercial paper is the primary means of ?nance for much of corporate
Figure 1.
The implied market
value of Lehman’s
assets relative to
its total liabilities
20.0
10.0
-
(10.00)
(20.00)
(30.00)
(40.00)
May 31, 2008 June 30, 2008
July 31, 2008 August 31, 2008
$6 BN capital raised on 6/9,
including $4 billion in common equity
and $2 billion in preferred equity
Lehman-implied MV of Assets Relative to Total Liabilities
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Note: The implied market value of assets is equal to the market value of equity
plus the market value of its liabilities
Source: Valukas (2010, p. 1580)
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America, the Treasury hastily provided insurance for money market mutual funds.
Later the Federal Deposit Insurance Corporation (FDIC) increased the deposit insurance
ceiling for banks from $100,000 to $250,000 and provided an unlimited guarantee for all
non-interest transactions accounts to reassure depositors and attempt to level the
playing ?eld between money market mutual funds and banks.
Still many observers interpreted this as a successful application of bankruptcy rules
to a large, complex ?nancial institution (Ayotte and Skeel, 2010). Apart from the
unanticipated spillover to the wholesale money market and knock-on effect on the
commercial paper market, the USA had shown that the economy could get on perfectly
well without Lehman Brothers.
This relatively orderly outcome contrasted with the chaos created abroad.
The immediacy of the impact was largely due to the tight integration of the lines of
business of the Lehman Group. The operational structure bore little resemblance to its
legal corporate structure. Like many other global ?rms Lehman managed substantially
all of the cash resources centrally at the holding company. Since LBHI declared
bankruptcy before cash could be swept out again to the subsidiaries, they found
themselves suddenly illiquid and unable to continue operation. Uncoordinated
bankruptcy proceedings were initiated in a variety of jurisdictions including Australia,
Japan, Korea, and the UK. Ultimately, the LBHI Chapter 11 case precipitated insolvency
actions throughout the world and the appointment of receivers or administrators in over
80 insolvency proceedings.
Because London was Lehman’s largest center of activity outside the USA, many of
the most complex problems emerged there. The London subsidiaries, including
Lehman Brothers International Europe, its largest broker-dealer in Europe, ?led for
bankruptcy and turned to PwC for administration. Because British law made no
provision for debtor in possession ?nancing, the administrators had to struggle to ?nd
money to keep minimal functions such as security, housekeeping, or the canteen going.
PwC was confronted with forty-three thousand trades that were still “live” and would
need to be negotiated with each individual counterparty.
The integration of the group was such that a trade performed in one af?liate could
be booked in another, without the client necessarily being aware that the location of the
asset had shifted. Record keeping fell into disarray when LBHI ?led for bankruptcy.
At the time of ?ling, Lehman maintained a patchwork of over 2,600 software systems
and applications, many of which were outdated or arcane. These systems were highly
interdependent, but dif?cult to decipher and not well documented. Moreover, most
systems to cover operating functions, trading, valuation, ?nancial accounting and
other data had been transferred to Barclays in the sale and Barclays had integrated its
own proprietary and con?dential data into some of the systems. Thus, other Lehman
af?liates experienced enormous dif?culties even in determining what their balance
sheets were and who owed what to whom.
Although arrangements were ultimately negotiated with Barclays for access to some
essential information, the delay made it almost impossible to salvage much going-concern
value out of the rest of the group (with the exception of the sale of the foreign equity
business to Nomura). In London, where much of the prime brokerage business had
shifted, it was permissible to mingle clients’ funds with the ?rm’s own funds and so
several hedge funds suddenly became illiquid and faced close-out netting procedures
that added further downward pressure on prices in some already illiquid markets.
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The fragmented data system impeded the salvaging of going-concern value fromthe
remainder of the Lehman Group. Different parts of any particular line of business were
lodged in different subsidiaries in various parts of the world with no way of
reintegrating themeven if they had been viable. Clearly, signi?cant value was destroyed
by the lack of cooperation in the unwinding of the Lehman Group. The process
(and costs) may continue for a decade[11].
3. Lessons and policy consequences from the Lehman collapse
The Lehman collapse focused the attention of world leaders on the lack of preparedness
of regulators and supervisors to manage ?nancial crises. First, Lehman provided yet
another example of the inadequacy of the Basel II capital ratios[12]. Although Lehman
had not technically violated its capital requirements, the denominator failed to capture
the risks to which Lehman was exposed and the numerator clearly was inadequate to
absorb Lehman’s losses and permit it to remain as a going concern.
Second, it showed the ineffectiveness of supervisors in constraining the risk-taking
of a ?rm determined to take greater risks. Lehman violated its own internal risk
constraints and it managed to engage in accounting arbitrage to overstate its balance
sheet strength without detection. When warned by the Secretary of the Treasury, the
senior most ?nancial authority in the US government, to raise more capital or prepare a
recovery plan, it simply ignored the warning. Lehman did not formulate a resolution
plan, but, even more remarkably, neither did the regulatory authorities. This and the
inadequacy of capital adequacy measures were indications that despite roughly thirty
years of effort, the international supervisory authorities had failed to implement
effective prudential measures.
Third, the Lehman collapse also highlighted the complete absence of any
international attention to the resolution of internationally active ?nancial institutions
even though even a casual analysis of insolvencies of international institutions since
the mid-70s foreshadowed all of the problems revealed in the Lehman collapse
(Herring, 2002).
Since neither Lehman nor the regulatory authorities had made any plans for the
resolution of the group, the last-minute ?ling for bankruptcy was chaotic. Even though
Lehman was active in at least 40 countries, this action was taken without consultation or
cooperation with any foreign government. Moreover, it demonstrated the ?rst-mover
advantage in seizing assets. In this case, the USA gained control over all of Lehman’s
liquid assets because of the timing of the bankruptcy ?ling. 80 uncoordinated insolvency
proceedings quickly followed.
Fourth, the lack of congruence between Lehman’s lines of business and its legal
corporate structure made it virtually impossible to salvage going-concern value in most
of the rest of the world. This problem was exacerbated by the fact that Lehman’s
management information systems for valuation, accounting, risk management and even
the location of assets were centralized and quickly sold to Barclays Capital Management
and this meant that other resolution authorities could gain access to vital information
only with a substantial lag. In addition, Lehman had engaged in regulatory arbitrage to
mingle clients’ funds with the ?rm’s own funds so that many clients were surprised to
?nd themselves general creditors of the ?rm.
The disorderly collapse of Lehman Brothers focused international attention on the
lack of a coherent framework for dealing with the insolvency of a ?nancial institution
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with substantial international operations. The Group of Twenty (G20) heads of State
met in Washington just after the Lehman bankruptcy. In the Communique´ issued after
meeting, they agreed that as a matter of priority (White House, 2008, p. 6):
National and regional authorities should review resolution regimes and bankruptcy laws in
light of recent experience to ensure that they permit an orderly wind-down of large complex
cross-border ?nancial institutions.
Thus, the issue of cross-border resolution of large complex ?nancial institutions rose
from obscurity to a prominent place on the policy agenda.
At the same meeting the leaders of the G20 expanded the membership in the
Financial Stability Forum (FSF) to include the members of the G20 and in the follow-up
meeting in London in 2009 rechristened the FSF as the Financial Stability Board (FSB).
This was the ?rst international institutional innovation of the G20 since the crisis.
The FSB was given broad responsibility to help implement the G20 recommendations
on strengthening the safety and soundness of the international ?nancial system. At the
request of the G20 during their meeting in Seoul in November 2010, the FSB (2011) set
out an agreement on “key attributes of effective resolution regimes for ?nancial
institutions”, which attempted to ?ll the obvious gap in the international prudential
framework highlighted by the crisis.
The FSB identi?ed eight essential features that should be part of an effective
resolution regime for banks (FSB, 2011, p. 3):
(1) ensure continuity of systemically important ?nancial services and payment,
clearing and settlement functions;
(2) allocate losses to ?rm owners and unsecured and uninsured creditors in a
manner that respects the hierarchy of claims;
(3) not rely on public solvency support and not create an expectation that such
support will be available;
(4) avoid unnecessary destruction of value, and therefore seek to minimize the
overall costs of resolution in home and host jurisdictions and, where consistent
with the other objectives, losses for creditors;
(5) provide for speed and transparency and as much predictability as possible
throughlegal andprocedural clarityandadvancedplanningfor orderlyresolution;
(6) provide a mandate in law for cooperation, information exchange and
coordination domestically and with relevant foreign resolution authorities
before and during a resolution;
(7) ensure that non-viable ?rms can exit the market in an orderly way; and
(8) be credible, and thereby enhance market discipline and provide incentives for
market-based solutions.
Many of these features can be read as attempts to establish a new regime that would
prevent another disorderly, Lehman-like bankruptcy. The emphasis is on planning,
sharing of information, cross-border cooperation, the protection of systemically
important functions and avoiding the unnecessary destruction of value. All of these
goals will be dif?cult to achieve, especially because many of the G20 countries have not
established special resolution regimes for complex, international ?nancial institutions.
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Perhaps the greatest challenge, however, is to achieve credibility. The authorities tend
to be judged by what they do, not what they say, and most of the interventions and
resolutions that occurred during the crisis were too late to plan for an orderly
liquidation or restructuring process, failed to allocate losses to unsecured and
uninsured creditors, involved major commitments of public funds, and showed little
evidence of substantial cross-border cooperation. None of these interventions could be
described as speedy, transparent or predictable.
The effort to establish credibility, however, is not advanced by the vague way in
which the FSB (2011, p. 7) describes the point at which resolution should take place:
“resolution should be initiated when a ?rm is no longer viable or likely to be no longer
viable, and has no reasonable prospect of becoming so”. Although the clear intent is for
the authorities to intervene before equity is wiped out, the clause “has no reasonable
prospect of becoming so” can be very permissive. Given the demonstrated tendency of
managers, accountants and supervisors to take an overly-optimistic view of a ?rm’s
prospects for recovery, this clause seems to provide scope for delaying intervention
until long after a ?rm’s equity has been destroyed, which will mean more or less
business as usual in ad hoc resolution improvisations.
One of the most signi?cant new requirements was that each jurisdiction ensure that
every systemically important ?nancial institution ?les a “robust” recovery and
resolution plan. The resolution plan should include:
.
identi?cation of ?nancial and economic functions for which continuity is critical;
.
suitable resolution options to preserve those functions or wind them down in an
orderly manner;
.
data describing the ?rm’s business operations, structures, and systemically
important functions;
.
potential barriers to effective resolution and actions to mitigate those barriers;
.
actions to protect insured depositors and ensure the rapid return of segregated
client assets;
.
clear options or principles for the exit from the resolution process; and
.
assurance that key service level agreements can be maintained in crisis situation
and in resolution, and that underlying contracts include a provision that prevents
terminations triggered by recovery or resolution events and facilitates transfer of
contracts to a bridge institution or a third party acquirer.
Although the key attributes proclaim the intent to enhance market discipline and to
provide incentives for market-based solutions, no mention is made of public disclosure
of recovery or resolution plans. Howmarket discipline is to be enhanced is far fromclear.
4. Resolution plans in the US response
At more or less the same time that the FSB key attributes were being negotiated the
Dodd-Frank (D-F) reforms were being implemented in the USA[13]. A key provision
under Title I of the D-F Act requires that all large, systemically important ?nancial
companies submit resolution plans[14] to demonstrate how they would be resolved
under the Bankruptcy Code. This is particularly noteworthy because the USA has
long had an administrative procedure for the FDIC to resolve a failing bank and,
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when appropriate, establish a bridge bank to continue systemically important
functions. The key attributes advocate that other countries adopt a similar set of
powers, but Congress wanted to make clear than an institution should not count on
intervention from the FDIC. Although the FDIC would continue to resolve all insured
depository institutions, it would manage the resolution of the group only under Title II
of the D-F Act (orderly liquidation authority). They emphasized this point by insisting,
in Title I of the D-F Act, that groups prepare for a resolution under Chapter 11 of the
Bankruptcy Code in their resolution plans.
Section 165(d) of the D-F Act requires that each non-bank ?nancial company
supervised by the Federal Reserve Board (FRB) and each bank holding company with
at least $50 billion in assets (which together are termed “covered companies”) present a
plan for rapid and orderly resolution to the FRB and the FDIC. Foreign banking groups
with US operations must also comply with this requirement. The plan must include
(US Congress, 2010):
(A) information regarding the manner and extent to which any insured depository institution
af?liated with the company is adequately protected from risks arising from the activities of
any nonbank subsidiaries; (B) full descriptions of the ownership structure, assets, liabilities,
and contractual obligations of the company; (C) identi?cation of the cross-guarantees tied to
different securities, identi?cation of major counterparties, and a process for determining to
whom the collateral of the company is pledged.
This resolution plan is to be accompanied by a credit exposure report.
The implementation details were left to the FRB and FDIC. They published the
implementing regulation on November 1, 2011 (FDIC and FRB, 2011b), that
emphasized living wills should indicate how the covered company can be sold, broken
up, or wound down quickly and effectively without jeopardizing US ?nancial stability.
Living wills must include:
.
an executive summary with a strategic analysis describing the ?rm’s plan for a
rapid and orderly resolution (without, however, de?ning what period of time
quali?es as “rapid”);
.
a description of how resolution planning is incorporated in the ?rm’s corporate
governance structure;
.
a description of the group’s overall organizational structure that includes a
hierarchical list of all material entities, as well as jurisdictional and ownership
information and mapping of core business lines and critical operations into
corporate entities;
.
a description of management information systems that support the covered
company and its material entities, including a detailed inventory and description
of key applications along with identi?cation of the legal owner or licensor and
related service level agreements;
.
a description of interconnections and interdependencies among a covered
company and its material entities and the covered company’s critical operations
and core business lines along with a description of how service levels would be
sustained during a material ?nancial distress or insolvency; and
.
identi?cation of supervisory authorities and regulators that oversee the covered
company.
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For the largest andmost complicatedbankinggroups that have thousands of subsidiaries,
the third requirement has been onerous. It demands not only a mapping of lines of
business into corporate entities, but also details regarding material entities, critical
operations andcore business that, at a minimum, describe types andamounts of liabilities.
It alsorequires details about the bookingof tradingandderivatives activities, as well as an
identi?cation of major counterparties including descriptions of any interconnections or
interdependencies among them. Finally, it requires that covered companies list all
material trading, payment, clearing and settlement systems in which they participate.
Most of these requirements can be seen as attempts to minimize the prospect of a
Lehman-Brothers-like disorderly bankruptcy by ensuring that both covered companies
and regulators have thought through the end game in advance.
The compliance costs for both covered companies and the regulatory authorities
have been very heavy[15]. 11 ?rms submitted living wills in 2012. Several of the
submissions were reported to be thousands of pages in length. Based on an early
evaluation of these submissions, William Dudley, President of the Federal Reserve
Bank of New York, concluded that:
[. . .] this initial exercise has con?rmed that we are a long way from the desired situation in
which large complex ?rms could be allowed to go bankrupt without major disruptions to the
?nancial system and large costs to society. Signi?cant changes in structure and organization
will ultimately be required for this to be achieved.
While the D-F Act generally supports greater market discipline, it does not address the
issue of public disclosure of resolution plans. The FRB and FDIC, however, have
required disclosure of a public section of the plan containing an executive summary
that describes the business of the covered company including: “(i) the names of
material entities; (ii) a description of core business lines; (iii) consolidated or segment
?nancial information regarding assets, liabilities, capital and major funding sources”.
During the comment period following the Advance Notice of Proposed Rulemaking
(ANPR), the FRB and FDIC received many expressions of concern from the industry
regarding the possibility that details of the resolution plan might be made public through
the Freedom of Information Act (FDIC and FRB, 2011b, p. 67326). The ANPR dealt
with the issue by requiring that any covered company that desired con?dential treatment
of the information must ?le a request for con?dential treatment under the general rules of
the FDICand FRB(2011a, p. 22660). This was essentially an opt-out approach that left the
institutionwiththe burdenof justifyingwhether some informationshouldbe con?dential.
In the commentary preceding the ?nal proposal, the FDIC and FRB (2011b, p. 67322)
tried to ease these fears and added their own concern that:
[. . .] release of this information would impede the quality and extent of information provided
by covered companies and could signi?cantly impact the efforts of the Board and the
Corporation to encourage effective and orderly unwinding of the covered companies in a
crisis.
The upshot was a disclosure requirement observing that FDIC and FRB (2011b,
p. 67332):
While information in the public section of a resolution plan should be suf?ciently detailed to
allow the public to understand the business of the covered company, such information can be
high level in nature and based on publicly available information.
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In effect, this creates a safe harbor for an institution that does not wish to disclose any
information that is not already publicly available.
If the information is already publicly disclosed, it is not clear what value this
disclosure requirement adds. This timid approach represents a signi?cant lost
opportunity. If the authorities had been serious about enhancing market discipline, they
should have required disclosure of information that would enable potential creditors of
the covered company to understand the statutory hierarchy of claims on the various
entities in resolution, and precisely how the authorities propose to conduct a resolution.
In the absence of such information, creditors cannot be expected to price claims
ef?ciently. Moreover, some of the information in the ?rst round of disclosures falls short
of the more modest goal of helping the public understand the business of the covered
company because it is dif?cult to reconcile with other publicly available information.
The next section summarizes and analyzes the data provided by the 11 banking groups
that submitted resolution plans during 2012. The ?nal section argues that the lack of
agreement on howcross-border ?rms will be resolved casts a huge uncertainty over how
an international insolvency would be dealt with.
5. How informative are public sections of living wills?
The 11 banking groups that submitted their living wills in 2012 include seven US
institutions – Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs,
JPMorgan Chase, Morgan Stanley, State Street Corporation – and four foreign banking
groups – Barclays, Credit Suisse, Deutsche Banks, UBS[16]. In their implementing
regulation, the FRB and FDIC speci?ed the format that each resolution plan should
follow. We focus on aspects of the public section of the living will that might have
improved market discipline if they had been more rigorously speci?ed and carefully
implemented[17].
A major weakness of the disclosure format is the vague way in which the
authorities have de?ned material entities: “material entity means a subsidiary or
foreign of?ce of the covered company that is signi?cant to the activities of a critical
operation or core business line” (FDIC and FRB, 2011b, p. 67335). Critical operations, in
turn, are de?ned as:
[. . .] those operations of the covered company, including associated services, functions and
support, the failure or discontinuance of which, in the view of the covered company or as
jointly directed by the Board and the Corporation, would pose a threat to the ?nancial
stability of the USA (FDIC and FRB, 2011b, p. 67335).
No speci?c asset or income threshold has been set for identifying material entities that
may be either branches or subsidiaries[18]. This may be appropriate in cases in which
a key entity that services the group, such as providers of information technology or
risk management services, has been set up as a separate entity. In fact, such entities are
material even though they have negligible income or balance sheets.
Although we have no way of identifying material entities that have negligible income
statements or balance sheets, it is possible to check whether the material entities that the
banking groups chose to list include all of the entities that have a balance sheet size
exceeding the $50 billion threshold – the same threshold which at the consolidated level
would require bank holding companies to ?le a resolution plan under the D-F Act.
To determine whether entities that exceed the $50 billion threshold have been omitted,
Living wills
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we have used Bankscope data fromMay 2013, data fromSEC ?lings as of yearend 2011,
Federal Reserve/National Information Center data as of June 2012, information available
in the banks’ annual reports and other information published on their web sites[19].
The results (Table I) indicate that eight of the 11 banking groups did not identify a few
large subsidiaries withassets greater than$50 billionas material entities. Table I displays
the number of material entities reported byeach of the 11 bankinggroups andthe number
and name of subsidiaries with more than $50 billion that were not identi?ed as material
entities in the public section of the resolution plan. Most “missing” material entities are
intermediate holdingcompanies, but inthe absence of additional informationabout where
suchholdingcompanies sit inthe legal organizationstructure of the group, it is impossible
to tell whether such information might be redundant because all of the material entities
that are subsidiaries of anholding company – or its parent holdingcompany – have been
reported. Of course, even if all of the main subsidiaries, or controlling entities, of the
holding company are reported, information about an omitted holding company may be
important as well, especially if it issues debt or makes guarantees to other af?liates.
The FDIC/FRB implementing rule requires that each group provide a hierarchical
list of material entities. Oddly, these appear to have been omitted from the public
section. No organization or corporate structure tree chart is provided[20], much less
information about the percentage of ownership in each subsidiary. Presumably, the
con?dential section of the plan contains such information, but no clear case has been
made about why such information should be excluded from the public portion of the
plan. With considerable effort some of this information can be gleaned from other
public documents, but it is not readily available in a format that is easy to compare
across institutions.
At least some of these “missing” material entities might be regarded as material.
For example, both Bank of America and Citigroup have disclosed high level
organizational structure trees on their web sites. These are purported to include the
material holding companies of each group, but some of these holding companies are
not included in the public sections of their resolution plans. In Figures 2 and 3, we have
circled the large subsidiaries (all holding companies) that are missing from the relevant
public section of each living will[21]. In some cases it is clear from information
outside the living wills that such entities could have important interactions with other
af?liates in the group. For example, Citigroup Global Markets Holdings Inc. may have
signi?cant liabilities to af?liated depository institutions[22].
One can only speculate about why such entities are omitted from the public sections
of living wills, but this does raise troubling questions about the criteria that have been
employed to select the reported entities.
Surely investors would gain a better understanding of the groups’ business and
structure if they were required to provide detailed explanations about their decision
criteria and an organizational chart including, at a minimum, the type of business, the
legal form, the location, total assets and the percentages of ownership for each of the
displayed entities. Without more quantitative and qualitative details on material
entities and the methodology to select them, the public sections of the living wills are
less informative than they should be. Moreover, it is dif?cult to imagine that a strong
rationale could be advanced that this sort of information should be proprietary.
Although it is crucial to have better information about the reported material entities,
the other entities that are implicitly deemed “non-material” should not be ignored
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Material entities
in resolution plans
Living wills
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JFEP
5,4
374
D
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(
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altogether, if only because of their magnitude. For example, Citigroup listed seventeen
material entities, but in fact it had 2,319 subsidiaries according to the Federal
Reserve/National Information Center data as of June 30, 2012. While many of these
subsidiaries may be irrelevant for understanding how an institution would be resolved,
the living will should at least categorize these subsidiaries and explain why they are
not relevant to the orderly resolution of the group.
More broadly, much of the other information contained in the public section of
the living wills seems far more general than it should be if the objective is to
enhance public understanding of the group’s business or enhance market discipline.
Figure 2.
The corporate structure
of Bank of America
Notes: Red circles indicate the large subsidiaries not included in the material entities list in the
public section of Bank of America resolution plan submitted in 2012;
a
this chart includes only
select major operating subsidiaries and asssociated material holding companies of Bank of
America Corporation. Not all subsidiaries of Bank of America are represented;
b
reflects a
majority-owned subsidiary
Source: Bank of America web site, own elaborations
Living wills
375
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Table II summarizes the information provided regarding the number of core business
lines, the number of entities with balance sheet or income statement data reported, the
number of material payment, clearing and settlement systems in which the group
participates and the number of supervisory authorities that oversee the ?rm.
In virtually every case, the lack of speci?city in the “material entity” concept
undermines the usefulness of the other information disclosed and the resulting
differences across institutions can be very large. For example, the number of core lines of
business varies from State Street Corporation, which lists 2, to JPMorgan Chase, which
identi?es 30. The average for the 11 institutions is eight. While business models across
Figure 3.
The corporate
structure of Citigroup
Notes: Red circles indicate the large subsidiaries not included in the material entities list in the
public section of Citigroup resolution plan submitted in 2012;
a
for a list of ratings for
Citigroup Investor Relations website:http://www.citigroup.com/citi/investor/rate.htm
Source: Citigroup web site, own elaborations
JFEP
5,4
376
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the 11 banking groups do differ signi?cantly in many respects, one is left with the
uncomfortable feeling that differing de?nitions of “core business lines” may also play a
role[23]. Although the groups report basic information about the business conducted by
each material entity, it is generally left to the reader to map lines of business into material
entities and, even then, it is not clear how these might be preserved in the bankruptcy
process.
Financial data about material entities are very sparse, usually including only the
assets and liabilities (and sometimes income data) of the largest depository institution,
which must disclose its balance sheets periodically in any event[24]. While this is
consistent with the FRB/FDIC requirement, it leaves huge gaps in a reader’s
understanding of the material entities and how they operate.
The systemicallyimportant ?nancial institutions were requiredto indicate the number
of “material” payment, clearing and settlement systems in which they participate, as well
as the number of “material” supervisors and regulators with whom they must interact.
This information is often used as a proxy for the complexity and interconnectedness of a
?nancial institution that are believed to be two aspects of systemic risk.
Number of
core business
lines
Number of entities with
individual balance
sheet/income data
reported
Number of material
payment, clearing and
settlement systems
Number of material
supervisory
authorities
a
Bank of
America
5 2 (depository
institutions)
15 8
Bank of
New York
Mellon
4 1 (depository
institution)
15 11
Barclays
(USA)
b
4 2 (1 depository branch,
1 broker-dealer)
18 19
Citigroup 12 1 (depository
institution)
16 10
Credit
Suisse
11 0 11 18
Deutsche
Bank
(USA)
b
10 0 16 10
Goldman
Sachs
4 1 (depository
institution)
c
19 45
JPMorgan
Chase
30 2 (depository
institutions)
18 11
Morgan
Stanley
3 1 (depository
institution)
19 19
State Street
Corporation
2 0 10 13
UBS (USA)
b
7 0 na 14
Notes:
a
Italics indicates that the bank reports only supervisory authorities of material entities;
we have included in our calculations only supervisors explicitly named;
b
information largely related to
US operations;
c
included in the resolution plan for the depository institution submitted as a separate
document
Source: Public section of banks’ 2012 resolution plans
Table II.
Overview of selected
information provided
by banking groups
in the public portion
of resolution plans
Living wills
377
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Clearly the groups have taken the materiality guideline quite rigorously in reporting
these two dimensions of proxies for systemic risk. Citigroup is reported to be
a participant in 550 clearing and settlements systems in another source (Herring, 2013).
While many of these may not be material, it is crucial to understand what standard of
“materiality” is being applied. Similarly, the largest number of material supervisory
authorities, 45, is reported by Goldman Sachs, which is by no means the largest or most
complicated group. Indeed, most of these groups are active in more than 45 countries
and so it is dif?cult to infer what standard of materiality has been employed and what
the information implies about the dif?culty of resolving the ?rm.
In short, the FDIC/FRB regulation set up guidelines for the public section of living
wills that permitted groups to avoid providing any new information even if it was
critical to understanding how dif?cult it would be to resolve an institution. Our
examination of the actual public sections of the reports indicates that most groups took
full advantage of their discretion to maintain con?dentiality of information that is
crucial to understanding how easily they could be resolved without, in many cases, any
plausible rationale for holding such details in con?dence. Nonetheless, even if the groups
had been more forthcoming with information, investors and creditors would still be
unable to price claims ef?ciently because of?cials have not yet agreed on how to handle
cross-border resolutions.
6. Why resolution policy remains uncertain
The crisis revealedthe US lacked a coherent regime for resolving systemicallyimportant
global ?nancial institutions. In this it was not alone. The Basel Committee on Banking
Supervision (2010) concluded that no country had a framework for adequately
addressing the problems that arise in the resolution of a purely domestic banking
conglomerate, much less a cross-border or global systemically important institution.
The D-F reforms were intended to enhance the ability of the authorities to resolve a
purely domestic institution. Since the new regime remains untested, it is too early to
judge whether it is suf?cient to resolve a large institution without cost to taxpayers
and without threatening ?nancial stability. The cross-border aspects of resolution
policy remain a challenge and the obstacles are formidable.
A cross-border resolution is bound to involve multiple supervisory authorities with
differing statutory powers and responsibilities. Some may be charged with taking
?nancial stability into account, others may simply be responsible for taking whatever
measures they can to protect the customers of the part of the group they oversee.
In addition to these differences in objectives, bankruptcy and administrative processes
differ markedly, as do the competencies and powers of individual supervisory and
regulatory authorities. The sheer number of authorities whose actions must be
coordinated is mind boggling. One moderately large foreign bank, not large enough to
be included on the FSB list of Global Systemically Important Banks (G-SIBs), held a
meeting of its key national and international regulators to discuss its resolution plan
and was obliged to convene the meeting in a large hotel ballroom.
Since November 2010, the members of the FSB have been developing resolution
strategies, operational resolution plans and ?rm-speci?c cross-border cooperation
agreements that establish a process for cooperation and information sharing. In its
April 2013 progress report, however, the FSB (2013, p. 1) concluded that:
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[P]rogress has been relatively slow both because the issue is complex and because in many
jurisdictions the powers necessary for implementing a preferred resolution strategy have not
yet been provided.
This is particularly worrisome with regard to the European Union because it is home to
a large number of G-SIBs and several of these institutions hold more assets outside
their home country than within.
Table III lists 11 European banking groups and one US banking group (Citigroup)
that have less than half of their assets in the home country. In order for the market to
function properly, it needs to understand not only living wills, but also what the
authorities will do in a crisis. In the absence of ?rm, credible and binding cooperation
agreements, it must remain a matter of speculation.
The problem is complicated by the fact that the authorities have not achieved a
consensus on the appropriate model for cross-border resolution. Idealists favor a
universalist approach in which insolvency laws are harmonized and an insolvent ?rm’s
assets are pooled in one proceeding and shared equitably across claimants without regard
to where they reside or which part of the group they have dealt with. Cynics consider this
approachtobe the Esperanto of resolutionpolicies andbelieve that no matter what of?cials
saythey will ringfence those parts of the failing institution that they cancontrol inthe end.
Banking groups
Total assets
in US$
billion
World
assets
rank
Home country as
% of total assets
Rest of region as
% of total assets
Rest of world as
% of total assets
1. Deutsche bank
(Germany) 2,800 1 34 32 34
2. HSBC (UK) 2,556 3 35 11 54
3. BNP Paribas
(France) 2,543 4 49 34 17
4. Barclays (UK) 2,417 7 34 27 39
5. Citigroup
(USA) 1,874 14 36 21 43
6. Banco
Santander
(Spain) 1,619 17 27 41 32
7. UBS
(Switzerland) 1,508 19 36 20 44
8. ING bank (The
Netherlands) 1,244 23 40 38 22
9. UniCredit
(Italy) 1,199 24 42 56 2
10. Credit Suisse
Group
(Switzerland) 1,115 25 21 26 53
11. Nordea group
(Sweden) 927 27 21 74 5
12. Standard
Chartered (UK) 599 41 15 4 81
Source: Schoenmaker (2013, p. 62)
Table III.
Large international
banking groups
with . 50 percent of
assets outside home
country, yearend 2011
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These extremes are re?ected to some extent in two approaches that are widely
discussed: a single point of entry strategy (SPE) and a multiple point of entry strategy
(MPE). The Bank of England and the FDIC (2012) have developed a SPE strategy. This
approach attempts to leapfrog the seemingly hopeless task of harmonizing national
bankruptcy laws and resolution procedures by vesting resolution powers in a single
resolution authority that is responsible for overseeing the top holding company or
parent company in a G-SIB. The responsibility of the single resolution authority would
be to ensure that the top level institution would be restructured in such a way that it
would serve as a source of strength by recapitalizing subsidiaries and down-streaming
liquidity as necessary. The hope is that this would ?nesse most cross-border problems
by preserving the assets and operations of subsidiaries on a going concern basis.
This presumes that the top level entity will be required to be suf?ciently
well-capitalized to absorb losses throughout the group – and, indeed, that the group is
structuredinsucha waythat there is a clear top-level entity. Of course, this canonlywork
if the single resolution authority has access to suf?cient resources to maintain the
subsidiaries in the group while the restructuring of the top level institution takes place,
whichmaybe anissue inseveral countries that are host to institutions withliabilities that
are a substantial multiple of domestic GDP. Moreover, in the case of the USAit appears to
assume that resolution will take place under the administrative procedures of Title II of
the D-F Act rather than the bankruptcy resolution plans required in the livings wills.
This approach raises tricky issues in a scenario in which a foreign subsidiary is the
major source of losses and should be liquidated. The authorities, of course, do not want
to be in the position of propping up an institution that has no going-concern value. But
once they admit the possibility that some foreign subsidiaries may not be protected,
creditors have reason to be concerned about all of the foreign subsidiaries and it may
not be possible to implement the resolution without creating unwanted spillovers as
creditors engage in a ?ight to quality.
In addition to the hope that foreign authorities can be convinced to forbear and leave
the resolution to the headquarters authority, the laws underlying many ?nancial
contracts will need to be changed or the single resolution authority will need to have the
ability to impose a stay. Otherwise the initiation of resolution proceedings with regard to
the top-level entity can be interpreted as an event of default that permits counterparties
to terminate their ?nancial contracts. This could destabilize markets and frustrate the
attempt of the single resolution authority to ensure the continuity of operations.
A MPE strategy involves the application of resolution powers by multiple
authorities to multiple parts of the group and the break-up of the group into separate
parts along national, regional or functional lines. Unless the multiple authorities have
?rm agreements about how to coordinate their actions and allocate losses, this
approach amounts to ring fencing[25]. This approach is opposed by most G-SIBs
because they believe it would reduce the ef?ciency with which they can allocate capital
and liquidity within the group.
It is dif?cult to imagine both approaches operating simultaneously without causing
enormous uncertainty – not unlike the current situation. The key point, however, is that
how the cross-border resolution will be conducted is a critical factor that must be taken
into account in valuing the claims on any entity within the group. When this uncertainty
is considered in conjunction with the meager public disclosures in living wills, market
discipline cannot be expected to reinforce and support regulatory discipline.
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Despite an enormous amount of effort, one must conclude that we do not yet have
the framework to undertake the orderly resolution of a G-SIB. This means that these
institutions are likely to enjoy an implicit subsidy that is completely unrelated to their
ef?ciency or the quality of their services. Too-big-to-fail may be too-costly-to-continue,
but a solution to the problem remains elusive.
Notes
1. Failures were counted as direct bankruptcies, conservatorships, or substantial government
interventions. They numbered 26 over these two decades.
2. For example, Dudley (2012), in the mid-1990s, the top ?ve banks in the USA had total assets
of $1 trillion or about 14 percent of GDP. By the end of 2007, the top ?ve banks had assets of
$6.8 trillion or 49 percent of GDP. Similarly, in the mid-1990s, the top securities ?rms had
total asset equal to about 9 percent of GDP. By the end of 2007, these had grown to
$3.8 trillion, about 27 percent of GDP.
3. The resolution process was much more orderly for smaller banks that were entirely subject
to FDIC administrative procedures.
4. This is an unusually clear example of the law of unintended consequences. The EU
threatened to force the large American investment banks to form holding companies in
Europe if they did not submit to consolidated supervision by a competent authority.
Although it had no prior experience, the SEC somehow convinced the EU that it was a
competent supervisory authority and in 2004 the ?ve largest investment banks became
voluntary Consolidated Supervised Entities (CSEs) subject to Basel II-like capital regulation.
When they measured their required capital under Basel-like rules that had been extended to
the net capital computation for the broker-dealer, the ?ve CSEs discovered that they had
considerable excess regulatory capital and quickly increased their leverage, which was
surely not what the EU intended. See Lo (2012, p. 34) for an analysis of the regulatory
change, emphasizing that before 2004, the holding companies of the broker/dealers had not
been subject to any oversight or leverage constraint. Lo also raises doubts about the
magnitude of the impact of the change in rules on leverage. Kwak (2012), however, notes that
Lo’s analysis fails to emphasize a key point: the SEC’s intent was to permit the large
broker/dealers to substitute mathematical models for traditional risk weights so that the
net-capital calculation would “probably will be lower”.
5. Lehman’s debt to equity ratios often exceeded 40:1, and during the middle of any reporting
period might go up to 60:1 (Miller and Horwitz, 2013).
6. Lehman exceeded its risk limits by margins of 70 percent with regard to commercial real
estate and 100 percent with regard to leveraged loans (Valukas, 2010, p. 50).
7. Valukas (2010) gives a full account of the so-called 105 repo transactions that could be
reported as sales rather than borrowings.
8. By September 12, 2008, two days after reporting $41 billion in its liquidity pool, Lehman had
less than $2 billion of readily monetizable assets (Valukas, 2010, p. 10).
9. The authorities claimed that they lacked legal authority to make a direct investment in
Lehman and that Lehman’s assets were insuf?cient to support a loan large enough to avoid
collapse.
10. It should be noted that this relatively benign result was unlikely to have happened if not for
the substantial liquidity provided to the broker/dealer by the Federal Reserve while it was
being prepared for a SIPC resolution.
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11. Desmos (2010) reported that the total fees paid to lawyers, administrators and other advisers
in the Lehman bankruptcy through October 2010 totalled nearly $2 billion. At least 1,300
people have been working on the Lehman bankruptcy since it began. This, of course, was
merely an interim report.
12. Luckily, many of the world’s largest banks had not yet made a full transition from Basel I to
Basel II, so that when the crisis hit these banks had a somewhat greater ability to absorb
losses than if they had been fully authorized to operate under the Basel II advanced internal
models approach.
13. See the Appendix 1 for a summary of the EU proposal on bank recovery and resolution
plans, contained in the directive harmonizing bank crisis resolution tools and procedures
proposed by the European Commission in 2012 and currently under discussion.
14. Although “resolution plan” is the of?cial name for such documents, they are commonly
referred to as a “living will” or, more sardonically, a “funeral plan”. In the remainder of the
text we will generally use the terms “resolution plans” and “living wills” interchangeably.
15. The ANPR (FDIC and FRB, 2011b) estimated that averaged over the 124 covered companies,
the initial burden of compliance would be 12,400 hours. For the largest institutions, the
number of hours required to comply with the regulation was surely a substantial multiple of
this amount. The burden on the supervisory agencies to analyze and evaluate the data has
undoubtedly been quite substantial as well.
16. The resolution plans ?led by foreign banking groups mainly focused on US operations and
entities.
17. We will not, for example, comment on the institution’s responsibility to provide a high-level
resolution plan because in most instances the information was so high-level as to be
uninformative. In addition, we have sympathy with the reluctance of institutions to specify
to whom they might sell various lines of business because the grounds for maintaining
con?dentiality about this sort of information seem self-evident on competitive grounds.
18. Luciano and Wihlborg (2013) emphasize that the practical distinction between a subsidiary
and a branch in cross-border banking is often quite blurred. Some countries oblige foreign
branches to meet liquidity and capital requirements within the host country as if they were
separately incorporated subsidiaries.
19. See the Appendix 2 for details regarding the statistical benchmarks.
20. With the partial exception of Morgan Stanley’s (2012, p. 24) submission for the depository
institution.
21. Three “missing” material entities of Citigroup are not shown in Figure 3: Citigroup Funding
Inc., Citigroup Korea Inc. and Citigroup Overseas Holdings GK.
22. “Some of Citigroup’s non-bank subsidiaries have credit facilities with Citigroup’s subsidiary
depository institutions, including Citibank, N.A. Borrowings under these facilities are
secured in accordance with Section 23A of the Federal Reserve Act. Citigroup Global
Markets Holdings Inc. (CGMHI) has borrowing agreements consisting of facilities that
CGMHI has been advised are available, but where no contractual lending obligation exists.
These arrangements are reviewed on an ongoing basis to ensure ?exibility in meeting
CGMHI’s short-term requirements”. (Citigroup, 2012a, p. 217).
23. The FDIC/FRB regulation de?nes core business lines as “those business lines, including
associated operations, services, functions and support that, in the ?rm’s view, upon failure
would result in a material loss of revenue, pro?t, or franchise value” (FDIC and FRB, 2011a,
p. 67334).
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24. Moreover, banking groups also have to submit to the FDIC a resolution plan for their
depository institutions with at least $50 billion in total assets, as required by a January 2012
FDIC rule. In most cases this plan was incorporated in the same public document with the
resolution plan for the banking group.
25. New Zealand has taken this position and attempted to apply it more rigorously than any
other national authority. It has tried to ensure that even if the foreign parents of their four
largest banks should fail, the New Zealand subsidiaries could continue to operate. See the
contribution of Mayes (2013) in this issue.
26. These groups were required to submit their resolution plans by July 1, 2012 as their nonbank
assets (US nonbank assets for foreign covered companies) were at least equal to $ 250 billion.
A second group of banks, with total nonbank assets between $ 100 billion and $ 250 billion,
had to submit their plans by July 1, 2013; ?nally, covered companies with less than
$100 billion in total nonbank assets must submit their plans by December 31, 2013. BNP
Paribas, HSBC, Royal Bank of Scotland and Wells Fargo submitted their plans in the second
round and the public sections were released by regulators on July 2, 2013. In our analysis we
have focused on the resolution plans submitted in the ?rst round in 2012.
References
Ayotte, K. and Skeel, D. (2010), “Bankruptcy or bailouts?”, Journal of Corporate Law, Vol. 35.
Bank of England and FDIC (2012), “Resolving globally active, systemically important, ?nancial
institutions”, A Joint Paper by the Federal Deposit Insurance Corporation and the Bank of
England, December 10.
Basel Committee on Banking Supervision (2010), Report and Recommendations of the
Cross-border Bank Resolution Group, Basel Committee on Banking Supervision, Basel,
March.
Cairns, A. (2009), “Breaking the insolvency mould”, International Corporate Rescue,
Vol. 6 No. 2, p. 115.
Citigroup (2012a), Annual Report on Form 10K, Citigroup, New York, NY.
Desmos, T. (2010), “Lehman’s US bankruptcy costs top $1 bn”, Financial Times, November 23,
available at: www.ft.com/intl/cms/s/0/39d642a0-f699-11df-b434-00144feab49a.html
Dudley, W. (2012), “Solving the too big to fail problem”, Remarks at the Clearing House’s Second
Annual Business Meeting and Conference, November 15.
European Commission (2012), Proposal for a Directive of the European Parliament and of the
Council Establishing a Framework for the Recovery and Resolution of Credit Institutions
and Investment Firms and Amending Council Directives 77/91/EEC and 82/891/EC,
Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC and 2011/35/EC
and Regulation (EU) No. 1093/2010, COM(2012) 280 Final, European Commission,
Brussels, June 6.
FDIC and FRB (2011a), “Resolution plans and credit exposure reports required, proposed rule;
request for public comment”, Federal Register, Vol. 76 No. 78, pp. 22648-22662.
FDIC and FRB (2011b), “Resolution plans required, ?nal rule”, Federal Register, Vol. 76 No. 211,
pp. 67323-67340.
FSB (2011), Key Attributes of Effective Resolution Regimes for Financial Institutions, Financial
Stability Board, Basel, October.
FSB (2013), “Implementing the FSB key attributes of effective resolution regimes – how far have
we come?”, Report to the G20 Finance Ministers and Central Bank Governors, April 15.
Living wills
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Herring, R. (2002), “International ?nancial conglomerates: implications for bank insolvency
regimes”, Policy Challenges for the Financial Sector in the Context of Globalization,
Proceedings of the Second Annual Policy Seminar for Deputy Central Bank Governors,
Federal Reserve Bank/IMF/World Bank.
Herring, R. (2013), “The case for rapid resolution plans”, Review of Economics & Finance, Vol. 3,
pp. 1-7.
Kuritzkes, A. (2010), “A safer world ?nancial system – improving the resolution of systemic
institutions, Geneva report: discussion”, overhead presentation at the Geneva Conference,
May 7.
Kwak, J. (2012), “What didthe SECreally do in2004?”, The Baseline Scenario, January 30, available
at:http://baselinescenario.com/2012/01/30/what-did-the-sec-really-do-in-2004/
Lo, A. (2012), “Reading about the ?nancial crisis: a 21-book review”, Journal of Economic
Literature, Vol. 50 No. 1, pp. 151-178.
Luciano, E. and Wihlborg, C. (2013), “The organization of bank af?liates: a theoretical
perspective on risk and ef?ciency”, International Centre for Economic Research,
Working Paper No. 6/2013, May.
Mayes, D. (2013), “Achieving plausible separability for the resolution of cross-border banks”,
Journal of Financial Economic Policy, Vol. 5.
Miller, H.R. and Horwitz, M. (2013), Resolution Authority: Lessons from the Lehman Experience,
Weil, New York, NY.
Morgan Stanley (2012), Resolution Plan, Morgan Stanley, New York, NY, June 29.
Schoenmaker, D. (2013), Governance of International Banking – The Financial Trilemma, Oxford
University Press, New York, NY.
US Congress (2010), “The Dodd-frank wall street reform and Consumer Protection
Act”, 111th Congress of the United States of America, January 5.
Valukas, A. (2010), Report of Anton R. Valukas, Examiner, on Lehman Brothers Holdings Inc.,
United States Bankruptcy Court, Southern District of New York, New York, NY, March.
White House (2008), Declaration of the Summit on Financial Markets and the World Economy,
Of?ce of the Press Secretary, Washington, DC, November 15.
Further reading
Bank of America (2012), Bank of America Corporation Resolution Plan, Bank of America, N.A.
Resolution Plan, FIA Card Services, N.A. Resolution Plan, Public Executive Summary,
Bank of America, Charlotte, NC.
Bank of NewYork Mellon (2012), BNYMellon Resolution Plan, Public Section, Bank of NewYork
Mellon, New York, NY, October 1.
Barclays (2012), Resolution Plan, Section 1: US Public Section, Barclays, London, July.
Citigroup (2012b), Resolution Plan for Citigroup Inc. & Citibank, N.A., Section 1: Public Section,
Citigroup, New York, NY, June 29.
Credit Suisse (2012), Credit Suisse Global Recovery and Resolution Plan, Chapter 1 – Public
Section, Credit Suisse, Zu¨rich, June 29.
Deutsche Bank (2012), Deutsche Bank Resolution Plan, Section 1 – Public Section, Deutsche
Bank, Frankfurt, June 29.
Goldman Sachs (2012), Summary of Resolution Plan, Goldman Sachs, New York, NY, June 29.
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JPMorgan Chase & Co. (2012), Resolution Plan, Public Filing, JPMorgan Chase & Co., New York,
NY, July 1.
State Street Corporation(2012), ResolutionPlanfor State Street Corporation&State Street Bankand
Trust Company, Section 1: Public Section, State Street Corporation, Boston, MA, October 1.
Taylor, J. (2008), “The ?nancial crisis and the policy responses: an empirical analysis of what
went wrong”, A Festschrift in Honor of David Doge’s Contributions to Canadian Public
Policy, Bank of Canada, November, pp. 1-18.
UBS (2012), Resolution Plan, Section 1 – Public Section, UBS, Zu¨rich.
Appendix 1. The EU approach to bank recovery and resolution plans
In the European Union, the European Commission presented in June 2012 a proposal for a directive
on bank recovery and resolution, with the goal of introducing new bank crisis management and
resolution tools to facilitate orderly resolution and avoid bailouts (European Commission, 2012).
Negotiations with the European Parliament and the Council of the European Union to adopt the
?nal legislation are still in progress (the most recent compromise has been reached at the end of
June 2013, with a ?nal approval expected by the end of 2013).
The directive aims to harmonize policy instruments and procedures to deal with banking crises
across EU countries and to improve the ability to manage the crisis and failure of cross-border
banks. The proposal included provisions on preparation and prevention, early intervention and
resolution tools and powers. Preparation and prevention measures include the requirement for
banking groups and individual institutions within a group to prepare recovery plans, and for
authorities to draw up resolution plans for them. Colleges of resolution authorities are also
introduced, in which home and host countries resolution authorities participate under the lead of
the group (home) resolution authority; the European Banking Authority would participate too,
facilitating joint actions and acting as binding mediator in case of need. Finally, the proposed
directive also requires the creation of national resolution funds to bear the costs related to
resolution procedures (e.g. provide capital for a bridge bank), but never to bail out banks: these
funds would have to be ?nanced to a large extent by risk-based fees paid ex-ante by banks.
The directive introduces a requirement for banking groups to prepare and submit a recovery
plan to their consolidating supervisor, which will transmit it to resolution authorities. The plan
should include measures for the stabilization of the group as a whole in case of distress, indicating
also arrangements for intra-group ?nancial support. The preparation and submission of the
recovery plans shall have at least an annual frequency, and an updated version should be
presented in case of changes to the legal or organizational structure of the institution, its business
or its ?nancial situation. The plans must include a wide range of information, including:
a communication and disclosure plan outlining how the ?rm intends to manage any potentially
negative market reactions; a range of capital and liquidity actions required to restore the
institution’s ?nancial position; the identi?cation of critical functions; a detailed description of the
processes for determining the value and marketability of the core business lines, operations and
assets of the institution; arrangements and measures to reduce risk and leverage, to restructure
liabilities andbusiness lines, to maintainthe continuous functioningof the institution’s operational
processes, including infrastructure and ITservices; preparatory arrangements to facilitate the sale
of assets or business lines in a timeframe appropriate for the restoration of ?nancial soundness.
Competent authorities, after consultation with relevant foreign authorities, must assess the
effectiveness of the measures proposed in the recovery plan to rapidly restore viability without
producing adverse effects on the ?nancial system; the European Banking Authority will develop
guidelines specifying minimum criteria to be followed for such assessment. If competent
authorities are not satis?ed with the plan, they may request the institution to revise the plan: if it
fails to submit the revised plan or changes are not considered satisfactory, then authorities may
direct the institution to take corrective measures, such as a reduction of the risk pro?le of the
bank, timely recapitalization, changes to the funding strategy or to the governance structures.
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While banks are required to draw up recovery plans, resolution authorities are entrusted with
the preparation of resolution plans, outlining the resolution measures that will be adopted if the
bank is taken through resolution. Resolution authorities, however, may require the banks to assist
theminthe preparationandupdatingof the resolutionplan, and their requests mayconcern, among
other issues, the following information: a detailed description of the institution’s organizational
structure includinga list of all legal entities; the identi?cationof the direct holder andthe percentage
of voting and non-voting rights of each legal entity; the location, jurisdiction of incorporation,
licensing and key management associated with each legal entity; a mapping of the institution’s
critical operations and core business lines by reference to legal entities; a detailed description of the
components of the institution’s andall its legal entities’ liabilities, separatingat a minimumbytypes
and amounts of short term and long term debt, secured, unsecured and subordinated liabilities;
a description of the off-balance sheet exposures of the institution and its legal entities, including
a mapping to its critical operations and core business lines; the identi?cation of the major or most
critical counterparties of the institution as well as an analysis of the impact of the failure of major
counterparties on the institution’s ?nancial situation; each payment, clearing or settlement system
of which the institution is directly or indirectly a member, including a mapping to the institution’s
legal entities, critical operations and core business lines; an identi?cation and mapping of the legal
entities and the interconnections and interdependencies among the different legal entities
(e.g. capital, funding and liquidity arrangements, cross-guarantee arrangements).
As for recovery plans, resolution plans must be updated at least annually or in case of changes
to the legal or organizational structure of the institution, its business or its ?nancial position that
might have an impact on the plan. The latter shall include a demonstration of how critical
functions andcore business lines could be legally andeconomically separated fromother functions
so as to ensure continuity upon the failure of the institution; a description of the processes for
determining the value and marketability of the critical functions, core business lines and assets of
the institution; an explanation by the resolution authority on how the resolution options could be
?nanced without any extraordinary public ?nancial support; a detailed description of the different
resolution strategies that could be applied according to the different possible scenarios;
a description of critical interdependencies; a description of essential operations and systems for
maintaining the continuous functioning of the institution’s operational processes.
If resolution authorities identify signi?cant impediments to the resolvability of a group, they
may require the institution to take measures in order to facilitate its resolvability. Such measures
might include a reduction of complexity through changes to legal or operational structures in
order to ensure that critical functions can be legally and economically separated from other
functions; the drawing up of service agreements to cover the provision of critical functions; limits
to maximum individual and aggregate exposures; imposition of reporting requirements;
restrictions of activities and new business lines or products; requirement to issue additional
convertible capital instruments.
Appendix 2. Methodology for the identi?cation of large subsidiaries not listed by
banking groups as “material entities” in the public section of resolution plans
Table I displays the number of material entities listed by the 11 banking groups[26] in the public
portion of their resolution plans as well as the number, name and location of large subsidiaries
which have not been included in the list of material entities. To identify these “missing” material
entities we have ?rst collected information on large subsidiaries provided by the Bankscope
database (as of May 2013): we have chosen $ 50 billion of total assets as the size threshold to select
large entities and selected all subsidiaries that Bankscope reported to have surpassed such
threshold, based on the latest ?nancial data indicated by Bankscope in the list of subsidiaries.
To obtain the Bankscope list of subsidiaries we have used the 50 percent majority-ownership ?lter
made available by the database: companies included in the list of subsidiaries are only those that
the banking group owns with at least a 50.01 percent stake in every single piece of the
ownership chain.
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Second, we have excluded some large subsidiaries included by Bankscope but not active any
longer (e.g. due to bankruptcy or merger): for this purpose, we have used information provided
by Bankscope in other sections of their database and by the Orbis database (which follows the
same criteria and format of Bankscope but has a wider coverage with regard to details on
subsidiaries).
Third, we have checked whether any large subsidiary included by Bankscope was not in the
material entities list provided by banking groups in the resolution plan, ?nding a few “missing”
entities for eight out of the 11 banking groups of our sample.
Fourth, in order to double-check our results with of?cial regulatory sources and to make sure
that large subsidiaries identi?ed by Bankscope as of May 2013 were existing at the time of
submission of the resolution plans, we have veri?ed whether the missing entities were included
by banking groups in the list of subsidiaries displayed in the SEC 10-K form for US groups and
in the SEC 20-F form for foreign groups; we used data for year-end 2011 as this is the most recent
date before the submission of the resolution plans for which SEC data were available. For a
couple of foreign banking groups we were not able to ?nd the list of subsidiaries in the SEC 20-F
form and performed the double-check with 2011 annual reports or other of?cial documents
published by the banks.
Moreover, we have performed this double check also with Federal Reserve data on banks’
organization hierarchy made publicly available through the National Information Center
database. Since these data can be retrieved for any point in time, we have used the end of June
2012 data, corresponding to the timing of submission of resolution plans.
Our missing entities were included in both the SEC and the Federal Reserve data, or in
documents published by the banks (only in one case a subsidiary was included in the Fed data
as of June 2012, but not in the SEC list as of yearend 2011, while being included in the SEC list
for yearend 2010).
Corresponding author
Prof. Richard John Herring can be contacted at: [email protected]
Living wills
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