## 1. Early Intervention Frameworks in Denmark and Canada ## Source details **Canonical URL:** [1. Early Intervention Frameworks in Denmark and Canada](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11228.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11228.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11228.pdf.json) --- ### I. INTRODUCTION - Prepared by Göran Lind (Sveriges Riksbank and IMF external consultant) and Sean Kerr (IMF/LEG). - Key context and observations: - The United Kingdom was badly hit by the global financial crisis starting in 2007. - London’s role as a major global financial center increased contagion from developments abroad. - Domestic imbalances included high leverage in lending to the real estate sector and a developing price bubble in real estate. - U.K. authorities responded with measures, some harmonized through European Union (EU)-wide agreements. - Crisis management revealed gaps in instruments, legal frameworks, and cooperation arrangements, prompting reforms including permanent law for bank resolution. ### II. SUMMARY OF KEY FINDINGS AND RECOMMENDATIONS - A. On Crisis Prevention and Early Intervention - Support enhanced role for macro prudential oversight; mandate should be transparent and limited to what the Financial Policy Committee (FPC) can realistically deliver. - Provide the FPC with appropriate tools; align macro and micro supervision to avoid gaps and duplication. - Balance governance issues between monetary policy and macro prudential oversight. - Strongly support forward-looking approach: use of stress tests across a wide range of deposit-taking institutions; step-wise indicator-based early supervisory action by the FSA. - Embed early-identification approaches in FSA, and as relevant, BoE, FSCS, and HMT processes. - Ensure FSA has a wide range of supervisory tools, clear legal powers and obligations, and means to monitor implementation. - B. On the Special Resolution Regime (SRR) and Resolution Tools - Encourage expanding/amending SRR to establish resolution tools for other potentially systemically important firms (investment banks, insurance firms, payments infrastructure). - Certain SRR features, particularly private sector transfer arrangements, could be useful for other firm types. - Support extending temporary suspension of contractual termination clauses to derivatives and other financial contracts, subject to European legislative amendment; transferred contracts enforce early termination only if transferee defaults. - C. On Large Groups (SIFIs) - SRR is useful for small- and medium-sized deposit-takers but faces operational, legal, and political limits for large banking groups, notably lack of extraterritorial effect. - Support U.K. efforts to improve resolvability of large banks through: - Stricter regimes for bank capital and liquidity; FSA supervisory tools and international harmonization. - Contingent capital (CoCos) and bail-in capital, requiring international agreements. - Recovery and resolution plans (RRPs) to increase resilience and resolvability; agreement on RRPs between home and host authorities. - Protecting key economic functions (current deposits and payment services); IMF expresses no view on depositor preference merits. - D. On the Need for International Harmonization - Unilateral U.K. action limited by benefits of harmonized EU legislation and global reforms. - Encourage U.K. contribution to international solutions on SIFIs, cross-border resolution, and deposit guarantee schemes. - Use supervisory colleges or cross-border crisis management groups; resolve differences in international insolvency regimes. - U.K. deposit guarantee scheme is post-funded; EU discussion includes common funding approaches. - E. On Exit Strategies - Encourage orderly dismantling of crisis special measures to return to normal market functions. - Promote institutions reducing reliance on support earlier than formally agreed to avoid concentrated repayment “humps” and increase market confidence. ### III. INSTITUTIONAL FRAMEWORK - Current arrangements broadly appropriate; financial stability responsibilities set out in a memorandum of understanding (MoU) between BoE, FSA, and HMT. - Statutory roles since the Banking Act (BA): - BoE: statutory objective to contribute to protecting and enhancing stability of the U.K. financial system; payment system oversight; lead resolution authority for failing U.K. banks and building societies under the SRR. - FSA: prudential supervisor; operational role resolving problems before SRR via capital raising and business disposals; triggers SRR and authorizes/supervises bridge banks under SRR. - HMT: sets institutional structure of financial regulation and legislation; informs and accounts to parliament on management of serious disruptions; provides exceptional solvency support. - FSCS is not party to tripartite MoU but has an MoU with FSA and a protocol with BoE. - Cooperation and information sharing increased; FSA stress-tests identify outliers and tripartite joint working groups monitor potential problem institutions. ### IV. CRISIS PLANNING AND PREVENTION - SRR and normal crisis framework best for small- and medium-sized standalone deposit-takers; large cross-border banking groups present greater execution risk and SRR lacks automatic extraterritorial effect. - Supplementary approaches to increase resilience and resolvability: - Strengthen resilience via tougher capital and liquidity requirements for large banks; U.K. working within FSB and Basel Committee. - Ensure private stakeholders contribute to stabilizing weak banks before non-viability via contingent capital instruments (CoCos) or statutory bail-in powers. - Simplify legal and operational structures of large banks; FSA, supported by BoE, requires RRPs. - Improve macro-prudential oversight. ### V. SUPERVISORY ACTION FOR PROBLEM BANKS - Early identification and remedial action critical. - FSA historically preferred voluntary corrective steps; recommendation to follow with formal requirements if short-term rectification is unsatisfactory. - Strengthened early identification: across-the-board stress tests and planned indicator-based early warning system (EWS) that is not fully automatic and leaves room for supervisory judgment. - Comparative early-intervention frameworks: - Denmark (The Diamond framework): five quantitative indicators; until end-2012 monitor movement toward limits; from 2013 take remedial action where limits breached. Indicators include limits on large exposures, lending growth, commercial real estate lending share, funding ratio, and liquidity coverage (retail deposits in relation to wholesale funding must be at least 50 percent). - Canada (OSFI framework): four stages (in addition to “all normal”), with stage-specific conditions and supervisory measures and guidelines for interaction with Canada Deposit Insurance Corporation (CDIC). - FSA remedial measures under Financial Services and Markets Act include: - Temporarily stopping dividend payments. - Requesting postponement of new activities or termination of existing activities. - Ultimately revoking a bank’s license. - FSA uses discretionary capital requirements under Pillar 2 within Basel II to require additional capital based on higher risk assessments. ### Box: Canadian early-intervention stages (stage 2–4) — selected measures - Stage 2 - OSFI informs CDIC of results and data from enhanced reviews; OSFI and CDIC commence contingency planning. - Stage 3: Future financial stability in serious doubt - Conditions: combination of net risk, capital, and earnings vulnerability; significant risk management/control deficiencies. - Interventions: direct specialists, enhance business restrictions, station OSFI staff on-site, expand contingency planning, communicate need to consider resolution options including seeking a purchaser. - Governance: regular sub-FISC and FISC meetings; CDIC and OSFI discuss institution in depth. - Stage 4: Nonviability/insolvency imminent - Conditions: failed to meet regulatory capital with inability to rectify immediately; statutory conditions for taking control met; failed to implement acceptable business plan. - OSFI activities: assume temporary control of assets; take control; request Attorney General apply for winding-up order. - Coordination: regular inter-agency (FISC) meetings for coordinated implementation. ### VI. CRISIS MANAGEMENT TOOLS — key lessons from the U.K. experience - Major lesson: need for a legal framework for bank resolution (SRR); absence at Northern Rock in 2007 undermined credibility. - Authorities need flexibility; BoE provided liquidity on more flexible terms during crisis; HMT recapitalized banks and provided solvency support. A. Official financial support — banking sector liquidity support - BoE measures during crisis: - Created facilities outside normal repo facility, on longer terms (up to one year), and against a wider range of collateral. - Provided liquidity in foreign currency, notably U.S. dollars. - Special Liquidity Scheme (SLS): - Allowed banks to swap high-quality but illiquid securities for U.K. treasury bills. - Between April 2008 and January 2009, treasury bills with a face value of approximately GBP 185 billion were lent under scheme against illiquid collateral (mostly mortgage-backed securities). - SLS being dismantled; treasury bills being gradually repaid, somewhat ahead of planned schedule to avoid major repayment humps. - Discount Window Facility (DWF) and stigma: - BoE instituted a permanent DWF for bilateral liquidity support; perceived stigma remains an issue. - Firms encouraged to pre-position collateral at BoE to facilitate rapid draw down. - New permanent BoE facility (June 2010): - Counterparties can bid for funds against a “narrow” set (high-quality debt expected to remain liquid in all but most exceptional circumstances) and a “wider” set (high-quality debt expected to remain liquid in most circumstances). - BoE regards facility as a diagnostic tool: increasing demand against wider pool could indicate growing market tension. - Emergency Liquidity Assistance (ELA): - BoE provided ELA packages discretionarily for specific problem institutions; BoE has very broad, legally robust discretionary powers. - Tripartite MoUs since 1998 set expected framework for ELA decisions. A. Official financial support — solvency support - HMT measures: - Recapitalization of two problem banks; guarantees of assets and liabilities (Asset Protection Scheme (APS) and senior bank debt guarantees). - Rationale/issues: - Solvency support enabled banks to meet regulatory requirements and avoid resolution. - Ad hoc measures require correct incentives: shareholders and junior debt holders should generally be written off before new capital is inserted. - Under APS, first loss and part of secondary loss fall on the bank; guarantee invoked thereafter. - Case examples: - Lloyds Banking Group exited the APS in late 2009 and paid £2.5 billion levy for the protection received. - RBS continued participation, paying an annual premium; beyond the first £60 billion of losses on covered assets (which RBS would bear), losses fall on RBS and government at a ratio of 1:9. - Original shareholders in RBS were substantially diluted but left a small portion to maintain market presence — deviation from the ideal that shareholders fully absorb losses. B. Banking Act 2009 — special resolution and insolvency framework - Pre-crisis reliance on general corporate insolvency law (The Insolvency Act of 1986) was inadequate for banking special features. - BSPA (February 2008) was emergency temporary measure; most powers moved into permanent Banking Act 2009 (BA). - BA establishes a permanent SRR including directed transfer powers (“stabilization powers”) and a Bank Insolvency Procedure (BIP) for winding up insolvent banks while protecting insured depositors. - SRR features: - Objectives to consider (not ranked): protect and enhance stability of U.K. financial systems; protect public confidence; protect depositors; protect public funds; avoid interfering with property rights contrary to Human Rights Act 1998. - Stabilization options: (i) transfer to a private sector purchaser; (ii) transfer to a bridge bank; (iii) temporary public ownership (TPO). - Preconditions: FSA must determine two general conditions: (1) bank is failing, or likely to fail, threshold conditions unmet; (2) not reasonably likely that action (ignoring stabilization powers) will enable bank to satisfy threshold conditions. - FSA determines general conditions and consults HMT and BoE; BoE leads transfers to purchaser or bridge bank, HMT leads TPO. - TPO is last resort for a “serious threat” to financial stability. - If no specific conditions for stabilization are met, BIP or FSCS pay-out used. - Secondary legislation sets compensation standards and creditor safeguards to protect netting, security interests, and collateral rights. - To date, BA resolution powers used in one case: the building society Dunfermline. Useful features of BA and SRR - Transparency and predictability: finite number of resolution options and objectives guide choice. - Creditor and property-rights safeguards: - HMT must set compensation arrangements to comply with Article 1 Protocol 1 of the European Convention on Human Rights. - Partial property transfers: compensation on a “no-worse-off-basis.” - Secondary legislation (SI 2009/322) prevents partial property transfers from interfering with netting rights, security interests, clearing house default rules, or payment flows in certain capital markets transactions. Orderly procedure and suspension of termination rights - SRR permits temporary suspension of contractual termination rights triggered by use of transfer powers. - Exception: financial derivatives subject to EU directives with netting clauses must be given effect “in accordance with their terms”; BA suspension powers do not currently extend to such contracts. - U.K. authorities may benefit from powers similar to U.S. 24-hour suspension for “qualified financial contracts” while resolution authorities decide on transfer. - Any suspension should be underpinned by robust cost-benefit analysis. - Forthcoming European legislative proposals likely to address temporary suspension of early termination and netting rights pending transfer. Scope and perimeter of SRR; cross-border limitations - SRR currently applies to commercial banks and, with modifications, to building societies that accept deposits in the U.K.; credit unions may be covered after HMT regulation. - Holding companies included only to a limited extent (TPO only). - Stabilization powers largely orientated at deposit-taking entities; usefulness for complex international groups may be limited unless TPO used. - Property transfer powers only effective if property is within SRR perimeter; foreign-law governed contracts and assets located overseas may not be transferred by SRR alone. - BA 09 Section 39 requires transferor and transferee to take steps to make transfers of foreign property effective under relevant foreign law. - Cross-border resolution requires international collaboration; EU Winding Up Directive may provide limited assistance for EU branches. Debate on expanding scope to nonbanks - Public debate on including investment banks, insurance companies, market infrastructure providers, money market funds and hedge funds if failures could have systemic consequences. - Mission agrees U.K. would benefit from special resolution tools for certain nonbanks but notes differences in operations and risks may limit applicability of SRR tools. Financing bank resolution and the FSCS - FSCS may fund resolution under SRR up to amount not exceeding cost to FSCS, net of recoveries, of paying out to insured depositors in an insolvency. - FSCS is funded ex post and has access to HMT finance and liquidity via National Loan Fund. - Normally resolution costs met by sales and proceeds from bank; FSCS can contribute only where not more costly than pay-out/liquidation. Investment Bank Insolvency and Client Assets (Box 3) — key findings and measures - LBIE insolvency exposed problems with applying standard insolvency to complex, internationally interconnected investment firms and with safeguarding client property. - HMT introduced new insolvency regulations for investment firms; FSA strengthened Client Assets Sourcebook (CASS). - Special Administration Regulations (SARs) introduce modified administration under Schedule B1 to speed administration, clarify objectives/priorities, and reduce legal challenge potential. - SARs objectives for administrators: (i) return client assets quickly; (ii) ensure timely engagement with market infrastructure providers and authorities; (iii) wind down or rescue business in creditors’ best interests. - SARs permit setting a bar date for client property claims and allow pro rata allocation of shortfalls. - Operational reserve proposal under consultation for administrators to retain key supplies and personnel; mission views ring-fenced operational reserve as potentially useful. - LBIE litigation highlighted segregation failures and resulted in extensive legal dispute; improved monitoring of compliance with segregation obligations is paramount. General bank resolution funds — EU discussions and U.K. position - EU discussions on ex ante industry-funded general resolution funds ongoing; member state views vary. - United Kingdom currently does not have a general bank resolution fund; the bank levy is purely fiscal, not intended to fund public resolution costs. Need for early intervention and changing the “no-failure” perception - Balance clear rules for transparency and reduced moral hazard with supervisory judgment. - Perceived “no-failure” attitude creates incentives to delay resolution; change achieved via external communication and practical examples (letting banks fail where idiosyncratic and non-systemic). - BA and Code of Practice indicate idiosyncratic bank problems should be allowed into insolvency under Bank Insolvency Procedure rather than stabilized by SRR. Triggering of the SRR and Condition 2 - FSA must be satisfied that ignoring SRR powers it is not reasonably likely action will enable the bank to meet threshold conditions (Condition 2, Section 7(3) of BA). - Code of Practice: bank could only enter SRR where no realistic prospect it will continue as an authorized deposit taker. - Condition 2 formulation makes early triggering unlikely. Advantages and disadvantages of a late trigger - Advantages: - SRR entry signals loss of bank, potentially improving chances of rescue outside SRR. - Provides legal certainty and avoids uncertainty/contagion from keeping failing institution operating. - Disadvantages: - Late trigger may lead to loss of value where no private-sector solution found. - Fewer stabilization options remain for BoE with later triggers. Pre-resolution, supervisory intervention and early warning - Emphasize pre-resolution supervisory intervention powers to provide early warning and ensure remedial action. - FSA early-warning/stepladder system should assist allocation of supervision and act as pre-warning when bank approaches resolution trigger. - Processes should ensure tripartite authorities and FSCS receive early information; supervisory orders must be monitored with clear time limits for implementation. Cross-border issues - SRR limited when assets/contracts governed by foreign law; foreign authorities may ring-fence assets. - U.K. authorities work with FSB and BCBS to harmonize where possible. - Interim facilitation steps: map relevant legislation, identify legal issues among supervisory college countries, and agree not to take unilateral actions prior to consultation where feasible. Financial Services Compensation Scheme (FSCS) - Structure and funding: - FSCS operationally independent, accountable to FSA; five sub-schemes including one covering insured depositors. - Ex-post funded: member institutions cover costs pro rata when scheme incurs costs. - Treasury provided FSCS with a loan; principal repayable from 2012 onwards; interest currently being repaid. - In winding-up where FSCS subrogated, FSCS ranks pari passu with other unsecured creditors. - Depositor preference and SRR interactions: - U.K. does not give depositors preferential ranking in insolvency; SRR transfer tools can achieve practically similar outcomes for insured depositors even though FSCS claims pari passu. - International progress on ‘bail-in’ could result in de facto depositor preference. - Permitted FSCS uses: - Pay-out to depositors in BIP. - Financing transfer of insured deposits under BIP. - Contributing to non-payout resolution using stabilization powers only upon order of HMT and FSCS and not more costly than pay-out/liquidation. - Operational readiness and pay-out timing: - FSCS has unlimited access to borrow from the National Loan Fund for pay-outs. - FSA will alert FSCS on potential problem institutions; FSCS ensures pay-out readiness. - All banks required to have systems allowing a “single depositor view.” - FSCS expects a pay-out period of maximum 7 days for most deposit accounts and up to 20 days for more complex claims. - Desirable target: FSCS pay out all eligible claims within 7 days. - Cross-border pay-out conflict reduced by EU rules that no longer allow “topping-up” by host-country depositors. CONCLUSIONS - The United Kingdom developed a bank resolution framework that filled a significant pre-crisis gap. - Authorities regard the crisis management framework as a “living being” to be continually reviewed and improved, and actively contribute to international debates on resolving LCFIs and SIFIs. *Source: _cr11228* ### 1. Early Intervention Frameworks in Denmark and Canada ............................................17 ### 1. Early Intervention Frameworks in Denmark and Canada ### I. INTRODUCTION - The United Kingdom was badly hit by the global financial crisis starting in 2007. - London’s role as a major global financial center meant the U.K. market was closely interconnected with institutions, markets, and activities elsewhere, contributing to contagion from developments abroad. - Domestic imbalances included high leverage in lending to the real estate sector and a developing price bubble in real estate. - The U.K. authorities responded with a number of measures, some harmonized through European Union (EU)-wide agreements to ensure level playing field conditions. - Crisis management revealed gaps in instruments, legal frameworks, and tested cooperation arrangements, leading to some ad hoc and more disruptive interventions. - Introducing permanent law for bank resolution was a key reform; new legislation on bank resolution provides increased certainty to bank stakeholders and authorities, improving prospects for retaining or restoring confidence. - This technical note discusses the framework for crisis management in the United Kingdom covering: - crisis prevention and early intervention; - the Special Resolution Regime (SRR) under the Banking Act 2009 (BA); - emergency liquidity assistance (ELA) and solvency support; - deposit insurance under the Financial Services Compensation Scheme (FSCS); - concluding remarks and assessment of framework contributions to financial stability. *Prepared by Göran Lind (Sveriges Riksbank and IMF external consultant) and Sean Kerr (IMF/LEG).* ### II. SUMMARY OF KEY FINDINGS AND RECOMMENDATIONS A. On Crisis Prevention and Early Intervention - The IMF mission supports the enhanced role for macro prudential oversight. - The mandate should be transparent and limited to what the Financial Policy Committee (FPC) can realistically deliver. - The FPC must be provided with appropriate tools to achieve its objectives. - Align roles of macro and micro supervision to avoid gaps and duplication. - Address governance issues, including balancing objectives of monetary policy and macro prudential oversight. - The mission strongly supports the forward-looking approach adopted since the crisis onset: - Use of stress tests across a wide range of deposit-taking institutions to identify potential problem institutions at an early stage and to share information with other relevant authorities. - Support for the Financial Services Authority’s (FSA) plans to introduce a step-wise approach based on indicators to take early supervisory action. - Approaches to identify and address problems at an early stage should be embedded in FSA, and as relevant, Bank of England (BoE), FSCS, and Her Majesty’s Treasury (HMT) processes. - The FSA needs a wide range of supervisory tools, clear legal powers and obligations to act flexibly, adequately, and in a timely manner, and adequate means to monitor implementation of its orders. B. On the Special Resolution Regime and Resolution Tools - The mission encourages considering expansion, amendment, and adaptation of the SRR to establish resolution tools for other potentially systemically important firms such as investment banks, insurance firms, and payments system infrastructure providers. - Certain SRR features, particularly private sector transfer arrangements, could be useful for other firm types. - The mission agrees it might be beneficial to extend the power to temporarily suspend contractual termination clauses for a short period at initiation of a resolution, pending possible transfer of such contracts, to derivatives and other financial contracts. - If contracts are transferred to a solvent transferee, enforcement of early termination rights should not be available unless and until the transferee itself defaults; if not transferred, termination rights should be enforceable. - This issue will require amendment of European legislation and is on the European Commission’s current agenda. C. On Large Groups (SIFIs) - The SRR is a useful framework for small- and medium-sized deposit-taking institutions and a significant step forward, but operational, legal and political challenges limit its practical use for large banking groups, especially given lack of extraterritorial effect. - The mission supports U.K. discussions aiming to improve resolvability of large banks. Possible solutions include: - Stricter regulations: support for stricter regimes for bank capital and liquidity used as supervisory tools by the FSA; U.K. authorities promote international negotiations to harmonize stricter rules for Systemically Important Financial Institutions (SIFIs). - Contingent capital (CoCos) and bail-in capital: progress requires international agreements and the U.K. authorities take an active role in promoting such agreements. - Recovery and resolution plans (RRPs): encourage progress from collecting information to presenting approaches that increase bank resilience and make them easier to resolve; achieve agreement on RRPs and implementation between home and host authorities for international groups. - Protecting depositors: concur with the aim to protect key economic functions (current deposits and payment services) while remaining flexible on means; the IMF expresses no view on depositor preference merits but notes the issue may be revisited in the U.K. debate on large institutions. D. On the Need for International Harmonization - U.K. authorities’ unilateral regulatory action is limited by the benefit of harmonized EU legislation and globally agreed reforms; integration of financial markets and groups reduces effectiveness of nationally introduced measures. - The mission encourages U.K. efforts to contribute to international solutions on: - SIFIs (as above). - Cross-border resolution: avoid unilateral measures such as geographical/territorial ring-fencing at resolution that may produce suboptimal overall solutions. - Use supervisory colleges or cross-border crisis management groups to reach compromises between home and host authorities. - Increased insight and influence by host authorities could be offered by home authorities in exchange for commitments on joint solutions, including principles for burden sharing in a crisis. - Differences in international insolvency regimes must be resolved to facilitate cross-border resolution. - Deposit guarantee schemes: current U.K. deposit guarantee arrangements are flexible and useful for crisis resolution via direct payout and contributions to resolution transactions. - U.K. scheme is post-funded. - EU discussion includes whether countries can agree on common funding approaches. E. On Exit Strategies - Encourage dismantling of crisis special measures in an orderly manner to return normal market functions. - Support approach encouraging institutions to reduce reliance on support measures earlier than formally agreed to reduce market pressure from concentrated repayment “humps” and to increase market confidence. ### III. INSTITUTIONAL FRAMEWORK - Current institutional arrangements for crisis management are broadly appropriate. - Financial stability responsibilities are set out in a memorandum of understanding (MoU) between the BoE, FSA, and HMT. - Regulatory architecture is subject to imminent change by HMT; the Financial Sector Assessment Program (FSAP) is a ‘point in time’ exercise. - Since the introduction of the BA, some responsibilities are on a statutory footing: - BoE: statutory objective to contribute to protecting and enhancing stability of the U.K. financial system; payment system oversight on a statutory footing; lead resolution authority for failing U.K. banks and building societies under the SRR. - FSA: prudential supervisor; operational role in resolving problems before resolution via capital raising and business disposals; triggers the SRR and is responsible for authorization and supervision of bridge banks under the SRR. - HMT: institutional structure of financial regulation and legislation, informs and accounts to parliament regarding management of serious disruptions and measures to resolve them (including exceptional solvency support from HMT itself). - The FSCS is not a party to the tripartite MoU but has a MoU with the FSA and a protocol with the BoE; FSCS role and responsibilities are detailed in paragraphs 71 to 77. - Cooperation and information sharing among authorities is key; interaction has increased in frequency and earlier involvement of other authorities. - FSA stress-tests identify outlier institutions; tripartite joint working groups monitor development of potential problem institutions and discuss preventative measures. - Early dialogue among authorities helps stabilize banks before thresholds for special resolution are breached. ### IV. CRISIS PLANNING AND PREVENTION - The United Kingdom is embracing crisis planning and prevention initiatives important for larger, more complex banking groups. - The SRR and normal crisis management framework are best equipped for small- and medium-sized standalone deposit-takers; large cross-border banking groups present greater execution risk and complexity, and SRR powers do not automatically apply extraterritorially. - To avoid expensive government recapitalization of going concerns, the authorities pursue supplementary and mutually reinforcing approaches to increase resilience and resolvability: - Strengthen resilience in normal times with tougher capital and liquidity requirements for large banks; U.K. working within international bodies (FSB and Basel Committee) to reach agreements on international standards. - Ensure private stakeholders contribute to stabilizing weak banks before they become non-viable, exemplified by international debate on increased loss absorbency via contingent capital instruments with contractual triggers (‘co-cos’) or statutory ‘bail-in’ powers tied to resolution. - Simplify legal and operational structure of large and complex banks to make isolation and resolution of core components easier from a public interest perspective: - FSA, supported by BoE, requires large banks to present recovery and resolution plans (RRPs). - RRPs outline preparations for contingencies (sudden capital and liquidity needs) and identify how group entities and activities may be split off and sold without endangering systemically important functions. - FSA may recommend structural simplification during normal times to improve manageability, supervision, and resolvability. - Improve macro-prudential oversight. *Italic line: IMF technical note content as provided in the supplied source.* ### 17. The IMF mission concurs with the approach taken by the U.K. authorities and ### 17. The IMF mission concurs with the approach taken by the U.K. authorities and ### A. Capital and Liquidity - The IMF mission concurs with the approach taken by the U.K. authorities and recognizes that the international debate in these areas is still evolving. - Failures in large groups are potentially of a much greater magnitude and the groups are not easily resolvable through the ordinary methods. - Stricter regulatory and supervisory requirements constitute a necessary first line of defense and help maintain a level playing field, since the costs of capital and funding are generally lower for SIFIs due to the implicit assumption of their being too big to fail. - Since 2009, the FSA applies an enhanced regime for bank capital and bank liquidity. The supervisory framework for bank capital is known as “4/6/8”. The numbers imply: - In the outcome of a stress test based on FSA-generated parameters, the bank’s common equity capital should not drop below 4 percent during the coming ‘x’ years. - The bank’s common equity capital should remain at or above 6 percent on a continuous basis also in nonstressed situations. - The bank’s tier 1 (core) capital, including common equity but also other accepted instruments, such as certain forms of hybrid capital, should at all times be at or above 8 percent. - On liquidity, the FSA conducts intensified monitoring according to quantitative as well as qualitative rules. - The enhanced regime is primarily aimed at banks that received some form of public support during the crisis; the IMF mission concurs that the enhanced measures will assist authorities in identifying weak banks at an early stage and facilitating remedial action. - Challenges remain regarding: - The terms and modalities of contingent capital instruments designed to improve (via contract) a firm’s pre-resolution resilience. - The possible scope of statutory bail-in powers, which may further increase loss absorbency in a resolution. - Investor appetite for instruments susceptible to contractual or statutory conversion or write down. - The lack of an international agreement on giving regulators “bail-in” powers as a resolution tool; nevertheless, broad global acceptance among policymakers exists that the approach should be explored further and the United Kingdom is actively involved in the international debate. - The vulnerabilities of the SIFIs are a global issue; the U.K. market is heavily affected as home to several domestic SIFIs and hosting entities in many SIFIs domiciled abroad. The ultimate solution must be reached through global agreements and harmonization. ### B. Size and Structure - Stricter regulatory requirements and the use of bail-in powers, if adopted, could reduce the risk of disorderly failures in SIFIs. - Simplifying the legal and operational structures of SIFIs, if done in normal times, could reduce the risk of failures, e.g., through reducing intra-group connections, and simplifying resolution to enable more orderly winding down. - The Independent Banking Commission (IBC) is analyzing broad issues related to the size and structure of U.K. banks; public pronouncements to date have hinted at the possibility of drawing some kind of dividing lines. - The IBC interim report (published on 11th April, 2011) proposes mandatory subsidiarization of the retail activities of a bank, allowing but limiting the exposures between the retail subsidiaries and other parts of the bank. The retail subsidiaries should maintain a core capital ratio (CET1) of at least 10 percent provided there is an increased loss absorbency of debt through the use of CoCos or bail-in instruments (if not the CET1 capital should be even higher). - The question of subsidiarization as a means of separating depositor-related functions from riskier investment operations remains open; no preferred approaches have yet been identified. - It will be important to see how IBC findings move the debate forward later in the year. ### C. Cross-Border Issues - The United Kingdom is both a home and a host country to banks; as a member of the EU, it must apply the Passport Rules, which allow a bank established elsewhere in the EU to open branches in the United Kingdom that are regulated and supervised by the home country supervisor. - EU rules do not allow a host country to force EU-domiciled banks to change their presence from branch status to subsidiary status. If subsidiaries are opened, they will be domiciled and authorized in the United Kingdom and U.K. supervisors will become the home authority. - Passport Rules are intended to promote financial integration in Europe. - Problems in a U.K. branch of a foreign bank could, under certain circumstances, have negative implications for financial stability in the overall system or important parts thereof, even if the branch has a limited market share (e.g., by affecting depositors’ and other counterparties’ confidence). - Many host countries, including the U.K., have pushed to be allowed stronger tools to supervise and, if necessary, protect themselves from potential problems of branches; under current EU legislation, the host country may regulate the liquidity of the branch, but not anything else. - Changes to the Capital Requirements Directive may yet limit host countries’ ability to regulate liquidity locally. - The U.K. authorities place increased importance on obtaining frequent whole-firm liquidity information in respect of banks for which they are the host supervisor, in order to make their own risk assessments. - As a first step, the U.K. authorities would seek progress through multilateral approaches, such as closer coordination and information sharing between home and host authorities, for instance by using the supervisory colleges established for all significant groups. - The U.K. authorities believe there needs to be a better balance between home and host supervisors to make decisions to protect the branch. - The IMF mission acknowledges the seriousness of the issue, citing effects on the U.K. financial market from the failures of Lehman Brothers and the Icelandic banks. - A solution must be sought through internationally harmonized agreements; the main incentive could be mutual interest in collaboration: host authorities need more information and more influence, whereas the consolidating supervisor needs commitments from host authorities on crisis management (e.g., against taking unilateral action). ### D. Recovery and Resolution Plans (RRPs) - The Financial Services Act 2010 requires the FSA to make rules for the preparation and presentation by banks of RRPs. - The aim of a recovery plan is to compel the institution’s leadership in normal times to make contingency plans for mitigating various stresses, e.g., by raising capital and liquidity. - Firms are also required to provide resolution analysis and information to explain how the institution’s key or systemically significant economic functions are distributed across the organization. - The aim is for the bank to explain which economic functions are systemically important and how they could be separated in the event of failure; authorities then develop institution-specific resolution plans based on that material to facilitate resolution of large and complex financial institutions (LCFIs). - Primary responsibility for the ‘recovery’ element rests with the firm; the regulator is primarily responsible for the ‘resolution’ plan if recovery proves unable to turn the firm’s fortunes. - While there is no regulation yet on the modalities and content of an RRP, an important pilot project is at an advanced stage: the FSA and the BoE have produced detailed draft templates for RRPs being used in a pilot study covering six major U.K. bank groups. - The template has a five module structure: - The Overview: intended to ensure the RRP is agreed and understood by the Board and senior management and integrated into the bank’s risk management approach. - The Recovery Plan: invites the bank to select some 5 to 10 options (e.g., contingency plans) for addressing extreme financial stress; the template prescribes inclusion of options for recovering from or avoiding capital and liquidity difficulties. - Group Structure and Key Legal Entity Information: aimed at understanding how and where significant economic functions are performed and major financial intra-group interdependencies. - U.K. Economic Function Identification Matrix: provides an overview of main economic functions performed by the institution in the U.K. market to single out functions significant to U.K. financial stability. - U.K. Critical Function Contingency Analysis (CFCA): analyzes how each critical economic function may be separated from other parts of the group while preserving continuity or enabling orderly wind-down. - The IMF mission welcomes efforts to make RRPs concrete and operational; the pilot study is the second in a short period and the banks and authorities conduct an iterative process to refine processes and the template. - Filling in and assessing an RRP involves significant work for both bank and authorities because data and information must be collected and analyzed in new ways; RRPs imply looking at structures and operations differently from past analyses. - Cautions regarding RRPs: - There should be caution against having too high expectations of RRPs; many circumstances could limit their usefulness in a crisis, particularly if systemic. - An individual firm’s capacity to generate planned capital and liquidity may be reduced in systemic crises. - Contingency arrangements may not work as planned (e.g., committed liquidity lines may not be available due to broad market disturbances; lack of interested purchasers for businesses or entities). - Benefits of RRPs: - Forces bank leadership to collect, structure, and analyze information in new ways; may lead management to question organizational choices and potentially voluntary simplification. - Authorities may require structural and organizational changes if RRP discussions suggest a firm is not easily resolvable. - The RRP exercise should improve ordinary regulatory and supervisory work. - The approach to identify systemically critical economic functions (module four) is appreciated: focusing on functions rather than legal entity structure may facilitate resolution measures and understanding of structural changes to improve resolvability. - The FSB is developing internationally consistent RRPs for internationally active groups; U.K. authorities aim to harmonize and integrate their templates into the developing international standard. - Information pertaining to RRPs should be shared between home and host members of cross-border crisis management groups for major international financial groups, subject to strict secrecy requirements because of the sensitivity of the information. ### V. SUPERVISORY ACTION FOR PROBLEM BANKS - Effective crisis management hinges on authorities identifying and addressing bank problems at an early stage. - Previously, the FSA tended to postpone taking formal remedial action, attempting voluntary corrective steps by persuading bank management to act; while appropriate as a first step, it should be followed by formal requirements if satisfactory rectification is not obtained in the short term. - Formal requirements must be monitored by requesting frequent progress reports from the relevant bank. - Processes to enable early identification have been strengthened, for instance by introducing across-the-board stress tests to identify vulnerable outlier institutions. - The FSA is planning to introduce an indicator-based early warning system (EWS) to signal the need for early action to mitigate vulnerabilities in individual banks; the system: - Is not expected to be fully automatic or nondiscretionary. - Will not be based just on quantitative indicators, such as bank capital, but will leave room for supervisor judgment. - By international comparison, the early intervention frameworks of Canada and Denmark are noted: - Denmark (The Diamond framework): consists of five quantitative indicators; until end-2012 the supervisor will monitor movement toward limits; starting in 2013 the supervisor will take remedial action where limits are breached. The five indicators include limits on large exposures, lending growth, commercial real estate lending share, funding ratio, and liquidity coverage (retail deposits in relation to wholesale funding must be at least 50 percent). - Canada (OSFI framework): consists of four stages (in addition to “all normal”); each stage identified by conditions and options for supervisory measures and includes guidelines for interaction between authorities, including the Canada Deposit Insurance Corporation (CDIC). Stage 1 (Early Warning) conditions and measures include management meetings, more frequent on-site supervision, additional reporting, and informing the CDIC. Stage 2 (Risk to financial viability or solvency) conditions and measures include requiring rectification within a specified timeframe, extending audit scope, or developing contingency plans to enable rapid control of assets. - Under the ‘own initiative variation of permission power’ in the Financial Services and Markets Act, the FSA has a broad range of remedial measures, including: - Temporarily stopping the paying of dividends. - Requesting postponement of taking up new activities or terminating existing activities. - Ultimately revoking a bank’s license if it no longer meets licensing conditions. - The FSA regularly uses discretionary capital requirements under Pillar 2 (within the Basel II framework) to require individual banks to hold additional capital when a bank’s risks are deemed higher than peers (e.g., based on stress test results). *IMF mission report excerpt* ### Box 1. Early Intervention Frameworks in Denmark and Canada (concluded) ### Box 1. Early Intervention Frameworks in Denmark and Canada (concluded) ### Canadian early-intervention stages (stage 2–4) - Stage 2 - The OSFI will inform the CDIC of results and data obtained from enhanced supervisory reviews, expanded audits, and enhanced monitoring. - The OSFI and CDIC will commence contingency planning. - Stage 3: Future financial stability in serious doubt - Conditions: - (i) the combination of the institution’s overall net risk, capital, and earnings makes it vulnerable to adverse business and economic conditions, which pose a serious threat to its financial viability or solvency, unless corrective action is promptly taken; and - (ii) the institution has significant issues in risk management or control deficiencies, which present a serious threat to its financial viability or solvency, unless effective corrective action is promptly implemented. - Supervisory interventions include: - directing specialists to assess specific areas such as the quality of loan security, asset values, and sufficiency of reserves; - enhancing the scope of business restrictions put on the institution; - sending OSFI staff to the institution to monitor the situation on an ongoing basis; - expanding contingency planning; - communicating to the management the importance of considering resolution options, including seeking a prospective purchaser. - Governance and coordination: - regular meetings in the sub-FISC and the FISC to discuss the evolving situation and contingency planning; - the CDIC and the OSFI will discuss the situation of the institution in depth. - Stage 4: Nonviability/insolvency imminent - Conditions: - (i) the institution has failed to meet regulatory capital requirements in conjunction with an inability to rectify the situation on an immediate basis; - (ii) the statutory conditions for taking control have been met; and - (iii) the institution has failed to develop and implement an acceptable business plan, resulting in either of the two preceding circumstances becoming inevitable within a short period of time. - At stage 4, OSFI has determined that the financial institution will become nonviable on an immediate basis. - Coordination: - regular inter-agency (FISC) meetings shall be held, focusing on coordinated implementation of intervention measures. - Potential OSFI activities at stage 4: - Assuming temporary control of the assets (provided that the statutory conditions exist); - Taking control of the assets (provided that the statutory conditions exist); - Requesting that the Attorney General apply for a winding-up order. *Italic line: Source: _cr11228 - Box 1. Early Intervention Frameworks in Denmark and Canada (concluded)* ### VI. CRISIS MANAGEMENT TOOLS — key lessons from the U.K. experience - Major lesson: - Need for a legal framework for the resolution of banks (i.e., a special resolution regime). Lacking such a framework at the time of the Northern Rock crisis in 2007 undermined credibility and aggravated the crisis. - Flexibility requirement: - Characteristics of crises can differ; authorities need flexibility rather than reliance on a fixed framework. - During the crisis the BoE provided liquidity on more flexible terms; HMT recapitalized banks and provided solvency support through guarantees of assets and liabilities. ### A. Official financial support — banking sector liquidity support - Emergency liquidity measures used: - BoE provided liquidity through newly created facilities outside the normal repo facility, on longer terms (up to one year), and against a wider range of collateral. - Liquidity provided in foreign currency, notably U.S. dollars. - Special Liquidity Scheme (SLS): - Via the SLS, banks were allowed to swap their high-quality, but temporarily illiquid securities for U.K. treasury bills. - These extraordinary measures are now being dismantled; the treasury bills lent under the SLS are being gradually repaid, actually somewhat ahead of the planned schedule in order to avoid major repayment humps when the bonds mature. - Between April 2008 and January 2009, treasury bills with a face value of approximately GBP 185 billion were lent under scheme against illiquid collateral (mostly mortgage-backed securities). - Discount Window Facility (DWF) and stigma: - Since the crisis, the BoE has instituted a permanent DWF for bilateral liquidity support. - Perceived risk of stigmatization remains an issue; banks avoid using extraordinary funding facilities to avoid being regarded as “being in need.” - The BoE and the FSA have encouraged firms to identify and to pre-position large amounts of collateral at the BoE to facilitate rapid draw down of funds in the DWF if needed. - New permanent BoE facility (June 2010): - Allows counterparties simultaneously to bid for funds against two distinct collateral sets: - a “narrow” set (high-quality debt expected to remain liquid in all but the most exceptional circumstances); - a “wider” set (high-quality debt expected to remain liquid in most circumstances). - The BoE regards this facility as a diagnostic tool: increasing demand for liquidity against the wider pool of collateral could indicate growing market tension or funding difficulties. - Emergency Liquidity Assistance (ELA): - During the crisis, the BoE provided ELA packages for specific problem institutions on a discretionary basis, aiming for a longer-term solution for the recipient. - The BoE faces no legal restriction on its provision of ELA and enjoys very broad, discretionary powers, which are legally robust. - Tripartite MoUs since 1998 have set out the framework through which ELA decisions would be expected to be made. ### A. Official financial support — solvency support - HMT measures during the crisis: - Recapitalization of two problem banks; guarantees of assets and liabilities (Asset Protection Scheme (APS) and senior bank debt guarantees). - Rationale and issues: - Solvency support measures enabled banks to fulfill regulatory requirements and avoid resolution. - Ad hoc measures require correct incentives: shareholders and other junior debt holders should, as a rule, be written off before new capital is inserted. - Asset protection design: under the APS, the first loss risk and part of the secondary loss risk would fall on the bank and only after that would the guarantee be invoked. - Case examples and deviations: - Holdings of original shareholders in RBS were substantially diluted but left a small portion to maintain market presence and avoid outright nationalization — a deviation from the ideal of shareholders fully absorbing losses. - Lloyds Banking Group exited the APS in late 2009 and paid £2.5 billion levy for the protection received during its participation. - RBS continued to participate, paying an annual premium; beyond the first £60 billion of losses on covered assets (which RBS would bear), losses would fall on the RBS and the government at a ratio of 1:9. ### B. Banking Act 2009 — special resolution and insolvency framework - Pre-crisis gap: - Resolution of U.K. banks had relied on general corporate insolvency law (The Insolvency Act of 1986), but banks’ special features require specific resolution approaches to protect functions such as deposits, critical lending, and payment services. - Emergency to permanent regime: - The BSPA (February 2008) was an emergency temporary measure with a one-year sunset clause; most BSPA powers moved into the permanent Banking Act 2009 (BA). - The BA placed “private sector purchaser” and “TPO” stabilization options on a permanent footing and introduced a “bridge bank” resolution. - Scope of BA: - Establishes a permanent resolution framework built around a SRR (special resolution regime) including directed transfer powers (“stabilization powers”) and a Bank Insolvency Procedure (BIP) for winding up insolvent banks while protecting insured depositors. - Sets out trigger points for invoking the SRR, objectives of the SRR, stabilization options, and tools. - Confers powers on the BoE and HMT to effect specific stabilization options and creates an obligation to consult with other authorities. - Secondary legislation sets standards for compensation to stakeholders and creditor safeguards to prevent interference with netting, security interests, and collateral rights. - To date, resolution powers under the BA have been used in one case: the building society Dunfermline. ### Useful features of the Banking Act 2009 and the SRR - Transparency and predictability: - BA defines a finite number of resolution options and tools and includes the objectives for resolution to guide choice of options and tools. - Box 2 — Special Resolution Regime Summary (selected points) - Objectives to be considered (not ranked): - Objective 1: to protect and enhance the stability of the financial systems of the United Kingdom - Objective 2: to protect and enhance public confidence in the stability of the banking systems of the United Kingdom. - Objective 3: to protect depositors - Objective 4: to protect public funds - Objective 5: to avoid interfering with property rights in contravention of a convention right (within the meaning of the Human Rights Act 1998). - SRR stabilization options: - (i) transfer to a private sector purchaser; - (ii) transfer to a bridge bank; - (iii) temporary public ownership (TPO). - Preconditions and decision process: - Before any stabilization power is used, the FSA must determine that both general conditions are satisfied: - condition 1: the bank is failing, or is likely to fail, to satisfy the threshold conditions for holding a banking license; - condition 2: having regard to timing and other relevant circumstances it is not reasonably likely that (ignoring the stabilization powers) action will be taken by or in respect of the bank that will enable the bank to satisfy the threshold conditions. - The FSA makes the determination of the general conditions but must consult with HMT and BoE. - If general conditions are met, either the BoE (for transfer to a private sector purchaser or bridge bank) or HMT (for TPO) may use a stabilization option, subject to the relevant specific conditions (public interest tests). - The TPO is a “last resort” option depending on necessity to counter a “serious threat” to financial stability. - If no specific conditions for a stabilization option are met, the bank would be placed into the bank insolvency procedure with insured deposits transferred to another bank, or FSCS paying out to insured depositors as rapidly as possible. - Leadership and administration: - Upon entry into the SRR, the BoE is the lead authority (except for TPO—for which HMT leads) conducting any sale of the bank to private parties or by establishing a bridge bank. - After transfer powers have been used, the SRR includes a bank administration process for the insolvency of the residual entity, with a requirement for the residual institution in administration to provide continued services and facilities as needed to the recipient of the transferred business. - Creditor and property-rights safeguards: - The BA requires HMT to put in place compensation arrangements so persons affected by transfer powers are appropriately compensated to comply with Article 1 Protocol 1 of the European Convention on Human Rights. - For partial property transfers, the framework provides compensation on a “no-worse-off-basis.” - Secondary legislation (Banking Act 2009 (Restriction of Partial Property Transfers) Order 2009 (SI 2009/322)) establishes creditor safeguards preventing partial property transfers from interfering with netting rights, security interests, clearing house default rules or payment flows in certain capital markets transactions. *Italic line: Source: _cr11228 - Box 1. Early Intervention Frameworks in Denmark and Canada (concluded)* ### 54. Learning from the experience of earlier failures, the SRR contains a number of ### _cr11228 - 54. Learning from the experience of earlier failures, the SRR contains a number of ### Orderly procedure and suspension of termination rights - Under the SRR, the authorities may temporarily suspend contractual termination rights that might otherwise be triggered by the use of asset and capital transfer powers under the SRR. - Exception: financial derivatives contracts that contain netting clauses are required under relevant EU directives to be given effect “in accordance with their terms” and without qualification; suspension of termination powers under the BA does not currently extend to such financial contracts subject to netting clauses or otherwise subject to the relevant EU directives. - U.K. authorities may benefit from powers similar to U.S. counterparts permitting a 24-hour suspension of close-out rights relating to “qualified financial contracts” (QFCs), which include most derivatives, while resolution authorities decide whether or not to transfer those contracts. - Any use of a temporary suspension should be underpinned by a robust cost and benefit analysis, taking into account impacts on wider market participants. - The forthcoming European legislative proposal on bank resolution is likely to include provisions regarding the temporary suspension of early termination and close out netting rights pending a transfer when a resolution has been initiated. - If such a suspension is included, upon expiry of the suspension, full close-out and termination rights would be available for all financial contracts left in an insolvency procedure, but would not be available (other than for new, post-transfer defaults) for contracts transferred to a solvent bridge bank or private sector purchaser. ### Code of Practice and the exercise of discretion - Under the SRR, the authorities are required to have regard to a Code of Practice that provides guidance on the application of the regime. - The SRR often requires different authorities to exercise discretion and judgment; the Code of Practice provides guidance on the choice between different resolution options and whether general and specific conditions for the use of special resolution tools have been met. ### Scope and perimeter of the SRR - The SRR in its existing form is applicable to commercial banks and, with some modifications, to building societies that are authorized to accept deposits in the United Kingdom. - BA provisions may apply to credit unions after a regulation by HMT to implement this provision in the legislation. - U.K. holding companies of banking groups are included to a limited extent (TPO is the only stabilization option to which holding companies may be subject). - Certain “continuity obligations” may be imposed on a residual bank or other banking group companies to continue to provide services and facilities to a solvent transferee (including a bridge bank). - The stabilization powers of the SRR are largely orientated at deposit-taking entities; usefulness in resolving a complex group may be limited (particularly international groups), unless the TPO power, meant to be a last resort, is exercised. - Practical and legal limitations (for example, restrictions on financial assistance limiting a cash-rich subsidiary’s ability to recapitalize an ailing parent through direct purchases of equity) constrain efforts to resolve an entire group. - It is important that supervisory and resolution perimeters map each other as closely as possible; given the SRR’s limited scope at present, it is not clear that this is the case. ### Property transfer powers and cross-border limitations - Property transfer powers are crucial to the SRR but are only useful if the property is within the SRR perimeter. - If property is located in an entity outside the SRR perimeter (due to nature of the entity or its location overseas) or if a contract to be transferred is governed by a foreign law, the SRR’s transfer powers alone may not perfect the transfer. - This issue is a general problem for any domestic bank resolution regime in a cross-border context and underscores the essential requirement for international collaboration to realize resolution frameworks useful for international groups. - Note in the EU context: the EU Winding Up Directive for Banks may provide limited assistance to ensure primacy of UK proceedings affecting EU branches of UK banks, but the SRR per se cannot perfect transfers of foreign property. - The BA 09 addresses foreign property at Section 39 by requiring transferor and transferee entities to take necessary steps to ensure transfers of foreign property become effective under relevant foreign law. ### Debate on expanding scope to nonbanks - Public debate includes views that other potentially systemically important categories should be included, such as investment banks, insurance companies, market infrastructure providers and maybe money market funds and hedge funds if their failure could have systemic consequences. - Rationale: the framework is intended to protect against disorderly winding-up of institutions whose failure might have systemic repercussions (e.g., failures of a key settlement system or central counterparty causing serious contagion). - The mission agrees the United Kingdom would benefit from having special resolution tools for certain nonbanks, but: - Most nonbanks have operations and risks very different from banks; existing SRR options and tools may not be applicable or only partially so. - Including some nonbanks under special resolution arrangements would likely have beneficial effects, such as improving market confidence. - The United Kingdom is taking steps to improve the corporate insolvency framework as it applies to investment firms (see Box 3). ### Financing bank resolution and the FSCS - The FSCS (the U.K.’s DGS) may participate in funding resolution under the SRR. - The FSCS may contribute to funding SRR resolution transactions up to an amount not exceeding the cost to the FSCS, net of recoveries, of paying out to insured depositors in an insolvency. - The FSCS is funded ex post and has access to HMT finance. - Normally, resolution costs would be met by sales and other proceeds from the bank itself; if additional funds are needed, the FSCS has access to liquidity support via loans from the National Loan Fund. ### Investment Bank Insolvency and Client Assets (Box 3) — key findings and measures - Lehman Brothers’ U.K. operation (LBIE) insolvency exposed problems applying standard corporate insolvency to complex, internationally interconnected investment firms; proceedings across jurisdictions remain unresolved and slow the return of clients’ property and settlement of claims. - In the U.K., legal disputes exposed LBIE’s poor compliance with rules designed to safeguard client property. - Following 2010 consultation, HMT introduced new insolvency regulations for investment firms; the FSA has taken steps to improve protection of client property held by brokers and custodians through changes to the Client Assets Sourcebook (CASS). - Special Administration Regulations (SARs) for investment firms: - Introduced under powers in the BA to provide a modified form of administration under Schedule B1 of the 1986 Insolvency Act. - Aim to speed up administration by clearly establishing administrator objectives and priorities and giving the FSA power to direct the administrator’s order of priorities. - Administrators under Schedule B1 face potential personal liability, which can lead to caution and inefficiencies; SARs aim to reduce legal challenge potential by clarifying objectives and requiring speed and efficiency. - An investment firm administrator under SARs has three statutory objectives to work speedily and efficiently toward: (i) ensure the return of client assets as quickly as possible; (ii) ensure timely engagement with market infrastructure providers and the authorities; and (iii) either wind down or rescue the firm’s business in the best interests of its creditors. - The FSA, following consultation with HMT and the BoE, can direct the administrator to prioritize one objective. - SARs allow setting a bar date for submitting client property claims and permit allocation of any shortfalls in client securities to all clients on a pro rata basis. - Operational reserve proposal: - HMT’s December 2009 consultation discussed introducing an operational reserve of cash/liquid assets for administrators to retain key supplies and operational personnel during insolvency. - Discussions on whether to introduce and ring-fence such a reserve are ongoing; the mission believes a ring-fenced operational reserve could be a useful addition. - Lehman Brothers client money litigation highlighted issues: - Some firms used a permitted ‘alternative’ approach allowing intraday commingling of client and house assets with once-daily reconciliation, risking client property received after last segregation failing to be segregated on insolvency. - LBIE appeared to have substantial failures in segregation over a prolonged period; much client money had been deposited inside the group at a Lehman entity in Germany that entered insolvency. - As a result, the pool of available LBIE client money suffers from a substantial shortfall and legal disputes arose over (i) availability for distribution of identifiable client money not properly segregated but possibly in other firm accounts, and (ii) whether claimants should include clients whose money had not been properly segregated. - High Court (first instance, January 2010) ruled only properly segregated client money was available for distribution and only to those whose money had been properly segregated; Court of Appeal (August 2010) disagreed on these issues; litigation continues on appeal to the supreme court. - Practical observation: improved monitoring of firms’ compliance with segregation obligations is paramount; over two years since LBIE’s insolvency, client money has yet to be returned. - The FSA has taken steps to improve oversight of compliance with client property rules and is likely to undertake a comprehensive review of CASS after LBIE litigation concludes. ### General bank resolution funds — EU discussions and U.K. position - Discussions in the EU on merits of general bank resolution funds funded ex ante via industry contributions are ongoing. - The commission notes some DGS already play enhanced roles in resolution; general resolution funds could provide resolution financing above DGS participation caps. - Member state views vary: - Opponents cite increased moral hazard and potentially insufficient amounts raised; fiscal costs cannot be completely eliminated because much of a pre-fund would sit as government paper whose large-scale liquidation when needed could nudge up rates. - Proponents value political signaling effect of raising general resolution funds ex ante via industry contributions; some countries are building up such funds. - EU discussions are far from finalized. - Currently, the United Kingdom does not have a general bank resolution fund; the bank levy is a purely fiscal measure and is not intended specifically to fund public costs for resolving banks. ### Need for early intervention and changing the “no-failure” perception - Crisis management and bank resolution frameworks must balance clear rules (for transparency and to avoid moral hazard) and the use of judgment (because bank distress situations differ). - Too much subjectivity and discretion might increase the danger of mistiming resolution initiation; a perceived “no-failure attitude” creates incentives to delay drastic actions. - The “no-failure” perception must be altered; the authorities have expressed their will and shown a stricter approach in dealing with potential problem banks. - Change in perception will be achieved through external communication and practical examples, i.e., by letting banks actually fail. - The BA and the Code of Practice indicate that where bank problems are idiosyncratic and failure is not likely to have adverse systemic consequences, the bank is expected to be allowed to enter insolvency and be wound up under the Bank Insolvency Procedure contained in Part 2 of the BA rather than resolved using stabilization options. *IMF staff summary extracted from the provided source content.* ### 64. The ‘general conditions’ for resolution would likely only be met at quite a late ### The ‘general conditions’ for resolution would likely only be met at quite a late stage ### Triggering of the SRR and Condition 2 - The FSA must be satisfied that it is not reasonably likely that (ignoring the SRR tools) action will be taken by or in respect of the bank that will enable the bank to satisfy the threshold conditions. This is “Condition 2” (Section 7(3) of BA). - The Code of Practice under the SRR states that a bank “could only enter the SRR at a point where it is clear that there is no realistic prospect that it will be able to continue as an authorized deposit taker.” - The formulation and intent of Condition 2 make it unlikely the FSA could trigger SRR at a very early stage. ### Advantages and disadvantages of a late trigger - Advantages: - Bank management’s awareness that SRR entry implies loss of the bank may improve chances of restoring viability outside SRR. - SRR provides legal certainty: if existing stakeholders cannot rescue the bank, the BA ensures it will be sold, resolved, or liquidated with minimum disruption. - SRR avoids uncertainty, contagion, and instability from keeping a failing institution operating. - Disadvantages: - Late triggering may lead to loss of value18 where no private-sector solution was found. - The later the trigger, the fewer realistic stabilization options may remain for the BoE, potentially limiting their choice. ### Pre-resolution, supervisory intervention and early warning - Greater emphasis on pre-resolution supervisory intervention powers is recommended to: - Provide early warning of potential problem banks well before threshold conditions are met. - Ensure remedial action is taken by firms themselves where possible. - The FSA plans to introduce an early warning system that: - Identifies banks’ situations in a step-wise assessment system. - Allows the FSA to react with various measures as certain steps, defined through criteria, are reached. - Retains FSA discretion in responses. - The early-warning/stepladder system should: - Assist allocation and extent of supervision in normal times. - Act as pre-warning when a bank moves closer to the resolution trigger point. - Be linked to integrated processes so the tripartite authorities and the FSCS receive early information, especially for sudden or sharp downward movements. - Supervisory execution: - FSA should fully use available powers and be expected to intervene early, with a sufficiently wide range of remedial measures. - Processes must ensure monitoring of orders for corrective measures and set clear early time limits for implementation. - Many supervisory authorities operate dedicated units/reporting systems to monitor implementation; these should cooperate closely with supervisory teams responsible for the institution.19 ### Cross-border issues - There are clear limitations to SRR effectiveness when assets are held under other jurisdictions; transfers of assets from overseas into a U.K. resolution cannot be achieved with certainty. - Foreign authorities may ring-fence assets to minimize local losses, limiting transfers into a U.K. resolution. - U.K. authorities work with international bodies (FSB and BCBS) to harmonize international resolution approaches where possible. - Interim steps to facilitate cross-border resolution techniques include: - Mapping relevant legislation and identifying legal issues among supervisory college countries. - Agreements not to take unilateral actions, such as ring-fencing, prior to consultation—recognizing in some jurisdictions legal constraints may require unilateral action. ### Financial Services Compensation Scheme (FSCS) - Structure and funding: - The FSCS is an operationally independent body accountable to the FSA managing a protection scheme with five sub-schemes; one covers insured depositors in deposit-taking institutions. - It is ex-post funded: when the scheme incurs costs, member institutions with insured deposits cover costs pro rata (their share of protected deposits up to the compensation limit per individual depositor per authorized bank). - Principal costs for pay-outs during 2008 have not yet been allocated pending liquidation proceedings; the Treasury provided the FSCS with a loan whose principal will be repaid from 2012 onwards (interest on the loans is currently being repaid). - In winding-up procedures when FSCS is subrogated to transferred depositors, FSCS ranks pari passu with other unsecured creditors. - Depositor preference and SRR interactions: - The United Kingdom does not give depositors preferential ranking in insolvency; depositor preference was considered during BA consultations but not adopted. - For individual insured depositors, SRR transfer tools and powers can be used in ways expected to achieve a practically similar outcome to depositor preference, even if FSCS must claim pari passu in the insolvency of the residual failed bank20. - International progress on ‘bail-in’ arrangements could result in a de facto depositor preference and may prompt consideration of formalizing such preference de iure. - Permitted FSCS uses: - Pay-out to depositors in an application of the bank insolvency procedure. - Financing the transfer of insured deposits to another institution under the bank insolvency procedure.21 - Contributing to a non-payout resolution of a failed bank using stabilization powers, only upon order of HMT and the FSCS; such contribution must be no more costly to the FSCS, net of recoveries, than if pay-out/liquidation had been used. - Operational readiness and pay-out timing: - FSCS has unlimited access to borrow from the National Loan Fund for pay-outs. - FSA will alert FSCS on potential problem institutions; FSCS will contact institutions to ensure pay-outs can be handled quickly. - All banks are required to have account systems allowing a “single depositor view.” - FSCS expects a pay-out period of maximum 7 days for most deposit accounts and up to 20 days for more complex claims. - It would be desirable for FSCS to pay out all eligible claims within a target of 7 days. - Cross-border pay-out conflict: - The risk of conflicts in cross-border pay-outs (e.g., Icelandic banks) has been reduced since EU rules no longer allow “topping-up” by host-country depositors paying a premium to access higher cover. - The EU is discussing further changes to harmonize deposit guarantee schemes. - IMF mission view: - The U.K. deposit guarantee system is viewed as well advanced and more useful because it can be used beyond simple pay-outs to facilitate other resolutions. - FSCS appears prepared to act quickly if informed early by the FSA. - Identifying “trigger points,” in addition to supervisory discretion and FSA obligations to inform FSCS, would underpin the process. ### Conclusions - The United Kingdom has developed a bank resolution framework that fills a significant pre-crisis gap. - Authorities view the crisis management framework as a “living being” that can be continually reviewed and improved, with ongoing contributions to international debates on resolving LCFIs and SIFIs.22 *IMF mission report text* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11228.pdf_