Regulators Looking for Quality Over Quantity on Living Wills

WASHINGTON — Large banks are being forced to provide voluminous amounts of data to regulators as part of a requirement to create "living wills," but most of the attention is on companies' Cliff Note's version of how they might be taken apart.

In the three months after regulators set standards for the resolution plans, a clearer picture of what they will look like when firms submit their first drafts next year is starting to emerge.

While banks will provide exhaustive details about their firm's legal entities, business lines and infrastructure, a more condensed section outlining how to dismantle a firm appears to be drawing the most focus.

"There is clearly going to be narrative-based description of strategically how would you go about resolving the firm and 'unplugging' it from the systemic portions of the financial system and the economy," said Chris Mazingo, an associate principal at McKinsey & Co. "In some ways, that's maybe the most important part of this conceptually: how would you strategize the unwinding of the firm and all of its components?"

Observers said the agencies and industry insiders are reviewing which aspects of living wills can be included in common templates used by multiple firms, and which would be unique to specific institutions.

The various components could include details about who at the firm is responsible for resolution planning and an actual resolution process; how a company's multiple entities could be partitioned to prevent systemic fallout; and key licensing agreements.

"They will need to do a 'separability' analysis, looking at the legal entities that would need to be split off, particularly those that contain the critical functions considered to be systemically important," said Susan Krause Bell, a managing director at Promontory Financial Group. "They need to analyze whether those entities can survive on their own, or how intertwined they are with the company."

The Federal Deposit Insurance Corp. and Federal Reserve Board finalized rules in September outlining some of the standards. Under the Dodd-Frank Act, an initial plan and regular updates are required of bank holding companies with over $50 billion in assets and nonbanks deemed systemically risky. While the plans will guide supervisors through a theoretical bankruptcy, they are designed to help the FDIC use its Dodd-Frank authority to subject failing giants to a new resolution process.

But observers said pinpointing the details the Fed and the FDIC will want has been an ongoing process.

"There are significant uncertainties that are now being negotiated on an institution-by-institution basis. There are very big uncertainties, like what needs to be in the public disclosure. … Then there are operational issues, like how many contracts or 'key' personnel need to be disclosed. The rules are not always specific," said Karen Shaw Petrou, managing partner at Federal Financial Analytics Inc.

"One of the big issues is: Do you make the regulator happy by handing them a thousand pages of multiple three-ring binders, and if so, how useful is that really? If you literally followed the rules and named everybody and had a page for every functional versus legal unit, the shelf of three-ring binders would be inadequate for that."

The rules require the largest companies — those with over $250 billion in nonbank assets — to submit their first versions before July 2012, with subsequent due dates of July 2013 and December 2013 for smaller firms. In addition to the "strategic analysis", other components required in the rules include a mapping of core business lines, data about credit exposures and information about other financial positions. A separate FDIC rule laid out a similar planning process for large depository institutions.

"It's all your assets, presumably, in some level of detail," said Anat Admati, an economics and finance professor at Stanford University. "There will be multiple volumes for the large banks."

But while most agree a living will for a complex firm could total hundreds or thousands of pages, participants in some of the recent discussions said the regulators have signaled an interest in quality over quantity.

"While there are many pieces of information regulators would need in event of failure, not all of it needs to be in the plan, particularly if an institution shows regulators how to find that information if they need it," said John Bovenzi, a partner in Oliver Wyman's financial services practice and formerly the FDIC's chief operating officer.

Bovenzi believes regulators will view the strategic analysis as a major component. He said he also expects that regulators, despite the initial due dates, will work over time in consultation with banks to develop a proper plan. The more punitive measures in Dodd-Frank against companies with sub par plans — including forced divestitures — will not be in play for their first submission, he said.

"What [institutions] have been told is, 'We understand you won't have all the answers immediately, so submit a plan, and we'll have constant interaction back and forth about the plan through different iterations,'" Bovenzi said.

Others agreed that the mounds of information a company could provide may not get as much attention as the narrative firms choose to tell about their hypothetical demise.

There will be "additional binders of backup data containing information like where the licensing agreements are, how you turn on the computers, and what employees handle payment-processing," said one attorney who spoke on the condition of anonymity. "But the key piece is a section, which won't be stacks of binders, on the strategy for how the institution would be resolved. That's going to be where the very careful thought is."

Krause Bell said regulators will likely want an analysis of more than one resolution scenario per company.

"The regulators will want more of a playbook — a menu of resolution options — than a guidebook," she said. "An example of that would be resolution options that depend on the scenario that brings the company to the point of resolution. Is it a systemic scenario, meaning the entire market is in distress? Or is it an idiosyncratic scenario? The ability to sell off parts of the institution is very different in those two scenarios."

She identified other information regulators will likely want: a cataloguing of who at a company is responsible for the plan and who would be making decisions in a crisis; a "picture of what the institution might look like at the point of resolution"; and an analysis of why a firm is structured the way it is.

"They need to describe and justify their structure," Krause Bell said. "To the extent that a company's structure is complex, with potential obstacles to orderly resolution, they need to justify the business purposes of their structure and consider taking steps to improve resolvability."

Discussions have also hinted at there being common formats approved by the agencies for certain sections that institutions can use.

In a recent meeting with about 100 industry participants, the regulators "said they wanted to work with banks to come up with a template so that everyone has the same framework or table of contents," said the attorney.

But no one is expecting the plans to be homogeneous.

Mazingo said the diverse characteristics of different companies will likely distinguish their resolution plans from each other. He added that a company could omit financial data that is changing constantly as long as the plan details how to access that information in a resolution.

"There will be a lot of common ground. All firms will end up with a narrative resolution scenario, legal entity mappings, descriptions of the IT systems and the functionality of the data rooms in order to produce real-time or daily positions," Mazingo said.

"But since firms differ somewhat in their line of business focus and complexity, there are individual pieces of the living will that will differ by firm depending on the different lines of business that they have. Do they have capital markets business or not? Do they have international operations in a meaningful way?"