Banks' Living Wills Face First Critical Test

WASHINGTON — Nearly two years after the enactment of the Dodd-Frank Act, a crucial part of the regulatory reform law that will help determine whether "too big to fail" is really over is about to come into play.

Thousands of pages will soon arrive in Washington in the first round of living wills for systemically important firms.

Though filers and regulators have discussed this first batch due July 1 for months, the two sides are still in uncharted waters. Many observers say these initial drafts, which detail how a firm can be unwound and could total 2,000 pages each, are akin to test cases that will help shape future standards and determine their effectiveness.

"As no one has ever done this before, this first round of filing will effectively set the floor for this process," said Sylvia Mayer, a partner at Weil, Gotshal & Manges. "The regulators have said informally that with this first round, nobody is going to fail. But after these first submissions, regulators are going to have expectations."

So what does it take to pass?

"It may have to satisfy what was once described to me as the 'oomph' factor," Mayer said. "When you drop it on your desk, does it go, 'Oomph!'?"

Between five and 10 firms are expected in the first group of banks that must submit living wills by July 1, and each draft will include a public portion — a fraction the size of the overall plan — giving a high-level overview of the firm's resolution strategy. Officials and industry representatives expect significant interest in the public section, but say it will not come close to the level of detail seen by the regulators. (It is unclear exactly when the public portions will be released, but sources say it could be just days after the July 1 submission.)

"It may be something like 30 pages long summarizing what's in the other 1,500 pages that are confidential," said John Douglas, a former Federal Deposit Insurance Corp. general counsel and now a partner at Davis, Polk & Wardwell. "But there will be some public impact. … It's the first real glimpse of how these institutions think about themselves in terms of what they would do in a crisis."

James Wigand, the director of the FDIC's Office of Complex Financial Institutions, said that, while "parties will be interested" in seeing the reports, "we just hope they view public plans in the proper context."

"There has to be recognition by the public that although the public portion may seem cursory, the regulators will be reviewing a more detailed description of the resolution approach and framework that needs to include the proprietary and supervisory information necessary to evaluate the plan's credibility," Wigand said.

In a September rule, the FDIC and Federal Reserve Board divided companies into three sets. The first due date is for companies with at least $250 billion in nonbank assets, including foreign firms with that much in U.S.-based nonbank assets. While each plan will have a public portion, the agencies are not yet naming the first filers. It is widely assumed JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley are on the list. (The second subset of institutions must file first drafts by July 1, 2013, followed by a third on Dec. 31, 2013.)

"This will be a check mark that says they at least finished the first step in compliance, and the regulators will have a road map that they didn't have prior to" the Dodd-Frank Act, said Mitchell Glassman, formerly the FDIC's director of resolutions and receiverships and now a director at Deloitte Consulting.

Yet others said these initial drafts will still likely trigger a back-and-forth between the agencies and firms about how individual plans can be improved.

"With the first one, the regulators are not just going to say, 'This is great.' They're going to find something missing or have more questions for the company to answer," said John Lane, a former FDIC official who is now a special advisor at Promontory Financial Group. "I wouldn't be surprised if they come back to the institutions with pages of questions."

In addition to expanding the FDIC's resolution authority to systemically risky nonbanks, Dodd-Frank requires those firms, including bank holding companies with assets of more than $50 billion, to draft wind-down plans based on the bankruptcy code to help guide the FDIC's work.

The September rule established certain required content, including a "strategic analysis" explaining options for resolution, detailed descriptions of the firm's structure, and a mapping of business lines and legal entities. Other mandatory pieces include details about a firm's information systems, and capital and cash flows. In addition to the initial draft, firms must file annual updates, and material changes in a firm's business strategy require notice thereafter of how such a change will affect the resolution plan. Meanwhile, a separate FDIC rule requires insured depositories with over $50 billion of assets to also draft resolution plans.

But other guidelines have come out through discussions between the agencies and the early filers since the rule's release, and firmer expectations from the regulators, will likely emerge as more drafts are evaluated.

"The rules were unspecific in terms of exactly what they were looking for. … What we'll find is these initial drafts become blueprints for future living-will exercises," said Samantha Regan, an executive in Accenture's risk management practice.

The Fed and FDIC, which under Dodd-Frank can force structural changes at firms with subpar plans, have told firms they will not use those punitive measures the first time around.

"The first round of … plans will be serious products. However, this is a significant learning exercise for all parties. We expect that as we review the plans, we will discuss issues like impediments to resolution, adequacy of information content and analytic gaps," Wigand said. "The only way you can get to a robust evaluation is by dealing first with the specific factual content about a particular institution and then parsing it out in a bankruptcy framework."

For all first drafts, the agencies have established a relatively simple baseline scenario for firms to imagine in drawing up their plans. That scenario is that the company goes straight to failure after operating in healthy economic conditions.

Observers said that introductory scenario is a sign regulators during the first round are most interested in understanding how each company is built. Subsequent updates are expected to incorporate more stressed scenarios, which may make a resolution more difficult.

"In many ways, this first round is probably a little bit less about potential resolution than it is about how these organizations are structured," said Heath Tarbert, also a partner at Weil. "The goal over time will be to have the various scenarios built into the overall plan."

But many say the industry has already come a long way toward accepting the living-wills process since it was proposed in the legislation that became Dodd-Frank. Indeed, in testifying recently before Congress, Jamie Dimon, the chief executive of JPMorgan, discussed the living-will process as a central component in combating the notion that his institution is too big to fail.

"It used to be everybody was afraid to even talk about the fact that you might plan for how to handle a large bank failure, since that might create a panic itself that could precipitate a problem," said John Bovenzi, a partner in Oliver Wyman's financial services practice and formerly the FDIC's chief operating officer.

"There was a long period of time where that inhibited everyone from addressing the 'too big to fail' problem. But postcrisis, people are more comfortable talking about it. A lot of the fear associated with discussing something like this is gone. It's out there that this is an important issue, and that it's a planning exercise — it's not what's really happening."