Likely Battle Ahead for FDIC's 'Single Point' Resolution Plan

WASHINGTON — A new Federal Deposit Insurance Corp. policy statement on its "single point of entry" resolution strategy may signal the start of a broader debate on the plan's merits.

The document was seen by many in the financial community as a means to provide more detail about the agency's internal approach to seizing and unwinding systemically important financial institutions, or "SIFIs". But deliberations by the agency's board, which met publicly Tuesday to release the strategy, indicate the plan may also still be in flux.

The document asked for comment on a range of issues and three board members highlighted the need for input on key questions. Among their concerns were the potential for conflicts with other countries over cross-border resolutions and whether "single point" cleanups could give some firms an unfair competitive advantage. (Commenters will have 60 days to weigh in.)

"The statement to be released today outlines one strategy for resolving these firms, called the Single Point of Entry. However, in outlining this strategy, the FDIC also recognizes that there are many challenges to its implementation and is appropriately seeking public comment on its viability," FDIC Vice Chairman Thomas Hoenig said at the meeting.

FDIC officials have promoted the methodology — versions of which are also being mulled in other countries — for well over a year as it seeks to carry out Dodd-Frank Act powers to clean up failed behemoths. The 2010 reform law included a provision known as "Title II" allowing firms to be placed in a special FDIC receivership if their bankruptcy could have systemic consequences.

The basic "single point" approach is that a failed firm would be seized by isolating and closing its parent holding company and moving its subsidiaries into a FDIC-managed bridge company, that would operate until a successor firm — with entirely new shareholders and management — could emerge. Unsecured creditors of the old firm would become investors in the new one.

The document attempts to expand on that basic concept. For example, the strategy includes processes to restructure or even liquidate subsidiaries to ensure that the resulting firm — or series of smaller firms — no longer poses the same threat to financial stability that brought down the failed company. Meanwhile, the management of the bridge firm — selected by the FDIC — would conduct an in-depth process with accountants and investment bankers to assess the new company's value.

"The FDIC's goal is to limit the time during which the failed covered financial company is under public control and expects the bridge financial company to be ready to execute its securities-for-claims exchange within six to nine months," the document said.

The document also makes clear that the FDIC would seek private funding before needing to utilize its authorized access under Dodd-Frank to Treasury Department funding for managing a resolution. The reform law allows the establishment of an "orderly liquidation fund" within Treasury. Yet if that access had to be tapped, the paper said, it could be used to provide guarantees to private creditors instead of borrowing directly from the government.

"Alternatively, funding could be secured directly from the OLF by issuing obligations backed by the assets of the bridge financial company," the document said. "These obligations would only be issued in limited amounts for a brief transitional period in the initial phase of the resolution process and would be repaid promptly once access to private funding resumed."

But the document included several meaty questions for comment in addition to added details about the strategy. Those included whether the FDIC needs stronger checks on its ability under Dodd-Frank to repay certain creditors more than others in the same class, and how much debt and equity a living institution would need to hold to make its resolution under the SPOE strategy work, among others. Commenters were also asked to weigh in on alternatives to SPOE for internationally active firms, including a process known as "subsidiarization," in which a firm's business lines are divided into legally separated entities that are easier to resolve in a failure scenario.

Even Martin Gruenberg, the FDIC's chairman and most vocal supporter of the strategy on the board, signaled that it is still being fleshed out. "We look forward to detailed public comment to further inform the development of our resolution strategy," he said.

But Hoenig as well as board member Jeremiah Norton were more explicit. (All five board members approved the document going out for comment.)

Since the SPOE strategy assumes that subsidiaries of a failed parent would keep operating, Hoenig expressed concern about whether those smaller firms would have a perceived guarantee from the government as a result of their surviving in the receivership.

"Given the practice in the U.S. and elsewhere, and since Title II can be implemented only if the SIFI's failure would have systemic consequences, it is likely that the government would step in to assure an operating subsidiary does not fail," he said.

Hoenig added that an operating subsidiary of a failed firm resolved by the government could seek access to Treasury liquidity under Dodd-Frank.

"In times of financial stress, the knowledge that operating units will be provided funding to meet liquidity demands could serve to encourage corporate treasurers and others to place their funds with SIFIs' operating subsidiaries over other financial firms for whom such assurances are unavailable. Therefore, this assumption and access to funding provides SIFIs a significant competitive advantage," he said. "It is important that the FDIC receive views on whether SPOE strategy adequately addresses this funding advantage and if not, how it might be more fully addressed going forward."

Norton agreed, saying that "given that the single point of entry strategy would provide for the continuing operation of the operating subsidiaries, it is important to consider potential impacts on the competitive landscape."

The questions raised by the two board members were echoed in a general comment by Consumer Financial Protection Bureau Director Richard Cordray, who sits on the FDIC board.

"I would like to agree with the vice chairman and Director Norton that there are some serious issues that it would be helpful to hear more about," Cordray said.

Hoenig and Norton also raised concern about how the SPOE strategy would work in accordance with host countries where foreign operations of U.S. SIFIs are based.

Noting that cross-border cooperation has improved since the crisis, Hoenig said that cooperation "has not been tested under crisis."

"There is a strong inclination among governments to ring fence funds to the local jurisdiction since it is to their citizens' financial security that sovereigns owe their first allegiance and is a natural reaction when managing through a financial crisis," he said.

Norton said "ring-fencing in host jurisdictions should be considered in the context of any resolution regime."