For quite some time now, discussions have been ongoing both in the Netherlands and abroad as to the measures that should be taken in order to prevent a repetition of the financial crisis. A recurring subject in these discussions is the imposition of an obligation for financial institutions to draw up a "living will" (a type of emergency plan for crisis situations). However, although it is becoming increasingly likely that such an obligation will actually be imposed, it seems that no clear consensus has been reached regarding the exact contents of a living will. This newsletter is intended to outline the current state of affairs on the subject, based on the most recent developments.

The concept of a living will


As yet, there is no simple definition of "living will", as far as financial institutions are concerned. In its Report and Recommendations of the Cross-Border Bank Resolution Group, issued in March 2010, the Basel Committee on Banking Supervision describes a living will as a plan to maintain the institution as a going concern in times of severe financial distress.

In a letter to the lower chamber of the Dutch Parliament last year (document TK 2009-10, 32 013, no. 6), the Minister of Finance outlined the government's intentions for reforms with regard to the financial sector. In this context, he mentioned living wills as one of the new types of tools that are intended to enable the supervisory authorities to intervene effectively. He also stated that a living will should give insight into the structure and the most important aspects of the institution, as well as the interlinkages within it, so that effective action can be taken in the event of a crisis situation.

Besides describing how an institution can survive severe financial distress, a living will has a second function. The Dutch Central Bank (De Nederlandsche Bank, or DNB) noted in its annual report for 2010 that a living will must explain how the institution can be resolved in a rapid and orderly manner. In this connection, the British Independent Commission on Banking has indicated in its Interim Report - Consultation on Reform Options (April 2011) (also known as the "Vickers report") that the Commission is supportive of national and international initiatives to implement living wills, as that will improve the resolvability of financial institutions.

In view of the above, it would seem that a living will can best be described as an emergency plan or set of step-by-step instructions for situations in which the institution is facing serious financial problems. For this reason, it is also referred to as a "contingency plan" or a "recovery and resolution plan".

Funeral plan

In the United States, the aspect discussed immediately above is addressed by what are referred to as "funeral plans". The obligation to draw up such a plan has recently been imposed on large financial institutions under the Dodd-Frank Wall Street Reform and Consumer Protection Act: an institution must periodically submit plans for a "rapid and orderly resolution in the event of material financial distress or failure" to the supervisory authorities.

Effects of a living will

The Minister of Finance has stated, in the abovementioned letter, that requiring financial institutions to draw up a living will is intended to achieve three aims. Firstly, as part of the continuing supervision over these institutions, more attention will be paid to potential stress situations. This will enable preventive measures to be taken at an earlier stage in order to reduce the chance of certain problems arising in the event that these stress situations materialise. Secondly, drawing up the document will give insight as to what steps the institution should take in order to emerge from a crisis situation intact. Thirdly, according to the minister, living wills will provide the supervisory authorities with a supplementary tool for monitoring financial institutions and initiating the implementation by the latter of any necessary measures. Drawing up a living will is therefore a process of "made-to-measure tailoring", and the will's structure, contents and level of detail will therefore depend on the size, complexity and systemic importance of the relevant institution.

Mild and strong variants

A distinction can be made between two variants of living wills: a "mild" variant and a "strong" one. The mild variant consists of an information system that enables the institution and the authorities to respond effectively in crisis situations. The strong variant can be used by the supervisory authorities to impose a specific business structure in order to facilitate the unbundling of the institution's group structure in the event of a threatened bankruptcy.

From its annual report for 2009, it seems that – for now – the Dutch Central Bank is not in favour of the strong variant. The Dutch Central Bank believes that if a financial institution's group structure is unbundled this will eliminate the synergy effects between the different divisions, which is more likely to increase – rather than reduce – the institution's vulnerability. The Minister of Finance, however, has stated (in the abovementioned letter to the Lower Chamber) that living wills will make it possible for preventive actions or measures to be taken.

Under the strong variant described above, the supervisory authorities would have the power to impose certain structural changes on the relevant institution, based on the information set out in the living will, if the will indicates that the social costs of dismantling the institution would be too high. Possible preventive measures under the mild variant would include the amendment of legislation and/or other rules so as to eliminate or reduce any burden on government funds in the event that an institution is dismantled, as well as the sharpening of the applicable capital and liquidity requirements so as to lower the risk of a bankruptcy.

At the end of 2009, the UK's Financial Services Authority (the "FSA") started a pilot exercise under which a number of major UK banks are required to draw up living wills. Together with the Bank of England, the FSA will assess whether the risks signalled by the living wills, and the measures needed to mitigate these risks, should lead to further action to remove any obstacles that could hinder a recovery or dismantlement. The FSA intends to publish a consultation paper in the second quarter of 2011 setting out its initial policy regarding living wills.

In the Turner Review Conference discussion paper of October 2009, the FSA has explicitly stated that such further action can also include a preventive restructuring of the relevant financial institution. This seems to indicate the FSA wishes to adopt a strong variant of living wills. In an interview with the Financial Times published on 3 September 2009, FSA chairman Lord Turner said: "Living wills will be a forcing device for the clarification and simplification of legal structures".

Global living wills

On an international level, discussions are ongoing as to how to deal with the failure of large, globally active financial institutions. The Financial Stability Board, the IMF and the Bank for International Settlements have announced in their Macroprudential policy tools and frameworks - Update to G20 Finance Ministers and Central Bank Governors (14 February 2011) that plans are in the pipeline to - among other things - make living wills mandatory for Global Systemically Important Financial Institutions, or "G-SIFIs". The living will of a G-SIFI will have to include an assessment of the institution's resolvability and an explanation of how any obstacles to resolution will be removed.

European developments

EU Framework for Crisis Management in the Financial Sector

In a letter sent on 25 October 2010 to the lower chamber of the Dutch Parliament regarding proposed financial markets legislation, the Minister of Finance indicated that an expansion of the crisis tools available to the supervisory authorities and government – such as the living will – should in his view be organised mainly at European level. This point of view is consistent with the policy document presented five days earlier by the European Commission called EU Framework for Crisis Management in the Financial Sector. This document describes, among other things, the Commission's policy objectives in relation to crisis management. Several months later, the Commission refined these objectives in the consultation document published on 6 January 2011 regarding the "technical details of a possible European crisis management framework". The Commission expects to produce concrete legislative proposals on this subject in the summer of 2011.

The policy and consultation documents refer, among other things, to the obligation of financial institutions to draw up and maintain recovery plans. Such plans must set out the measures the institution would take in different scenarios to address liquidity problems, raise capital or reduce risk. A notable feature is that the plan must assume that there will be no access to support from public funds.

In addition to a recovery plan, financial institutions must, in close cooperation with national supervisory authorities, also draw up a resolution plan. A resolution plan must give insight into how the institution's business can be transferred, wound down or split up in an orderly manner in the event of the institution's failure (i.e. the resolution tools).The Commission would seem to favour the strong variant of a living will: if the resolution plan reveals the existence of impediments to the application of the resolution tools, the competent supervisory authorities should be able to compel the institution to take certain measures. These measures expressly include requiring changes to its business operations or corporate structure.

Recovery plans and resolution plans would be required at both entity and group level.

Contents of a living will

The contents of a living will have not yet been fully worked out. It is therefore impossible to give a specific and exhaustive list of the subjects that must be handled. Based on Dutch and foreign publications, however, it can be concluded that a common position is developing in this regard. If, as in the EU policy document, a living will makes a distinction between recovery plans and resolution plans, it is expected that it will have to cover the following subjects:

Recovery plan

In its recovery plan the financial institution must explain the extent to which it can restore its capital and liquidity by adopting de-risking measures. A manual containing step-by-step instructions must be available so that each of the de-risking measures can be implemented on short notice. The subjects that must be described in the manual include:  

  • the process for deciding to adopt and for implementing each measure;  
  • the conditions that must be met before adopting each measure;  
  • the provision of information to the supervisory authorities – and also employees, shareholders and creditors – in connection with the adoption and execution of each measure; and  
  • the legal, financial and operational impediments to the adoption of each measure.  

The following are examples of de-risking measures:  

  • raising extra capital through the issuance of convertible bonds or preference shares that will be converted into ordinary shares if a specific condition is met (such as the institution's capital ratio falling below a particular limit), called "contingent convertible capital instruments" or "cocos";  
  • arranging reliable "reserve sources" of liquid assets in the market or at a central bank and ensuring that security can be provided to call upon these sources;  
  • making preparatory arrangements to divest, on short notice, certain business units or group companies;  
  • generating liquidity by closing out positions in the securities trading portfolio.  

In addition, the institution must have a contagion control or anti-contagion plan, describing how the institution will deal with a failure of its largest competitors and the operational impact of such a failure for the institution. For example, the institution must assess whether in such a situation it will still have access to the settlement system and to what extent close-out netting will remain possible.

Resolution plan

In general it can be said that the information that an institution must provide in a resolution plan will be equivalent to the information that a bankruptcy trustee would gather in connection with the institution's liquidation. The resolution plan must enable the authorities to assess how the institution should be wound down. For this purpose, the institution must be able to provide the authorities with all relevant information within a very short period. For example, this information could be made available to the authorities via a virtual data room set up specifically for this purpose.

The resolution plan must describe the relationships between the different entities within a group, the basis of those relationships (for example, legal, financial, or arising from shared personnel, IT systems or business premises) and contingency arrangements for if those relationships are interrupted. The financial institution must keep its client's assets sufficiently separate from its own assets, so that the former can be transferred to third parties on short notice. The institution must make a detailed assessment of the potential legal, financial and operational problems or obstacles should the authorities decide to adopt any of the following measures:

  • the resolution of the institution via ordinary bankruptcy proceedings;  
  • the use of public funds to keep the institution viable;  
  • a partial transfer of the institution's assets and liabilities to another institution or to a "bridge bank" set up on a temporary basis for this purpose;  
  • a transfer of all of the institution's assets and liabilities; or  
  • the temporary nationalisation of the institution or its holding company.  

In addition, the institution must describe in its resolution plan how it can be separated in an orderly manner from the market and payment infrastructures to which it is connected.


The making of a living will by financial institutions is a subject of great current interest both in the Netherlands and abroad.