One of the most elegant legal innovations to emerge from the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is the FDIC’s Single Point of Entry (SPOE) initiative, whereby regulatory authorities will be in a position to resolve the failure of large financial conglomerates (corporate groups with regulated financial entities as subsidiaries) by seizing a top-tier holding company, down-streaming holding company resources to distressed subsidiaries, wiping out holding company shareholders while simultaneously imposing additional losses on holding company creditors, and allowing the government to resolve the entire group without disrupting business operations of operating subsidiaries (even those operating overseas) or risking systemic consequences for the broader U.S. economy.
Although there is much to admire in the creativity underlying SPOE, the approach’s design also raises a host of novel and challenging questions of implementation. In our recent article, we explore a number of these questions and elaborate upon the following points. First, in contrast to traditional approaches to resolving financial conglomerates, SPOE is premised on the continued support of all material operating subsidiaries, thereby potentially extending the scope of government support and thus posing the possibility of mission creep and expanded moral hazard. Second, SPOE contemplates the automatic down-streaming of resources to operating subsidiaries in distress, but effecting that support is likely to be more difficult than commonly understood. If too much support is positioned in advance, there may be inadequate reserves at the top level to support a single subsidiary that gets into an unexpectedly large amount of trouble. Alternatively, if too many reserves are retained at the holding company level, commitments of subsidiary support may not be credible (especially to foreign authorities) and it may become difficult legally and practically to deploy those resources in times of distress.
SPOE is most easy to envision operating in conjunction with the FDIC’s expanded authority under its Orderly Liquidation Authority (OLA) established under Title II of the Dodd-Frank Act. However, the act’s preferred regime for resolving failed financial conglomerates is the U.S. Bankruptcy Code (where Lehman was resolved) and not OLA. Our article sketches out what is emerging as a complex choice architecture for the resolution of financial conglomerates, built around this statutory preference for the Bankruptcy Code. Which resolution method is ultimately utilized for an individual firm will depend upon the size and complexity of the firm in question as well as the practical ability of the Bankruptcy Code to handle such a firm.
Several complexities could arise were a bankruptcy court today called upon to implement an SPOE resolution plan. While many legal experts are working on legislative proposals to amend the Bankruptcy Code to facilitate SPOE resolutions, we examine a number of legal levers that federal authorities could deploy under current law to increase the likelihood that the SPOE strategy could be effected through traditional bankruptcy procedures. First, the Federal Reserve Board could use its expanded prudential regulatory authority under the Dodd-Frank Act to restrict or prohibit a financial conglomerate from entering into financial contracts with certain cross-default provisions that could trigger value-depleting runs on the conglomerate’s subsidiaries upon the holding company’s bankruptcy filing. Second, with appropriate pre-failure planning, section 365(o) of the Bankruptcy Code could be used to prioritize holding company commitments to all material operating subsidiaries, including non-IDI affiliates. Such priority status would shield the down-streaming of value to operating subsidiaries from challenges brought by holding company creditors, thereby alleviating some of the difficulty of the pre-positioning dilemma. Third, broad-based credit facilities under section 13(3) of the Federal Reserve Act or targeted lending under the Federal Deposit Insurance Act’s systemic risk exception may be available to provide necessary government-sponsored debtor-in-possession financing where no private or other public alternative (like that provided under OLA) is available.
The task of implementing these strategies would be challenging and would require considerable advanced planning. But there are substantial benefits to be had from taking steps now to increase the likelihood that the bankruptcy option represents a viable and credible alternative for effecting SPOE transactions without resort to OLA and Title II of the Dodd-Frank Act.
This post comes to us from Professor Howell Jackson at Harvard Law School and Stephanie Massman, a graduate of the law school. It is based on their recent article, “The Resolution of Distressed Financial Conglomerates,” available here.