University of Hong KongDepartment of Law

Corporate Conflicts 2010—2011Research Paper

Name: Brandon Tee Zhi Yi

University Number: 2010982505

Number of Words: 5429

Introduction

The globalization-driven demise of national frontiers has led to a rapid

expansion of cross-border banking activities and international markets over the

past decade. Many contemporary banks are constituted by an extensive network

of branches and subsidiaries that span across several jurisdictions. While cost

efficiencies and economies of scale and scope derive from such integration, the

failure of a bank with cross-border operations can generate spillovers that

threaten financial stability in countries which it has operations in. Thus, the

advent of cross-border banking activities presents a host of challenges which are

particularly salient in the field of cross-border insolvency. The present approach

to cross-border insolvency is a fragmented one, comprising a mélange of locally

based and entity-centric legislations, and based necessarily on the voluntary

cooperation between different national authorities. The stakeholders involved in a

cross-border bank insolvency, however, are multifarious, with potentially

conflicting interests1. The objectives and interests of different domestic laws are

also often at variance, and in the absence of an ex ante resolution framework,

this cooperation is often an uneasy one. These various factors render the present

regime limited and inadequate for the support of cross-border resolution of

banks, which must be decided by national authorities under the severe time

1 Lastra, Rosa M. and Wihlborg, Clas. “Resolving Cross-Border Banking Crises”. Paper presented at Financial Markets Group (FMG), Conference on Prompt Corrective Action & Cross Border Supervisory Issues in Europe, London School of Economics, London, United Kingdom, 2006 at 6.

pressure and uncertainty of acute crisis, as was thoroughly exposed by the Fortis

experience2 of the 2007-2009 financial crisis.

In the interests of financial stability, a clear, certain and credible legal

framework is necessary, particularly during a financial crisis, to govern how a

bank in financial distress would be reorganized to salvage its going concern

value or liquidated where reorganization is not a realistic prospect in an orderly

and coordinated fashion that minimizes systemic repercussions and therefore

fiscal costs. A practical solution in the wake of the financial crisis is one that

steers a path between universalism and territorialism and which emphasizes an

ex ante framework for effective inter-jurisdiction cooperation.

For the purposes of the following discussion, insolvency in the context of

banks is a two-pronged regime incorporating reorganization and liquidation, with

the latter only occurring upon the determination of the futility of the former. While

liquidation may by the simplest resolution procedure, it is not necessarily the

least costly, particularly in the context of banks that operate internationally.

Therefore, an effective cross-border bank insolvency regime necessitates timely

intervention to try and salvage a distressed bank’s going concern value, with

liquidation constituting the measure of last resort. This need for a robust early-

intervention structure was highlighted by the Northern Rock crisis, which

culminated in the introduction of a special resolution regime in England under the

2 For an account on Fortis’ resolution, see Kudrna, Zdenek. “Cross-Border Resolution of Failed Banks in the EU: A Search for the Second-best Policies”. Institute for European Integration Research Working Paper No. 08/2010 (November 2010), available at: http://www.eif.oeaw.ac.at/downloads/workingpapers/wp2010-08.pdf at 12—17.

auspices of the U.K. Banking Act 20093.

Lex Generalis Versus Lex Specialis

As alluded to earlier, insolvency legislations vary widely across

jurisdictions, with some being pro-creditor and others pro-debtor. There are, in

general, two different approaches to bank insolvency laws. Some jurisdictions

like Germany adopt the lex generalis approach to bank insolvency4, viz, banks

are treated like any other corporation and therefore subject to general insolvency

laws, while others like the U.S. and New Zealand adopt the lex specialis

approach5, viz, banks are subject to a separate insolvency regime. Bank

insolvency, it is suggested, requires a lex specialis which empowers a relevant

authority such as the supervisor or the deposit insurance agency to intervene.

Whereas general corporate insolvency laws are designed around the utilitarian

objectives of maximising the collective return to creditors6 and the “fair and

predictable treatment of creditors”7, banks perform a systemically significant

3 Lastra, Rosa M. et al. “Bankruptcy and Reorganization Procedures for Cross-Border Banks in the EU: Towards an Integrated Approach to the Reform of the EU Safety Net”. J. of Fin. Reg. and Comp., 17(3):240—276, 2009 at 246.4 Mayes, David G. “Financial Stability in a World of Cross-Border Banking: Nordic and Antipodean Solutions to the Problem of Responsibility Without Power”. Presented at the Annual Meetings of the Allied Social Science Associations, Boston, MA, January 6, 2006, available at: http://www.wlu.ca/viessmann/Capri/Mayes.pdf at 19.5 Ibid.6 Fince, Vanessa. Corporate Insolvency Law: Perspectives and Principles. Cambridge: Cambridge University Press, 2002, at 28; Mevorach, Irit. Insolvency Within Multinational Enterprise Groups. Oxford: Oxford University Press, 2009 ¶ 4.2.2.1.7 Hüpkes, Eva. “A New Architecture for Regulating Global Financial Institutions”. European Business Organization Law Review 10(3): 369-385, 2009 at 373.

function in today’s integrated financial market, such that the laws that govern

their insolvency merit additional idiosyncratic considerations. The role of banks

has expanded beyond the mere supplying of liquidity and taking of deposit to

functioning as a payment and settlement intermediary. As such, the global

financial market is highly interdependent and interconnected by a complex

network of exposures. In addition, as the financial crisis has demonstrated, a

substantial part of a bank’s primary liabilities are short-term and international

money markets are relied upon for constant refinancing. Consequently, a sudden

shock to market confidence can precipitate a liquidity crisis with systemic

implications8. The systemic repercussions of a bank failure, if not appropriately

and adequately contained, can spillover to the rest of the financial market and

wider economy, resulting in a domino effect reminiscent of the 2007-2009

financial crisis. Thus, there is a public interest in ensuring “sound banking and

the smooth functioning of the payment systems”9. Accordingly, the primary

objectives of bank insolvency laws are to serve the broader public interests of

preserving the integrity of the payment systems and maintaining the stability of

financial system at large by containing systemic spillovers10.

8 Krimminger, Michael. “Deposit Insurance and Bank Insolvency in a Changing World: Synergies and Challenges”. International Monetary Fund Conference, May 28, 2004. Available at: http://www.imf.org/external/np/leg/sem/2004/cdmfl/eng/mk.pdf at 3.9 Lastra, Rosa M. “Cross-Border Resolution of Banking Crises” in International Financial Instability: Global Banking and National Regulation. Evanoff, Douglas D. et al. (eds.). Singapore: World Scientific Publishing, 311—330, 2007 at 313.10 Lastra, Rosa M. “Northern Rock, UK Bank Insolvency and Cross-border Bank Insolvency”. Journal of Banking Regulation, 9(3):165—186, 2008 at 171; Leckow, Ross B. “The IMF/World Bank Global Bank Insolvency Initiative – Its Purposes and Principle Features” in Banking Restructuring and Resolution. Hoelscher, David S. (ed.). New York: Palgrave MacMillan, 2006 ¶ 7.

Against this backdrop, preserving going concern value and increasing the

chances of continuing viability take priority in bank insolvency laws. Thus, a lex

specialis is required for banks to empower the authorities to facilitate the timely

intervention and taking control of the distressed bank from existing shareholders,

since a lex generalis means that the process has to be handed over to the courts

and that quick resolution is less likely. With a lex specialis, the loss of public

funds are minimized, the reputation of the regulator is safeguarded, the risks of

bank run-type events and the resulting systemic repercussions are better

contained, and political pressure to keep failing banks (particularly banks

classified as too-big-to-fail) afloat are eased11. In addition, the prospect of early

intervention also acts as a restraining mechanism over excessive risk-taking

behaviour, thereby encouraging the exercise of management prudence12.

When is a Bank “Insolvent”?

The foregoing discussion on the importance of the ability to institute

insolvency proceedings at a relatively early stage of a bank’s difficulties

necessitates a definition of insolvency, i.e. a trigger for insolvency. Two tests are

usually applied in the context of general corporate insolvency. First, the liquidity

test postulates that a corporation is insolvent when it fails to pay its obligations as

11 Marinč, Matej and Vlahu, Razvan. “The Economic Perspective of Bank Bankruptcy Law”. Paper Presented at the Conference on Resolving Insolvent Large and Complex Financial Institutions held in Cleveland, OH (2011, April 14-15), available at: http://www.clevelandfed.org/research/conferences/2011/4-14-2011/Marinc_Vlahu.pdf, at 11—12.12 Ibid at 13.

they fall due. While the test is fairly straightforward, there is, in the context of

banking, no bright-line between illiquidity and insolvency. Indeed, a bank can

experience temporary liquidity difficulties without being fundamentally insolvent,

as for example an inability to honour the convertibility guarantee of deposits is

not a proof of insolvency per se, but merely evidence of illiquidity. Secondly, the

balance-sheet test posits that a corporation is insolvent when its liabilities exceed

its assets. While the balance-sheet test is clearly more commensurate with the

realities of the financial state of a bank, it is nonetheless inappropriate in the

context of bank insolvency. As averred previously, an important aspect of bank

insolvency laws is the facilitation of early and prompt intervention by the

authorities so as to, if possible, restore the bank’s viability. Thus if insolvency

proceedings can only be commenced when the bank’s liabilities already exceed

its assets, it may be too late to take any action other than to liquidate the bank.

Furthermore, the sheer magnitude and complexity of banking activities afford

banks considerable scope to gamble for resurrection by employing discretionary

accounting to distort or conceal true losses from the authorities, as was widely

practised during the 2007-2009 financial crisis13, which undermines the efficacy

of the balance-sheet test as a barometer of financial distress.

In light of the shortcomings of the traditional tests applied in the context of

ordinary corporate insolvencies, an appropriate trigger for bank insolvency

should be based on a combination of a concrete quantitative threshold as well as

discretionary intervention by the relevant authority based on a qualitative

13 Huizinga, Harry and Laeven, Luc. “Accounting Discretion of Banks during a Financial Crisis”. International Monetary Fund Working Paper, WP 09/207 (2009).

assessment of relevant circumstances. It is suggested that the criteria for the

quantitative threshold should be modeled after the Basel III capital rules with

slight modifications, buffered by a grace period afforded to the bank to

recapitalise itself before official administration is imposed. Accordingly14,

insolvency will be triggered once common equity held by a bank falls below a

threshold of 7%. In addition, a countercyclical buffer of 2.5% should be included

to empower regulators to require banks to increase capital levels to a higher

ceiling of 9.5% during periods of excessive aggregate credit growth. However,

instead of the risk-weighting approach to calculating capital ratio endorsed by the

Basel Committee, the ‘backstop’ leverage ratio of common equity to total assets,

it is suggested, should be the primary capital control. In this author’s opinion,

retaining the risk-weighting approach is the principle failure of Basel III. One of

the key components of Basel II was to increase the amount of capital that banks

had to hold against riskier assets, and extremely low-risk assets, meanwhile,

could be held with very little or even no capital. Risk, moreover, was calculated

primarily by reference to the rating assigned by one of the recognized ratings

agencies, which, as the subsequent crisis proved, is an unreliable indicator of an

asset’s riskiness. An unfortunate consequence of the Basel II reform was

therefore to disincentivize lending to lowly rated enterprises, and to encourage

the concentration of apparently risk-free assets. This was one of the primary

contributors to the financial meltdown, as securitization was a way to

"manufacture" apparently risk-free assets out of in fact risky clusters. Since

14 Under Basel III, banks are required to hold a common equity floor of 4.5% of risk-weighted assets and an additional capital conservation buffer of 2.5%, bringing the total common equity to 7%.

banks will need to hold more common equity against their risk-weighted assets

under Basel III, the incentive to find low-risk-weight assets with some return is

greater, since these assets can be leveraged much more than risky assets. To

illustrate, if a bank lends to a start-up, it would require 7% in capital; on the

contrary, if it lent that money instead to an AAA or AA-rated sovereign like

Greece, the bank would only require 1.6% in capital, thereby allowing it to

leverage its capital 62.5:1. Thus, in order to restrain this method of regulatory

arbitrage, the leverage ratio should function as the primary capital control.

Finally, the leverage ratio under Basel III is pitched at 3%, which translates into

an uncomfortably high maximum leverage of 33:1. To put things into perspective,

Lehman Brothers’ leverage was 30.7:1 just before it went into liquidation15.

Accordingly, a more appropriate figure would be somewhere between 4-5%16,

which would produce a leverage of 25:1 and 20:1 respectively.

As propounded in the preceding paragraph, a second subjective trigger

should be in place to empower an authority to institute insolvency proceedings

against a distressed bank even if it has not (yet) breached the formal threshold.

This second trigger affords some degree of flexibility to facilitate a more

calibrated response, as the first trigger does not purport to cover all scenarios

and may therefore be under-inclusive. The circumstances warranting the

15 Lehman Brothers Holdings Inc Annual Report at or for the year ended November 30, 2007, available at: http://fclass.vaniercollege.qc.ca/~laroccag/FOV1-00043009/FOV1-00051364/Lehman%20Brothers%20yr%202007%20Annual%20Report.pdf?FCItemID=S002288FE&Plugin=Loft.16 Pursuant to Section 38 of the U.S. Federal Deposit Insurance Act of the 1950, a financial institution is considered undercapitalized for the purposes of Prompt Corrective Action once its leverage ratio falls below 4%.

exercise of discretion should take into account a number of factors, including but

not limited to: (1) whether there are any indicators of a significant risk that the

bank would fail the threshold conditions explicated above in the near future17,

such as management failures and growing financial losses; (2) liquidity and

transformative risks18 that the bank is exposed to; (3) the necessity of such

intervention for maintaining the stability of the financial system; and (4) whether

the bank is exposed to any macroeconomic shocks19. In the interests of

transparency and certainty, a standardized set of considerations should be

articulated at the international level.

A Cross-Border Bank Insolvency Regime?

The experience of the 2007-2009 financial crisis has revealed the pressing

need for a clear, certain and credible cross-border bank resolution regime so as

to minimize the systemic repercussions and fiscal costs of a distressed

international bank and in turn enhance financial stability. Broadly speaking,

jurisdictions around the world either adopt universal principles consistent with a

single court applying a single procedure to the resolution of an international bank

and its branches abroad, wherever they are located, or territorial principles,

consistent with separate procedures for each of a bank’s entities in different

17 Dewatripont, Mathias and Rochet, Jean-Charles. “The Treatment of Distressed Banks” in Macroeconomic Stability and Financial Regulation: Key Issues for the G20. Dewatripont, Mathias et al. (eds.). London: Centre for Economic Policy Research, 2009 at 154.18 Ibid.19 Ibid.

jurisdictions. The universalism-territorialism debate has been the subject of much

academic discourse in recent years20, and in the following sections, the author

attempts a non-discursive analysis of their respective merits and flaws and

proposes a balanced solution to the dichotomy.

A. Universalism

In its purest manifestation, the theory of universalism propounds that

cross-border bankruptcy proceedings should be “unitary and universal”21, treating

the various branches of a bank as a single entity. Accordingly, a unitary

bankruptcy proceeding” will be heard “in the court of the bankrupt’s domicile”22 or

by a “supranational entity”23, and either the lex concursus24 or a harmonized set

of insolvency laws will govern the effects and conditions of the proceedings,

including the ranking of creditors, erga omnes in the other jurisdictions in which

the parent bank may have assets or branches. Thus, ideal universalism

20 See, e.g., Perkins, Liza. “Note, A Defense of Pure Universalism in Cross-Border Corporate Insolvencies”. N.Y.U. J. Int’l L. & Pol., 32(3):787—828, 2000; Guzman, Andrew T. “International Bankruptcy: In Defense of Universalism Colloquy: International Bankruptcy”. Mich. L. Rev., 98:2177—2215, 2000; Westbrook, Jay L. “Universalism and Choice of Law”. Penn St. Int'l L. Rev.. 23(3):625—638, 2004; Baxter, Thomas C. et al. “Two Cheers for Territorality: An Essay on International Bank Insolvency Law”. Am. Bankr. L.J., 78(1):57—91, 2004; LoPucki, Lynn M. “Universalism Unravels”. Am. Bankr. L.J., 79(1):143—168, 2005.21 In re HIH Casualty and General Insurance Ltd [2008] 1 W.L.R. 852 ¶ 6.22 Ibid; Guzman, Andrew T., “International Bankruptcy: In Defense of Universalism”, (2000) 98 Mich. L. Rev. 2177 at 2179.23 Basel Committee on Banking Supervision. Consultative Document: Report and Recommendations of the Cross-Border Bank Resolution Group (2009), available at: http://www.bis.org/publ/bcbs162.pdf?noframes=1 ¶ 70.24 Goode, Royston, Principles of Corporate Insolvency Law, 3rd ed., (Durham: Sweet & Maxwell, 2005) ¶ 14-07; Guzman, ibid.

envisages the administration of cross-border bank insolvencies by a single court

applying a single insolvency law. The universalism ideal, as Westbrook25

contends, conforms to the notion that bankruptcy, being a “collective legal device

that operates in each case to protect and adjudicate the interests of many

stakeholders”, requires a regime that is “symmetrical with the market”, such that

it covers “all or nearly all transactions and stakeholders in that market with

respect to the legal rights and duties embraced by those systems”26.

Proponents of universalism argue that such an approach to bankruptcy

will yield a variety of benefits, including a more efficient ex ante allocation of

capital27; reduced administrative costs due to a reduction in the number of

proceedings28; avoidance of forum shopping and the race to file29; facilitating

reorganizations30, which is a critical advantage in the context of banks31;

increased liquidation value32; and the provision of clarity and certainty to all

25 Westbrook, Jay L. “A Global Solution to Multinational Default”. Mich. L. Rev., 98:2276—2328, 2000.26 Ibid at 2283.27 Bebchuk, Lucian A. & Guzman, Andrew T., “An Economic Analysis of Transnational Bankruptcies”. J.L. & Econ., 42:775—808, 1999.28 Bebchuk, ibid at 778.29 Rasmussen, Robert K., “A New Approach to Transnational Insolvencies”, (1997) 19 Mich. J. Int’l. L. 1 at 6—10.30 Westbrook, Jay L. “Theory and Pragmatism in Global Insolvencies: Choice of Law and Choice of Forum”. Am. Bankr. L.J,, 65(4):457—490, 1991 at 465. 31 Hadjiemmanuil, Christos. “Europe’s Universalist Approach to Cross-Border Bank Resolution Issues” in Systemic Financial Crisis : Resolving Large Bank Insolvencies. Evanoff, Douglas et al. (eds.). Singapore: World Scientific Publishing, 2005 at 223.32 Supra Note 29 18.

parties33. Indeed, a cursory survey of existing literature reveals that universalism

is deemed by scholars to be the ideal approach to cross-border insolvency34.

While a universal regime, along with its associated advantages, is an

attractive proposition, several practical constraints render it, at least in the

foreseeable future, a mere chimera. The primary hurdle is, in this author’s

opinion, a political one. Global financial centres such as New York and London

tend to have large concentrations of funds invested in their jurisdictions by banks

around the world. Thus, for example, Deutsche Bank is likely to have a

substantial amount of funds invested in government securities in New York,

which translates into a larger pool of assets which may be “ring-fenced” for the

benefit of local creditors. As such, there is little incentive for such jurisdictions to

lobby for a global solution which would require them to relinquish their

sovereignties. Moreover, a universal regime requires a major overhaul of existing

national legal frameworks, which is a daunting task considering that national

legislations are founded on different principles, conflicting policies and deep

seated cultural differences. Thus, at present, the practical hurdles to a universal

solution appear to be quite insurmountable.

33 Westbrook, Jay L. “Universal Participation in Transnational Bankruptcies” in Making Commercial Law: Essays in Honour of Roy Goode. Cranston, Ross (ed.). Oxford: Clarendon Press, 419—437, 199s7 at 421.34 See e.g., Westbrook, Jay L. “A Global Solution to Multinational Default”. Mich. L. Rev., 98:2276—2328, 2000; Silverman, Ronald J. “Advances in Cross-Border Insolvency Cooperation: The UNCITRAL Model Law on Cross-Border Insolvency”. Ilsa J. Int’l & Comp. L., 6(2):265—272, 2000; Perkins, Liza. “Note, A Defense of Pure Universalism in Cross-Border Corporate Insolvencies”. N.Y.U. J. Int’l L. & Pol., 32(3):787—828, 2000; Bufford, Samuel L. “Global Venue Controls Are Coming: A Reply to Professor LoPucki”. Am. Bankr. L.J,, 79(1):105—142, 2005.

B. Territorialism

In contrast, the theory of territorialism, or pejoratively referred to as the

“grab rule”35, contemplates the confinement of the effects of insolvency

proceedings to such property as is located within the territorial jurisdiction of the

country in which the proceedings are instituted. It is firmly entrenched in the

concepts of national sovereignty and vested rights, which imposes the law of the

sovereign on all that is within its territorial reach, and that law grants vested rights

in assets so situated at the time an insolvency proceeding is instituted36. Thus, it

entails the notion of “plurality of proceedings”37, which envisages that courts in

different jurisdictions act independently, applying their respective local laws to the

administration and distribution of assets located in their jurisdiction38, without

regard to the fact that the bank operates globally and that there may be parallel

bankruptcy proceedings taking place concurrently elsewhere. One would surmise

that jurisdictions that adopt a territorial approach are motivated by considerations

of “national interests”39, with local assets being “ring-fenced” for the purposes of

minimizing losses that accrue to local stakeholders to whom they are

35 Westbrook, Jay L. “Universalism and Choice of Law”. Penn St. Int'l L. Rev.. 23(3):625—638, 2004 at 625.36 Westbrook, Jay L. “Multinational Enterprises in General Default: Chapter 15, The ALI Principles, and The EU Insolvency Regulation”. Am. Bankr. L.J,, 76:1—42, 2002 at 5. ()37 Goode, Supra Note 24 at 621.38 LoPucki, Lynn M. “Cooperation in International Bankruptcy: A Post-Universalist Approach”. Cornell L. Rev., 84(3):696—762, 1999 at 701.39 Supra Note 23 ¶ 53; International Monetary Fund. “Resolution of Cross-Border Banks—A Proposed Framework for Enhanced Coordination”. Prepared by the Legal and Monetary and Capital Markets Departments (2010, June 11), available at: http://www.imf.org/external/np/pp/eng/2010/061110.pdf ¶ 20.

accountable40. The contrasting approaches taken by the U.S. in respect of U.S.

branches of a foreign bank and a U.S. bank with foreign branches highlight how

national interests are the paramount consideration in the context of cross-border

bank insolvencies. In particularly, the U.S. adopts a ring-fencing approach to the

liquidation of U.S. branches of a foreign bank, as was the case in the BCCI

liquidation where the New York court refused to make assets available to the

U.K. liquidator, whereas a unitary approach is purportedly applicable where the

bank concerned is a U.S. bank with foreign branches, where the Federal Deposit

Insurance Corporation (FDIC) will act as receiver for the failed bank, collecting

and realizing all assets, as well as responding to all claims against the bank

regardless of situs41. The primary difficulty with the territorial approach is that the

restrictions on capital flows imposed as a result of ring-fencing produce allocative

inefficiencies in respect of capital and liquidity42. This can have the

counterproductive effect of exacerbating the financial woes of the distressed

bank and consequently hastening its failure in a manner that erodes value43. In

addition, a fragmented approach excludes the possibility of a recovery effort that

seeks to preserve the continuity of critical functions the failure of which could

have dire systemic ramifications44.

40 Ibid ¶ 53—54; Campbell, Andrew. “Issues in Cross-Border Bank Insolvency: The European Community Directive on the Reorganization and Winding-Up of Credit Institutions” in Current Developments in Monetary and Financial Law, vol. 3. Washington: International Monetary Fund, 2005 at 5.41 Pursuant to statutory powers conferred by the U.S. Banking Act of 1933.42 Claessens, Stijn et al. A Safer World Financial System: Improving the Resolution of Systemic Institutions. London: Centre for Economic Policy Research, 2010 at 8843 IMF, Supra Note 39 ¶ 22.44 Ibid.

As was clearly demonstrated by the financial crisis of 2007-200945, most

nations adopt a moderated territorialist approach which invokes a system

entrenched in territorialism principles but which includes an element of

international cooperation – a “cooperative territorialism”46. Under this approach,

the starting point would be that each jurisdiction involved would separately

administer the assets located within their respective borders while voluntarily

cooperating with the other jurisdictions in a variety of matters. Given the

voluntary basis upon which cooperation is extended, the amenability to

cooperation is conceivably dependant on the utility or mutual benefits that it

yields47. Hence, in the absence of a robust ex ante legal framework, coorperation

is uncertain, especially when there are no incentives for relevant authorities to

consider the broader cross-border spillovers that could ensure from a narrowly

focused national resolution – apart from the risk that a deteriorating international

financial environment may end up affecting the national economy48. One might,

for example, doubt the prospect of Mexico coorperating with the FDIC in a

resolution of Citigroup, given that the 100% owned subsidiary of Citigroup in

Mexico, Banamex, is Mexico’s second largest bank49. Hence, the present regime

of ex post and ad hoc cooperation, if it takes place at all, stands as a significant

45 Supra Note 23 ¶ 53.46 Supra Note 38 at 702; LoPucki, Lynn M. “Case for Cooperative Territoriality in International Bankruptcy, The Colloquy: International Bankruptcy”. Mich. L. Rev., 98(7):2216—2251, 2000; LoPucki, Lynn M. Courting Failure: How Competition for Big Cases Is Corrupting the Bankruptcy Courts. Ann Arbor: University of Michigan Press, 2005, chapters 7—8; LoPucki, Lynn M. “Universalism Unravels”. Am. Bankr. L.J,, 79(1):143—168, 2005.47 Supra Note 38 at 750.48 Supra Note 42 at 96.49 http://www.relbanks.com/north-america/mexico/banamex.

impediment to coordinated and effective action being taken under circumstances

where time is of the essence to minimize disruptions, contain contagion and

preserve value.

In the absence of a framework conducive to inter-state cooperation, a

plausible solution would be to de-globalise cross-border banks into a network of

independent national entities that are “structured separately for capital, liquidity,

assets and operations within each jurisdiction”50, such that their operations,

regulation, supervision and resolution would be conducted strictly on a national

basis without any extensive cross-border cooperation and burden sharing. By

promoting the functionality of banks through stand-alone subsidiaries –

“subsidiarization”51 – the mismatch between cross-border banks and national

regulations is substantially reduced. The resolution of an international banking

group organized as a network of subsidiaries is likely to be less costly and

destabilizing since healthy subsidiaries that operate independently of the parent

should, in principle, be better able to survive the failure of the parent52. As such,

subsidiarization is said to enhance “the resilience of host country operations”53.

Indeed, this approach has its merits, especially for countries like the U.K., which

bore the brunt of the fiscal strains from bailing out foreign banks like the Icelandic

banks54, whose home country did not possess the capacity and fiscal resources

50 Supra Note 23 ¶ 9.51 Supra Note 2 at 24.52 Fiechter, Jonathan et al. “Subsidiaries or Branches: Does One Size Fit All?”. International Monetary Fund Staff Discussion Note, SDN/11/04 (2011, March 7), available at: http://www.imf.org/external/pubs/ft/sdn/2011/sdn1104.pdf at 4.53 IMF, Supra Note 39 ¶ 27.54 Edmonds, Timothy. “Icelandic Bank Default”. House of Commons Briefing Paper, SN/BT/4864 (2009, July 21), available at: http://www.parliament.uk/briefingpapers/commons/lib/research/briefings/snbt-

to finance even the mandatory deposit insurance, much less rescue the failing

banks. Notwithstanding the obvious benefits, subsidiarization has its difficulties.

Compartmentalising an international bank into subsidiaries that straddle various

legal structures increases the cost of providing cross-border financial services by

preventing synergy gains arising from economies of scale and scope55. This may

in fact have the perverse effect of increasing systemic risk, since the restrictions

in capital and liquidity flow prevent resources make it harder for international

banks to respond to localized crises as they emerge56. Additionally,

internationalization of banks can in fact, in some cases, strengthen the resilience

of the financial markets in which they operate. The experience of Central and

Eastern Europe clearly demonstrates that the financial support provided by

parent banks to subsidiaries operating in member countries experiencing a

financial crisis played a crucial role in crisis resolution57. Thus, without such

“parental support,” the host country subsidiary would probably be more likely to

require a costly taxpayer rescue.

C. Modified Universalism – The Middle Ground Approach

In light of the shortfalls of attempting a cross-border bank resolution

04864.pdf.55 Supra Note 42 at 91.56 Sheeren, David. “U.S. Policy Toward Foreign Banks During the Financial Crisis: Lessons for Cross-Border Banking Regulation”. Paper Submitted for the Seminar in International Finance (2010, April 23), available at: http://www.law.harvard.edu/programs/about/pifs/education/select-papers-from-the-seminar-in-international-finance/llm-papers-2009-2010/sheeren.pdf at 57.57 IMF, Supra Note 39 ¶ 28.

regime based on either the principle of universalism or territorialism in their

strictest sense, a more practical approach would be to adopt a solution that

balances the merits and flaws of both principles, i.e. a middle ground approach.

Under this model, host countries are empowered with the right, but not the

obligation, to bring local resolutions against local components of an international

bank, while the home jurisdiction addresses the overall resolution of the

international bank.

As the idiosyncratic characteristics of banks necessitate a coordinated in

the resolution phase, a high emphasis should be placed on developing an

effective ex ante legal framework for the facilitation of cooperation between

jurisdictions. There are two elements to developing such a framework. First,

some aspects of national laws pertaining to bank resolution need to be amended

to create “a more complementary legal framework that facilitates financial

stability and continuity of key financial functions across borders”58. Critical areas

where legal convergence is necessary include the trigger for the commencement

of insolvency proceedings59 as suggested previously, the powers available to the

supervisors to deal with an insolvent bank and the treatment of local and foreign

creditors. More aligned resolution laws makes it more likely that authorities will

take consistent actions, with fewer conflicts ex post and therefore less delay and

destruction of value.

Second, efficient and equitable burden-sharing mechanisms between

home and host countries need to be determined ex ante. Each country’s

58 Supra Note 23 ¶ 67.59 IMF, Supra Note 39 ¶ 17.

respective burden, it is suggested, could be determined on the basis of the

assets held by the international bank in each of the participating countries, as

assets are “a good proxy for the real and contagious effects of a bank failure”60 in

each other participating countries. Another possible measure is the participating

countries’ respective gross national product (GDP). The difficulty with GDP-

based burden sharing, however, is that countries with small economies but large

banking sectors such as the UK may refuse to participate.

Conclusion

The veritable financial meltdown highlighted the frailties of the current

cross-border bank insolvency regime, or the lack thereof. The Basel III rules

designed to prevent another financial crisis of similar scale will not fully be

adopted until 2019, and if history, which suggests that the financial industry faces

a crisis typically every 7-10 years, is anything to go by, then there is certainly real

risk of an interim crisis. Thus, there is a compelling need to establish a robust

cross-border bank insolvency framework so as to contain systemic risk and

minimise financial loss. While full universalism is perhaps the ideal solution to the

conundrum, the political dimension renders it unfeasible at least in the

foreseeable future. At the other end, while territorialism delineates loss

apportionment clearly during a crisis, it comes at significant costs to global

60 Avgouleas, Emilios et al. “Living Wills as a Catalyst for Action”. Paper Presented at the International Financial and Monetary Law Conference held at Benjamin Cardozo School of Law, New York City, 3-4 June 2010, available at: http://fic.wharton.upenn.edu/fic/papers/10/10-09.pdf at 6.

economic growth and perhaps with the perverse consequence of increasing

systemic risk in the global banking system. Thus, it has been suggested that a

“middle ground” approach which emphasizes on enhanced inter-jurisdictional

cooperation by achieving some degree of legal convergence necessary to

facilitate a coordinated response, particularly in areas like the trigger for the

commencement of insolvency proceedings. The second fundamental aspect to

enhanced cooperation is putting in place ex ante burden-sharing mechanisms. In

this connection, the author has suggested the measure for apportioning burden

to be the assets held by the international bank in each of the participating

countries.

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