Financial Stability Board’s Consultative Document Regarding Cross-Border Recognition of Resolution Actions Represents an Important Step Towards Removal of Impediments to Resolution
On September 29, 2014, the Financial Stability Board (the “FSB”) published a consultative document concerning cross-border recognition of resolution actions and the removal of impediments to the resolution of globally active, systemically important financial institutions (the “Consultative Document”).1 The Consultative Document encourages jurisdictions to include in their statutory frameworks seven
elements that would enable prompt effect to be given to foreign resolution actions. In addition, due to a recognized gap between the various national legal resolution regimes that are currently in place and those recommended by the FSB, the Consultative Document sets forth two “contractual solutions” – that is, resolution-related arrangements to be implemented as a matter of contract among the private parties involved – to address two underlying substantive issues that the FSB considers critical for orderly cross- border resolution, namely:
temporary restrictions or stays on early termination rights, including with respect to cross-defaults, in financial contracts (for example, derivatives and repos); and
write-down or conversion of debt instruments in resolution – so-called “bail-in” provisions – where the instruments are governed by the laws of a jurisdiction other than that of the issuing entity.2
According to the FSB, “significant progress” can be made by adopting these proposed contractual solutions even before the necessary statutory frameworks are adopted and fully implemented. To that end, the Consultative Document includes an implementation timeline that applies to both authorities and firms under which the FSB will finalize guidance on key principles for recognition clauses in debt
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instruments that are intended to be eligible for “bail-in,” FSB member governments are to take official action to promote adoption of the two contractual solutions proposed in the Consultative Document, and the FSB is to finalize guidance on core elements of statutory recognition frameworks by the end of 2015.3 In addition, the Consultative Document states that, by the end of October 2014, 14 G-SIBs and other large banks that engage in significant cross-border trading activities are to commit to adopt the ISDA
protocol or equivalent contractual clauses as to temporary restrictions on early termination rights, to have effect from 2015.4 In addition, certain jurisdictions, most notably the United Kingdom, have adopted requirements for contractual provisions regarding bail-in.
The next Group of 20 (the “G-20”) leaders’ summit will be held on November 15 and 16, 2014, in Brisbane, Queensland.
The FSB invites comments on the Consultative Document by December 1, 2014.5
In September 2009, the G-20 leaders called on the FSB to propose measures to address the systemic and moral hazard risks associated with systemically important financial institutions (“SIFIs”).6 In response, the FSB proposed a policy framework aimed at reducing the moral hazard risks posed by SIFIs and addressing the “too-big-to-fail” problem (the “SIFI Framework”) – a problem that, according to the FSB, “arises when the threatened failure of a SIFI leaves public authorities with no option but to bail it out using public funds to avoid financial instability and economic damage.”7 The SIFI Framework sought to address this problem by attempting to reduce the probability and impact of SIFI failures and includes requirements for more effective resolution mechanisms.8
In October 2011, the FSB published Key Attributes of Effective Resolution Regimes (the “Key Attributes”), which sets out the “core elements that the FSB considers to be necessary for an effective resolution regime.”9 Notably, one of these Key Attributes requires jurisdictions “to establish transparent and expedited processes that would enable resolution measures taken by a foreign resolution authority to have cross-border effect provided that domestic creditors are treated equitably.”10
In September 2013, the FSB indicated that “legal uncertainties about the cross-border effectiveness of resolution measures [remain] one of the main obstacles to the resolution of [SIFIs] that operate across borders.” According to the FSB, “[u]nless resolution actions can be given prompt effect in relation to assets that are located in, or liabilities or contracts that are governed by the law of a foreign jurisdiction, authorities are likely to face obstacles in implementing group-wide resolution plans effectively for cross-
The Consultative Document represents the FSB’s more concrete policy proposals to ameliorate these issues.
THE CONSULTATIVE DOCUMENT
The Consultative Document proposes a two-part package of policy measures and guidance:
statutory changes that jurisdictions should consider adopting in order to enhance the effectiveness of cross-border resolution; and (2) contractual approaches that global systemically important banks (“G-SIBs”) should implement to achieve the same purpose pending widespread adoption of comprehensive statutory changes.12 The Consultative Document states that statutory frameworks are the preferred longer-term solution, but acknowledges that very few jurisdictions have such frameworks in place and that they will take time to implement.13 The FSB has therefore proposed contractual solutions for two substantive areas perceived as being critical to achieving orderly cross-border resolution:
contractual arrangements providing for the recognition of temporary restrictions or stays on early termination rights, including with respect to cross-defaults, in financial contracts in resolution; and
contractual recognition of the possible “bail-in” of debt instruments in resolution where the relevant instruments are governed by the laws of a jurisdiction other than that of the issuing entity.14
According to the FSB, these contractual solutions should not be considered a substitute for statutory regimes, but given their importance should be supported by regulatory action to encourage or even require the adoption of the necessary contractual arrangements.
Statutory Frameworks for Cross-Border Recognition
The Consultative Document contemplates two statutory approaches for giving effect to foreign resolution measures in a manner consistent with the Key Attributes: (1) recognition of a foreign proceeding; and
support for a foreign proceeding in the conduct of a domestic proceeding.15 Under a
recognition-based framework, a jurisdiction would accept the commencement of a foreign resolution proceeding domestically, empowering the relevant domestic authority – whether a court or an administrative agency – to enforce the foreign resolution measure.16 Under a support-based framework, the domestic resolution authority would take resolution measures, generally in the context of conducting its own domestic resolution proceeding, to help implement and support the resolution measures taken by the foreign home resolution authority.17 Thus, under a recognition-based framework, a stay imposed in the foreign proceeding could be given direct effect in the domestic context; under a supportive approach, the domestic resolution authority could impose a stay under domestic law in aid of the foreign proceeding.
According to the Consultative Document, a jurisdiction may implement either a recognition-based framework or a support-based framework, or some combination of both frameworks, but the framework must be judicial or administrative in nature.18
In the Consultative Document, the FSB identifies seven elements that jurisdictions should consider including in their frameworks, whether recognition-based or support-based, to give prompt effect to foreign resolution actions:
empowering domestic authorities to give effect to foreign resolution measures and clearly establishing the actions that may be taken by those authorities;
clearly establishing the process and conditions for giving effect to foreign resolution actions, including the extent to which the effect is automatic or subject to the discretion of an authority;
clearly identifying the grounds for granting recognition of foreign resolution proceedings or adopting measures to support foreign resolution actions;
equitable treatment of creditors as a guiding principle for the process of giving effect to foreign resolution measures;19
ensuring that the processes for giving effect to foreign resolution actions can be carried out with the necessary speed and predictability;
legal protections for resolution authorities and their officials, as well as limitations on actions that could constrain or reverse resolution decisions that give effect to foreign resolution actions; and
requiring or incentivizing firms to adopt contractual approaches to reinforce legal frameworks already in place and to bridge the gap where statutory frameworks have not already been adopted or fully implemented.20
The Consultative Document states that recognition should not be conditioned upon reciprocity, because such a requirement could prevent a jurisdiction from recognizing a foreign proceeding even when it is in the jurisdiction’s own interest to do so. At the same time, the Consultative Document indicates that a jurisdiction’s discretion to refuse recognition of a foreign proceeding should be limited to circumstances where the foreign resolution measures would have adverse effects on local financial stability, contravene local public policy, or have material fiscal implications. In practice, these exceptions would give national regulators a certain degree of discretion not to implement coordinated recognition of foreign resolution measures if they conclude that recognition would not be in the jurisdiction’s interest.
Contractual Approaches to Cross-Border Recognition
The Consultative Document also proposes contractual solutions in two particular circumstances in which cross-border recognition may be particularly important: the imposition of a contractual stay on early termination rights in financial contracts in resolution, and a contractual recognition of “bail-in” powers in certain debt instruments that may be subject to bail-in under the law of the issuing entity. According to the FSB, in these two circumstances, achieving cross-border recognition is a “critical prerequisite for
First, with respect to temporary stays on termination rights (including with respect to cross-defaults), the FSB observes that, in the absence of appropriate contractual clauses, there is a risk that national courts may not enforce existing statutory stays when imposed under a foreign regime (or may not do so with sufficient speed), and that inclusion of a contractual agreement to stay enforcement actions can help
support the effectiveness of such stays across the jurisdictions in which a G-SIB may transact.22 In the
Consultative Document, the FSB points to the forthcoming protocol from the International Swaps and Derivatives Association, Inc. (“ISDA”) as a basis for the documentation of such agreements. If adopted by market participants, the protocol would establish a temporary stay on the exercise of early termination
rights with respect to over-the-counter derivatives governed by the ISDA Master Agreement.23 The FSB states that the ISDA protocol is “formulated in a manner that is sufficiently generic to be adapted for use” by other trade bodies in protocols amending their standardized documents for financial contracts as well as to amend financial contracts that do not use standardized documentation.24
Recognizing that a contractual solution can bind only the parties that agree to it, the FSB encourages prudential regulators to require the firms they regulate, and jurisdictions that have the authority to require firms to improve resolvability, including through living will and similar requirements such as those imposed
by Title I of the Dodd-Frank Act in the U.S., to adopt the necessary contractual language.25 The FSB
acknowledges, however, that there will be counterparties that are not subject to the direct authority of the prudential regulators and that may be reached only indirectly through the imposition of requirements on the firms that are within the regulators’ authority. The FSB urges the prudential regulators to monitor the effectiveness of this “indirect” approach and consider whether market conduct regulation or other means may be necessary to obtain sufficient adherence to the contractual approach.
Second, the FSB similarly notes that if a G-SIB has issued debt governed by the law of a jurisdiction other than its home jurisdiction, there is a risk that the statutory bail-in powers granted to the resolution authority by the laws of its home jurisdiction will not be recognized in the foreign jurisdiction, which may impair the ability of the resolution authority to conduct an effective resolution of the G-SIB. The FSB concludes that including in these debt instruments a contractual provision by which the holder of the debt instrument agrees in advance to the exercise of bail-in powers can support the cross-border enforceability
of the bail-in power.26 The Consultative Document identifies five “key principles” for clauses in debt
instruments that would support the exercise of bail-in powers in a cross-border context:27
the contractual provisions should contain a clear agreement by the debt holder to be bound by the terms of the bail-in under the relevant resolution and that the terms of the bail-in will be given effect;
the consequences of a bail-in should be disclosed prominently to debt holders in accordance with applicable disclosure requirements;
recognition provisions should be drafted in general terms so as to ensure that they don’t conflict with how the statutory bail-in regime may be applied in practice;
firms should seek independent legal advice from the jurisdiction of the governing law to ensure that the contractual provisions take into account relevant legal issues; and
firms should be required to demonstrate that any statutory bail-in of instruments governed by foreign law would be enforceable, including through the provision of an independent legal opinion.
The Consultative Paper indicates that inclusion of the proposed language could be a condition to the recognition of a debt instrument’s eligibility to serve as loss-absorbing capacity, if the laws of the jurisdiction governing the instrument do not provide a “bail-in” mechanism. Furthermore, any rule requiring these provisions would apply only to newly issued debt.
PRACTICAL IMPORTANCE OF THE CONSULTATIVE DOCUMENT
The Consultative Document represents an important step towards achieving the cross-border recognition of resolution actions and removing impediments to the cross-border resolution of SIFIs. The Consultative Document’s flexible approach – permitting jurisdictions to choose how they will adjust their statutory frameworks, recognizing that those adjustments will take time and effort, and proposing contractual solutions as an interim measure – suggests that cross-border recognition can be achieved in multiple ways. At the same time, the Consultative Document sets forth an approach that is markedly different from the “ring-fencing” approach to resolving foreign bank branch assets, which has become more prevalent following the recent financial crisis, and may be difficult to achieve in some jurisdictions. In the U.S., for example, the FSB’s approach would require adjustments to both federal and state law, and the FSB’s interim contractual solutions would require counterparty consent. Accordingly, as the FSB acknowledges, efforts by regulators as well as regulated institutions will likely be necessary to ensure the effectiveness of the cross-border resolution of G-SIBs.