--The Federal Reserve has estimated roughly 124 institutions
must write "living wills," plans to dismantle themselves without
unsettling markets
--Some industry watchers say plans will result in more
streamlined, smaller global financial institutions
--Banks that don't write plans approved by regulators will need
to raise capital or divest assets
By Ronald D. Orol
How to divide a big failing global bank's assets and what parts
of a financial institution's structure and investments should be
publicly disclosed are two of the dozens of complex issues facing
U.S. regulators as they draft rules for bank "living wills."
At issue are regulations being drafted by the Federal Deposit
Insurance Corp. and the Federal Reserve to have banks with more
than $50 billion in assets write plans detailing how they would
dismantle themselves in a way that does not ripple throughout the
financial markets the way Lehman Brothers Holdings Inc. (LEHMQ) did
when it disintegrated in 2008.
The central bank estimated in April that roughly 124
institutions--including dozens of foreign banks--will need to
submit living wills.
Regulators had planned in July to adopt a rule laying out the
structure for these resolution plans. However, they delayed it,
with expectations for adoption later this month. Financial
institutions await the rules with apprehension, in part, because
banks that don't get their wills approved by regulators must raise
capital or divest assets.
One area of disagreement between regulators focuses on what
aspects of living wills must be disclosed, and whether institutions
forced to resubmit plans must make that information public,
something the lenders would be reticent to do.
Key banks expected to be required to submit plans include Bank
of America Corp. (BAC), J.P. Morgan Chase & Co. (JPM),
Citigroup Inc. (C), Wells Fargo & Co. (WFC) and Goldman Sachs
Group Inc. (GS).
Some observers believe the wills will result in more streamlined
and smaller financial institutions. Banks are expected to be
pressured to submit organizational structures with clear divisions
so that the Fed and FDIC will know the value of different units and
which assets can be sold off immediately when an institution is
failing. The goal is to use the capital from the sales to raise
money to pay creditors.
"Complex institutions that have revenue streams coming from all
over the place will have to disaggregate their units so that
regulators can value them and understand the business," said Dennis
Kelleher, president of progressive watchdog group Better
Markets.
Donald Lamson, a former Office of the Comptroller of the
Currency official and an attorney with Shearman & Sterling,
said resolution plans will drive top executives to take a greater
interest in where all the institution's subsidiaries are located
and who is working there.
Living wills may also drive regulators to press banks to
consolidate or sell units now, before a crisis happens.
"The FDIC may say, 'This is too complicated for us; why don't
you take away some of these boxes and divisions?'" Lamson said.
"The CEO may think that [regulators] will make the bank raise
capital so it's worth it to consolidate or divest units."
Michael Barr, a former assistant secretary for financial
institutions at the Treasury Department, said divestiture of some
units may be required if there is a "significant" operational risk,
he said.
"You have some legal complexity for tax-motivated reasons," Barr
said. "Financial regulators need to consider whether some of these
tax-motivated structures introduce unnecessary risks in the
system."
Another focus of concern is how to treat U.S. branches of
foreign institutions, such as Switzerland's UBS AG (UBS, UBSN.VX)
and Germany's Deutsche Bank AG (DB, DBK.XE), in a resolution
plan.
In a situation of an insolvency, the home country of the
institution has an incentive to have the firm's global assets
returned there to satisfy local claimants and creditors. The host
country, in this case, the U.S., has an incentive to put a
so-called "ring-fence" around the assets in the local branch to
satisfy domestic counterparties.
"It's a classic conflict-of-laws problem," Lamson said. "Greater
attention will be paid to the living will for a foreign
institution's U.S. operations and that plan will be important in
resolving disagreements between the home country and the host
country, such as the U.S."
Barr agreed that the question of which creditors get what assets
when a big global bank gets into trouble is a major problem facing
global regulators. However, he said living wills, the resolution
process and supervisory panels set up by the Basel committee in
Switzerland are all new efforts to do a better job of addressing
those concerns in advance.
"They won't eliminate the problem of ring-fencing, but the
resolution mechanism, supervisory colleges, and living wills will
help improve cooperation and expedite negotiations around a failing
financial institution," Barr said.
Kelleher said he is less concerned about international
coordination than about the U.S. setting up its own living wills
correctly.
"If at the end of the day the only thing the U.S. can do is
resolve the domestic components of an international institution
well then that's better than nothing," he added.
Two Bites At The Apple
A battle may also be forming between the Securities and Exchange
Commission and bank regulators over disclosure. For its part, the
SEC is charged with making sure shareholders receive public reports
about companies so they can make thoughtful investment decisions.
Such disclosures include so-called 8-K material-change reports,
which are filed to announce major events that shareholders should
know about.
However, the Federal Reserve and other bank regulators seek to
keep confidential discussions about the health of a bank, for fear
of the negative impact public disclosure might have on the
institution and broader markets. Enter the living wills; most
observers agree that the Fed and FDIC won't be satisfied with
initial plans provided by banks.
Jeffrey Hare, partner at DLA Piper in Washington, said a will
resubmission request by regulators would require an 8-K filing.
"That level of information should be made public," he said.
However, Shearman's Lamson said that bank examiners could get
around the problem by not formally rejecting a bank's resolution
plan. Instead, he said, the regulator could privately give a bank
an extension of time to file their plan and they could have private
conversations about what was wrong with their preliminary
submission.
"This way they avoid a negative filing and the obligation to
disclose to investors the fact that a draft will was rejected,"
Lamson said.
A possibly even bigger battle is taking place over how much of
the final living wills should be made public by regulators.
Barr, who was a key participant at the Treasury in talks leading
to the living-will legislation, said the final plans should be made
public.
"The intent is that the market, regulators and the bank's
counterparties understand what part of the companies they are doing
business with," he said.
However, Hare cautioned against revealing too much of the actual
plan. He contends that details about specific exposures a bank has
to other financial institutions should remain confidential, in
part, because it is proprietary content, and revealing too much
could unsettle markets.
"I would expect that who Bank A identifies as its counterparties
to be kept confidential and proprietary," he said, giving an
example of a firm making an internal assessment that a counterparty
is problematic. "If that allegation or internal assessment becomes
public, it could be self-fulfilling."
-By Ronald D. Orol; 415-439-6400; AskNewswires@dowjones.com