In August 2013, the Swiss Financial Market Supervisory Authority FINMA issued a position paper on the resolution of globally systemically important banks. With its new policy in relation to the importance of a bail-in strategy for large financial institutions FINMA joined regulators in the United States, Europe and elsewhere to focus on a bail in of troubled financial institutions rather than a bail-out by tax payers or a liquidation.
By René Bösch (Reference: CapLaw-2014-4)
Following the global financial crisis the G-20 leaders endorsed at the Pittsburgh Summit in 2009 the objective of strenghtening the financal regulatory system and, inter alia, ending “too big to fail”. National legislators and regulators moved to transform that objective into national law, and the Financial Stability Board (FSB) established key principles for the way how this objective shall be achieved. Various techniques and options for resolving large, internationally active financial institutions were discussed, including the forced sale of business/purchase of all or the majority of the business of a failing institution, bail-in of subordinated or senior debt, liquidation or state aid.
In an article published in the Economist in January 2010, Wilson Ervin and Paul Calello promoted a new, prefered process for resolving failing banks: the “bail-in” by way of converting stakeholders’ claims into equity, making them new owners of the bank. Ervin and Calello maintained that a bail-in could have allowed Lehman to continue operating and forestall much of the investor panic that froze markets and deepened the recession. This bail-in technique received quick and widespread interest, in particular in the United States. The Orderly Liquidation Authority section in the Dodd-Frank Act of 2010 provided a first, detailed framework for a bail-in within resolution. The EU in the meantime also accepted this technique as one of the resolution options within the framework of the Bank Recovery and Resolution Directive.
In its work towards the “Too Big to Fail”-Amendment to the Banking Act of 2012, the Swiss legislator, based on recommendations of an expert group, held that failing systemically relevant banks had to provide for an emergency plan on the basis of which they had to assure that in the case of threatening insolvency the systemically relevant functions should be transferred to a new legal owner. This “bridge bank concept” formed the cornerstone of Switzerland’s (initial) answer to the too-big-to-fail conundrum. While the bail-in option was not substantively considered as an alternative, the new TBTF legislation did not close the door to it. Rather, by way of a total overhaul of the Bank Insolvency Ordinance of FINMA that became effective in late 2012, bail-in received acceptance as a viable resolution technique for Swiss banks.
Guided by the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions of October 2011 and its discussions with other regulators, FINMA developed a resolution strategy for Switzerland’s global systemically important banks (G-SIBs). Giving regard to the various issues in the cross-border resolution of internationally operating financial institutions, in the Summer of 2013 FINMA arrived at the conclusion that its preferred resolution strategy for these financial groups consists of a resolution led centrally by the home supervisory and resolution authority, focusing on the top-level group company. This strategy is generally referred to as the “Single Point of Entry” (SPE) approach, in contrast to the “Multiple Point of Entry” (MPE) approach where several entities within a group shall be subject to bail-in. Creditors of the top-level company shall bear a share in the losses of the bank, allowing the entire group to be recapitalized. In a position paper published in early August 2013 FINMA has presented the reasoning for arriving at this conclusion.
First, FINMA considers that while the bridge bank concept may initially have been at the core of Switzerland’s considerations of how to address the too big to fail conundrum, international trends moved into the direction of bail-in as a preferred choice for the resolution of large international banks. SPE bail-in had been promoted as a preferred choice from a regulator’s perspective in a joint paper published in 2012 by the Federal Deposit Insurance Corporation and the Bank of England. Having received the legal basis for applying the bail-in technique to failing Swiss banks, FINMA considered and agreed that this technique may in fact be superior to the bridge bank concept. Weighing all pros and cons FINMA found that the SPE bail-in is “the best solution for the current group structure and the global business models of Switzerland’s two globally systemically important banks”.
FINMA is convinced that it can observe the three fundamental principles governing bank resolution proceedings when applying a bail-in: the hierarchy of creditors, the principle of equal treatment of creditors of the same class, and the “no-creditor-worseoff” test. However, FINMA equally concedes that there is one decisive condition for an SPE bail-in: a sufficient quantity of liabilities available for bail-in. But FINMA also expresses some concerns: for tax reasons a large proportion of the debt instruments of the Swiss G-SIBs has been issued out of foreign branches of the Swiss bank, and most of these instruments are governed by non-Swiss law. While FINMA asserts resolution authority over non-Swiss branches of Swiss banks, it concedes that local regulators may nevertheless be authorized to take possession over these branches by statute. Therefore FINMA identified execution risks of an SPE bail-in. In its view these execution risks could be addressed by several measures: host authorities should be encouraged to support a FINMA bail-in over a branch through which the bank issued its debt; cooperation agreements with host authorities should be executed, and “bail-in clauses” as well as Swiss law and jurisdiction should be introduced in the debt instruments.
With its reference to the “bail-in clauses” FINMA may have been referring for instance to the issuance by Barclays Bank PLC of $ 1bn Contingent Capital Notes in April 2013, the terms of which contain an agreement of the holder of these notes that it be bound to any UK bail-in power by the relevant UK resolution authority that may result in the cancellation of all or a portion of the notes. It will be interesting to see whether similar provisions will find their way into future debt issuances of Swiss banks.