On November 4, 2011, the Financial Stability Board (the "FSB"), an international board with a mandate from the G-20 Leaders to "develop a policy framework to address the systemic and moral hazard risks associated with systemically important financial institutions" ("SIFIs"), identified the first 29 SIFI banking groups ("G-SIBs") to be listed as global SIFIs ("G-SIFIs") based upon their size, complexity and systemic interconnectedness. The G-SIBs are banking groups whose "distress or disorderly failure," the FSB believes "…would cause significant disruption to the wider financial system and economic activity."

The Agreed Upon Policy Measures

The FSB's November 4, 2011 announcement also summarizes various agreed upon policy measures adopted by the FSB to address SIFIs, the details of which are set forth in three reports, two from the FSB and one from the Basel Committee on Capital Supervision (the "BCBS") which were released in October 2011.1 These policy measures are intended to set out "…the responsibilities, instruments, and powers that all national resolution regimes should have to enable authorities to resolve failing financial firms in an orderly manner and without exposing the taxpayer to the risk of loss." They also include requirements for resolvability assessments and for recovery and resolution planning for G-SIFIs, and for the phased adoption of additional loss absorption capacity, tailored to the impact of their default, for banking groups determined to be systemically important. The 29 G-SIBs identified by the FSB are expected to meet the resolution planning requirements by the end of 2012.2 While the FSB's initial list is limited to G-SIBs, the G-SIFI list is not fixed and will be updated annually and published by the FSB in November of each year, and may include nonbanking groups. No doubt the large insurance groups will welcome not being included in this first round of designations.3 Financial institutions will be added or removed based upon whether they meet the criteria for designation. National supervisors may request that institutions in their jurisdiction be added to or removed from the list.

The G-SIFI Loss Absorption Capacity or Capital Surcharge

The expectation is that eventually the G-SIFIs will have an additional "loss absorption capacity tailored to the impact of their default, rising from 1% to 2.5% of risk-weighted assets (with an empty bucket of 3.5% to discourage further systemicness), to be met with common equity." Effective beginning in November 2012, the published list of G-SIBs will show the level of additional loss absorbency that each such G-SIB would be required to meet had these loss absorbency requirements then been in effect. The additional loss absorbency requirements will be phased in starting in January 2016 to those G-SIBs identified in November 2014 as G-SIFIs using the BCBS methodology. Full implementation of these requirements for those firms designated as G-SIFIs is expected by January 2019. According to the FSB, the BCBS methodology will also be reviewed every three years to capture changes in the banking system and progress in measuring systemic importance.

The Impact of the Capital Surcharge

The capital surcharge will be a challenge for many G-SIBs who have already had to increase their capital levels in accordance with both domestic and international capital requirements and supervisory agency discretion. The reaction from many G-SIBs has been swift. They have asserted that the capital surcharge is unnecessary in light of the other enhanced capital requirements and the liquidity coverage ratio requirement. Likewise, many of the US headquartered G-SIBs have argued that the Dodd-Frank restrictions, especially the Volcker Rule, and the Basel III prudent earnings retention policy will mean that US G-SIFIs will be at a competitive disadvantage in world markets. The FSB's response has been equally quick. The FSB has responded that the "enduring global economic benefits of greater resilience of these institutions far exceed the modest temporary decline in GDP over the implementation horizon."

The Impact of the G-SIFI Designation

In the banking industry, the G-SIFI designation has been greeted with substantially the same reaction as the SIFI designation. The designated financial institutions believe that the designation will come at great costs to them without any offsetting benefits. Though the Federal Reserve has identified 34 statutory SIFIs as of September 30, 2011, the FSB list includes only eight US headquartered G-SIBs (Bank of America Corporation; JP Morgan Chase & Co.; Citigroup Inc.; Wells Fargo & Company; The Goldman Sachs Group, Inc.; Morgan Stanley; The Bank of New York Mellon Corporation; and State Street Corporation). If the G-SIB list were based solely upon asset size, then at least four other US headquartered banking groups would have been listed as G-SIFIs, including one insurance company. Virtually all of the non-US headquartered G-SIBs have significant US operations. The US regulatory agencies must regulate and supervise at least 20 non-US headquartered G-SIBs. The G-SIFI list also includes four UK headquartered banking groups (HSBC Holdings plc; Barclays plc; Lloyd's Banking Group plc; and Royal Bank of Scotland plc), four French headquartered banking groups (BNP Paribas SA; Credit Agricole SA; Societe Generale SA; and Banque Populaire), three Japanese headquartered banking groups (Mitsubishi UFJ Financial Group; Mizuho Financial Group; and Sumitomo Mitsui Financial Group), two banking groups each headquartered in Germany (Deutsche Bank AG and Commerzbank AG) and Switzerland (UBS AG and Credit Suisse AG) and one banking group headquartered each in China (Bank of China Limited), Italy (Unicredit Group SA), Spain (Banco Santander SA), Belgium (Dexia SA), Sweden (Nordea AB) and the Netherlands (ING Groep NV). Many of the G-SIBs have argued that these requirements will have a negative impact on the global recovery.

SNR Denton Observations

While the regulatory agencies have not yet clarified what the G-SIFI designations will mean in practice, it is likely to result in a new universe both for the regulatory agencies and for the G-SIBs.

  1. The regulatory agencies have not had a chance to update their supervisory process or examination manuals to take into account the numerous changes in law domestically and internationally. This means that examiners will continue to be under extreme pressure to work in a fast paced, ever changing environment which requires the examiners to be nimble. This also means that a process of dual learning must unfold where neither the examiners nor the G-SIBs know precisely what the requirements are. If both the regulatory agencies and the G-SIBs are patient, then the process will unfold without major pockets of distrust and animus. If either the regulatory agencies or the G-SIBs are impatient, then major pockets of distrust and animus will develop and the process of implementation will be dramatically slower and much more expensive for both.
  2. Since G-SIBs are likely to be closely regulated, supervised and examined in most of their major jurisdictions covering their critical operations and business lines, there will necessarily be inconsistent supervision due to varying national interests among supervisors. This is likely to play out not only in the US where G-SIBs have multiple supervisors of their operations, but also outside of the US where there may be fewer prescriptive written rules and more of a reliance on principles.
  3. Policy makers have intentionally made it more expensive for SIFIs to expand their operations. This means that G-SIBs are likely to have extremely high standards to meet when they file applications, particularly any application to grow their operations. Even if the standards are met, the supervisors are likely to require more robust risk management systems, more capital, stronger liquidity, enhanced information systems and stronger compliance regimes.
  4. When a problem arises, the supervisors are likely to be more aggressive and more willing to impose a supervisory action sooner than they would have if the firm under review were not a G-SIB. This will likely be the case because the risks to the financial system are greater and the patience of the supervisors will be shorter. It is also possible that when a problem of a G-SIB becomes public, investors, policy makers and the media will react more quickly to such new information than they would have to information about firms that are not G-SIBs. These reactions could substantially increase the pressure on supervisors and cause the supervisors to take more severe actions against the G-SIBs than were originally contemplated.
  5. Supervisors have not had a chance to determine the effectiveness of many of the new banking requirements, including the domestic and international Living Wills requirements, the domestic and international capital requirements, the domestic and international liquidity requirements, the new credit underwriting standards and concentration limits, and the overall domestic and international enhanced prudential supervisory requirements. When these challenges are coupled with the new requirements for nonbank financial institutions, then the supervisors will be stretched to the limits, and the new formerly unregulated (i.e., unregulated by a bank regulatory agency) nonbank financial institutions could very well suffer from exhausted, impatient supervisors who will have to make decisions on a case by case basis, which will lead to inconsistent and changing standards. Needless to say, this will not be ideal for either the supervisors or the newly regulated nonbank financial institution.
  6. It is likely that the G-SIB designation will mean that the stress test assumptions will be different (than if the banking group were not a G-SIB) and the stress test itself will be more robust.
  7. It is likely that the base case scenario used for resolution and recovery plans will be different (than if the banking group were not a G-SIB) and the interconnectedness and international analysis will require a much more comprehensive analysis and will be much more closely scrutinized by supervisors.
  8. Notwithstanding the foregoing, the regulatory agencies seem to be paying attention to competitive equality concerns and are attempting to limit the risk of creating an unlevel playing field. The G-SIFI proposals apply to all of the G-SIBs equally, and although there are differences between the regulatory reforms proposed by national supervisors, there appears to be consistency in direction. For example, while there is no Volcker Rule in Europe, all G-SIBs must comply with the Basel III requirements, and the four UK headquartered G-SIBs, who have large retail banking businesses, will have to comply with the restrictions of the Independent Commission on Banking – the Vickers report – which will require ring-fencing of retail deposit taking.
  9. style="padding:0;"Although the FSB pronouncements signal where the goal posts are moving, there still remains an intensive process ahead before there will be anything like uniform international implementation of these proposals across national jurisdictions. This means that G-SIBs will have to be proactive in their approach and obtain the assistance of advisers who know the international markets and stay ahead of the curve.
  10. These designations partly serve as notice to banking supervisors around the world that they must work together because a failure of a G-SIFI could bring down the global economy or at least be a major disruption to markets in multiple countries. The resources and expertise that differing banking supervisors will bring to regulating, supervising and examining G-SIFIs are uneven at best, and, at worst, many countries do not have the capabilities or the resources to supervise global financial institutions.

All of this means that whether the G-SIFI process works will depend in large part on whether the international supervisors cooperate successfully. Given the historical unwillingness of many countries to put the interest of the global financial system ahead of their own national interests, even in the midst of a financial crisis, overcoming this reluctance and receiving the requisite level of international cooperation to make the SIFI process successful will be a daunting challenge.