Making Bail-in Operational Charles Gray Vice President Financial Institution Supervision Group

Financial Safety Net Conference

May 2015

Disclaimer

The views expressed in this presentation do not necessarily reflect the views of the Federal Reserve Bank of New York, or any component of the Federal Reserve System.

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G-SIB resolution – overarching goals and the basics 

Overarching goals  Continuity of critical operations (market stability)  Avoid exposing taxpayers (public funds) to loss  Continuity of core business lines (preserving franchise value)  Enable reorganization of the firm

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The basics  Recovery actions have failed and firm has reached point of non-viability  Top parent is either a holding company or an operating bank  Under a single point of entry (SPOE) strategy, top parent is the entity placed into a resolution proceeding

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Pre-conditions to make G-SIB bail-in operational 

To enhance the feasibility and credibility of the SPOE bail-in resolution strategy for a global, systemically important bank (G-SIB), the following pre-conditions are essential:  Adequate loss absorbing capacity at the top-tier entity of the firm (“Parent”)  Adequate capacity of Parent to downstream capital to operating subsidiaries  Parent Holding Company (if present) is “clean” ▫ No short-term debt issued out of Holding Company ▫ Limited derivatives exposures to third parties issued out of Holding Company ▫ No upstream guarantees by operating entities of Holding Company obligations

 Counterparties and foreign authorities understand the home jurisdiction’s preferred resolution strategy and dual goals of preserving financial stability while preserving franchise value for creditors of Parent

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Overview of TLAC requirement 

The FSB’s proposed Total Loss Absorbing Capacity (“TLAC”) standard is designed to ensure that G-SIBs maintain sufficient resources that can be exposed to loss (written down or converted into equity) during resolution.  TLAC is the combination of existing regulatory capital instruments plus other qualifying loss absorbing instruments.  Under the FSB proposal, the quantitative minimum range of TLAC will be between 16% to 20% of risk-weighted assets (RWAs), and at least 2x the minimum leverage ratio requirement.

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While adequate TLAC is not by itself a sufficient condition for ensuring effective resolution, adequate loss absorbing capacity is a necessary condition to implement resolution strategies that are aimed at maintaining the continuity of critical functions and promoting market confidence without exposing taxpayers to the risk of loss.

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Location of TLAC (External vs. Internal) 

External TLAC. At the resolution entity level, the FSB has proposed external TLAC minimums for all resolution entities (e.g., the top parent entity for an SPOE firm).

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Internal TLAC. Required for designated material subsidiaries (i.e., entities incorporated in a national jurisdiction other than that in which the resolution entity is incorporated and that meet certain materiality thresholds).  Pre-positioned on the balance sheet of material subsidiaries  The proceeds of external TLAC committed to material subsidiaries can serve as internal TLAC.  Holding company should also maintain unallocated internal TLAC that can be downstreamed to material subsidiaries in the event that significant losses in resolution exceed the pre-positioned internal TLAC at such entities.  This allows the home country authority to have flexibility in restoring solvency to material subsidiaries in foreign countries in resolution, and diminishes the possibility of disruptive ring-fencing by host jurisdictions.

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SPOE: Group Structure Before Bail-in

Public shareholders

G-SIB Holding Company

Deposits / Advances 25

Parent Only Balance Sheet

Domestic Bank

Deposits / advances to subs

45

Unsecured long-term debt

55

Equity in subs

45

Unsecured short-term debt

0

Other assets

10

Secured liabilities

0

Other liabilities

0

Total

100

Equity Total

Equity 25

45

Advances 10

Equity 10

US BrokerDealer

Advances 10

Equity 10

Foreign BrokerDealer

Foreign Branch

100

Diagrams based on Bipartisan Policy Center, Too Big To Fail: The Path to a Solution (2013).

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SPOE: Hypothetical Losses

Public shareholders

G-SIB Holding Company

Deposits / Advances 25

Parent Only Balance Sheet Deposits / advances to subs

Domestic Bank

45

Unsecured long-term debt

55

Equity in subs

9

Unsecured short-term debt

0

Other assets

10

Secured liabilities

0

64

Other liabilities

0

Equity

9

Total

Total

Equity 25 5

Advances 10

Equity 10 2

US BrokerDealer

Advances 10

Equity 10 2

Foreign BrokerDealer

Foreign Branch

64

Diagrams based on Bipartisan Policy Center, Too Big To Fail: The Path to a Solution (2013).

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SPOE: Recapitalizing Operating Subsidiaries and Bridge

Convert debt to equity at operating subsidiaries Claims left behind

Failed G-SIB in receivership

Long-term debt: 55 Equity: 9

Bridge HoldCo Assets of failed G-SIB and guarantees of subsidiary obligations

Deposits / Advances 25 5

Equity 5 25

Advances 10 2

Equity 2 10

Advances 10 2

Equity 2 10

Receivership Balance Sheet Equity of Bridge FHC Total

64

Unsecured long-term debt

64

Equity Total

55

Domestic Bank

US BrokerDealer

Foreign BrokerDealer

9 64

Bridge HoldCo Balance Sheet Deposits / advances to subs

9

Equity in subs

45

Other assets

10

Total

Liabilities Equity Total

0 64

Foreign Branch

64

64

Diagrams based on Bipartisan Policy Center, Too Big To Fail: The Path to a Solution (2013).

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Process for operationalizing bail-in 

In the runway period leading up to the point of non-viability:  Identify losses – amounts and locations/jurisdictions  Identify funding sources to maintain liquidity in resolution  Identify new management team  Coordinate with Financial Market Infrastructure (FMIs) as needed to ensure continued access to services  Coordinate with affected domestic and foreign authorities (supervisory and resolution) to develop communication strategy and prepare other necessary pre-arrangements

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At the point of non-viability:  Holding company / bridge bail-in: ▫ Resolution authority converts the insolvent Holding Company’s unsecured debt into equity in a Bridge Company to which the original Holding Company’s assets are transferred. Holding Company fails and bail-inable debt is left behind. ▫ Creating the Bridge Company and effectuating the asset transfer is expected to occur over resolution weekend. ▫ Determining the ultimate value to be distributed to holders of bailed-in TLAC liabilities can occur over a longer time.

 Operating bank / direct bail-in: ▫ Resolution authority converts TLAC liabilities of the parent operating bank into equity to recapitalize the operating bank. 10

Challenges to operationalizing bail-in 

SPOE is untested. The theory is compelling, but execution in practice will raise numerous issues of first impression.

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Requires sufficient external TLAC and internal instruments to absorb losses  FSB currently conducting a Quantitative Impact Study with respect to the proposed TLAC standard.

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Need to effectively balance certainty for host regulators associated with “prepositioned” internal TLAC instruments in material entities (i.e., reduce incentives to ring-fence) while retaining appropriate flexibility at the holding company to be able to move capital where it is needed in a particular situation

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Key areas of ongoing work to operationalize bail-in and each home jurisdiction's preferred resolution strategy include:  Funding in resolution  ISDA protocol  Operational Continuity ▫ Continuity of Critical Shared Services ▫ Continuity of FMI Access  Valuation methodology 11