Liechtenstein 15 July 2013: Some 18 months had passed since the publication of the Key Attributes of Effective Resolution Regimes (“Key Attributes”) when the Financial Stability Board (FSB) conducted its first thematic review of the implementation of said standards by its member jurisdictions. The pace at which the FSB is working on a framework for resolving financial institutions, especially those that are globally systemically important (“G-SIFIs”), demonstrates the subject’s priority in the post-crisis regulatory and political world. The implementation of such a framework is seen by many as the key to ending the undesired effects of the “too big to fail” status that major financial institutions have exploited with great success. Heads of State are determined to ensure that national authorities never again experience the necessity – for lack of viable alternatives – to bail out shareholders and unsecured/uninsured creditors of failing financial institutions with public funds. Accordingly, national resolution authorities, legislators and regulators have been busy these past months bringing domestic rules and structures in line with the recommended set of Key Attributes. But also the staff of financial institutions’ compliance departments have likely worked overtime to fulfil their share of follow-up work.

In its report to the G-20 on the results of the thematic review exercise, the FSB establishes some, limited progress. Given the duration of regular legislative procedures in most countries, this is nothing less than what could have realistically been expected – not to mention the technical complexity of the subject and its political delicacy.

The FSB identifies a need for further legislative or regulatory action in several areas in relation to the establishment or reform of resolution regimes. (1) In some jurisdictions, the law still does not empower authorities to deploy the full range of resolutions tools such as “bail-in” (debt write down and/or debt-to-equity conversion) and the transfer of assets and liabilities. (2) Resolution frameworks should cover all types of financial institutions with potential systemic importance, i.e. apart from banks also insurance companies, investment firms and financial market infrastructures. This should include, according to the FSB, effective segregation and record-keeping of client assets, which will facilitate resolutions. (3) Only few national frameworks currently provide for effective powers to resolve financial groups and conglomerates by enabling authorities to intervene at the level of the financial holding or parent company (“top-down approach”). (4) Most jurisdictions lack procedures for giving effect to resolution action by foreign authorities so as to support a group-wide transnational resolution strategy. Australia represents the only FSB jurisdiction imposing an obligation to avoid bank resolution actions adversely affecting the financial stability of other jurisdictions (albeit currently limited to New Zealand). (5) In many jurisdictions, the capacity to share confidential information relevant for resolution purposes with foreign authorities needs to be strengthened. (6) All resolution authorities should possess the power to stay temporarily the exercise of contractual acceleration and early termination rights granted by financial contracts during resolution. (7) Perhaps representing the most controversial aspect of the review exercise, the FSB identifies a need for temporary public financial support as a supplement of (or alternative to?) countries’ privately financed resolution funding schemes such as deposit guarantee schemes or resolution funds. (8) Authorities often lack powers to impose changes to financial institutions’ organizational or financial structures so as to improve their resolvability. (9) Finally, the FSB points to the necessity that resolution authorities possess adequate resources in terms of both funding and staff expertise.

Sound domestic legal and institutional resolution regimes constitute a precondition for effective recovery and resolution planning. Because most jurisdictions have not yet concluded the necessary reforms, financial institutions and authorities currently possess limited options regarding their planning for events of financial stress (recovery) and failure (resolution). Nevertheless, the FSB points out that Cross-Border Crisis Management Groups (CMGs) have been established for all G-SIFIs and have taken up their work. These Groups aim to develop high-level resolution strategies on a cross-border basis prior to an actual crisis event. Eventually, CMGs are expected to come up with firm-specific cross-border cooperation agreements, i.e. operational plans with a clear distribution of responsibilities among home and host country authorities (potentially including aspects of resolution financing). Not surprisingly, no such agreement has been concluded to date.

The FSB refers in its report to two broad types of resolution strategies: the “single point of entry” and the “multiple point of entry” approaches. According to the former approach – often the preferable one from an efficiency point of view –, resolution action is taken only at the top holding or parent company level so as to preserve the group structure as a going concern. The latter approach involves multiple resolution actions at subsidiary level leading to a break-up of the group along territorial or functional lines. Which approach is given priority will depend on many factors, including political will, fiscal capacity and mutual trust. The U.S. Federal Deposit Insurance and the Bank of England in a joint paper announced their commitment to pursue a “single point of entry” strategy when resolving U.S.-U.K. financial groups. In other cases, authorities may apply a combination of both approaches.

Finally, the FSB reports that its work is not done yet. Further guidance on technical aspects of designing sound resolution strategies is under way. Moreover, supporting guidance will be issued on procedures for information sharing within CMGs and with host authorities for which a G-SIFI’s operations are locally systemically important without them being represented on the CMG. Once resolution plans have taken shape, the FSB intends to stress test their operability. A group of high-level experts from both home and key host countries will assess the resolvability of each G-SIFIs within the Resolvability Assessment Process.

Overall, the extent to which the FSB is able to intrude into policy areas typically seen as at the very core of national sovereignty is astounding. Such far-reaching influence was unthinkable prior to the crisis. With one of the main post-crisis lessons being that financial stability constitutes a global concern, this development is necessary and desirable. In strict legal terms, the Key Attributes constitute “soft law” unable to be enforced by traditional legal means. However, the FSB’s announced assessment methodology, which will provide a basis for future peer reviews and IMF/World Bank financial sector assessments, is designed to impose a level of “naming and shaming” that renders systematic non-compliance unlikely. Understandably, pressure on small FSB members like Switzerland – home to two G-SIFIs – looms particularly large. Apparently effectively: the FSB’s review revealed that the country’s resolution framework meets the FSB standards almost entirely (with the exception of resolution funding arrangements). Significant reforms are under way in other jurisdictions, including a harmonized resolution framework within the European Union as well as a single resolution mechanism for the euro area.

The achievements to date may seem small given the many gaps that need to be filled before it can credibly be claimed that G-SIFIs are resolvable in a way that protects financial stability and taxpayers. Looking back at pre-crisis times, they are a big improvement, though.