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International Coordination in Cross-Border Bank Bail-ins: Problems and Prospects

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Abstract

Bail-in is quickly becoming a predominant approach to banking resolution. The EU Bank Recovery Resolution Directive and the US Federal Deposit Insurance Corporation’s single point of entry strategy envisage creditors’ recapitalisations to resolve a failing financial institution. However, this legislation focuses on the domestic aspects of bail-in, leaving the question of how it is applied to a cross-border banking group open. Cross-border banking resolution has been historically subject to coordination failures, which have resulted in disorderly resolutions with dangerous systemic effects. The goal of this article is to assess whether bail-in is subject to the same coordination problems that affect other resolution tools, and to discuss the logic of international legal cooperation in bail-in policies. We demonstrate that, in spite of the evident benefit in terms of fiscal sustainability, bail-in suffers from complex coordination problems which, if not addressed, might lead to regulatory arbitrage and lengthy court battles, and, ultimately, may disrupt resolutions. We argue that only a binding legal regime can address those problems. In doing so, we discuss the recent Financial Stability Board’s proposal on cross-border recognition of resolution action, and the role of international law in promoting cooperation in banking resolution.

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Notes

  1. Financial Stability Board (2011).

  2. For instance, § 214 of the Dodd-Frank Act states that ‘[n]o taxpayer funds shall be used to prevent the liquidation of any financial company…’.

  3. The Dodd-Frank Act put in place a specific mechanism to resolve failing banks, called ‘orderly resolution authority’, administered by the Federal Deposit Insurance Corporation (FDIC). In implementing the requirements of Dodd-Frank, the FDIC chose to adopt the single point of entry strategy, in which the recapitalisation takes place after the failing bank is divided into a good and bad bank (the so-called ‘closed bank’ model). Under the EU BRRD, Chapter IV, Section 5, the recapitalisation can take place directly in the failing bank (open bank model). See Goodhart and Avgouleas (2014); Gordon and Ringe (2014), at pp 19–20.

  4. Among them, Switzerland and Japan.

  5. See Pazarbasioglu et al. (2011), at p 9.

  6. For an overview of the problems posed by bailouts see Chen and Hasan (2011); Dell’Ariccia and Ratnovski (2013); Kaufman (2014).

  7. Financial Stability Board (2011).

  8. Coffee (2010), at p 6.

  9. Pazarbasioglu et al. (2011), at p 7.

  10. For instance, Title VI of the EU Bank Recovery and Resolution Directive (‘Relation with Third Countries’) simply provides general guidance on international cooperation.

  11. Schoenmaker (2013), at pp 72–87.

  12. J Plender, ‘Financial reforms will make the next crisis even messier’, Financial Times, 1 September 2014.

  13. Most of the literature suggests that bail-in would be better used to sustain the stability of the bank when the bank is almost on the point of non-viability or even balance-sheet insolvent. Therefore, bail-in takes place at a later phase of the resolution procedure, compared to CoCos. See Financial Stability Board (2011); and Zhou et al. (2012), at p 11.

  14. Financial Stability Board (2014b).

  15. Clifford Chance (2011), at pp 6–7.

  16. Gleeson (2012), at p 4.

  17. Ibid., at p 7.

  18. It is important to highlight the distinction between (1) banking creditors (depositors), (2) investment creditors (swap and credit counterparties, and short-term lenders) and (3) financial creditors (long-term bondholders and unsecured finance providers). See Clifford Chance (2011); see also Goodhart and Avgouleas (2014), at p 25.

  19. Rosa Maria Lastra reports that this technique was used by the English authorities during the secondary bank crisis of 1974. See Lastra (2003), at pp 85–86; similarly, in 1998, the US Long-Term Capital Management (LTCM) bank was rescued by a lifeboat operation involving the biggest New York banks.

  20. The stabilisation phase during a resolution must necessarily take place over the weekend, when markets are closed. The extremely short timespan does not allow individuating all creditors of a large banking conglomerate in a few days. See Clifford Chance (2011), at p 4.

  21. Freixas (2003).

  22. Ibid., at pp 102–119; Schinasi and Gaspar (2010).

  23. Goodhart and Schoenmaker (2009), at p 142.

  24. Claessens et al. (2011), at pp 29–32.

  25. Ojo (2011); Pauly (2009); Spendzharova (2012).

  26. Hulster (2011).

  27. See Schinasi and Gaspar (2010); Schinasi and Teixeira (2006).

  28. See Schoenmaker (2013), at pp 27–33; and Kudrna (2010).

  29. Schoenmaker (2013), at p 29.

  30. Weijs de (2013).

  31. According to the creditors’ bargain theory, the role of bankruptcy laws is to solve the common pool problems otherwise present in an insolvency by providing a collective procedure that coordinates the creditors’ claim. See Jackson (1982).

  32. Gleeson (2012).

  33. Ibid.

  34. Ibid.

  35. See UNCITRAL (2005), at pp 69–75.

  36. National Bank of Greece and Athens S.A. v. Metliss [1958], UKHL [1958] A.C. 509 concerns the rights of English holders of sterling bonds issued by the National Bank of Greece.

  37. Gleeson (2012), at p 12.

  38. Recently, in Fir Tree Capital Opportunity Master Fund, LP v. Anglo Irish Bank Corp. [2011] S.D.N.Y. [2011] No. 11 Civ. 0955 the plaintiff (an investment fund) tried to sue AIB under New York law (where the bonds were issued) for the violation of its creditors’ rights following the nationalisation of the bank by the Irish authorities. In the first phase, the New York court dismissed the claim, arguing that the nationalised bank was granted sovereign immunity as a foreign state entitled under the US Foreign Sovereign Immunities Act.

  39. Zhou et al. (2012), at p 11.

  40. The 5th Amendment of the US Constitution prescribes that nobody can be deprived of their property without due process.

  41. Gleeson (2012), at p 13.

  42. Zhou et al. (2012), at p 14.

  43. In this regard, the IMF recognises that for a quick and effective resolution procedure, it would be advisable to limit the role of the courts. Ibid., at p 12.

  44. In this regard it is important to stress that under EU law (Article 34 of the BRRD), bail-in could in theory be stretched to apply to uninsured bank deposits. However, it would follow a strict seniority rule and, presumably, be applied only to junior creditors and senior financial creditors.

  45. For instance, on 4 August 2014, the UK Financial Conduct Authority officially prohibited ordinary investors from buying CoCos. See E Dunkley, ‘FCA to restrict sale of “cocos” to individual investors’, Financial Times, 5 August 2014. Similarly, on 31 July 2014, the European Banking Authority warned banks against selling CoCos directly to consumers as a standard financial product.

  46. Various authors have argued that non-insured senior creditors have an incentive to sell their assets if not given enough guarantees. See Goodhart and Avgouleas (2014).

  47. Pazarbasioglu et al. (2011), at p 7.

  48. Ivo Welch suggests that banks strongly contest priority in financial distress of a non-financial corporation if they are junior. See Welch (1997), at p 1210.

  49. Goodhart and Avgouleas (2014), at p 27.

  50. Ibid., at p 29.

  51. Ibid., at p 30.

  52. M Arnold, ‘Investors file legal challenge over Portugal’s BES rescue’, Financial Times, 1 November 2014.

  53. Hardy (2013), at pp 12–13.

  54. Ibid., at pp 12–13.

  55. Alesina and, Drazen (1991).

  56. See Pistor (2013).

  57. The economic literature on capital markets is extremely vast. See Himmelberg et al. (2002); Shleifer and Wolfenzon (2002); La-Porta et al. (2002).

  58. Nieto (2014).

  59. Holthausen and Rønde (2004).

  60. For instance, similar issues were dealt with under the UNCITRAL Model Law on Cross-Border Insolvency, which, however, explicitly excludes banks.

  61. Institute for International Finance (2012).

  62. Financial Stability Board (2014b).

  63. Ibid., at pp 11–15.

  64. On 11 October 2014, the International Swaps and Derivatives Association announced a Protocol to the ISDA Master Agreement whereby counterparties agree to the cross-border enforceability of temporary stays on early termination and cross-default rights in over-the-counter (OTC) bilateral derivatives contracts.

  65. This was first proposed by the IMF. See Zhou et al. (2012), at p 18.

  66. Dell’Ariccia and Marquez (2006).

  67. Ibid.

  68. Ibid.

  69. Federal Deposit Insurance Corporation and Bank of England (2012).

  70. Financial Stability Board (2014b), at pp 13–15.

  71. See Singer (2007).

  72. Simmons (2001); See also Gadinis (2008).

  73. Schoenmaker (2013), at pp 34–67.

  74. In this case, the main issue is to ensure that the host supervisors do not sell the healthy subsidiary at the first sign of trouble in the parent. See Huertas (2013b), at p 21.

  75. Schoenmaker and Oosterloo (2005).

  76. Claessens et al. (2011), at pp 83–100.

  77. Schoenmaker (2013).

  78. See Huertas (2013b).

  79. Ibid., at p 16.

  80. Financial Stability Board (2012), at pp 15–16.

  81. This could be done by transferring marketable securities from the parent to the subsidiary in exchange for new equity in the subsidiary. See Huertas (2013a), at p 182.

  82. As Huerta notes, the bail-in at the parent of HC level does not by itself recapitalise the subsidiary. Without converting into equity or writing down the claims of the parent towards the subsidiary, the subsidiary will remain insolvent. Ibid., at pp 182–184.

  83. In the US, most holding companies are very well capitalised and equipped with various types of debt, which makes them particularly suited for an SPoE approach. Continental European and UK banks, however, have a different structure in which the liabilities are scattered around the group. See Federal Deposit Insurance Corporation and Bank of England (2012), at p 13; See also, Gordon and Ringe (2014), at pp 19–20.

  84. Goodhart and Avgouleas (2014), at p 37.

  85. Ibid.; Gordon and Ringe (2014).

  86. Federal Deposit Insurance Corporation (2013); Skeel (2014).

  87. Huertas (2013b), at p 20.

  88. Ibid., at p 28.

  89. It is however important to note that, when the Single Resolution Mechanism will enter into force, the Single Resolution Board will be the only competent authority for bail-in among banking union countries.

  90. This means that the total amount of non-core Tier I capital, Tier II capital and senior debt should range around 7 to 10 % of the foreign bank’s risk-weighted assets. See Huertas (2013b), at p 4; the UK Vickers Report proposed 17–20 % in primary loss-absorbing capacity.

  91. Financial Stability Board (2014a).

  92. Freixas (2003).

  93. Freixas (1999).

  94. This can be seen, for instance, in cross-border bank insolvencies and bailouts.

  95. Huertas (2013b), at p 21.

  96. Schoenmaker (2013), at pp 68–88.

  97. Zhou et al. (2012), at p 15.

  98. Goodhart and Avgouleas argue that foreign creditors will more likely flee at the first sign of distress, thereby forcing the bank to rely only on local creditors. Goodhart and Avgouleas (2014), at p 26.

  99. Zhou et al. (2012), at p 17.

  100. Huertas (2013b), at p 29.

  101. The Federal Reserve’s ‘Final Rule’ implementing Section 165 of the Dodd-Frank Act requires large foreign banks with operations in the US to establish a US holding company through which all the bank’s subsidiaries will operate.

  102. Huertas (2013b), at p 28.

  103. Ibid., at p 29.

  104. Goodhart and Avgouleas (2014), at p 44.

  105. Posner and Sykes (2012), at pp 17–20.

  106. Switzerland has requested its main banks to change their business structure to fit the single point of entry approach. See FINMA (2013).

  107. Huertas (2013b), at p 22.

  108. Ibid., at p 21.

  109. Financial Stability Board (2014b), at pp 8–10.

  110. Claessens et al. (2011), at pp 42–55.

  111. Verdier (2009), at pp 125–126.

  112. See also Goodhart and Avgouleas (2014), at p 36.

  113. Garcia and Nieto (2005); Huertas (2014), at p 21; Claessens et al. (2011), at p 96.

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Acknowledgments

Sincere thanks go to the Australian Research Council for its support of this research by Discovery Project DP130103501, and to our research assistant Rebecca Stanley. All responsibility is the authors’.

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  1. UNSW Australia, Faculty of Law, UNSW, Sydney, NSW, 2052, Australia

    Federico Lupo-Pasini & Ross P. Buckley

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Lupo-Pasini, F., Buckley, R.P. International Coordination in Cross-Border Bank Bail-ins: Problems and Prospects. Eur Bus Org Law Rev 16, 203–226 (2015). https://doi.org/10.1007/s40804-015-0010-2

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