Sea of ChangeRegulatory reforms to 2012 and beyond

The Critical Importance of Group Resolution

Simon Gleeson

Group StructuresGroup Structures

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1. “Bank/nonbank” Model

Financial

Creditors

Holding Company

Financial

2

Bank Investment firm

Bank Group

Investment

Business

Creditors

Financial

and

Banking

Creditors

2. “Big Bank” model

Bank Holding Company

Bank

Financial and

Banking

Creditors

3

Bank Group

Investment business Investment

Business

Creditors

3. “Global multi-bank” Model

Bank Holding Company

Bank Bank Bank Bank

4

Bank

(Country A)

Bank

(Country B)

Bank

(Country C)

Bank

(Country D)

Financial and

Banking

Creditors

Financial and

Banking

Creditors

Banking

Creditors

Banking

Creditors

4. “Conglomerate” model

Industrial Company Financial and

Commercial

Creditors

5

Bank

Financial and

Banking

Creditors

Investment firm Investment

Business

Creditors

Financial Holding Company

Bank

Summary of US Bank Group Regulation

Bank Investment Firm

Inter-group transaction restrictions

– Reg W

Bank activityrestrictions– Reg Y

Financial Holding Company activity Restrictions –Reg Y

6

Financial Holding Company

Retail Bank

Summary of UK Bank Group Regulation post Vickers

Retail Bank Commercial Bank

Inter-group transaction restrictions

– Large Exposures

Bank activityrestrictions– Legislation

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Bank GroupsBank Groups

The Problem

� “The challenge in putting forward a proposal for the structure of group supervision …is to balance two competing views of a …. group: one view sees a …group as a single economic entity within which risks are pooled and diversified, the second recognises the group as a collection of

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second recognises the group as a collection of separate legal entities with segregated risks”

What is a group

� An association of separate legal entities

■ Different insolvency rules and jurisdictions■ Company law regulates inter-company dealings■ Assets of each entity ring-fenced for the benefit of

creditors of that entity in distress

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creditors of that entity in distress■ Transmission of surplus capital difficult■ Dividends■ Share redemptions■ Regulatory resistance to capital reduction

■ Contribution to a capital shortfall almost impossible

The Group

“Contagion risk”

■ The name for the fact that in credit terms the market disregards legal niceties and perceives the group as a whole

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Risks managed at group level

■ Liquidity■ Concentration■ Operational■ Management

Let them eat cake...?

Management structure

IT system IT systemIT system

Company Company

IT system

Company Company

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Resolving Legal and Risk Positions

■ In an insolvency the individual creditors’ recourse is to the assets of the legal entity

■ Prior to insolvency, the individual creditor’s best hope is a group restructuring

■ Surplus capital should be capable of being moved around the group as efficiently as possible

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around the group as efficiently as possible■ Liquidity, concentration and operational

management should not be affected by balance-sheet issues relating to specific subsidiaries

BUT■ Investors who have invested on the strength of a

particular balance sheet should have recourse to the specific assets of that issuer

Group Holding Company

Bank

UK GermanyFrance Non-EU

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Bank Bank

Subsidiary

Bank

Group Holding Company

Bank

UK GermanyFrance Non-EU

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Passported Bank

Subsidiary

� Use of cross-border recognition measures

� Creditor safeguards

� Ownership caps

� Events of default

� Transition to the new regime

Additional issues

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Bank Resolution TriggersBank Resolution Triggers

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� Banks (credit institutions)

� Some investment firms

� Bank holding companies

� Affiliate service providers (some

Scope

� Affiliate service providers (some powers)?

� Branches of non -EU banks?

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� Proposed core trigger test:■ Insolvency-based tests■ No longer fulfils conditions for authorisation; OR■ Regulatory capital test■ Actual or “likely” failure

� Supplemental condition■ Last resort: no other measures available

Resolution triggers

■ Resolution is in the public interest

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Resolving Deposit-Funded banks Resolving Deposit-Funded banks

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Balance Sheet – Bank B

AssetsCash 50Retail Loans 200Mortgage loans 300Commercial loans 100

650

Unexpected loss of 60 in commercial loan portfolio

Equity eliminated –unsustainable

BUT

Resolving the Retail Bank - 1

650

LiabilitiesDeposits 500Short-term funding 100Equity 50

650

NCWO means that short-term funding providers will receive at least 90% of nominal (assuming all depositors preferred)

Therefore bail-in can only create 10 of new equity without breaching NCWO test

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Balance Sheet – Bank B

AssetsCash 50Retail Loans 200Mortgage loans 300Commercial loans 100

650

Unexpected loss of 40 in commercial loan portfolio

Equity reduced to 10 –unsustainable

BUT

Resolving the Retail Bank - 2

650

LiabilitiesDeposits 500Short-term funding 100Equity 50

650

NCWO means that short-term funding providers will suffer no loss.

Therefore any resolution violates NCWO?

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� Questions?

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� Simon Gleeson, Partner, London+44 20 7006 4979Simon.gleeson@cliffordchance.com

Contact

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These slides are for illustration only. They are not intended to be comprehensive or to provide legal advice. For more information, contact the above partner or your usual Clifford Chance contact.

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The Critical Importance of

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The Critical Importance of Group Resolution