a tale of two situations

8/4/2019 A Tale of Two Situations

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Due to the enormous cost, both financial and reputational, of the increased

need for public money to be used to support the largest too big to fail

banks and others, the UK authorities have decided that they need to have

better control over any possible future institution that falls upon hard times.

2011

Lee Werrell

CEI Compliance Limited


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A Tale of Two Situations FSA Recovery & Resolution Plans

2

Contents

Introduction ............................................................................................................................. 3

So who will qualify as members of this elite club? ................................................................ 5

Where next?............................................................................................................................. 6

Recovery Plans what is needed? .................................................................................... 8

Resolution Planning what is needed? ........................................................................... 9

Bailing In.............................................................................................................................. 11

The Financial Services Authority invites comments on this Consultation Paper. Comments should

be sent by 9 November 2011.

Full Text of the Consultation Paper CP 11/16 can be downloaded as a PDF document from

here

Comments may be sent by electronic submission using the form on the FSAs website

at:www.fsa.gov.uk/Pages/Library/Policy/CP/2011/cp11_16_response.shtml.
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Introduction

Following the demise of some of the most prestigious financial institutions in recent history, due to

the recent financial crisis, issues concerning the recovery and resolution of banks and other

significant financial institutions in the UK have been highlighted. Due to the enormous cost,

both financial and reputational, of the increased need for public money to be used to support

the largest too big to fail banks and others, the UK authorities have decided that they need

to have better control over any possible future institution that falls upon hard times.

On reviewing the level of control that the UK authorities hold, this then spawned the

realisation that there was a further need, an obvious hole in previous planning. Clearly they

needed more effective tools and information to enable the orderly resolution of financial

institutions without needing to resort to taxpayer support. Not only were the authorities

keen see the potential plans that firms would use on the rocky road to the summit of

breakdown and insolvency (predicted by many pundits in the press) but they were keen to

see the firms identify and understand their own plans to recover from situations of severe

stress.

Following the Turner Review Conference in 2009 the UK authorities started a pilot RRP

project initially involving four and ultimately involving six of the largest UK firms.

RRPs have two aspects. The first, Recovery requires affected firms to

identify options to recover their financial strength and viability should a

firm come under severe stress. This is work that should be conducted in

detail, providing a menu of options under differing situations and the

likely solutions that may be available. Secondly, Resolution planning

requires firms to submit detailed information about their business andoperational structure in the form of a Resolution Pack. The authorities will then write their

resolution plans for them, so that they know precisely what, how and when to instruct the

Insolvency Practitioner (IP) to do if the time comes to wind down the firm.

So essentially, the RRPs aim to ensure that financial institutions:

assess and document the recovery options which they believe would normally beavailable to them in a range of severe stress situations;

enable these recovery options to be identified and mobilised quickly and effectively;and

supply the regulatory authorities with information and analysis on their businesses,organisation and structures to enable the authorities to ensure that an orderlyresolution could be carried out by the authorities should it become necessary.

So who is this going to affect? This Consultation Paper (CP) should be read by:

all FSA-authorised banks and building societies; significant investment firms; and all firms subject to the FSAs client asset custody rules and investment business client

money rules.

Although principally intended for policymakers and a wider range of authorised firms, such as

insurers, the minimal limit is a 730K CAD firm however it may well become extended to other

categories of firms over time, after consultation, as usual.
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Additionally this is likely to be of interest to policymakers and practitioners involved in the

resolution of failed firms, as it discusses the existence and removal of barriers to resolution

and the potential costs to taxpayers of a firms failure.

New Legislation is planned to be enacted under which the FSA will be reformed into the

Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).It is therefore

expected that the bulk of the preparation of RRPs will have been implemented by the FSA

before the PRA takes on responsibility for supervising the relevant firms.

Although welcoming discussion, the formal consultation on rules for RRPs and for the CMA

proposals found in the CASS Resolution Pack (CASS RP). There are a number of documents

which have been published alongside this paper:

The proposedHandbook textfor RRPs theCASS RP, (see Annex 4) aguidance packon how firms should complete their RRPs, and; several otherannexesincluding the cost benefit analysis and compatibility statement.

So what makes a good recovery

plan?

The FSA state that a Recovery Plan must

be developed and maintained by the

firm and should have the following

features:

sufficient number of credible

options to cope with a range ofscenarios, including both

idiosyncratic and market-wide

stress; (yes, there could well be

overlap from the ICAAP document

but remember an ICAAP stress test is an immediate and one off stress, whereas a

recovery plan is more like a menu of options and mini-events may have to play

out for further events to take place).

options that address capital shortfalls and liquidity pressures and which shouldaim to return the firm to a stable and sustainable position (this can include bail

in which is explained further in Chapter 11 of the CP) ; and

appropriate governance processes, including intervention conditions andprocedures, to ensure timely implementation of recovery options in a range ofstress situations (which may involve multiple crisis team occurrences in series or

parallel).

It is very likely in the early iterations that cases are considered where the firm does not

currently have credible options to enable it to recover from extreme stress situations. In such

cases the Recovery Plan should indicate the preparation measures (and a timetable for such

measures) that the firm will take to create such options.

There are obviously going to be cases of globally significant financial institutions (G-SIFIs), and

in these events the Recovery Plan will also assist discussions among international regulators

led by the home authority using the Crisis Management Groups (CMGs), established underthe guidance of the Financial Stability Board (FSB). Recovery Plans will help to reassure host
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regulators that the firm could deal effectively with difficult c ircumstances. This cooperation

should help to discourage host and home regulators from taking pre -emptive actions to

protect national in terests which could be to the detriment of wider global interests.

When things go awry - Resolution planningWithin the Resolution pack is a host of analysis and information identifiers that will help theUK authorities to prepare a resolution plan with their specific aims:

to ensure that resolution can be carried out without public financial support; to seek to minimise the impact on financial stability; to seek to minimise the effect on depositors and consumers; to allow decisions and actions to be taken and executed in a short space

of time (for example, over a resolution weekend);

to identify those economic functions for which continuity is critical to theeconomy or financial system;

to identify those economic functions which would need to be wound upin an orderly fashion;

to identify and consider ways of removing barriers which may preventcritical functions being resolved successfully;

to allow a resolution that separates the identified critical economicfunctions from non-critical activities which could be allowed to fail; and

to enhance international cooperation and crisis management planningbetween international regulators for G-SIFIs.

With full analysis and the information supplied in the pack will allow the authorities to commit

firms that fail to meet threshold conditions into resolution smoothly and swiftly with minimal

impact on the financial system, regardless of the size or complexity of the firm.

So who will qualify as members of this

elite club?The current basis is that the FSAs RRP requirements

will apply to deposit takers in the first instance and

also significant investment firms, in particular, to full

scope BIPRU 730k investment firms with assets

exceeding at least 15 billion on its last accountingreference date.

Be warned however, that investment firms that could present significant risks either to the

stability of the financial system or to one or more other PRA-regulated entities within their

group should be subject to the same RRP requirements as deposit-takers, including

supporting their orderly resolution under investment bank Special Administration Regime. We

expect such firms will be designated as being subject to regulation by the PRA, but the exact

scope of PRA regulation is still being determined.

So for now, the current discussion is around the firms that are relating to CMA (CASS RP) apply to

all firms subject to CASS 6 or 7 due to their holding of investment business client money orcustody assets. See Chapter 6 for more detail.


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Also there is the likelihood of international impacts and given the financial and operational

interdependencies often found in most financial services group, consideration will be

expected, when providing resolution analysis to the authorities, how all significant members of

the group (both regulated and unregulated) could be resolved. Recovery Plans should similarly

address all significant parts of a group.

Where next?On the 12

thSeptember 2011 the Independent Commissions of Banking (ICB) published its final

report recommending far-reaching changes to all banks headquartered in the U.K.

In the wake of the global economic crisis of 2008, the 5-member ICB was charged with the

responsibility of understanding how stable and competitive the financial system is in the U.K., and

for suggesting how to handle banks that were too big to fall.

In April this year, the ICB expressed the need to implement measures which would make banks

capable of absorbing losses while curbing their incentives for excessive risk-taking. The final report

just builds on the draft proposal to achieve this.

The ICB report itemises a set of reasons justifying the need to

separate a banks retail and investment banking operations. The

list includes reducing the risks on retail customers from volatile

investment banking businesses, making it easier and less

expensive to bail out banks in trouble and aiding the process of

monitoring banks by introducing more transparency.

The relief for U.K. banks is that the ICB report stops short of

recommending a complete separation of investment banking

and retail operations. It instead proposes steps to ring-fence

various essential retail banking functions in banks, defining what

activities should be or should not be permitted inside the ring-fence.

And the ICB report acknowledges the impact of this ring-fencing on the banks. The direct operational

costs for banks are expected to increase due to the proposed changes with additional increases to

the cost of capital and funding for banks.

The increased capital requirements for banks would further push costs higher. Estimates peg the

additional costs to the countrys biggest banks to be 7 billion (U$11 billion) annually.

With direct and far reaching consequences and a recommendation to ensure proposed changes are

in place by 2019, the ICB has shaken up the U.K. banking sector. When the changes are called into

law would determine how the banks respond with drastic measures like shifting headquarters also

not ruled out completely.

The next development for RRPs i s the G20 meeting in November. Then there will be further

consultation document in 1Q12 and final rules are expected in 2Q12 with earliest

submissions around June 2012. RRPs complement existing policies with respect to capital,

liquidity and stress testing. They are also consistent with the proposed PRA Proactive

Intervention Framework (PIF).

As I mentioned earlier, the aim is for the RRP policy set out in the CP is to come into effect


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during the fi rst quarter of 2012. In due course, RRP policy as i t relates to deposit-takers and

systemic investment firms will fall under the remit of the Prudential Regulation Authority

(PRA).

The CASS RP policy is expected to come into effect six months after the publication of the

relevant PS. As stated firms in scope for the CASS RP will include some firms that are also inscope for the rest of the RRP policy and some that are not.

The Bank of England and FSA set out in the joint paper, The Bank of England, Prudential

Regulation Authority: Our approach to banking supervision , the PRAs role will be to

contribute to the promotion of the stability of the UK financial system. It will have a single

objective to promote the safety and soundness of regulated firms, including seeking to

minimise any adverse effects of firm failure on the UK financial system and by ensuring that

firms carry on their business in a way that avoids adverse effects on the system. As recognised

in its statutory objective, it will not be the PRAs role to ensure that no PRA-authorised firm

fails.

RRP and existing capital stress-testing links

So whats wrong with the ICAAP/ILAS stress testing? There are obviously strong links between the

Recovery Plan and the existing capital and liquidity stress testing requirements, given their

common objective towards maintaining sufficient financial resources for a going-concern firm in

a stressed environment. The FSA is keen for any firm not to try and re-invent the wheel.

Firms may find that their existing capital and liquidity stress testing can serve as useful inputs

in developing their Recovery Plans. However, the Recovery Plan will extend further by asking

firms to plan for additional actions when the impact or the speed of a crisis turns out to be

more severe than the scenarios they had projected in their stress tests. A menu of items

including triggers and mitigating actions, set processes at certain times will be required to

show all avenues of recovery had been not only mapped and travelled down, but also which

of the kerbstones had been painted.


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RRP and reverse stress-testing links

The FSAs policy on reverse stress testing used as a risk tool, requires a firm to explicitly identify

and assess the scenarios that are most likely to cause its business model to fail, after

considering existing, realistic management actions. Where those tests reveal that business failure

will occur within the firms existing risk appetite or tolerance, the firm will be required to

identify and adopt effective arrangements, processes, systems or other measures to try toprevent those risks from crystallising.

Given the roles of reverse stress testing in improving a firms contingency planning as well as

in preventing it from failing, there are clear links between reverse stress testing and the RRP

requirements. In practice, the development of a firms RRP will inform its reverse stress

testing planning and vice-versa, providing the glue to connect all the risk reporting tools

together.

Recovery Plans what is needed?Briefly, recovery plans;

are developed and maintained by the firms and the authorities willreview their adequacy

should include a robust menu of options to deal with a range of stressedsituations

should have unambiguous triggers which, when breached, will createa strong presumption th at the plan will be activa ted

should be reviewed at least annually and approved by the board.The purpose of a Recovery Plan is to enable a firm to plan how they would try to recover

from severely adverse condit ions that could cause their failure. It wil l set out in advance a

firms menu of options for dealing with a range of severe stress events. These stresses may be

caused by an idiosyncratic problem, a market-wide problem or a combination of both, and

extend beyond the firms current regulatory stress testing scenarios and remedies.

Firms will be required to produce a Recovery Plan that can be readily implemented when

necessary and that is integrated within its risk management framework and processes.

Firms will need to ensure the necessary measures and preparations are in place in advance for

the plan to be effective.

The recovery options need to be material in impact and capable of being executed with

relative ease and in a timely manner.

The proposals cover the following key areas:

governance framework for the Recovery Plan; key Recovery Plan options; criteria for assessing recovery options; and intervention conditions, i.e. a trigger framework.For a detailed explanation of the expected components of

Recovery Plans, see modules 1 and 2 of theRRP Guide.
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Disposal options

For any Recovery Plan to be considered robust, it is likely to be necessary for firms to

consider radical choices which change the structure of their businesses. These choices are

likely to include, but are not limited to, disposal options for part of a firms business or even

selling the firm itself. Although it may be difficult accurately to assess the value of such

options, firms should be able to provide some broad estimates. Consideration of suchoptions and how they might be executed will form an important part of most Recovery

Plans, particularly those of the larger firms. When considering potential disposal options,

consideration should be given to the long-term viability of the firm post-transaction.

The Resolution Plan is prepared by the authorities based on the ResolutionPack containing extensive information and analysis provided by the firms.

Modules 3 to 6 of the RRP Guide explain the work that firms must do. For theHandbook text on Resolution Packs see FINMAR 4.3.

A key part of the firms work is a separation or wind-down plan for deposit-taking and other critical economic functions.

Firms will be expected to identify barriers to resolution and proposechanges to remove those barriers.

The Resolution Pack must be reviewed at least annually and the board will beresponsible for ensuring there are p rocesses in place to produce timely an d

accurate data.

The Resolution Pack must be updated on an ongoing basis to reflect anymaterial developments in a firms business.

Resolution Planning what is needed?

Alternatively, the aim of the Resolution Plan is to provide a clear and detailed strategyroadmap to resolve a failed firm or even a group in such a manner that minimises the impact

on financial stability without needing to resort to public sector solvency support.

The key element here is that the Resolution Plan is prepared by the UK authorities. However, i t

is vital that the authorities have the level of understanding necessary to make the

appropriate decisions. They can only implement an effect ive action plan when resolution is

imminent; which requires not only the provision of reasonably current information on the

specific business operations, structures and critical economic functions, but also a detailed

resolution analysis prepared by firms.

Effectively the authorities need to be able to form opinions

on the resolvability of each firm. To enable this, firms willneed to provide a very significant level of detail and, in

particular, the authorities wi ll be asking firms to undertake

a separability or wind-down analyses in relation to each

of its critical economic functions.

The information and analysis to be supplied by firms is

called the Resolution Pack.

Economic functionsThese refer to the services delivered by a firm and will not always necessarily correspond

directly to legal entities within a firms group structure . It may also not be clearly mapped to thebusiness units operated by the firm. What is required is that firms should explain how the


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economic functions they provide map to the business units through which the group may

organise itself. Consequently a further mapping will be necessary to understand how these

business units map to the legal entity structure of the group.

Typical Economic Functions the financial services sector provides three high-level services to

the real economy:

payment services, to facilitate transactions between agents in the real economy; intermediation of credit and capital, to allow agents in the real economy to

save, invest and borrow efficiently; and

risk management products and services, to facilitate risk pooling and protectagents against adverse events.

These high-level services can then be broken down into separate economic functions which

firms perform. For example, (i) current accounts facilitate the provision of payment services;

(ii) mortgage lending contributes to the intermediation of credit; and (iii) market-making

activities contribute to the provision of risk management. Sometimes, an economic function

may support the provision of more than one of the high-level services to the real economy.

Examples of economic functions are as follows:

retail current accounts including overdrafts; retail savings/time accounts; retail lending: mortgages/other secured; retail lending: unsecured personal loans; retail lending: credit cards issuance and underwriting; corporate deposits; corporate lending; long-term capital investment; credit card merchant acquiring/services; payment services; clearing services; cash services; third-party services; derivatives; securities financing; trading portfolio; equity and debt capital markets; asset management; brokerage; custody services; prime brokerage and related securities services;

general insurance, re-insurance, underwriting and/or broking services; life, pensions, investments and annuities


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corporate advisory services; and research.

Ongoing maintenance of data by firms

A clear signal and an obvious requirement is that it will be important that, while preparing

the initial RRPs, firms plan for their regular maintenance and update. This will surely be a less

onerous task than the initial preparation of the plans and, if systems for capturing and

recording data are properly established, particularly for resolution information, this should

help the firm to provide updated information quickly and efficiently when required.

A firm should review its Recovery Plan at least annually and when it has been through a major

reorganisation, especially when it involves an acquisition or disposal. The plans should also be

refreshed whenever the firm looks likely to encounter a severe stress situation and on request

from the FSA.

Bailing In

What is bail-in?The term Bail-in is provided in this documentation and it usually refers to a process of internal

recapitalisation that is triggered once a firm has reached the point of non-viability. There is an

automatic Loss imposed on certain of a firms direct stakeholders of a firm by a process of

bailing-in, either by writing down their claims or by converting them to equity. As a result, the

firm is recapitalised from within and the need for new capital resources to be provided by the

public sector (i.e. a bail-out) is avoided.

Whilst it all seems a very straightforward arrangement, Bail-in will almost always need to be

accompanied by changes in the firms senior management . Coupled with this would be the

adoption of a new business plan that addresses the causes of the firms failure. A vital

objective of the bail-in process is to secure the continued existence of at least a part or even

the entire firm on a going concern basis. If this can be done then disruption of services to

customers of the firm should be minimised, while its shareholders and uninsured creditors

are subject to going concern losses rather than the much larger gone concern losses that

they would suffer if the firm went into insolvency or liquidation.

Full details of the Bail-In can be found in Chapter 11 of theCP11/16.
http://www.fsa.gov.uk/pubs/cp/cp11_16.pdfhttp://www.fsa.gov.uk/pubs/cp/cp11_16.pdfhttp://www.fsa.gov.uk/pubs/cp/cp11_16.pdfhttp://www.fsa.gov.uk/pubs/cp/cp11_16.pdf


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Companies that CEI have been involved with in the last 10 years;

CEI Compliance can help provide a full compliance support service,

reducing

required management time, ensuring all areas are up to date and working

for your firms long term benefit. Call 0800 689 9 689 today or go online at

www.ceicompliance.co.ukThis whitepaper was written

by Lee Werrell FInstSMM Chartered MCSI

Cert PFS, founder of CEI Compliance Limited.

Avoid S166 Skilled Persons Reportsdownload our free guide here
http://www.ceicompliance.co.uk/http://www.cei-compliance-limited.co.uk/s166_download.htmlhttp://www.cei-compliance-limited.co.uk/s166_download.htmlhttp://www.cei-compliance-limited.co.uk/s166_download.htmlhttp://www.cei-compliance-limited.co.uk/s166_download.htmlhttp://www.cei-compliance-limited.co.uk/s166_download.htmlhttp://www.cei-compliance-limited.co.uk/s166_download.htmlhttp://www.cei-compliance-limited.co.uk/s166_download.htmlhttp://www.ceicompliance.co.uk/


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How to Choose a Compliance Consultant(Acknowledgements to Alan Weiss, www.summitconsulting.com)

Every financial services business occasionally needs outside help. Even well -run giants such as RBS, Lloyds,

Aviva, Barclaycard, and many other firms deliberately choose to bring in compliance consultants on a regular

basis. For smaller businesses, an outside consultant can offer the following advantages:

Objective advice, not geared toward political advancement or promotion

Frame of reference and best practices from other clients

Models and methodology to gain results more quickly than internal trial and error

Permanent transfer of skills to internal people The problem, however, is that those external

consultancies can create as many problems as they solve. (One definition of a consultant: someone

who comes to fix a problem and remains to become a part of it.)

These include:

Threatening employees by the mere presence of an outsider

Reliance on off-the-shelf fixed methods which dont fit the current client very well

Lack of sensitivity to the clients business, culture, and environment (a financial adviser practice is not

run the same way as an accountancy practice)

Solutions that worked for large organisations cannot always be simply scaled down

Ideal solutions not really practical for the clients business and have limited or no real value

Ive been in consulting since 2000 and, to my astonishment, I find currently that about 50% of those calling

themselves consultants dont really know what theyre doing, but what is worse is that almost 90% of those

buying consulting services dont know how to tell the difference! To remedy that, here is a primer on how to

hire the best possible consultant for your needs:

A good consultant frames an issue quickly but doesnt suggest solutions too quickly, because they realise that

they dont know what they dont know until they be gin to gather more data.

A good consultant will not promise the moon and the stars, and will never base an approach on tests or

instruments that are purchased for a few pounds from other companies. (You get what you pay for.)

A good consultant is someone youll hate to see go when the project ends on time, and who youll want to

invite back at the first appropriate new challenge.

CEICOMPLIANCEworks on an alternative basis by collaboration and does not charge per hour, day or week.

Call CEI on 0800 689 9 689to make your first appointment.
http://www.summitconsulting.com/http://www.summitconsulting.com/http://www.summitconsulting.com/http://www.summitconsulting.com/

a tale of two situations

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