As I’ve said before, I’ve become a big fan of the “resolution plans” (a.k.a., “living wills”) that Dodd-Frank requires. They’ll be enormously useful in resolving large financial institutions under the new resolution authority, primarily because they’ll ensure that regulators have all the information they need to actually execute a smooth resolution of a major bank (e.g., organizational structure, funding practices, trading systems, major counterparties).
Resolution plans are one of those things that have the potential to be incredibly important, but that you could also see regulators basically ignoring — that is, requiring the minimum amount of information, or allowing banks to include only publicly available information, or something like that. For resolution plans to be as important as I think they can be, the regulators absolutely have to take them seriously.
The Fed and FDIC approved a joint proposed rule on resolution plans earlier this week, and I’m pleased to report that they’re clearly taking resolution plans very seriously — and then some. These are going to be substantial documents. It’s going to require a lot of work for banks to put these resolution plans together. The proposed rule requires a ton of information, covering all major aspects of the whole financial institution, and I haven’t thought of any area that they’ve missed.
This is just one paragraph from the overview of the informational content of the resolution plans:
The information regarding the Covered Company’s overall organization structure and related information should include a hierarchical list of all material entities, jurisdictional and ownership information. This information should be mapped to core business lines and critical operations. An unconsolidated balance sheet for the Covered Company and a consolidating schedule for all entities that are subject to consolidation should be provided. The Resolution Plan should include information regarding material assets, liabilities, derivatives, hedges, capital and funding sources and major counterparties. Material assets and liabilities should be mapped to material entities along with location information. An analysis of whether the bankruptcy of a major counterparty would likely have an adverse effect on and result in the material financial distress or failure of the Covered Company should also be included. Trading, payment, clearing and settlement systems utilized by the Covered Company should be identified.Seriously, good luck with that, guys. (I’m glad I’m not in-house anymore, because with my luck, I just know I would’ve been asked to do this. Although my old bank was actually quite good at maintaining this kind of firm-wide information, so it might not have been that bad. Plus, I would’ve delegated the crap out of it.)
I do have two complaints though. Both relate to the other major aspect of the resolution plan — the part where the financial institution describes how it can be resolved in an orderly manner. Now, I already think that this aspect of the resolution plan will be less useful, simply because the structure of every resolution/bankruptcy/restructuring depends critically on the specific circumstances the institution faces at the time. It’s impossible to know who the potential buyers will be, because whether another institution is interested in the acquisition depends on its own health, including how well it could manage the fallout from a major bank being resolved under the resolution authority. And the identity of the acquirer absolutely drives the structure of any deal.
That said, I don’t think this aspect of the resolution plan will be completely useless. Regulators could glean some legitimate insights from the financial institution’s hypothetical plan.
So my first complaint is that the proposed rule requires the financial institutions to describe how they would resolve themselves only under the Bankruptcy Code, and not under the new resolution authority. I understand that the statute requires the regulators to evaluate the resolution plans on whether they would facilitate an orderly resolution under the Bankruptcy Code. But the text of the statute, while confusing, does not require that the financial institutions only describe resolutions under the Bankruptcy Code — or even that they address the Bankruptcy Code at all.
The key provision in Dodd-Frank, § 165(d)(1), simply requires that a financial institution periodically submit “the plan of such company for rapid and orderly resolution in the event of material financial distress or failure.” Notice that it doesn’t say that the “rapid and orderly resolution” has to be under the Bankruptcy Code. This leaves the door open for the regulators to require the financial institutions to describe how they could be smoothly resolved under the new resolution authority as well. Regulators couldn’t deem a bank’s plan “deficient” because of its description of a resolution under the new resolution authority, but who cares? At least the regulators would have the description.
My point is: why not require the financial institutions to describe a resolution under both the Bankruptcy Code and the resolution authority? There are key differences between the two insolvency regimes, so having two separate descriptions would be useful.
My second complaint is that the proposed rule requires the financial institutions to describe a resolution under the Bankruptcy Code that can be accomplished “within a reasonable period of time.” I strongly suggest that this language be changed to something like, “on an expedited basis.” The problem is that a “reasonable period of time” for a resolution under the Bankruptcy Code is much longer than we can afford the resolution of a major financial institution to take. To successfully resolve a major financial institution, the resolution has to be effectively over-and-done-with in a few days — a week, tops. The uncertainty in the Lehman resolution was crippling — it was pure Knightian uncertainty in action, as everyone in the market (and especially Lehman creditors) assumed the worst and panicked.
Resolutions under the Bankruptcy Code often take years. Even “pre-packaged” bankruptcies can take a month. If the next resolution of a major financial institution takes a month, I absolutely guarantee that there won’t be anything “orderly” about it. So please, if you’re going to have the financial institutions describe how they would resolve themselves under the Bankruptcy Code, at least make sure they describe a resolution that would, you know, actually work.