Transaction Banking and the Impact of Regulatory Change: Basel III and Other Challenges for the Global Economy

By R. Wandhöfer

This book takes you on a journey through post-crisis regulatory reform, highlighting the unintended consequences of some of the measures on transaction banking, a business that provides the backbone of financial markets.

• Language: English
• Publisher: Palgrave Macmillan
• Release date: Dec 17, 2015
• ISBN: 9781137351777

Book preview

1

Regulation and Transaction Banking: A journey through a relationship at the crossroads

Since banking has been public enemy number one for the last few years, little has been said about the relevance of banking to the real economy. Having witnessed the financial meltdown over the last few years, and having been closely involved in following, analysing and discussing the set of regulatory measures that followed – and continues to pour out from various committees, institutions and governments – I felt that writing a book dedicated to the topic of regulation and banking to be a rather appealing and interesting project.

Banks continue to be the focus of attention and supervisors continue to get tougher and tougher with their fines. A great example is the UK supervisor, which fined Credit Suisse GBP £4 million in 2002 for attempting to mislead the Japanese regulatory and tax authorities in the nineties. In 2013 they fined RBS GBP £87.5 million for misconduct relating to the Libor. A mere 2000 % increase in the level of fines over just little more than ten years – clearly adjusted for inflation, or rather over-adjusted. US bank fines have been extraordinary so far: HSBC $1.9 billion in 2013, Credit Suisse $2.6 billion in 2014 and BNP Paribas with a fine of $9 billion in the same year.

It turns out, however, that not all banking is necessarily bad; indeed, despite the known culprits, certain bank businesses are quintessential to the well being of the world economy. Transaction banking is a business that had just about nothing to do with the financial crisis and it is a business that provides the fundamental basis of financial markets and the real economy by moving money, securities and trade finance flows around the world. Writing about this particular business in light of the explosion of regulatory measures, developed to ensure that a systemic crisis of the scale of 2007 can be prevented in the future, is to my mind a necessity. And the reason for this is that many of the new bank regulations can often have unintended consequences on a business that needs to be able to continue to deliver the service of connecting the world’s financial flows.

When searching the term ‘transaction banking’ on the Internet, it turns out that there is no clear definition of this area of banking. There are more general definitions that explain the nature of ‘wholesale banking’, which is close, but not right to the point. This is one of many indicators of the fact that the mainstream lacks an understanding of what this business actually does. Regulators are often also not aware as to the specific role of this business, which of course threatens to become a major problem when detailed rules and regulations are defined.

At the same time, the amount of regulations that have been developed since 2007 is mind-boggling. The problem here is that on the one hand regulators have been designing more and more detailed legislation for banks as a measure to avoid future crises, but in doing so regulators had little time to concentrate on the different business models and services that banks provide. The plethora of reforms that have been issued are now the major focus of banks with significant resources and time being spent in order to understand and be able to comply with the broad set of measures. Furthermore, the political arm of the regulatory decision-making process has played an increasingly important role and often contributes to modifying initial proposals in significant ways. In this regard, to ensure a future proof and impactful legislative framework, political long-term objectives continue to be a crucial element of the reform, such as economic growth, employment, stability and resilience of the banking industry, etc. In the broader context banking is one of the pillars that supports the economic cycle, which is why governments are taking great care in the design of legislation as well as enhanced supervision going forward.

In Chapter 2 I will introduce the background of the large scale of regulatory reform that the banking industry is faced with. An outline and brief analysis of key regulatory developments that target financial stability, customer protection, and standardisation and harmonisation will be given to that effect.

Then I will move on to an in-depth explanation in Chapter 3 of what transaction banking actually is. Essential services such as payments, trade finance, securities settlement, issuer and fund services as well as liquidity management are all part of this field of services and regulators should be careful when designing broad one-size-fits-all measures that could unintentionally impair the delivery of these services.

In Chapters 4 and 5, I develop two areas in the form of regulatory case studies, one global and one regional.

First I will focus on Basel III. This broad Accord of prudential rules is complex and requires detailed analysis in order to assess its implications. My objective is to provide a clear and easy to understand version of what regulators have developed at a global level, in order to reform banking and help ensure financial stability.

The second case study, this time of regulation that directly impacts transaction banking, comes from the area of payments legislation. For those readers that have already been eagerly awaiting a sequel to my first book, EU Payments Integration, I will discuss the continuing evolution of the European payments landscape in light of equally continuous regulatory measures. Here, the European rules to harmonise the payments landscape with SEPA and the Payment Service Directive will feature as examples of significant regulatory measures in this area. Consequences and challenges for users of payment services, in particular corporate clients, are being assessed in detail with potential measures for remedy being outlined. Interestingly, the European ideal of consumer protection in payment services has made its way across the Atlantic. Hence I will also provide an account of the US payments environment, where regulation of cross-border funds transfers will be subjected to detailed analysis and comparison with some features of European legislation.

I then go on to analyse the effect of the regulatory reform agenda in Chapter 6, in particular Basel III but also many other identified laws and regulations, on the key business areas of transaction banking. Having identified a number of unintended consequences on this business I will also provide several solutions that would need to be put into action. This section will be of practical advice for the reader (including regulators), on what provisions and angles in the regulatory space will need tweaking to ensure continued and unimpaired provision of vital transaction banking services.

The overall implications of regulatory change, both in terms of positive stabilising consequences as well as with a view to cumulative impacts on the broader economy, will need to be considered carefully. In many regions of the world economic recovery is an important imperative. Transaction banking provides essential support for economies around the globe. The continued delivery and viability of these types of services will be important towards the objective of economic progress and development. Measures that risk to impair transaction banking could have direct implications on the economy, some of which may not be intended.

In conclusion, in Chapter 7 I review the key learnings, summarise some of the identified problems encountered and propose a set of measures to solve these. I suggest an alternative model for prudential regulation of banks and propose solutions to various questions including that of being ‘too big to fail’. It is clear that the culture of the banking industry has to change, but in addition to that, more transparency and standardisation, clearer principles, closer cross-border co-operation of regulators and governments and protection of consumers combined with full responsibility of investors can help to create an environment where even large banks can continue to operate without creating the risk of global financial breakdown.

For the transaction banking space in particular, the creation of local ring fencing, bank subsidiarisation and other measures to increase local government control over a foreign bank will threaten to destroy the global network, which the economy so vitally relies upon. There are other ways that can bring more stability and certainty without removing the benefit that global transaction banking provides.

So, all that remains for me to say is that I wish you an interesting, stimulating and, hopefully, rather pleasant reading experience from which you will have taken away key learnings and insights that may be of use in your day-to-day life, whether you are a practitioner, regulator, politician, supervisor or student. As we will see through the course of this book the regulatory reform process plays the important role of stabilising the banking industry with a view to significantly reducing the risk of future crisis. Whilst the path will be long, it is clear that regulatory change is essential to achieve this goal.

2

Post-Crisis Regulatory Change

Introduction

I will look at two building blocks: regulatory reform and transaction banking. We will begin with an overview and analysis of the plethora of banking regulation that is focused on the bank as a whole. Usually known by the term ‘prudential regulation’, the regulation of deposit-taking institutions aims to ensure the safety of customer deposits and stability of the financial system. This overview will constitute the background to understanding and analysing the potential impact and implications of all these changes to the business of global transaction banking. The overview will be followed by an in-depth explanation of what transaction banking services actually are – payments, trade finance and securities services – and how these services support the real economy at a local, regional and global level. Armed with these insights we can then analyse the effect of key regulatory reforms, such as Basel III, in the following chapters. Given the many uncertainties in the implementation of new banking regulation, this analysis cannot cover every consequence for transaction banking. However, it provides an essential overview of the key regulatory pillars that support banking services today and how these are impacted by twenty-first century law reform. Alongside the many intended consequences, there is also a risk of unintended consequences that some of these reforms could bring for the transaction banking business and thus the functioning of financial markets as well as the and growth of the global economy overall.

Post-financial crisis, the amount and speed with which regulatory change is being proposed and pushed for implementation is impressive. We are still in a phase of continued implementation of measures as well as ongoing design of new legislations, which means that the regulatory reform agenda is still in motion.

Even though international coordination of regulatory reforms has substantially increased – and we will review the new global regulatory architecture below – the array of regulatory developments is slowly but surely creating barriers to international finance, in the absence of a full analysis of their potential impacts on a deeply globalised, interconnected and digital world where business and financial flows are expected to be ubiquitous and far reaching. The regulatory floodgates have been opened far and wide but no one really knows at this stage what this will mean.

In the old days, banking followed the simple pattern of, as the English put it, ‘Borrow for £3, lend for £4 and go to the pub at 5 o’clock!’ As it turns out, history has changed the course of this traditional banking business. Classical bank lending no longer generated sufficient revenue for banks and this is not a recent phenomenon. In consequence, some banks began to look into other ways to make money and in several cases this involved taking more risks. But it is clear that a number of factors played a role in pushing the overall systems into crisis.

So let us now review some of the current regulatory proposals and high-level decisions that have thus far been put forward and partially implemented in reaction to the financial crisis; a crisis that is also often understood to be a US–European crisis, rather than a truly global one. After all, Latin American and Asian markets already went through their own crises during the 1990s and early 2000s, although even today the stability of some emerging market countries is certainly not a given.

To my mind, some of the regulatory changes will have the power to completely change the face of banking … and regulators, supervisors and politicians will need to consider the consequences and factor them into their future policy approach. For me the key question really is whether there is a future for global banking in any shape or form once the current list of regulatory measures – which continues to evolve – is implemented. In that regard, this book will also constitute a reminder of the benefits that a global universal highly diversified banking structure brings to the economy and how a mix of bank models ranging from small, medium and large with de-centralised or centralised set-ups actually supports the overall resilience of the global financial market.

2.1What is in store for the global banking industry

The first set of measures proposed in response to the financial crisis was a revision of the international framework for prudential supervision, or what we call for short ‘Basel III’. The key amendments to the existing framework were focused on improving the quality and quantity of bank capital as well as introducing liquidity requirements and a cap on banks’ leverage. We will examine the Basel regimes in detail in Chapter 4 of this book.

One could argue that if banks were to follow Basel III, not many additional reforms would be required, as more capital and more liquidity combined with leverage limits should really do the job and create a streamlined and stable safety buffer for the global financial industry. However, once the process of regulatory reform was initiated, the breadth and depth of measures continued to increase.

In the current state of affairs (2014) the banking industry is faced with a myriad of regulatory measures, which broadly fall into three categories of policy objectives:

I. Financial Stability

II. Consumer/Investor Protection

III. Standardisation/Harmonisation

Some measures along these policy objectives have been developed and endorsed at global level (G20), whilst others are more specific to certain countries or regions such as the European Union or the US. Let’s look in more detail at a selection of key measures in these categories and understand the challenges, benefits and potential consequences of implementing them.

I. Financial Stability.  Measures to address and improve financial stability, that is the resilience of banks, with the objective of limiting risks of future financial crises and bank bailouts, broadly cover the following areas: the Basel III Accord, the Recovery and Resolution regime for financial institutions (so-called ‘living wills’), mandating central trading and clearing of OTC derivatives and most recently measures to ring-fence certain bank operations in order to reduce the risk of taxpayer money being spent for bailout purposes. Structural reform and limitations on certain bank activities, such as proprietary trading with the US Volcker Rule and proposals by the EU that go along similar lines add to this list. Furthermore, discussions around changing the behaviour and freedom of internationally operating banks by trapping liquidity and capital in local legal entities are becoming more and more a reality, threatening the efficient cross-border operation of financial markets at their core. The question of how to deal with ‘too big to fail’ banks remains unanswered as long as close international cooperation is not being progressed.

Bank supervision is another area that is being strengthened. In particular, the experience of the Eurozone crisis has led to an approach of more centralised supervision of large European banks by the European Central Bank (ECB) via the Single Supervisory Mechanism (SSM).

In parallel, compliance requirements around Anti-Money Laundering (AML) and Know Your Customer (KYC) continue to be fragmented but are further increasing in toughness, especially when it comes to regulatory fines for non-compliance.

Rules on intraday-liquidity monitoring – also laid out by the Basel Committee on Banking Supervision (BCBS) – raise another significant challenge, which has yet to find a practical solution for implementation.

II. Consumer/Investor Protection.  One of the objectives of consumer protection post crisis is to reduce the likelihood of taxpayers having to pay for a bank’s failure through bailouts. In addition to strengthening banks at the core via measures introduced to support financial stability, specific actions to further protect depositors are being considered; for example, via deposit guarantee schemes, or the requirement of bank branches to turn into subsidiaries. In the area of investor protection, regulation of alternative investment funds (AIFs) and measures in the field of shadow banking (currently still in their infancy) have been introduced to enhance the transparency of financial market services. With more protection across the different types of investor classes the likelihood of Madoff-type Ponzi schemes should be greatly reduced in the future. When looking at specific transactional banking services, several measures designed to regulate conduct of business, increase the responsibilities of providers and change the nature and operation of transaction banking infrastructures both in the payments and securities space are also being proposed or have been introduced. Many of these are again found in the European Union and the US with selected countries in Asia and elsewhere being inspired to follow suit. Initiatives such as the Payment Services Directive I+II in Europe and the revised Funds Transfer Rules (Regulation E, section 1073) under the US Dodd-Frank Act (DFA) are key examples.

III. Standardisation/Harmonisation.  For Europe, legislation in this space is chiefly inspired by the Single Market policy, which continues to harmonise the way financial services and markets operate in this region. The Single Euro Payments Area (SEPA) harmonisation initiative has moved from market standardisation to regulatory implementation and conduct of business rules under the Payment Services Directive I+II (see above). In addition, legislation to regulate the cards market has emerged in Europe following similar rules that have already been implemented in the US. Global initiatives such as the Legal Entity Identifier (LEI) and the spread of ISO 20022 standards are a key indicator of the increasing standardisation and transparency of global financial flows, processes and financial market participants. These developments are also again linked to the objective of enhancing financial market stability given that electronic identification of participants will play a key role in applying corrective action where required. More initiative of markets to embrace internationally harmonised accounting standards, essential to enable regulators and investors to compare banks across the globe, will be crucial.

Banks continue to be subject to ever-increasing demands of governments to control the legitimacy of financial flows, whether this comes in the form of anti-money laundering rules or transparency requirements in financial messaging. Here, banks are playing a key role in supporting government policy enforcement by policing financial flows to the benefit of society at large, for example in curbing flows of capital to rogue regimes or prohibited groups.

Other initiatives such as the US Foreign Account Tax Compliance Act (FATCA) and the proposed European Financial Transaction Tax (FTT) require banks to become the extended arm of the tax authorities. Potential implications of such developments on financial markets and the real economy, in the case of the FTT, for example, could become significant and even damaging.

Many of these measures, although costly to implement and comply with, are of course positive in terms of the objectives they want to achieve. However, what is concerning – and should be of concern not only for financial institutions (FIs) themselves but also for governments, citizens and businesses alike – is the fact that despite the many global agreements reached (by, for example, the Group of Twenty (G20), the Financial Stability Board (FSB) or the BCBS) we are witnessing a growing trend of regulatory nationalism in the approach to implementation, which is sometimes combined with a degree of extraterritoriality when domestic laws are being proposed and endorsed (the US is a key example but other regions are also jumping onto the extraterritoriality bandwagon). This combination of maintaining domestic control whilst striving to gain international control with extraterritorial consequences does not bode well for a globalised economy that today relies on a globalised financial market. The term ‘balkanisation of financial markets’, which has recently found its way into our vocabulary, is one of many signs that the direction of post-crisis regulation is not evolutionary, but backward looking.

In order to set the scene of global, regional and national regulatory reform, which will form the backdrop for our story, I will briefly remind the reader of what the current global regulatory architecture looks like and how it interacts with the domestic regulatory environment.

As outlined in Figure 2.1, law making has become more complex but also more international over the last few years. The G20 – a key forum for international cooperation in the field of global economic and financial developments, which was founded in 1999 and brings together finance ministers and central bank governors from 19 countries (someone couldn’t count there …) – is instrumental in shaping the global response to the financial crisis. Recommendations, in form of communiqués and declarations usually published after each G20 summit, continue to increase and refine the key themes of financial stability and prudential legislation, bank recovery and resolution, derivatives reform, regulation of rating agencies and hedge funds, with a recent focus on regulation shadow banking.

Figure 2.1 Global regulatory architecture in 2014

In April 2009 the FSB was established as the successor to the Financial Stability Forum (FSF). It includes all major economies and is also based in Basel. The FSB’s role is to coordinate information exchange between countries’ authorities; identify actions to address weaknesses of financial systems; monitor and advise with regard to implementing regulatory standards and best practices; and manage the contingency plans in the context of cross-border crises, with a focus on systemically important firms and collaboration with the IMF for the purpose of early warning exercises. The FSB is seen as a more technical committee that helps to put G20 political decisions into practice.

In addition to these two bodies there is a range of international standard setting bodies, the most important ones listed in the figure above. One of the Bank for International Settlements’ (BIS) most famous committees is the BCBS. The Committee for Payments and Settlement Systems (CPSS) is a key standard setter for the payments world and the International Organisation of Securities Commissions (IOSCO) would be its counterpart in the securities world. The International Accounting Standards Board (IASB), the International Association of Insurance Supervisors (IAIS) and the Financial Action Task Force (FATF, a specialised group for standards in the field of anti-money laundering and anti-terrorist financing) complete the list. International bodies, which are important both in a regulatory monitoring role as well as in their capacity as lenders of the very last resort, the International Monetary Fund (IMF) and the World Bank (WB), complement the picture. National authorities, regulators, supervisors and other specialised agencies are the ones responsible for implementation and compliance monitoring as well as potential sanctioning.

Despite international financial law being a form of ‘soft law’, which means that measures adopted at a global level only become effective if individual governments actually embrace them into their legislation, tools such as regulatory peer reviews (as, for example, conducted by the BCBS Regulatory Consistency Assessment Programme with regard to Basel compliance) and increased global transparency around national implementation or the lack thereof, can become a powerful way to increase adherence and regulatory consistency.

Armed with this background, let us now dive a bit deeper into some of the key regulatory changes that banks and other FIs have to cope with these days.

2.2Financial stability

We will begin with a high level review of some of the key measures that are targeted at increasing the stability of financial markets, globally as well as locally.

2.2.1Basel III

Swiftly after the collapse of Lehman Brothers in September 2008, the international community felt it needed to bring the BCBS back into action in order to rescue the banking industry with more rules and recommendations designed to make banks safer and avoid future crises of such a scale. According to the BCBS the significant degree of leverage that had been built up by the banking sectors of many countries was one of the chief reasons for the severity of the financial crisis that unfolded in 2008.¹ This leverage was accompanied by a gradual erosion of the level and quality of the capital base of banks and the fact that many banks were holding insufficient liquidity buffers. The banking system therefore was not able to absorb the resulting systemic trading and credit losses nor could it cope with the re-intermediation of large off-balance sheet exposures that had built up in the shadow banking system (that is any financial activity that lies outside the ambit of banking regulation). The crisis was further amplified by a deleveraging process and by the interconnectedness of systemic institutions through an array of complex transactions. Of course here we should also remember that one of the key reasons for the crisis in the first place was the American dream, housing for everyone, which led to a massive increase in mortgage loans, not all of them to creditworthy customers … but more reflection on that later.

In a very short timeframe the BCBS developed the Basel III framework, enhancing the existing capital requirements – demanding more quality and more quantity – and adding new key elements such as liquidity requirements and limits to bank leverage. These measures aim to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, enhance risk management and governance and strengthen banks’ transparency and disclosures.

The overall reform package, both from a microprudential (bank-specific) as well as from a macroprudential (system-wide) perspective, promises a more coherent and complementary approach to prudential regulation that should result in greater resilience across the whole industry.

However, the fundamental problem with Basel III and arguably its predecessors is that the proposed rules and requirements only become applicable in practice if countries enforce these via national legislation. Effectively they are only best practice recommendations, or ‘soft law’, as mentioned above. The national discretion around implementation is combined with the fact that the Basel Accord itself (in fact, all three of these Accords, which exist thus far) is littered with exemptions and options for countries to apply different rules and practices. This is especially problematic when we consider how countries define what constitutes prudential capital, with national regimes given significant discretion in this regard, potentially undermining the project from within. Therefore, when we look at the historical success levels of Basel implementation (even though Basel I was implemented by 120 countries), the track record of consistent and timely adherence by countries is not as impressive as one might hope. After all, the BCBS has no power to force countries to actually put those rules and recommendations into practice. So it is no surprise to see that despite the Basel III Accord published in December 2010 (and being continually revised, which adds to the confusion), individual countries are taking different approaches in implementing the reforms, with some rather not implementing them at all (at least for now) and others either watering down the requirements or putting more stringent rules on top. Again, and also no surprise, the BCBS has warned of the danger that national implementation could be weaker than the globally agreed standards in some key areas and says it is closely monitoring implementation globally.

All G20 jurisdictions have so far implemented Basel III and about two thirds of the remaining jurisdictions around the world have also done so as well. Countries implementing the rules have followed or proposed to follow different interpretations and nuances. This is understandable given that not all financial markets across the globe operate in the same way. However, it takes the wind out of the wings of Basel when it comes to wanting to achieve harmonised and stable global financial markets that can in future operate in a way that avoids or at least limits any large scale systemic crises as witnessed during the last decade.

Given that a significant portion of this book is dedicated to understanding the Basel framework and how it applies to the world of transaction banking, I will leave further details, including some national approach differences, for later. However, one thing I am certain of is that balkanisation, fragmentation and a return to national inwardly focused perspectives and approaches is a trend of our time. Surprisingly, this is quite the opposite of what you would expect. Without international collaboration and consensus, international crises cannot be mitigated in the future. The broader economic and political consequences of such an approach will need to be carefully considered.

2.2.2Recovery and resolution, or how to (try to) end the ‘too big to fail’ syndrome

The big problem in a financial crisis, as seen with the demise of Lehman Brothers but also other examples of shaky candidates and failures such as AIG, Bear Stearns, MF Global, Northern Rock, is the question of how to let a bank or investment firm fail without creating a systemic snowball effect on the rest of the market. And for some the practical question as to how to handle a bank or FI failure on a Sunday afternoon has become rather relevant. Recent experience shows that some FIs were considered ‘too big to fail’, meaning their respective governments bailed them out, whilst others – such as Lehman Brothers – despite being big and systemic (!), were left. The latter, as we know now, did have detrimental effects on the global financial market and pushed us further into the crisis.

Whilst Basel III already imposes supplementary capital requirements for so-called ‘global systemically important FIs’ (or G-SIFIs), and ‘global systemically important banks’ (or G-SIBs) these measures do not directly support the orderly unwinding of such large institutions in case they do fail. And given that the societal uproar associated with governments bailing out large banks during the crisis (whether that was in the US, Germany or the UK) is something that politicians would like to avoid in the future, a plan is required to solve this problem. The G20 endorsed a set of key recommendations in 2011 designed to ensure the recovery of large global FIs and banks on the one hand and the effective resolution of such institutions in case there is no hope and they cannot be saved, on the other. Regarding this joint set of recommendations, which arguably determines a crucial pillar of post-crisis financial reform, it is concerning that follow-up action by countries across the globe has been taking off surprisingly slowly in terms of progress in implementing respective recovery and resolution regimes. And what we do observe instead, or in addition to putting these recovery and resolution regimes in place, are measures to ring fence whole parts of a bank from what is considered as risky business, or to require pre-positioning of capital in local subsidiaries. This appears to indicate a domestic approach that seems to consider the global nature of the economy and of the financial market as having less of a bearing on the achievement of national objectives.

The 29 banks and FIs (as of 2013) that have been identified as systemically important at a global level – 8 US and 14 European headquartered institutions – as well as any additional institutions identified by national authorities will need to put in place recovery as well as resolution plans. Recovery plans set out what steps the institution will take within a three to six month timeframe to get back to financial health, for example by selling off non-core assets. This approach is in support of its shareholders. Once, however, it is clear that the institution cannot recover and resolution is unavoidable, the resolution plan, or ‘living will’, defines how it can be liquidated without bringing the financial system down and in a way that removes the necessity for taxpayer financed government bail-outs. Not all G-SIFIs or G-SIBs have the same structure, which means that not all resolution models will look the same. The two key models at play here are the Single-Point-of-Entry (SPE) and the Multiple-Point-of-Entry (MPE) resolution models. Under the SPE resolution powers are applied at the holding company or top parent level via a single resolution authority, usually the of the home country, where the institution is subject to global consolidated supervision. The whole model revolves around the strategy of absorbing losses by the holding company via bail-in (this is when unsecured debt issued is converted into equity) or write-downs. In that way, if enough loss absorbing capital is available, the other operating entities can continue business as usual. The SPE resolution model of course requires close cooperation between home and host countries, where the home country would be the primary regulator in charge.

For the MPE model, resolution powers would effectively be divided between resolution authorities that are responsible for different businesses of the group and could lead to breaking up the group into different parts. Multiple strategies could then be applied to those parts, ranging from bail-in, the creation of a ‘bridge bank’, sale of parts of the business to other institutions or a complete wind-down. Whilst this strategy is clearly providing more flexibility in terms of local control over what happens to which part of the institution, cross-border coordination would still be important to prevent contagion or a run on the institution as well as to ensure that each countries’ resolution measure in relation to the entity is actually effective.

The SPE strategy, which reflects the way large US institutions are organised, is a model that does not require branches or subsidiaries of the holding company located abroad to be governed and funded as if they were independent entities, because the holding company will have to hold high levels of equity and debt in order to be able to absorb losses, whilst foreign branches and subsidiaries will continue to operate normally. This would mean that in good times global institutions can continue to allocate resources amongst their different foreign entities in an efficient way and be able to support any troubled entities by shifting resources to it. This allows bringing out the benefits of a globally diversified universal banking model, where country, client and product risk can be balanced due to significant diversification.

In July 2013 the FSB published a guidance paper to assist authorities and firms in implementing recovery and resolution planning requirements. It argues that credible resolution strategies for large, cross-border firms are essential for reducing the moral hazard associated with such firms.² The FSB guidelines are based on the principle that resolution strategies and plans should help achieve an orderly resolution and facilitate the effective use of resolution powers. The aim is to make the resolution of any firm feasible without severe systemic disruption and without taxpayer solvency support, with the objective of having regimes in place by 2015.

In relation to recovery and resolution the US has moved forward quickly following the adoption of the DFA of 2010. [As a little reminder, the Dodd–Frank Wall Street Reform and Consumer Protection Act 2010 represents the largest-ever regulatory overhaul of banking in the US. The sheer size of the output – almost 400 separate sets of regulations, not all drafted or adopted just yet – is impressive and implementation will continue for some time.] Two resolution plan requirements are anchored in US legislation. The DFA includes a rule that requires large FIs that are not US depository institutions to regularly submit a resolution plan to the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC) and the Financial Stability Oversight Council (FSOC). The latter institution was itself created by the DFA with a view to ensuring consolidated monitoring and stability of the US financial market. Resolution plans by these foreign institutions had to be submitted from 1 July 2013 through to 31 December 2013, in line with the size of the FIs; large institutions were subject to early submission ($4.25 billion or more in non-depository institution assets).

For large US depository institutions the Insured Depository Institution Rule (IDI rule) applies, according to which a resolution plan must be submitted at regular intervals to the FDIC. The rule became applicable on 1 April 2013 and complements the DFA rule mentioned above.

In January 2012 the FRB approved final rules requiring bank holding companies with assets of $50 billion or more and non-bank financial firms designated by the FSOC for supervision by the FRB to annually submit resolution plans to the FRB and the FDIC. Under the final rule, companies had to submit their initial resolution plans on a staggered basis until the end of 2013.

Each plan must describe the company’s strategy for rapid and orderly resolution in bankruptcy during times of financial distress. A resolution plan must include a strategic analysis of the plan’s components, a description of the range of specific actions the company proposes to take in resolution, and a description of the company’s organisational structure, material entities, interconnections and interdependencies, and management information systems.

The FRB and FDIC released additional guidance, clarification and direction for the first group of institutions filing their resolutions plans pursuant to the DFA in 2013. The revised instructions include requests for more detailed information on, and analysis of, obstacles to resolvability under the Bankruptcy Code including global issues, financial market utility interconnections, and funding and liquidity, as well as to provide analysis to support the strategies and assumptions contained in the firms’ resolution