In September 2011 the Federal Reserve Board and the Federal Deposit Insurance Corporation issued a final rule under Dodd-Frank that required bank holding companies with assets of $50 billion or more and companies designated as systemically important by the Financial Stability Oversight Counsel, a “covered company,” to submit to the Fed, FDIC and the oversight counsel a resolution plan for resolution under the Bankruptcy Code in the event of material distress or failure.
In January 2012 the FDIC also issued a final rule (IDI Rule) that required insured depository institutions with assets of $50 billion or more to submit to the FDIC a plan for resolution in the event of failure under the Federal Deposit Insurance Act. The initial submissions under the two rules were due on July 1, 2012.
On the first submission date, nine major financial institutions with operations wholly or partly in the United States submitted plans including J.P. Morgan Chase, Bank of America and Citigroup.
The plans must contain the following:
• Executive Summary: Should include key elements of the plan for rapid and orderly resolution; material changes from any prior plan; and any actions taken by the covered company since the previous plan to improve the company’s effectiveness.
• Strategic Analysis: Should include a description of the plan, including a description of the various actions the company can take; important assumptions; and resources available (such as capital, funding and liquidity) to facilitate an orderly resolution of material entities, critical operations and core business lines.
• Corporate Governance: Should include a description of how resolution planning is integrated into its corporate governance structure; its policies, procedures and internal controls governing the preparation and approval of the plan; and the relevant risk measures used to report credit risk exposures.
• Organizational Structure: Should provide a detailed description of its corporate structure and related information, including: all material entities; ownership interests of each entity and foreign office; a “mapping” of critical operations and core business lines; extensive financial information including an unconsolidated balance sheet for the covered company and a “consolidating schedule for all material entities”; a description of pledged collateral; material off-balance sheet exposure; practices relating to the booking of trading and derivatives activities; material hedges, trading and derivatives activities and exposure limits; major counterparties; and trading, payment, clearing and settlement systems of which it is a member.
• Management Information Systems: Should include a comprehensive description of all aspects of the company’s management information systems and applications.
• Interconnections and Interdependencies: Should include a description of interconnections and interdependencies among (i) a company and its material entities, and (ii) its critical operations and core business lines.
• Supervisory and Regulatory Information: Should describe all of its regulators, supervisors and similar entities, domestic and foreign.
• Contact Information: Should identify the senior management official in charge of the plan and the related reporting process.
Each plan must be found to be “credible” in the judgment of the Fed or the FDIC. While such term is not defined in Dodd-Frank, it seems to contemplate furnishing such regulator with the information it needs to conduct a comprehensive, orderly and speedy resolution (i.e. winding up) of the distressed or failed entity.
Plans are required to be submitted with the appropriate regulators generally as follows: entities with $250 billion or more in assets, by July 1, 2012; those with $100 billion or more, by July 1, 2013; and those with less than $100 billion, by Dec. 31, 2013.
The delayed filing dates for the smaller entities was heavily lobbied by the financial services industries. Regulators were flexible because they wanted the most significant entities to file as early as possible.
An updated plan will be required to be submitted within one year from the original submission, and notices will generally be required to be provided within 45 days of any material event that would cause the previously submitted plan to be not credible. More frequent reports may be required.
Each plan will have a public section and a confidential section. Presumably, the former will be made available to all requests and the latter protected.
Two problems appear: (i) because of the breadth of information required to be included in the public section, the protection may be elusive; and (ii) there is no certainty that all of the information in the confidential section will be protected.
However, the regulators will be in charge, and they have indicated that they will approve confidentiality requests for significant portions of the plans. Time will tell.
It is interesting to note that, at present, neither Dodd-Frank nor the related rules of the Fed and the FDIC provide a definition of “credible.” However, it would seem that a plan would be found to be credible if all of the information, strategies and other facets it contains should enable the resolution authority to successfully complete its resolution in the manner contemplated. But, at the end, it looks like it will be a regulator judgment call.
The regulators plan to work closely with a covered company in developing its initial plan, and do not intend to declare it not credible. Rather, such plan is to be used as a basis for the development of a “better” annual resolution plan over subsequent years.
If a plan is determined to be not credible, the company must resubmit a revised plan within 90 days together with an explanation of why it is credible and would result in an orderly resolution of the company.
If the regulators determine that the deficiencies have not been corrected, they may impose a number of sanctions, including the following: higher capital, liquidity, leverage and other similar requirements; restrictions on operations and related activities; and, under certain circumstances, the divesting of assets.
A review of the public section of several of the submitted plans revealed the following:
• JPMorgan Chase & Co’s plan, called “Single Point of Entry Recapitalization,” contemplates the resolution of the firm under Title II of Dodd-Frank, which would involve the creation by the FDIC of a bridge entity for Morgan, the transfer of the systemically important and viable parts of its business (i.e. the stock of its main operating subsidiaries and any inter-company claims against such subsidiaries) to the bridge entity, the recapitalization of such businesses by contributing such intercompany claims to the capital of such subsidiaries and the exchange of debt claims against the liquidating “left-behind” parent entity for equity in the bridge entity.
Under this strategy, only Morgan would be placed in a Title II receivership and its principal operating subsidiaries would continue in business as subsidiaries of the bridge entity without being placed in resolution proceedings.
The stock of the bridge entity would be distributed to Morgan’s creditors in satisfaction of their claims against Morgan not assumed by the bridge entity. The plan points out that “any losses associated with recapitalizing the bank would be borne by equity holders and, to the extent necessary, the creditors of the firm and not by the U.S. government or taxpayers.”
The Morgan plan also points out that: “Recapitalization would be intended to preserve the operation of the Firm’s systemically important functions, promptly return the systemically important and viable parts of the Firm’s business to the private sector without a lengthy period of government control, preserve the going concern value of the Firm for the benefit of its creditors, and avoid the value destruction which could result from a disorderly liquidation of the Firm or its assets.”
Two alternative resolution plans, called “Recapitalization” and “Sale and Wind-Down,” are also described, but the above plan appears to be the favorite.
• Bank of America’s resolution plan contemplates the following: (i) its main U.S. banking subsidiaries (including Bank of America, N.A. and FIA Card Services, N.A.) would be placed in FDIC receiverships, and certain assets and liabilities would be transferred to a bridge bank that would emerge from resolution as a going concern; (ii) other material entities would be wound down in an orderly manner; (iii) the resolution of material non-bank, non-broker-dealer entities would be resolved through bankruptcy procedures; (iv) the liquidation of material domestic broker-dealer entities such as Merrill Lynch would be conducted pursuant to the Securities Investor Protection Act (SIPA); and (v) certain investment bank subsidiaries would be subject to applicable foreign regimes such as the U.K. Special Administration Regime and the Irish Special Resolution Regime.
Also, BofA stressed that the plan “includes strategies designed to insure continuity of certain core business lines and critical operation,” and the “strategies incorporate the importance of continued access to critical services including, but not limited to, technology, employees, facilities, intellectual property and supplier relationships.”
• Citigroup Inc.’s plan contains two basic alternatives:
The first contemplates that, before the failure of Citigroup, it would recapitalize Citibank, and then commence proceedings under Chapter 11 of the Bankruptcy Code. Under this formulation, Citibank (and other bank subsidiaries of Citigroup) would continue in business on a going concern basis, without the need for any formal FDIC resolution procedure. Citigroup would sell its broker-dealers before its failure; if this would not be possible, they would be liquidated under the insolvency regimes applicable to each.
Under this approach, Citigroup’s “core banking business would be separated from the failed Citigroup parent holding company and broker-dealer businesses and continued as a smaller but recapitalized and viable banking institution.”
The second alternative would involve resolution procedures being commenced solely with respect to Citigroup. Its “bank and broker-dealer subsidiaries would be recapitalized with capital of the holding company [i.e. Citigroup] and would continue as ongoing entities owned by a bridge holding company created under Title II of the Dodd-Frank Act.
Once the ongoing business operations of the bridge holding company’s subsidiaries were stabilized, the bridge holding company could return to the private sector as “a viable, well-capitalized financial institution under new management and ownership, without the use of taxpayer funds.”
• It is interesting to note that each of the three above plans states that the covered company has (i) strengthened its financial position and operations and (ii) developed a plan that will not require taxpayer support.
• Because of the rule requirements mentioned above, the nine recent submissions were generally similar in format (based upon their public sections). However, only the regulators can comment on the private sections. The second (July 1, 2013) and third (Dec. 13, 2013) waves (aggregating, with the above nine entities, approximately 124 institutions in all) will probably follow along even more closely unless the regulators decide to change the format.
• The economic assumptions for the first wave was that markets are generally functioning normally (i.e. only the submitting entity is in trouble, which seems naïve); it is assumed that future assumptions will be more stressed.
• While some observers feel that the “Living Will” process is a waste of time and money since there is no current problem, others feel strongly that the process is worthwhile since it will prepare both regulators and bank management to better deal with problems that may occur.
• Some observers wonder whether, in a stressed economy like 2008 when Bear Stearns crashed, there will be any willing or able institutions to step in and acquire assets of troubled institutions?
• Some observe that the living will process could point out to management ways that their institutions can be streamlined so that certain of their legal entities or businesses can be sold more easily.
• One concern shared by a number of commenters is whether the “implicit assumption” in the living will process, that our regulators will work closely with international regulators, is valid.
The Dodd Frank resolution proposal and Lliving will program certainly is a noble effort and, if it works, should help our regulators deal with the novel financial crises and problems that arise with no warning and require immediate decisions and actions. Time will tell.
Clyde Mitchell is adjunct professor of banking law at Fordham University School of Law, and a former banking partner at White & Case.