The Unsettled State Of U.S. Resolution – FedFin

The Unsettled State Of U.S. Resolution – FedFin
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The Unsettled State Of U.S. Resolution by Federal Financial Analytics

Congress will have a lot on its plate when they return after Labor Day – the Iran deal and, even more important for financial markets, the budget and debt limit are at the top of that list. However, before the August recess, committees in both the House and Senate turned to the long-festering question of how to make giant U.S. financial-services firms resolvable under the Bankruptcy Code. Earlier this summer, the Basel Committee laid out final principles for global banks (see FSM Report RESOLVE33). Aspects of the Congressional approach are compatible with the global framework, but the push to repeal Dodd-Frank’s orderly-liquidation authority (OLA) could put the U.S. very much at odds with global practice. For all the talk of ending too big to fail, most nations outside the U.S. have just a few, very big banks that are so intertwined with the national government and economy as to make them impregnable – or, at least, impregnable once taxpayer support is factored into the backstop equation. The U.S. Congress – and most especially its Republican Members – will have nothing to do with any resolution regime that includes a taxpayer backstop. The clearest expression of this is new legislation in the Senate (see FSM Report RESOLVE34) that not only creates a new chapter of the U.S. Bankruptcy Code to settle SIFIs, but also repeals OLA. Taken together with legislation to constrain the FRB’s emergency-liquidity powers, the new construct poses major policy issues. These include:

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  • Whether the new regime will work for non-banks. The bills, like the FDIC’s resolution protocols are largely premised on what is expected when bank holding companies fail. However, asset managers, insurance companies, CCPs, and other non-banks now pose at least as much systemic risk as the nation’s banks. Aspects of the proposed new bankruptcy regime (generally known as Chapter 14 in the Senate and Subchapter V of Chapter 11 in the House) work better than current law for these firms, but many questions remain unanswered;
  • The extent to which a single bridge company works for complex financial institutions that may well require resolution through multiple points of entry;
  • The degree to which the new approach settles cross-border resolutions any better than current law, especially with regard to automatic stays. Bankruptcy now could handle these – under current law, this is possible only under OLA – but that’s still only for counterparties subject to U.S. law;
  • The extent to which U.S. companies could operate branches across national borders given the tough-love approach of the revised Bankruptcy Code; and
  • Most of all, whether the U.S. financial system will be safer without OLA because investors will truly ensure that the largest financial-services firms can be shuttered without collateral damage.

We doubt Congress will resolve any of these issues in the fall, but many of them will advance. Any bill that repeals OLA will be vetoed, but all of them will color negotiations in the fall over global resolution protocols as the G-20 revs up, discussions over subsidiarization and ring-fencing at the IMF-World Bank annual meetings, and global and U.S. action on total loss-absorption capacity (TLAC) regulations. Global counterparties have no disagreement with making the U.S. Bankruptcy Code work better for SIFIs, but they have a lot of angst over any approach that takes away a government backstop, especially if intermediate emergency-liquidity support from the FRB or FDIC is also yanked. Congress doesn’t much care if U.S. banks are safe and sound from a global perspective as long as taxpayers aren’t at risk; global counterparties look to their own interests and are afraid.

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  • FRB-NY Uncertain if Market Liquidity Sufficient for Tail Event – The Federal Reserve Bank of New York released the first of a five-part series on liquidity, concluding that most measures indicate sufficient average liquidity in Treasury markets. However, the findings do not necessarily lead to a conclusion that markets are stable, with the FRB-NY noting the possibility that markets may become less liquid due to structural changes in the demand and supply of Treasuries coupled with monetary-policy normalization and the attendant rise in volatility. Furthermore, the authors did not examine less-liquid Treasuries, fixed-income securities, or liquidity risk (tail events where liquidity evaporates, such as during the October 15 flash crash). Such sharp, unexplained price changes in sovereign debt may be the types of events that concern market participants, and not a sustained decline in liquidity which is the post’s main focus.

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