Opening Statement
by
FDIC Director
Jeremiah Norton
on
Single Point of Entry Strategy
December 10, 2013
Mr. Chairman, I would like to thank the staff, particularly in the Office of Complex
Financial Institutions and the Legal Division, for its work in preparing this request for
comment.
Today's action requesting comments on the Single Point of Entry strategy represents
the latest effort on the path towards planning for a Title II resolution, which the FDIC
may utilize only if a Title I bankruptcy would result in serious adverse consequences to
U.S. financial stability. There are a number of key issues that require further
consideration and analysis, including but not limited to a minimum long-term debt
requirement, competitive equality, cross-border contracts, and ring-fencing.1 Along with
this brief statement, I am submitting for the record an Appendix highlighting each of
these issues in more detail.
(1) Given that debt is necessary for a Single Point of Entry strategy, the calibration of
the amount and the positioning of long-term debt is a critical issue;
(2) Given that the Single Point of Entry strategy would provide for the continuing
operation of the operating subsidiaries, it is important to consider potential impacts on
the competitive landscape;
(3) A full discussion is necessary regarding how cross-border contract issues will impact
resolution strategies generally, and the Single Point of Entry strategy specifically,
including derivatives contracts governed by foreign law; and
(4) Ex-ante and ex-post ring-fencing in host jurisdictions should be considered in the
context of any resolution regime.
I look forward to reviewing comments on these and other issues. Thank you.
Appendix – The Calibration of Long-Term Debt
The cornerstone of the SPE strategy is a holding company creditor-funded
recapitalization of troubled operating subsidiaries. The approach would require sufficient
long-term unsecured debt issued at the holding company level to recapitalize the newly
formed holding company following its exit from the receivership and bridge entities.2 Key
policymakers at the Federal Reserve have commented that the Board of Governors is
considering a proposal that would require LCFIs to maintain a minimum amount of long-
by
FDIC Director
Jeremiah Norton
on
Single Point of Entry Strategy
December 10, 2013
Mr. Chairman, I would like to thank the staff, particularly in the Office of Complex
Financial Institutions and the Legal Division, for its work in preparing this request for
comment.
Today's action requesting comments on the Single Point of Entry strategy represents
the latest effort on the path towards planning for a Title II resolution, which the FDIC
may utilize only if a Title I bankruptcy would result in serious adverse consequences to
U.S. financial stability. There are a number of key issues that require further
consideration and analysis, including but not limited to a minimum long-term debt
requirement, competitive equality, cross-border contracts, and ring-fencing.1 Along with
this brief statement, I am submitting for the record an Appendix highlighting each of
these issues in more detail.
(1) Given that debt is necessary for a Single Point of Entry strategy, the calibration of
the amount and the positioning of long-term debt is a critical issue;
(2) Given that the Single Point of Entry strategy would provide for the continuing
operation of the operating subsidiaries, it is important to consider potential impacts on
the competitive landscape;
(3) A full discussion is necessary regarding how cross-border contract issues will impact
resolution strategies generally, and the Single Point of Entry strategy specifically,
including derivatives contracts governed by foreign law; and
(4) Ex-ante and ex-post ring-fencing in host jurisdictions should be considered in the
context of any resolution regime.
I look forward to reviewing comments on these and other issues. Thank you.
Appendix – The Calibration of Long-Term Debt
The cornerstone of the SPE strategy is a holding company creditor-funded
recapitalization of troubled operating subsidiaries. The approach would require sufficient
long-term unsecured debt issued at the holding company level to recapitalize the newly
formed holding company following its exit from the receivership and bridge entities.2 Key
policymakers at the Federal Reserve have commented that the Board of Governors is
considering a proposal that would require LCFIs to maintain a minimum amount of long-
term unsecured debt at the holding company level.3 The calibration of a debt
requirement, both with respect to its size and how it is apportioned across and within
organizations, is critically important to the SPE model. Further, a key premise upon
which the effectiveness of a long-term debt requirement is based is that creditors of the
holding company will monitor and discipline the entire organization.
A primary consideration is how to establish the level of long-term debt that will be
required. Given some of the historical shortcomings of an ex-ante risk-weighted
approach, the ex-post framework for recapitalizing failed entities might not be served
well by basing debt requirements solely on a risk-weighted asset basis. A long-term
debt requirement could be implemented using both total assets and risk-weighted
assets.
In addition to the amount of debt required, the use of the debt is important to the SPE
strategy. Without sufficient intra-company debt to recapitalize a failed subsidiary, the
desired orderliness of a Title II SPE approach might not be achievable. In order to
effectuate an SPE resolution, policymakers might need to consider requiring that the
debt be apportioned, or pre-positioned, in a particular way among subsidiaries.
Appendix – Competitive Landscape
One of the central advantages of the SPE strategy is that it would provide for the
continuing operation and viability of operating subsidiaries by focusing the resolution at
the holding company level. However, this approach could also impact the competitive
landscape. For example, creditors of these subsidiaries could perceive that they would
not take a loss upon distress at an LCFI and therefore would require a lower return on
transactions or investments. Similarly, clients and counterparties might transact with
LCFI subsidiaries based on where they perceive greater safety and stability because of
government policy to prevent operational disruption and distress. To be clear, in the
event sufficient debt is not required, the market equilibrium could shift in favor of LCFI
subsidiaries. The converse could be true if too much debt is required at LCFIs,
contingent on appropriate market discipline. To remedy this competitive dynamic would
require either: (1) market participants transacting under the assumption that all firms
would be subject to the normal bankruptcy process, or (2) regulators calibrating the
long-term debt requirement at LCFIs with sufficient accuracy to eliminate non-market
advantages and incentives at their operating subsidiaries.
Appendix – Cross-Border Contracts
Derivatives contracts typically contain provisions that allow a party to terminate the
contract if its counterparty fails or defaults. A non-defaulting party could have an
incentive to exercise its termination rights when its position with respect to a particular
transaction is "in the money." The failure of a financial institution with a large derivatives
business could trigger a wave of derivative terminations that is disruptive. This risk is
magnified if the derivatives contracts contain cross-default provisions, which allow a
non-defaulting party to terminate a contract if an affiliate of its counterparty defaults or
fails.4 Cross-default provisions thus have the potential to create significant instability in
requirement, both with respect to its size and how it is apportioned across and within
organizations, is critically important to the SPE model. Further, a key premise upon
which the effectiveness of a long-term debt requirement is based is that creditors of the
holding company will monitor and discipline the entire organization.
A primary consideration is how to establish the level of long-term debt that will be
required. Given some of the historical shortcomings of an ex-ante risk-weighted
approach, the ex-post framework for recapitalizing failed entities might not be served
well by basing debt requirements solely on a risk-weighted asset basis. A long-term
debt requirement could be implemented using both total assets and risk-weighted
assets.
In addition to the amount of debt required, the use of the debt is important to the SPE
strategy. Without sufficient intra-company debt to recapitalize a failed subsidiary, the
desired orderliness of a Title II SPE approach might not be achievable. In order to
effectuate an SPE resolution, policymakers might need to consider requiring that the
debt be apportioned, or pre-positioned, in a particular way among subsidiaries.
Appendix – Competitive Landscape
One of the central advantages of the SPE strategy is that it would provide for the
continuing operation and viability of operating subsidiaries by focusing the resolution at
the holding company level. However, this approach could also impact the competitive
landscape. For example, creditors of these subsidiaries could perceive that they would
not take a loss upon distress at an LCFI and therefore would require a lower return on
transactions or investments. Similarly, clients and counterparties might transact with
LCFI subsidiaries based on where they perceive greater safety and stability because of
government policy to prevent operational disruption and distress. To be clear, in the
event sufficient debt is not required, the market equilibrium could shift in favor of LCFI
subsidiaries. The converse could be true if too much debt is required at LCFIs,
contingent on appropriate market discipline. To remedy this competitive dynamic would
require either: (1) market participants transacting under the assumption that all firms
would be subject to the normal bankruptcy process, or (2) regulators calibrating the
long-term debt requirement at LCFIs with sufficient accuracy to eliminate non-market
advantages and incentives at their operating subsidiaries.
Appendix – Cross-Border Contracts
Derivatives contracts typically contain provisions that allow a party to terminate the
contract if its counterparty fails or defaults. A non-defaulting party could have an
incentive to exercise its termination rights when its position with respect to a particular
transaction is "in the money." The failure of a financial institution with a large derivatives
business could trigger a wave of derivative terminations that is disruptive. This risk is
magnified if the derivatives contracts contain cross-default provisions, which allow a
non-defaulting party to terminate a contract if an affiliate of its counterparty defaults or
fails.4 Cross-default provisions thus have the potential to create significant instability in