A Paradigm’s Progress: The Single Point of Entry in Bank Resolution Planning

The latest chapter in the saga of resolution planning under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) unfolded in December 2016 when the Federal Deposit Insurance Corporation (the “FDIC”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) released their assessments of the October 2016 resolution plan submissions made by five systemically important U.S. banking institutions.[1] The October submissions were in response to FDIC and Federal Reserve Board determinations in April 2016 that identified deficiencies in the five institutions’ July 2015 resolution plans. In their December assessments, the FDIC and the Federal Reserve Board determined that Bank of America, Bank of New York Mellon, JP Morgan Chase, and State Street had adequately remediated the deficiencies in their 2015 resolution plans, but that Wells Fargo had not adequately remediated the deficiencies in its 2015 resolution plan. Moreover, for the first time, the FDIC and the Federal Reserve Board used the power available to them under the resolution plan requirement in the Dodd-Frank Act to restrict certain activities of Wells Fargo, pending remediation of the cited deficiencies.

The media have speculated on the reasons for the failing grade given to Wells Fargo. One prominent point of speculation was that Wells Fargo had failed to pick up on the assumed preference of the regulators for a single-point-of-entry (“SPOE”) resolution strategy.[2] Seven of the eight systemically important U.S. banking institutions have now adopted an SPOE approach in their resolution plans.[3] Only Wells Fargo continues to rely on a multiple-point-of-entry (“MPOE”) approach.

For those not steeped in resolution planning, some background may be helpful in deciphering this resolution plan jargon. Section 165(d) of the Dodd-Frank Act requires the largest bank holding companies (and other nonbank financial companies designated as systemically important) to prepare a plan for a “rapid and orderly resolution in the event of material financial distress or failure.”[4] Under this resolution plan provision, the FDIC and the Federal Reserve Board are required to determine whether a plan submitted by a company is credible and would facilitate an orderly resolution of the company under the Bankruptcy Code. If the FDIC and the Federal Reserve Board jointly determine that the plan is not credible or would not facilitate an orderly resolution of the company under the Bankruptcy Code, the regulators may impose restrictions on the company’s operations (as they have done with respect to Wells Fargo) and ultimately may order the company to restructure itself and divest operations.

The resolution plan requirement in Title I serves as a corollary to another important part of the Dodd-Frank Act, the Orderly Liquidation Authority in Title II. The Orderly Liquidation Authority is available as an alternative to and substitute for a bankruptcy process for a systemically important financial institution in financial distress. The Orderly Liquidation Authority involves an administrative resolution process modeled on the existing Federal Deposit Insurance Act (the “FDIA”) resolution regime for insured banks. The FDIC and the Federal Reserve Board have generally implemented the resolution planning process under Title I in parallel with the regulators’ own planning process under Title II. The initial regulatory planning process under Title II produced an important innovation in resolution thinking, the SPOE strategy. The SPOE strategy envisions that a resolution under Title II (and by extension under the Bankruptcy Code) would occur only at the top-tier holding company, avoiding to the greatest extent possible the need for the initiation of resolution proceedings at the level of the operating subsidiaries. As I noted in a previous post, an SPOE approach minimizes the complexities and conflicts that would invariably arise if multiple resolution proceedings in the United States and foreign jurisdictions had to be commenced at the level of the operating subsidiaries.[5]

An SPOE strategy is particularly well suited to a systemically important financial company that has significant nonbank operations or significant foreign operations. In contrast to an SPOE approach, an MPOE approach envisions the possibility of multiple resolution proceedings initiated by multiple authorities at the level of the top-tier holding company and at the level of the operating subsidiaries. An MPOE approach replicates the actual experience when large diversified financial institutions have failed in the past. The multiplicity of bankruptcy and insolvency proceedings for the various entities in the Lehman Brothers family is perhaps the starkest example of an MPOE resolution.

As a design matter, an SPOE strategy has much to recommend it as applied to a systemically important company with significant nonbank subsidiaries or significant foreign operations. In the resolution plans filed by the systemically important U.S. banking institutions in July 2015, six institutions adopted an SPOE approach. Two , Bank of New York Mellon and Wells Fargo, adopted an MPOE approach. The plans of those two banks envisioned a bankruptcy filing by the top-tier holding company and an FDIC receivership proceeding for the principal bank subsidiary of the holding company. This might be characterized as a minimalist MPOE strategy.[6] To minimize the consequences of placing a large banking subsidiary into a resolution proceeding, the plans envisioned that the most critical parts of the operation of the large banking subsidiary would be transferred to a “bridge bank” to assure continuity of services to customers during the resolution period.

The bridge bank concept was itself regarded as an important innovation in bank resolution when it was added to the FDIA in 1987. In an article published in March 2015, I discussed the history of the bridge bank provision as well as changes made to the FDIA in 1991 and 1993 that have created challenges for the use of a bridge bank.[7] One of the principal challenges is the requirement that a bridge bank approach must represent the least costly method to the federal deposit insurance fund for resolving the failed bank.[8] Related challenges arise if significant foreign deposits are to be transferred to a bridge bank. In the article I speculated that the ascendancy of the SPOE strategy could be seen as an implicit acknowledgement by the regulators that the use of a bridge bank to resolve a large bank with significant foreign deposits might not be feasible unless a systemic risk waiver were to be given.

The determinations made by the FDIC and the Federal Reserve Board in April 2016 shed further light on these issues. The regulators have reportedly said they are “agnostic” about whether a company chooses an SPOE or MPOE strategy.[9] There is some evidence of this agnosticism in the April determinations. The regulators jointly determined that the resolution plans filed by Bank of America, JP Morgan Chase, and State Street were not credible or would not facilitate an orderly resolution under the Bankruptcy Code. Each of these plans relied on an SPOE strategy. The regulators also jointly determined that the resolution plans filed by Bank of New York Mellon and Wells Fargo were not credible or would not facilitate an orderly resolution. Each of these plans relied on an MPOE and bridge bank strategy. The regulators identified several deficiencies with the Bank of New York Mellon bridge bank strategy, including issues relating to the least-cost test for the transfer of foreign deposits to the bridge bank, the transfer of custodial assets to the bridge bank, and the provision of shared services to the bridge bank. The regulators expressly invited Bank of New York Mellon to address these deficiencies “by presenting an alternative strategy.” Bank of New York Mellon accepted the invitation and switched to an SPOE strategy in its October 2016 submission to the regulators. Citing with approval the switch, the regulators found that the October submission by Bank of New York Mellon had adequately addressed the deficiencies in its 2015 resolution plan.

In their determination with respect to the Wells Fargo plan, the regulators noted that there were deficiencies in its financial projections relating to the least-cost test for the bridge bank strategy as well as the level of liquid assets to be available for the bridge bank. The regulators also cited the plan’s failure to identify shared services that would be critical to the execution of the bridge bank strategy as well as other operational issues relating to the bridge bank strategy. Unlike the response to Bank of New York Mellon, however, the regulators did not invite Wells Fargo to present an alternative strategy, suggesting that the regulators had concluded that Wells Fargo could address the deficiencies in its resolution plan while continuing to rely on a bridge bank strategy.

Of the eight systemically important U.S. banking institutions, Wells Fargo provides the most likely case for a bridge bank strategy, given the relatively small size of its nonbank and foreign operations. Another factor, however, may exert an overriding influence on the choice by Wells Fargo between an SPOE strategy and an MPOE strategy. Two days after releasing its December resolution plan determinations, the Federal Reserve Board issued its final regulation imposing a TLAC and external long-term debt requirement on the eight systemically important U.S. banking institutions. [10] For those institutions, the TLAC requirement itself creates a strong incentive to adopt an SPOE resolution strategy.

ENDNOTES

[1] Joint Press Release, Board of Governors of the Federal Reserve System & Federal Deposit Insurance Corporation, Agencies Announce Determinations on October Resolution Plan Submissions of Five Systemically Important Domestic Banking Institutions (Dec. 13, 2016), http://www.federalreserve.gov/‌newsevents/‌press/‌bcreg/‌20161213a.htm.

[2] See, e.g., John Heltman et al., Four Takeaways After Wells Failed Its Living Will Test, American Banker (Dec.13, 2016), http://www.americanbanker.com/news/law-regulation/four-takeaways-after-wells-failed-its-living-will-test-1092851-1.html; Zach Fox, Wells Fargo’s ‘living will’ failure shows preference for controversial strategy (Dec. 13, 2016), http://www.snl.com/‌InteractiveX/‌article.aspx?‌CDID=A-38694272-11051&KPLT=4.

[3] Bank of New York Mellon used an MPOE strategy in its 2015 resolution plan, but subsequently switched to an SPOE strategy in its October 2016 resolution plan submission.

[4] Dodd-Frank Act, §165(d) (codified at 12 U.S.C. §5365(d)).

[5] Paul L. Lee, The Case Against Repealing Title II of the Dodd-Frank Act, The CLS Blue Sky Blog (Dec. 12, 2016). The SPOE strategy has in turn spawned another resolution innovation, total loss absorbing capacity, and an accompanying acronym, “TLAC”. TLAC consists of equity, subordinated debt, and long-term senior debt at the top-tier company level that is available to absorb the losses incurred at the operating subsidiary level. The losses at the operating subsidiary level would be transmitted to and absorbed by the top-tier company through the conversion of pre-existing debt owed by the operating subsidiaries to the top-tier company (internal loss-absorbing debt) into equity of the operating subsidiaries. In December 2016, the Federal Reserve Board issued a regulation requiring the eight systemically important U.S. banking institutions and certain foreign banking institutions with large operations in the United States to maintain a prescribed level of TLAC, including a level of external long-term debt. See Press Release, Board of Governors of the Federal Reserve System (Dec 15, 2016), https://www.federalreserve.gov/‌newsevents/‌press/‌bcreg/‌20161215a.htm.

[6] The Wells Fargo resolution plan, for example, envisioned that only three entities would be put into resolution proceedings: the parent holding company into a case under Chapter 11 of the Bankruptcy Code, Wells Fargo Bank into a receivership under the FDIA, and Wells Fargo Securities into a proceeding under the Securities Investor Protection Act of 1970.

[7] Paul L. Lee, Cross-Border Resolution of Banking Groups: International Initiatives and U.S. Perspectives – Part IV, 11 Pratt’s J. of Bankr. L. 59 (2015).

[8] The least-cost resolution requirement in the FDIA can be waived if the FDIC, the Federal Reserve Board, and the Treasury Department make a “systemic risk” determination. However, under the resolution plan regulation, a company cannot rely on a systemic risk waiver in preparing its resolution plan. See 12 C.F.R. §243.4(a)(4)(ii) & 12 C.F.R. §381.4(a)(4)(ii)(2016).

[9] See sources cited supra note 2.

[10] See note 5 supra.

This post comes to us from Paul L. Lee, of counsel to Debevoise & Plimpton LLP and a member of the adjunct faculty of Columbia Law School. It is based on his two-part article, “Bankruptcy Alternatives to Title II of the Dodd-Frank Act,” available here and here, and his article, “Cross-Border Resolution of Banking Groups: International Initiatives and U.S. Perspectives—Part IV,” available here.