Transcript Slide 1
2 December, 2008
Too big to fail: what happens when a financial
institution gets into trouble?
Introduction
Consequences of a bank failure are (perceived to
be) different from those that arise when a plc
becomes insolvent:
systemic risk and potential impact on financial stability
impact on continuity of banking services
public confidence and depositor protection
international / cross-border dimension
Hence the “too big to fail” theory
But state rescues come at a cost to the taxpayer
Risk of moral hazard: should a bank ever be
allowed to fail?
Setting the scene: 2008
Feb
Northern Rock
nationalised
March
April
BoE SLS
announced
May
Bear Stearns
acquired by JPM
June
July
August
Sept
October
•Freddie Mac/Fannie Mae
nationalised
•Collapse of three Icelandic
banks in Iceland
•Lehmans collapse
•UK administrations of Heritable
and KSF
•Merrill Lynch acquired by BoA
•Lloyds/HBoS merger
announced
•US rescue of AIG
•JPM acquisition of WaMu
announced
•BoE discount window facility
announced
•UK GBP 50bn recapitalisation
scheme announced
•UK guarantee of inter-bank
borrowing announced
•Bradford and Bingley
nationalised
•US TARP (USD 700bn) enacted
•Benelux rescue of Fortis
•US capital purchase program
(USD 250bn) enacted
•US insurance program enacted
•US FDIC temporary liquidity
guarantee launched
Tools in the UK Authorities’ tool box
Private sector deal (e.g. HBoS, Alliance & Leicester)
State support
customer deposits (FSCS)
liquidity (e.g. BoE SLS and DWF)
capital (Government’s £50bn recapitalisation scheme)
guarantees of inter-bank borrowing
Emergency pre-insolvency legislation
Banking (Special Provisions) Act 2008
Banking Bill
Insolvency proceedings
current position vs. regime under Banking Bill
ranking of depositors
Existing insolvency proceedings
For both investment banks and deposit-taking institutions,
currently same as for any other UK corporate:
administration
liquidation
scheme of arrangement or company voluntary arrangement
EEA-wide recognition for insolvency proceedings re EEA
deposit-taking institutions:
consider Icelandic proceedings re three Icelandic banks
No automatic EU recognition for insolvency proceedings re
investment banks:
consider English administration of LBIE
FSCS for retail depositors:
no automatic subrogation to depositors’ interests
no priority for protected claims
Banking (Special Provisions) Act 2008
Came into force in February 2008 and was used the following
day to nationalise Northern Rock
Has now been used three times since then
Gives the Treasury very wide powers to transfer all or part of
the assets, liabilities or shares of a UK deposit-taking
institution:
to a private sector purchaser (e.g. ING)
to a nominee of the Treasury (e.g. Northern Rock, Bradford
& Bingley)
to a company wholly owned by the Bank of England or the
Treasury
Sunset provision: expires 20 February 2009
Intention is to replace provisions with Banking Act 2008
Banking Bill: timing
Introduced to House of Commons on 7 October as a result of a
lengthy consultation process (starting in October 2007)
Responses from BBA, ISDA, ILA, FMLC, CLLS and A&O all
raising concerns
Been through public committee stage in House of Commons,
next stage House of Lords
On-going consultation process re scope of secondary
legislation and carve-outs (responses by 9 January 2009)
Proposed that it will come into force in February 2009 (when
Banking (Special Provisions) Act 2008 expires)
Not too late to take action!
Banking Bill: application
Primary provisions will apply to UK banks:
UK incorporated deposit-taking institutions
UK incorporated banking subsidiaries of non-UK banks
any foreign branches of UK incorporated banks
BUT NOT UK branches of foreign banks
modified regime for UK building societies
what about insurance companies?
Significant cross-border issues (including how fits with existing
cross-border legislation)
Suggested in Pre-Budget Report that:
new special insolvency provisions for UK investment banks
pursuant to secondary legislation under the Bill (expected
summer 2009)
provisions may be extended to holding companies
Banking Bill: an overview
Pre-insolvency stabilisation tools (the “SRR”):
transfer of all or part of the business or shares to a private
sector purchaser
transfer of all or part of the business to a State-owned
“bridge bank”
full-blown nationalisation (as a temporary measure)
Secondary legislation to provide safeguards in respect of
partial transfers
Compensation provisions
New bank insolvency tools:
modified bank liquidation procedure
special “administration” procedure to deal with residual
bank following partial transfer
Special resolution regime: points to note (1)
Transfers of securities
compensation provisions for disenfranchised shareholders
but much of detail is missing
provisions wide enough to cover hybrid capital instruments
and bonds
allows Authorities to de-list securities or convert debt to
equity
overrides any contractual restrictions on transfer, voting
and consultation rights etc
can disapply any events of default triggered by the transfer,
even in contracts to which the bank is not a party (consider
CDS)
consider impact on shareholders, holders of hybrid capital
instruments, bondholders
Special resolution regime: points to note (2)
Transfers of property
powers purport to extend to foreign property but may be
recognition issues in practice
overrides any contractual restrictions on transfer
consider impact on exposure limits where counterparty
already has exposure to the transferee
can disapply any events of default triggered by the transfer,
even in contracts to which the bank is not a party (consider
CDS)
consider impact on securitisations if transfer order affects
ability of SPV to call for a transfer of legal title in the
mortgage loans
consider impact of partial transfers on set-off, netting and
security …
Safeguards for partial transfers
Partial transfers are the most contentious aspect of Bill
November consultation paper proposes safeguards for:
set-off and netting (with certain exceptions)
security interests (without exception)
structured finance (no details)
third party compensation (“no creditor worse off” principle)
Draft secondary legislation with consultation paper but still
needs a lot of work:
essential that in force at same time as Banking Bill
Safeguards do not solve problem of Henry VIII clause (clause
72 of Banking Bill)
Set-off and netting
Massive issue if counterparties had to account for credit exposure on
a gross, rather than a net, basis
Original suggestion: protection for “qualifying financial contracts”:
would have been arbitrary and stifled development of products
Now broader protection for all contracts containing netting provisions
subject to specific carve-outs:
foreign property – should be all or nothing
debt securities including bonds – should just be subordinated
bonds
deposits – should just be deposits covered by FSCS
regulated mortgage contracts – impact on offset mortgages?
liabilities – not clear why and inconsistent with EU law
Better to provide for protections on a counterparty by counterparty
basis?
Compensation provisions
No creditor worse off (NCWO) principle:
following a partial transfer, no creditor should be in a worse
position than that in which it would have been in a liquidation of
the bank
No detail as to how this will be funded – presumably through FSCS?
Independent valuer to be appointed to assess level of compensation
ignoring:
any partial transfer
any financial assistance given by Bank of England or Treasury
Devil will be in the detail but likely to be difficult in practice to assess
what recoveries would have been in a liquidation
On the basis that a liquidation would not prevent close-out netting,
set-off and enforcement of security, presumably these rights are to be
taken into account in assessing the level of compensation
New bank insolvency procedure
Modified form of liquidation
Can be commenced by Bank of England, FSA or Secretary of
State (trumps normal liquidation)
Bank must be unable to pay its debts, likely to become so or in
default of payment obligation
Primary objective: to work with FSCS to ensure transfer of
deposits or payment to depositors
Secondary objective: to wind up the affairs of the bank so as to
achieve the best result for the creditors as a whole
In practice, gives depositors priority?
Until primary objective achieved, control by liquidation
committee comprising Bank of England, FSA and FSCS
Winding up proceeding for purposes of EEA legislation?
Bank administration
To be used following a partial transfer to a bridge bank or private
sector purchaser
Only Bank of England can commence
Primary purpose: to ensure continued supply of essential services to
purchaser
Purposes of “normal” administration (rescue and better result for
creditors) are subordinated to primary purpose
Until primary purpose achieved, various powers can only be
exercised with consent of Bank of England
Compare approach taken in special insolvency legislation re PPP
companies (Metronet) and protected railway companies (Railtrack)
Administrator has the power to disclaim onerous contracts and bring
wrongful and fraudulent trading claims
Henry VIII clause (clause 150)
Reorganisation measure for purposes of EEA legislation?
Questions?
Jennifer Marshall
Partner, restructuring
Telephone: 020 3088 4743
Email: [email protected]
These are presentation slides only. The information within these slides does not
constitute definitive advice and should not be used as the basis for giving definitive
advice without checking the primary sources.
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