As Congress continues to work on a resolution regime for systemically important institutions, a parallel debate is emerging over whether such cleanups should be global efforts.
Several options for cross-border coordination are on the table, and the International Monetary Fund is studying the feasibility of charging a tax on internationally active institutions to help governments recoup resolution costs.
Though the issue has only just begun to be discussed, observers say everything from a central international resolution fund to a better cross-country framework — similar to Basel II for capital standards — is possible.
What's becoming clear: countries working in isolation may not be sufficient, especially when it comes to paying for large bank failures.
"If all you have are home-country funds, the only way you can do cross-border resolutions is to wall off institutions … and handle them on a nation-by-nation basis," said Karen Shaw Petrou, the managing partner of Federal Financial Analytics Inc.
The global tax idea — similar to the Obama administration's proposal to tax large U.S. banking companies — has gained momentum in international bodies, including the Group of Seven and Group of 20 nations, which asked the IMF to draft the feasibility report. The report is due in June.
The concept broadly would involve international banking firms paying an assessment fee — almost like a deposit insurance premium — to a body such as the IMF, which would assist nations trying to recoup the costs of a financial firm's failure.
"From a systemic perspective, I can understand why there's interest in having some kind of cross-border resolution plan," said Robin Lumsdaine, a former Federal Reserve Board official and now a professor at American University's Kogod School of Business. "The largest, systemically important firms have operations across the globe — making it difficult to ring-fence an ailing subsidiary and prevent contagion to other parts of the firm."
U.S. lawmakers have already proposed a domestic fund to deal with resolutions of systemically important institutions. The House regulatory reform bill, passed in December, would create a $200 billion fund. It is unclear if the Senate bill will follow suit.
Observers said an international fund could be a comprehensive solution to handle failures of global firms and would prevent companies from basing operations in countries without a fee. Institutions could pay into the fund directly, or nations could contribute assessment revenues they raise individually from their home-soil firms. "The driver to make it international is both the idea that you don't want to disadvantage some institutions versus others and create arbitrage opportunities for institutions to do greater business in a jurisdiction where they may not have an assessment," said Satish Kini, who co-chairs Debevoise & Plimpton's banking group.
"At the same time," he said, "you create a method whereby you can use the fund … to help resolve situations that have cross-border implications."
In March 2009 a report by Adair Turner, the head of the U.K.'s Financial Services Authority, analyzing regulators' response to the crisis used the example of Lehman Brothers' bankruptcy to illustrate why a coordinated system is necessary. "When the United States decided not to bail out Lehman … that had implications for Lehman not only in the United States but abroad as well," Kini said. "The Turner review makes the point that all of these decisions end up being made only locally but have … systemic implications abroad that, he felt in the Lehman context, weren't being considered adequately."
But an international effort would have complications, several observers said.
"If you had a general fund, then who would decide which creditors to bail out and which creditors not to bail out?" said Robert DeYoung, a finance professor at the University of Kansas. "It would no longer be up to an individual country's central bank or regulatory authority. All the countries would have to agree on the rules. It seems to me that would be the biggest hurdle."
Others said it was unclear how an international tax would affect similar concepts discussed in a firm's home country. For example, would a U.S. firm subject to President Obama's proposed tax also have to pay an international one?
"It seems to be too many tax proposals with too few rationales behind them," said Cornelius Hurley, the director of the Morin Center on Banking and Financial Law at the Boston University School of Law.
Moreover, countries have developed long-standing regimes for dealing with the financial industry that would need to work in conjunction for an international body to be effective.
"Given the legal and institutional frameworks of the various countries, it would be challenging to establish an international institution for resolutions," said Susan Krause Bell, a partner at Promontory Financial Group and a former senior official at the Office of the Comptroller of the Currency. "It's complicated, because it crosses into not only how sovereign countries regulate banks, but how they deal with bankruptcy, which gets into really complicated legal issues."
Lumsdaine agreed that regulatory differences between countries would pose a challenge.
"You can't think about the proposal in isolation," she said. "It has to be reconciled to different tax regimes, different accounting regulations and different legal frameworks" existing in each country, she said. "That's where coordination becomes very complex. It doesn't mean it can't be done. But it can be quite challenging to keep the costs from outweighing the benefits."
Observers said an international framework on home-country funds could be more attainable than a central fund.
"I could definitely see countries trying to work on an agreement that addresses how to assess institutions for the extra cost not only of resolution but of the extra supervision and data collection that would be required," Krause Bell said.
She added that after nations agree to impose a fee, "you then have principles on the banks that qualify, how each country is going to base the fee, how they would use it in their own resolution schemes and maybe some of the basics of those resolution schemes. It's really challenging, but something like that could work."
A global agreement on how to resolve troubled large firms would essentially mirror what Basel has done for capital standards, including that a firm would not be handicapped relative to a competitor as a result of different capital requirements among countries.
"The Basel analogy is a good one," Kini said. "It is the same idea, at least the competitive-equality elements of this are the same as [those] driving Basel — that an institution operating principally out of Germany, Switzerland or France is not advantaged versus an institution that's operating in the United States."
He added that nations could also create a combination of a home-country fee and assessments from other nations.
"One way policymakers could approach it … is individual countries charge an assessment based on the individual branch or subsidiaries based in those countries, and then the home country may charge an assessment based on the overall risks posed by the … organization," Kini said. "But there would be the risk of a double hit."
This story was reprinted with permission from American Banker.
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