On Tuesday, the FDIC held the first in a series of proposed roundtable discussions on the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which is intended to bring transparency to the rulemaking process. Government officials, industry executives, academics and investors were invited to participate in the discussion.

The agenda included the following three topics:

  • Overview of the New Resolution Framework
  • Treatment of Creditors
  • Living Wills

Overview of the New Resolution Framework

FDIC Chairman Sheila Bair began the discussion by reviewing the broad rulemaking authority granted by Dodd-Frank, including authority to resolve non-depositary firms as a response to the “too big to fail” issue in which taxpayer funds were used to rescue failing financial institutions whose failure posed systemic risks to the financial system. Chairman Bair noted the broad mandate of Dodd-Frank, giving the Federal Reserve “the authority to provide systemic support” to financial institutions. The resolution authority provided for in Dodd-Frank, she noted, in the context of other reforms, particularly higher capital standards and deleveraging, would promote better regulation in the event of another crisis. In the event of a crisis, weaker institutions would use the resolution authority but there would be market differentiation between those weaker institutions and the stronger ones so that those stronger institutions would not be unfairly perceived as facing the same problems as weaker firms.

Chairman Bair emphasized the need to respect existing law, "primarily the bankruptcy code” in the rules adopted. While the FDIC’s rulemaking authority is broad, she noted that policymakers wanted to “use it in the most prudent way possible to provide clarity to the marketplace.” She stated that the FDIC intended to produce an interim rule that will be a discussion point for market participants with respect to the new resolution authority. “There is no wiggle room for bailouts here,” she noted. “No more bailouts. So I think we would like to get an interim rule out fairly quickly.”

Treatment of Creditors

In discussing a new resolution authority framework, participants emphasized the need for parity in the way that market participants evaluate credit and the way creditors are treated under the existing bankruptcy code. Michael Krimminger, Chairman Bair’s deputy for policy, stated that Dodd-Frank’s intent was to ensure such parity in the treatment of creditors, emphasizing that the FDIC wanted to provide clarity “so the market would understand how creditors would be treated under either bankruptcy or the regulatory process.” He distinguished the regulatory process with the court-adjudicated bankruptcy code process, but acknowledging that, in each regime, “the treatment of the creditor flows through priorities and that the creditor takes the losses in accordance with the priority system.”

Chairman Bair agreed, and noted the importance of “real-time information” on counterparty exposure and valuations of the collateral of counterparties, which information would serve to determine which non-banks may be systemically important to markets, and to create a framework by which regulators can get real-time information on large companies’ counterparties, business lines, and international operations. The FDIC, she remarked, must demonstrate that any regulatory exceptions to the normal bankruptcy process are “necessary from a systemic standpoint.”

Living Wills

The discussion turned to “living wills,” or a predetermined wind-down process for major financial institutions so that they can be wound down in an orderly fashion by the FDIC. Participants raised concerns that investors would be reluctant to conduct business with covered institutions if the FDIC had the ability to cancel or disregarding provisions of contracts with the financial institutions, and that the FDIC’s rulemaking goal should not be elimination of constructive risk-taking. In response, Chairman Bair remarked that there had been a “paradigm shift” in perceptions against bailouts, but agreed that the problem of the internalization of risks within the financial system posed a problem.

The concept of a living will emerged as a result of the short, frantic periods leading up to the failures of Bear Stearns and Lehman, in which policymakers could not be expected to exercise judgment in evaluating the risks posed and the proper courses of action to take in the limited period of time provided. However, some participants warned against creating excessive expectations about the utility of living wills, noting that while the planning process was important to develop strategies and a realistic timetable for winding up a troubled firm, no credible resolution could be accomplished in a limited period of time. In response to a series of discussions, Chairman Bair distinguished the living will, which is in effect a preplanned resolution plan prepared by market participants, and resolution rules enacted in the absence of such a plan.

Subsequent roundtables will be announced on the FDIC’s website.