Our Take: financial services regulatory update – September 8, 2023

On August 29th, the Fed and FDIC (together, the Agences) issued several proposals related to resolution planning, including long term debt requirements and enhanced resolution planning requirements for insured depository institutions (IDIs) with over $50 billion in assets as well as guidance for both US banks and foreign banking organizations (FBOs) with over $250 billion in assets in Categories II and III of the Fed’s tailoring framework.

• Resolution planning requirements for IDIs. The IDI proposal creates two categories of filers: (1) Group A: IDIs with over $100 billion in assets and (2) Group B: IDIs with between $50 billion and $100 billion in assets.¹ Group A plans would alternate annually between interim submissions with select informational requirements and full submissions that would require more substantial and specific information than they do currently, including:
  • A resolution strategy using a bridge bank that would provide timely access to insured deposits and involve sale of business activities and asset portfolios to multiple acquirers over time (filers may, in certain circumstances, present alternate strategies as appropriate)
  • More rigorous valuation analyses of components like asset portfolios or lines of business that could be separated and sold in an severely adverse economic environment
  • Demonstration of the ability to stand up a virtual due diligence data room and valuation capabilities with a range of quantitative estimates of value to support various resolution options
  • More thorough descriptions of organizational structure, key personnel, cross-border activities, asset portfolios, deposit structure, digital services, and electronic platforms

Group B filers would be subject to many of the same expectations as Group A filers but would not need to include an executive summary, identified strategy, or failure scenario. The proposal would also subject IDIs to more intensive FDIC capability testing to assess the credibility of the plan and the ability to implement it. The FDIC would assess the degree of “engagement” of executives with the resolution planning process and, in the event that significant deficiencies were noted, could take enforcement actions under Section 8 of the FDIC Act.

• Long-term debt requirements. Banks with over $100 billion in assets that are not global systemically important banks (G-SIBs) would be required to issue sufficient long-term debt to be recapitalized in resolution. Specifically, the proposal requires that they maintain long-term debt equal to the greater of: (A) 6% of total risk-weighted assets; (B) 3.5% of average total consolidated assets; or (C) 2.5% of total leverage exposure under the supplementary leverage ratio. The long-term debt would need to be unsecured, have maturities greater than one year and have plain vanilla features (e.g., no structured notes or credit sensitive instruments). The Agencies estimate that impacted banks currently maintain 75% of the required long-term debt and would need approximately $70 billion in new issuances, which they would have three years to issue.

The proposal would further subject banks to clean holding company requirements (e.g., prohibit entering into derivatives with external counterparties). It would not subject non-G-SIBs to total loss-absorbing capacity (TLAC) requirements but would disincentivize them from holding long-term debt issued by other banks.

• Resolution plan guidance for US banks. The Agencies proposed enhanced guidance for resolution plans to be filed by Category II and III US banks with over $250 billion in assets as required by Section 165(d) of the Dodd-Frank Act.² The guidance provides different sets of expectations for firms with multiple point of entry (MPOE) resolution strategies versus for firms with single point of entry (SPOE) strategies.³ Capability expectations are set out in the areas of capital, liquidity, governance, operations, legal entity rationalization, separability analysis, IDI resolution, and, for FBOs only, analysis of the resolution of US branches and interactions with the global resolution strategy. For firms with SPOE strategies, capital expectations include implementing Resolution Capital Adequacy and Positioning (RCAP) and Resolution Capital Execution Need (RCEN) capabilities to appropriately position loss-absorbing resources to support an orderly resolution process and estimate capital needs in resolution.⁴ The guidance also incorporates expectations for Resolution Liquidity Adequacy and Positioning (RLAP) and Resolution Liquidity Execution Need (RLEN) capabilities to estimate the amount of liquidity available and needed to enable material entities to continue operations until the firm is resolved.⁵ Regarding governance, the guidance outlines expectations for firms with SPOE strategies to establish triggers to enable timely escalation of resolution information to the Board and senior management, and develop playbooks for certain actions. The proposal also raises the expectations for the depth of firms’ analyses of potential divestiture options and continuity of payment, clearing, and settlement services and share and outsourced services. These banks’ next resolution plans are due by July 1, 2024 but the proposal seeks comment on whether more time should be provided to account for the updated guidance.
• Resolution plan guidance for FBOs. The Agencies proposed guidance for Category II and III FBOs that is similar to that for US banks with a number of unique considerations for FBOs’ global footprints. The guidance removes the concept of Specified FBOs and instead describes expectations based on resolution strategy (MPOE or SPOE). Regarding capital, the proposal would bring parity with domestic filers by requiring RCAP and RLAP for FBOs with an SPOE strategy. In addition, it would expect FBO filers to outline how US resolution planning is complementary to their home country plans.

Comments on all of the proposals are due by November 30th.

Our Take

As expected from FDIC Chairman Gruenberg’s recent speech, these proposals represent one front of the Agencies’ response to the spring bank failures. The lower asset threshold of the IDI and long-term debt requirements ($50 billion and $100 billion, respectively) further rolls back regulatory relief for banks with under $250 billion in assets, reflecting the Agencies’ heightened understanding of the challenges and risks facing such banks. As the resolution plans of the failed banks were limited or had not yet been submitted due to extended deadlines, the IDI proposal would require all filers to develop the necessary capabilities to submit annual filings and significantly increase the information and capabilities they demonstrate in their plans. In particular, many Group A institutions will need to substantially rework their resolution strategies, either by creating a new bridge bank strategy or enhancing the analysis in their current plans, including providing detailed information on assets and liabilities to be transferred to the bridge, proposed asset sales / wind downs, and an approach to exiting the bridge. While Group B filers would not need to describe resolution strategies, their initial filing could be particularly burdensome and require significant build up of resolution teams as they have not submitted filings since 2018. Further, due to increased expectations for FDIC capability testing, IDIs would need to enhance their resolution-related operations, including by expanding their readiness playbooks with regard to interdependencies, communications, employee retention, and governance. If they have not done so already, they should develop capabilities to stand up a virtual data room and assess their ability to provide key information (e.g., deposit data) in a timely manner. In light of growing reliance on technology and third parties, IDIs should also document their digital services and electronic platforms as well as review agreements with internal and external service providers to ensure that critical services can be maintained in resolution.

Regarding the proposed long-term debt requirements, some large non-G-SIBs may not have significant difficulties in adjusting their debt but other in-scope banks may face net new issuance in a higher rate environment. The proposed requirements would likely increase the cost of capital for impacted banks, as many of these firms currently fund themselves largely with low-cost deposits. The proposal would effectively increase the leverage of these firms by requiring issuance of a substantial amount of high-cost long-term debt while the recent Basel III endgame proposal may also require an additional capital raise. The relatively short time frame under which firms must issue additional debt may lead to greater investor power over pricing and terms. While the spreads between TLAC debt and non-convertible debt have been historically negligible, the additional costs of incremental issuance in this higher rate environment will place additional pressure on bank earnings.

The overall effect of the proposed resolution planning guidance is to meaningfully heighten capability expectations for Category II and III banks, bringing requirements for these firms more in line with the US G-SIBs and largest and most complex FBOs. Category II and III firms should carefully re-evaluate their resolution strategies, taking into consideration the enhanced capability expectations in the proposed guidance, potential impacts to capital structure from the proposed long-term debt requirements, the feasibility of assumptions currently used in the resolution plan, and, for FBOs, interactions with the global resolution strategy. Firms adopting SPOE strategies should assess the resources needed to implement significant capability enhancements, with capital and liquidity analysis, governance triggers and playbooks, operational capabilities including analysis related to qualified financial contracts, legal entity rationalization, and separability among the most substantial. Firms with MPOE strategies likewise would require significant upgrades, particularly with respect to liquidity analysis, including demonstration of how the failure scenario results in material financial distress and related impacts to liquidity buffers, operational capabilities, separability analysis, and detailed analysis of how an IDI subsidiary can be resolved within the legal framework and without serious adverse effects on US financial stability. Finally, the expectations for FBOs to analyze US branch resolution impacts and interaction with the global resolution strategy would require extensive coordination between US operations and the head office, and may give rise to additional challenges where global resolution strategies are set by home country regulators.

_{¹Since the imposition of a moratorium on IDI resolution plans in 2018 (the moratorium was lifted for IDIs with over $100 billion in assets in 2021), IDIs with between $50 billion and $100 billion in assets have not needed to submit resolution plans.}

_{²Section 165(d) resolution plans focus on bank holding companies and all of their subsidiaries while IDI resolution plans focus on the IDI and its resolution by the FDIC.}

_{³Under SPOE, only the holding company enters resolution while subsidiaries remain operational. Under MPOE, the holding company enters bankruptcy and subsidiary insured depositories enter resolution managed by the FDIC. All US G-SIBs currently outline an SPOE strategy while the majority of banks covered by the proposed guidance described MPOE strategies in their most recent plans.}

_{⁴RCAP requirements are intended to ensure that firms’ material entities could operate while the parent company is in bankruptcy. They call for firms to have outstanding a minimum amount of total loss-absorbing capital and long-term debt to help ensure that the firm has adequate capacity to meet that need at a consolidated level. RCEN requires that firms have a methodology for estimating the amount of capital needed to support each material entity in case of bankruptcy, have internal TLAC to support the estimates, and incorporate the estimates into the governance framework.}

_{⁵RLEN calls for firms to develop a methodology for estimating the liquidity needed in the event of a bankruptcy to stabilize the surviving material entities and allow for their continued operation. The methodology should be incorporated into the governance framework, which should ensure that high-quality liquid assets do not drop below the RLEN estimate. RLAP requirements call for firms to measure high-quality liquid assets at each material entity less net outflows to third parties and affiliates and ensure that liquidity is readily available to meet any deficits.}