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THE UK’S SPECIAL RESOLUTION REGIME:

APPLICATION TO CROSS-BORDER BANKS

Mark Adams

Bank of England

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THE SRR: KEY FEATURES

• Pre-insolvency threshold

• Objectives specified in statute

• Tools: full/partial transfer to PSP; full/partial transfer to BB; TPO; liquidation/payout to eligible depositors

• Applies to deposit-taking institutions but includes provisions for holding and other group companies

• Creditor safeguards, especially in partial property transfers

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MOTIVATION FOR AND APPLICATION OF SRR

• Northern Rock Crisis 2007-2008

• Lack of SRR meant only two options for NR: insolvency or nationalisation

• Banking Special Provisions Act (BSPA) 2008

• Fear of consequences of insolvency for UK financial stability necessitated nationalisation, followed by good bank/bad bank resolution

• BSPA used also to resolve:

- Bradford and Bingley

- UK entities of Icelandic banks

• RBS and HBOS/LBG resolutions pre-date SRR: both recapitalised outside BSPA given holding company structure and cross-border operations

• Dunfermline Building Society only institution resolved under SRR so far

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KEY MESSAGE

• SRR NOT YET TESTED AGAINST FAILURE OF UK BANK WITH CROSS-BORDER OPERATIONS

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INTERNATIONAL REACH OF SRR

THE THEORY

• Applies to UK-incorporated banks and building societies

• This extends to foreign branches of UK banks

• It does not extend to foreign subsidiaries of UK banks

• It includes UK subsidiaries but not branches of foreign banks

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INTERNATIONAL REACH OF SRR

THE PRACTICE

• UK authorities have no powers to prevent non-UK authorities ring-fencing local assets of branches of UK banks

• Such action could undermine UK resolution under SRR

• Assuming SRR resolution recognised as proceeding covered by CIRWUD 2001, then it would apply to all EEA branches of UK bank

• BUT: that does not of course address possibility of separate resolutions/proceedings for branches of UK banks outside EEA

• This raises complex issues to do with international insolvency law

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INTERNATIONAL INSOLVENCY LAW:IMPLICATIONS FOR CROSS-BORDER BANK RESOLUTIONS

3 BROAD PARADIGMS

• 1 PURE UNIVERSALISM

Home country controls resolution of bank and all its entities abroad; host countries have no rights to bring local resolution or ring-fence assets within their jurisdictions

• 2 MODIFIED UNIVERSALISM

Home country controls resolution of bank and all its branches abroad; host country has rights to bring local resolution and ring-fence local assets, but

can remit assets immediately to home country authorities if deemed appropriate

• 3 TERRITORIALITY

Home country only controls resolution of parent bank and its domestic branches; host countries mandated or able to bring local resolution and ring-fence local assets for use in local resolution

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THE PARADIGMS IN PRACTICE

• Until last decade, territoriality dominant

• But recent signs of trend towards universalism, eg

- EU Credit Institutions Reorganisation and Winding-Up Directive (CIRWUD) 2001 (pure)

- European Insolvency Regulation (EIR) 2000 (modified)

- UNCITRAL MODEL LAW (UML) (modified)

- Chapter 15 of US Bankruptcy Code adopted in 2005 (modified)

• SRR in UK broadly consistent with universal principles

• BUT IN PRACTICE IN THE CRISIS:

- TERRITORIALITY RIDING HIGH AGAIN

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WHY TERRITORIALITY?

• Consistent with fiscal independence of nation states

• Lack of ex ante burden sharing agreements between home and host authorities

• Host authorities may lack confidence in home authorities’ supervisory and resolution regimes

• Encourages early intervention by and accountability of host authorities

• Conflicts of interest between home and host authorities

• It’s quicker – and in a crisis you need to move quickly

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PROBLEMS WITH TERRITORIALITY

• Undermines cooperative solutions

• Likely to encourage races for assets by both creditors and authorities, in which the “strong” win at the expense of the “weak”

• Undermines home country resolutions based on equitable treatment of worldwide creditors (eg under UK SRR)

• Individual authorities may not take into account global financial stability or preservation of going concern value

• Could undermine application of carve-outs/exemptions across borders, eg set-off rights, enforcement of collateral

• May destroy value (preservation of which is objective of SRR-type regimes)

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DO NOT LOSE ALL HOPE

• Countries with territorial approaches to the resolution of others’ cross-border banks may prefer to apply universal principles to the resolution of their own cross-border banks

• From this simple fact, could there be scope to make progress?

• But need to be realistic – any shift from territoriality only likely to embrace modified not pure universalism

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WHY NOT PURE UNIVERSALISM?

• Implies surrender of national sovereignty in relation to predefined rules that determine respective roles of different authorities

• Requires ex ante burden sharing agreements across jurisdictions

• Different views of home and host countries on whether financial stability or public interest endangered

• Vulnerable to forum shopping

• If extended to subsidiaries, requires “group interest” resolution and piercing of corporate veil

• Possibly a long-term objective

- like a World Government!

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BUT WHAT ABOUT MODIFIED UNIVERSALISM?

• An acceptable compromise for countries with territorial approaches?

• UML involves similar compromise for corporates and has been implemented by “territiorial” countries (eg US)

• Modified universalism would give host countries the right, but not the obligation, to bring local resolutions

• Subject to certain conditions, any host country could remit all local assets to home country resolution authority

• Akin in insolvency law to “ancillary proceeding” being subservient to “main proceeding”

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WHAT CONDITIONS WOULD BE NECESSARY?

• Equitable treatment of worldwide creditors of home bank and all its branches at home and abroad

• Burden-sharing principles governing contributions by each country, with amounts determined and negotiated on case by case basis

• Application of DGS and “resolution” funds on cross-border basis

• Sharing of information and cooperation between supervisory and resolution authorities, eg through CMGs, RRPs

• Mutual recognition of supervisory and resolution regimes

• Linked to that, or as a pre-condition, broad harmonisation of supervisory and resolution regimes (see EC Communication)

• Practicalities: eg key players trust each other, common systemic risk assessments, secure communications, need to overcome time pressures

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OBSTACLES

• Some countries’ laws mandate preferential treatment of creditors and/or depositors of local entities of bank (eg US national depositor preference laws)

• These countries may be able to treat creditors of domestic entities and creditors of non-domestic entities equitably in a non-liquidation resolution option but not in an insolvency

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SPOTLIGHT ON THE US

• US territorial approach to supervision and resolution of non-US banks

• BUT EU needs to acknowledge that US has good reasons for territorial approach (remember BCCI)

• AND EU and other countries can adopt territorial approach to resolution of non-EEA foreign banks

• In UK, SRR cannot be applied to UK branches of US banks, but UK-based creditors can still petition UK Court for insolvency

• UK court would grant local proceeding if it took view that creditors of UK branch likely to be penalised in US proceeding

• Application of US national depositor preference laws could cause depositors and creditors of UK entities of US banks to run

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THE WAY FORWARD

• Assuming conditions are met, countries sign up to modified universal approach to resolution of both their own and others’ cross-border banks

• US agree to repeal “national” element of depositor preference laws

• Countries agree principles for sharing cost of such resolutions among home and host countries

• Progress is made through:

- CMGs under aegis of FSB

- preparation and agreement of RRPs for all cross-border banks

- within EEA through EC’s consultation

• May also need a new Concordat (perhaps by FSB/G20) for resolution along similar lines as Basel Core Principles for supervision

• Aim is to ensure SRRs such as that in UK could be used effectively to resolve cross-border banks

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IF WE DON’T GET IT RIGHT

• Balkanisation of international finance

• Forced subsidiarisation of branches (undermining EU single market)

• Ring-fencing along national lines

• Increased costs and inefficiencies of cross-border provision of financial services

• Loss of gains from increased competition in global finance

• AND/OR: countries’ SRRs will only be effective in resolving purely domestic banks so “too big to fail” still not nailed