crossborder issues in bank resolution and implications for the UK by Professor Rosa M. Lastra

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cross-border issues in bank resolution and
implications for the UK by Professor Rosa M.
Lastra

• CCLS, queen mary university of london
• R.lastra_at_qmul.ac.uk
• April 2008

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Introduction

• In any financial crisis, it is necessary to have
  a clear and predictable legal framework in place
  to govern how a financial institution would be
  reorganized or liquidated in an orderly fashion
  so as not to undermine financial stability.
• We do not have such a framework yet with regard
  to cross-border banks, neither at the European
  level nor at the international level.

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Scope of bank crisis management

• Bank crisis management comprises an array of
  official private responses that extends beyond
  the insolvency proceedings that are the only tool
  typically available to deal with corporate
  bankruptcy in other industries.
• As regards the official responses, when
  confronted with failed or failing banks, public
  authorities have at their disposal
• (1) The lender of last resort role of the
  central bank
• (2) Deposit insurance schemes
• (3) Government policies of implicit protection
  of depositors, banks (the too-big-to-fail
  doctrine or the new too inter-connected test)
  or the payment system
• (4) Insolvency laws (lex specialis vs lex
  generalis)
• (5) Prompt corrective action and preventive
  measures
• If at the national level, bank crisis management
  is complex (with the involvement of several
  authorities and the interests of many
  stakeholders), this complexity is far greater in
  the case of cross border bank crisis management.
  This affects lender of last resort, deposit
  insurance arrangements and insolvency proceedings.

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Implications for the UK Tripartite arrangement

• The Tripartite arrangement does not deal with all
  the aspects of bank crises management. It deals
  with (1) ELA and (3). Need for consistency at the
  national level in the reform proposals, as well
  as compliance with EU rules of winding up and
  liquidation (there will be a new Directive on
  this), deposit insurance (there should be a new
  Directive) and state aid (clarification needed,
  where public interest can be invoked.
• The Tripartite arrangement is a good structure to
  respond to the problems of transferring
  supervision from the central bank (Bank of
  England) to a separate supervisory agency (FSA),
  while keeping the Treasury involved. However,
  the wisdom of separating the monetary and
  supervisory responsibility of the central bank
  remains a matter of controversy. Given that
  supervision is a key instrument in the
  maintenance of financial stability, depriving the
  central bank of this instrument, makes the
  pursuit of the goal of financial stability more
  difficult.

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Cross-boder issues the European dimension

• Though arguably the ECB has successfully provided
  liquidity to the market in recent months to
  alleviate the credit squeeze, the arrangements
  for managing and resolving a cross-border
  financial crisis in the EU remain untested and
  are, in my opinion, insufficient. The structure
  is inappropriate.
• Cross-border crisis management in Europe presents
  additional challenges for policy-makers and
  regulators, because of
• European Monetary Union. The ECB has no European
  fiscal counter-part, which means that the
  relevant fiscal authorities are by definition at
  the national level. Problem in rescue operations.
  The fiscal costs of resolving a banking crisis
  can be large. Who should bear the costs of any
  proposed failures occur in large cross-border
  banks. The ex-post allocation of the fiscal
  burden of the costs of recapitalisation is a most
  controversial issue (Goodhart and Schoenmaker)
• The complex European Financial architecture.
• The patchy and scattered legal framework
• Supervision remains at the national level -
  process of financial integration, the single
  market in financial services - the trilemma

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A patchy and scattered legal framework

• Primary Law article 105 EC Treaty and Articles
  18 and 25 ESCB Statute LOLR rules on state aid
  - Articles 87-89 EC Treaty.
• Secondary law (pursuant to Art 47 (2) EC Treaty)
• Directive 2006/48/EC of the European Parliament
  and of the Council relating to the taking up and
  pursuit of the business of credit institutions
  (Recast Banking Directive).
• Dir 2006/49/EC, Capital Requirements Directive
  Directive 2003/6/EC, Market Abuse Directive.
• Dir 2002/87/EC, Financial Conglomerates
  Directive
• Directive 2001/24/EC on the reorganisation and
  winding up of credit institutions.
• Directive 2004/39/EC on markets in financial
  instruments (MiFID)
• Dir 94/19/EC,Deposit-Guarantee Schemes
  Directive.
• Dir 97/9/EC, Investor Compensation Schemes Dir.
  
• MoUs (non-legally binding arrangements) 2001,
  2003, 2005 April 4-5, 2008, Slovenia.

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Supervision crisis
management in the EU STAGE PRINCIPLE1.
Licensing National competence with regulatory
harmonisation 2. Prudential supervision
National competence with regulatory
harmonization and consultation ECB and
Lamfalussy3. Sanctioning National
competence 4. Lender of last resort National
and European competence  5. Deposit
Insurance National competence with regulatory
harmonization6. Insolvency
proceedings National competence with regulatory
harmonization European competence -
centralizationNational Competence (typically
home country control) - decentralizationBoth
home country and host country are national
competence. In the case of consolidated
supervision the lead regulator is also a national
regulator.
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 Allocation of LOLR
responsibilities in the EUCASE PRINCIPLE LEGAL
BASIS Payment systems gridlock Centralisation A
rt. 105(2) EC Treaty

 Generalized liquidity
dry-up Centralisation Art. 18 ESCB Statute
 Emergency credit lines Decentralisation
Art. 105 (5) and (6) EC, Ambiguity, Art.18
ESCB Statute, MoUs, Subsidiarity. Art.
5 EC - The only ambiguity that can be
constructive in LOLR is the discretionary
component in the provision of such assistance, in
the sense that there is no obligation for the
central bank to provide LOLR loans. It is this
discretionary nature, this uncertainty, that
reduces the moral hazard incentives inherent in
any support operation.- Regarding Eurosystem
monetary policy operations, only institutions
subject to the Eurosystems minimum reserve
requirements (Article 19 ESCB Statute) are
eligible to be counterparties to Eurosystem
facilities and open market operations.
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The trilemma of financial supervisionThygesen
and Schoenmaker

• Stable financial system

National financial supervision
Integrated financial market
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Other considerations at the European level the
notion of Consolidated supervision provisions
on co-ordination information sharing

• Consolidated supervision is based on the
  assumption that financial groups form a single
  economic entity. However, when one comes to the
  question of the resolution of a failed
  multinational bank, or of a complex financial
  group with activities and business units with
  different legal entities incorporated in various
  jurisdictions, the assumption that financial
  groups form a single economic entity appears to
  be not always valid in a bankruptcy scenario
  where the group is split up into its many legal
  entities and where foreign branches are some
  times liquidated as separate units.
• Article 130 of Directive 2006/48/EC of 14 June
  2006 (The Recast Banking Directive) refers to a
  mechanism for coordination for the competent
  authority responsible for consolidated
  supervision but is that sufficient? How to
  co-ordinate potential conflicts of interest?
• The Recast Banking Directive, the MiFID, the
  Financial Conglomerates Directive and the Banks
  Winding-up Directive contain provisions relating
  to the exchange of information among the
  competent authorities responsible for the
  management of crises.
• Cooperation and coordination -- not enough in a
  crisis, as NR evidences. Clear rules, procedures
  and allocation of responsibility are needed.

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State aid to the banking sector under EU rules

• Banks (whether publicly or privately owned) are
  subject to EC competition rules (articles 81-89
  EC Treaty), including state aid rules (87-89) as
  confirmed by the ECJ in Zuchner v Bayerische
  Vereinsbank (Case 172/80 1981 ECR 2021).
• Further guidance has been provided in Comission
  Decisions.
• (See Commission Decision 95/547/EC and
  98/490/EC, Crédit Lyonnais Commission Decision
  98/288/EC, Banco di Napoli Commission Decision
  99/508/EC, Société marsellaise de Crédit
  Commission Decision 2001/89/EC, Crédit Foncier de
  France).
• Article 295 EC establishes that the Community is
  neutral re national systems of property
  ownership.
• Public interest/general interest considerations

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The role of the Commission

• Commission communications elaborate on the
  private market investor principle there is no
  state aid if public funds or guarantees are made
  available on terms which a private investor,
  operating under normal market conditions would
  find acceptable.
• Public interest considerations
• Commission Decisions See Commission Decision
  95/547/EC and 98/490/EC, Crédit Lyonnais
  Commission Decision 98/288/EC, Banco di Napoli
  Commission Decision 99/508/EC, Société
  marsellaise de Crédit Commission Decision
  2001/89/EC, Crédit Foncier de France.
• The Commission has not made it clear what type of
  central bank interventions are subject to state
  aid rules. Open market operations/monetary
  policy decisions are not. But direct liquidity
  support....
• Northern Rock nationalization (2008) - EU state
  aid rules

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Cross border issues the international dimension

• There is no international insolvency standard
  for banks or other financial institutions
  (Krimminger, 2004).
• In the absence of an international insolvency
  legal regime applicable to banks, the solution to
  the liquidation of a bank with branches and
  subsidiaries in several countries needs to be
  based on national legal regimes and on the
  voluntary co-operation between different national
  authorities. This co-operation is often uneasy
  and the division of responsibilities between home
  and host country authorities remains a matter of
  controversy
• National insolvency laws can adopt the following
  international law principles
• Universality or territoriality (inconsistencies
  in its application US bank insolvency law is
  universal with respect to US banks and
  territorial for US branches of a foreign bank)
• Single entity or separate entity approach to
  liquidation (the single entity approach is in
  line with the principle of the unity and
  universality of bankruptcy, which assigns
  extra-territorial effect to the adjudication of
  bankruptcy)
• Ring-fencing (though contrary to the pari passu
  principle and prohibited under Article 13.1 of
  UNCITRALs model law, it does happen).

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Need for international rules on bank insolvency

• Bilateral rules - MOUs
• Regional rules EC insolvency regulation and EC
  Directives on the winding up and liquidation of
  credit institutions and of insurance
  undertakings other regional rules Montevideo
  and Bustamante Treaties.
• International rules - Soft law concerning
  cross-border insolvency (even though they do not
  contain specific substantial rules with regard to
  banking), typically private international law,
  conflict of laws, rules allocating
  responsibilities. The most significant are
• Uncitral - Model Law on Cross-Border Insolvency
  (1997) and Legislative Guide on Insolvency Law
  (2004). Article 1(2) of the Model law contains
  an optional clause whereby special insolvency
  regimes applicable to banks may be excluded from
  its scope and Legislative Guide on Insolvency
  Law (2004). UNCITRAL Working Group V on
  insolvency has started working on the treatment
  of corporate groups in insolvency in 2006,
  examining both domestic and cross border issues.
  This could be the right forum to develop common
  principles concerning bank insolvency.
• World Bank/IMF standard on Insolvency and
  Creditor Rights (ICR ROSC) 2005.
• Special mention ought to be made to the new Basel
  Working Group set up in December 2007and
  co-chaired by M. Krimminger and Eva Hupkes to
  study the resolution of cross-border banks
  (meeting Feb 2008)

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What rules on International bank insolvency?

• Principles
• Lex specialis
• Single entity approach
• Universality (requires common trust)
• Rules - New rules (regulation) are needed to
  deal with cross-border bank insolvency. The Basel
  Committee has established a working group
  (December 2007) to study the resolution of
  cross-border banks.
• Definition of triggers for commencement of
  proceedings, including PCA rules
• Role of supervisors, courts and other authorities
• Minimum rights and obligations of debtors and
  creditors
• Right to set-off, netting, treatment of financial
  contracts.
• Burden sharing
• Protection of payment systems
• Prompt resolution

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A note on the need to have wide range of tools

• The need to have a wide range of tools in the
  tool-kit (even if they remain dormant in the
  legislation for ever or for a long time)
• E.g. Bear Stearns (March 2008) marks the first
  time since the 1960s that the Fed authorized the
  provision of emergency funds to any financial
  institution other than a regulated bank. Fed
  officials said that Bear Stearns (the 5th largest
  US investment bank) was not too big to fail, but
  too interconnected to be allowed to fail at a
  moment when markets were extremely fragile. The
  Fed acted under section 13.3 of the Federal
  Reserve Act, which gives it authority to lend to
  any individual, partnership or corporation in
  unusual and exigent circumstances. That
  authority was last invoked in the 1960s and Fed
  officials said loans were last disbursed in the
  1930s. As an investments bank, Bear Stearns did
  not have access to the Feds DWL. So the Fed
  arranged back-to-back transactions with JP Morgan
  to give Bear indirect access to the window. JP
  Morgan bought Bear Stearns paying 2 per share
  (later revised to 10 per share).

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A note on deposit insurance

• Deposit insurance needs to be explicit and
  credible
• Prompt payment (speedy payout). FDIC in the US
  pays insured depositors asap, normally achieved
  by next business day.
• Level of protection. Disadvantage of partial
  deposit insurance. In most other EU member
  states, deposits are covered for the entire
  amount, though with different ceilings.
• Only deposits. FSCS also provides compensation
  for insurance policies and investment business.
  The Financial Services Compensation Scheme was
  set up under the Financial Services and Markets
  Act 2000 (FSMA) as the UKs compensation fund of
  last resort for customers of financial services
  according to the Directives on Deposit Guarantee
  Schemes and Investor Compensation Schemes. FSCS
  has no real powers as opposed to FDIC in the US
  insurer, supervisor and receiver of failed or
  failing institutions

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A note on PCA

• Discretionary powers to discipline banks are not
  sufficient. PCA rules are only effective if they
  are mandatory and legally binding, as in FDICIA.
  As Goodhart points out the window of opportunity
  between closing a bank so early that its owners
  may sue and so late that the depositors may sue
  may have become vanishingly small.
• The trigger ratios should combine capital
  (solvency) and liquidity indicators.