Editor’s Note: This article provides a general overview of the current state of financial institutions’ resolution planning as required by the Dodd-Frank Act and is the first in a series of related articles.
With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) in 2010, there is no denying that life as it was known at the time for large financial institutions was inexorably changed. The Dodd-Frank Act was, drafted and passed in response to the financial crisis in 2007 and 2008, during which time a number of companies, large and small, failed in large part due to severe liquidity shortfalls and great market uncertainty. The failure of institutions showed that lack of advance planning and the complexity created by multiple jurisdictions and insolvency regimes could give rise to significant issues with the resolution process of complex financial institutions. The Dodd-Frank Act was an effort by Congress to ameliorate the repercussions of another, similar financial crisis in the future.
While not all have been fully implemented, numerous rules were created as part of the Dodd-Frank Act legislation. The specific requirement for financial institutions with assets greater than $50 billion and that meet the relevant regulatory definitions to create a so-called “living will” has impacted a significant number of financial institutions, ranging from the largest global organizations to more moderately sized regional banks. While the term “living will” generally encompasses both a “recovery” and a “resolution” plan, the required element for which final rules have been created by the Federal Reserve Board and the Federal Deposit Insurance Corp. (FDIC) is the latter: the resolution plan.
Recovery planning assumes that an organization is severely distressed but might have the ability to “rescue” itself from ultimate failure and a subsequent insolvency proceeding. Recovery plans are intended to develop a range of “self-help” options that are available to the institution to correct its current situation, whether by virtue of improving liquidity, raising capital or scaling back business operations. Consequently, a recovery plan presumes that the company’s board of directors and management remain in control and can exercise one or more recovery options to prolong its life and return to financial health.
On the other hand, resolution planning is designed to provide a guidebook for the appropriate financial regulators and authorities that will supervise the resolution in the event of the institution’s failure. These authorities could be the debtor in possession for a chapter 11 proceeding, a Securities Investor Protection Corp. (SIPC) trustee for a broker/dealer under a Securities Investor Protection Act (SIPA) process, state insurance commissioners or the FDIC as the receiver for a failed insured depository institution, among others. Depending on the complexity of the financial institution, more than one relevant authority might be involved. The resolution plan is intended to provide a manual of sorts for an orderly and timely resolution process, thus hoping to avoid a more chaotic process that may ultimately achieve the same goal but at greater expense, time and effort. Resolution plans created by the financial institution may, at present, not assume or incorporate any of the new powers granted to the FDIC under the Dodd-Frank Act, namely the Orderly Liquidation Authority (OLA).[1]
The first round of institutions, representing the nine largest global significantly important financial institutions (known as “G-SIFIs”),[2] submitted their initial resolution plans on or before July 1, 2012. The organizations that were part of this original filing group, as well as two additional companies required to submit a first plan by Oct. 1, 2012, have now submitted their second resolution plans to the regulators. A smaller group of institutions (referred to as “Wave Two” financial institutions) submitted their initial resolution plan by July 1, 2013. The largest group of filers (known as “Wave Three”), in excess of 100 institutions, filed their initial resolution plans by Dec. 31, 2013.
As it was clear by the guidance[3] that was provided by the regulators in response to the first round of filings from 2012, the process to prepare resolution plans will continue to evolve. How much of this guidance will be applicable to subsequent plan submissions for the second- and third-wave filers remains unclear at this point, but at a minimum, additional stress scenarios, more details regarding the insolvency processes and specific plans related to actions that the institutions have committed to take in order to mitigate difficulties identified in the potential execution of their resolution process likely will be required.
Now that a growing body of work related to resolutions plans has been created and more specific — albeit not comprehensive[4] — regulatory guidance exists, assessing the impact of resolution planning on those financial institutions required to prepare such a plan is a more meaningful exercise. At a very high level, the creation of a resolution plan is a time-consuming, resource-intensive and an often-costly exercise. Some institutions have created separate “living will” or “RRP” offices within their internal organizational structure to ensure that the annual resolution-planning process is completed; all are required to describe how resolution planning is incorporated into their day-to-day governance, whether a separate office exists or not. In many instances, outside consultants, such as law firms and financial advisers, have been an integral part of the process. Given the breadth of the content included in a resolution plan, a significant number of personnel inside an institution will also continue to be involved in the creation of the resolution plan to varying degrees. However, while the process continues to evolve, the iterative nature of the submissions should reduce some of the administrative elements over time.
While the resolution-plan process is lengthy and creates a heavy work load on the institutions identified as required filers, the content of the resolution plans have provided useful insight into each institution’s inner workings. The table of contents provided by the regulators and, more importantly, the elements defined in the Federal Reserve and FDIC resolution plan rules cover a broad range of topics, including the following:
- an overview of the institution and its operations;
- an identification and description of the company’s primary (i.e., material) legal entities and core business lines;
- the identification and description of any business operations conducted by the institution whose loss or cessation could have a systemically important impact on the U.S. economy as a whole (“critical operations”);
- the identification of internal support functions, such as human resources, treasury, finance, and management information systems, that are necessary to the organization’s continued operation, as well as its material legal entities, core business lines and critical operations (if any);
- a discussion of how the different legal entities, business lines, critical operations and support functions interact with each other, focusing particularly on any dependencies between two or more of these entities; and
- given specific criteria, a strategic assessment (or analysis) of how each material legal entity, core business line and/or critical operation can be wound down in an orderly manner to minimize any disruption to the U.S. economy and financial markets:
- this strategic analysis includes a description of the relevant insolvency regime for each legal entity under the current laws (i.e., not assuming OLA), and
- the analysis must also include an assessment of how liquidity and funding may be needed to complete the orderly liquidation process.
The plans must also note any impediments to an orderly resolution — or wind-down — of the institution and its components that were identified during the plan-drafting process. For example, these impediments might include a lack of clear funding/liquidity sources, the conflicts that are created by differing insolvency regimes, the challenges in providing relevant data by material entity,[5] unclear knowledge regarding the existence of any guarantees among the entities, and the inability to identify ownership of intellectual property, vendor contracts or information systems.
For those impediments that are under the control of the organization — in other words, those that would not require regulatory or legislative actions to fix — the organization must also create action plans, or mitigants, to reduce or eliminate these obstacles in the future. Simply indicating that “something” will be done is not sufficient; the action plans must include details of the steps to be taken, as well as a reasonable time frame for completion and the resources that are necessary to complete the actions. The institution must show in subsequent years how it is progressing on the mitigants and also identify any new obstacles that might have arisen since the last report was filed.
Given the nature of the resolution plans and their required content, it is easily understood why the process would perhaps not be welcomed with open arms. Additional regulatory requirements, including Comprehensive Capital Analysis and Review (CCAR) and the Basel III capital adequacy levels, create more work for the same financial institutions and also bring their own costs — both through monetary and time commitments. Arguably, however, with all of the resolution plan information in hand, financial institutions are in a better position to understand the nature of their respective companies and business, how the various businesses or divisions of the organization fit together and interrelate, and what issues could arise in a worst-case scenario where the institution fails. In some cases, institutions have already begun to reshape their organization in an effort to simplify structure and improve resolvability, which might involve a reduction in legal entities, reducing dependencies between entities, improving data-reporting capabilities, and even the creation of separate service companies that house most or all corporate support functions. However, these actions cannot solve all obstacles to resolution and other actions that might have a greater impact are simply too costly to contemplate. The in-depth self-examination that organizations have been undertaking have typically resulted in a new way of viewing their businesses, which by itself is a benefit that might not have existed without the resolution-plan process.
Given the uncertainty of what the world and the financial markets will look like when the next serious financial crisis occurs, which in turn could impact any number of these financial institutions — or the perhaps less likely scenario where an idiosyncratic event damages a single financial institution and not others — resolution plans are inherently subject to significant limitations. Too many permutations for a failure scenario exist to model all of the outcomes; in addition, the financial world continues to adapt to a changing environment, which might create the need for additional regulations in response. However, being better prepared for the eventuality of a single- or multi-institution failure cannot be a bad outcome and resolution plans, as well as the separate strategic plans being prepared by regulators, contribute to this preparedness despite those limitations.
[1] For more information regarding the OLA, view the Dodd-Frank Act at www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf and the FDIC website location at www.fdic.gov/regulations/reform/dfa_selections.html.
[2] For a complete list of institutions in the first group of resolution plan filers, as well as all other filers to date, visit the FDIC website at www.fdic.gov/regulations/reform/resplans/.
[3] Please refer to the “guidance” provided by the Federal Reserve and the FDIC in April 2013 (Guidance for 2013 § v165(d) Annual Resolution Plan Submissions by Domestic Covered Companies that Submitted Initial Resolution Plans in 2012 and Guidance for 2013 § 165(d) Annual Resolution Plan Submissions by Foreign-Based Covered Companies that Submitted Initial Resolution Plans in 2012. Information can be found at fdic.gov/news/news/press/2013/pr13027.html.
[4] The guidance provided was specifically directed only to the first-wave filers (which includes the two institutions originally filing in October 2012).
[5] Institutions have, in some instances, experienced difficulties in providing legal entity-level data, as this is not the typical lens that is applied by management and others, whose focus is instead on business operations.