FSA Consults on Recovery & Resolution Plans
Sarah Jane Leake | Bloomberg Law
Recovery and Resolution Plans – Financial Services Authority Consultation Paper and Discussion Paper CP11/16 of 9 August 2011; FSA publishes Recovery and Resolution Plans consultation – Financial Services Authority Press Release FSA/PN/070/2011of 9 August 2011
The financial crisis served to highlight that firms did not have sufficient recovery plans in place. In the wake of the crisis, the G20 called for the development of “internationally-consistent firm-specific contingency and resolution plans” by end-2010.1 In a similar vein, the Financial Stability Board (FSB) expects systemically important firms to have Recovery and Resolution Plans (RRPs) in place by end-2012.
On 9 August, the FSA published for consultation2 a number of proposals for RRPs required of certain financial services firms, and for additional preparations as to their investment client money and custody assets (CMA) holdings. In its latest consultation paper, the FSA also sets out what should be expected of firms with regard to planning for a stressed situation. In essence, this will require a firm to take action to recover or, where necessary, wind-down in an orderly fashion without recourse to public funds.
Recovery and Resolution Plans
RRPs primarily seek to:
- Identify appropriate recovery options available in a wide range of severe stress situations;
- Allow these recovery options to be actioned in a quick and effective manner; and
- Provide the relevant regulatory authorities with sufficient information on a firm’s business, organisation and structure for them ensure that an orderly resolution could be carried out if so required.
RRPs comprise two main areas, Recovery Plans and Resolution Plans.
— Recovery Plans
A Recovery Plan is intended to reduce the likelihood of failure by requiring firms to identify the options it could take to achieve recovery in the event of a crisis. To safeguard their business successfully, firms must ensure that appropriate measures and preparations are established and maintained well before any glimpse of a crisis appears on the horizon.
In the FSA’s view, firms should be required to:
- Set out a robust menu of credible options that can realistically cope with a wide range of severe stress events (whether caused by idiosyncratic or market-wide problems or a combination of both) which extend beyond the firm’s current regulatory stress-testing initiatives. The options need not be ranked, since recovery actions inevitably vary according to the type and severity of the stress encountered. The options identified should be capable of being actioned within six months and credible to a range of stakeholders.
- Identify options, which would not be considered in less critical circumstances, to address capital shortfalls and liquidity pressures, and provide greater stability and sustainability.3 These options may include: disposing of the firm’s business plan; completely eradicating dividends and variable remuneration; debt exchanges; and, as a last resort, selling the firm to a third party. These should be put to action in a proportionate fashion, according to the size, structure and nature of the firm’s business. The long-term viability of the firm post-transaction should always be questioned when considering disposal options.
- Ensure that their Recovery Plan is integrated into the existing governance framework. Appropriate governance processes should be in place, including triggers (including both qualitative and quantitative indicators) and procedures to guarantee the timely implementation of recovery options in a range of circumstances.
- Review their Recovery Plan at least annually and make sure that any changes are approved by the board. Furthermore, firms should review and update their Plans promptly after any material changes to the business (e.g., an acquisition or disposal).
As to globally significant financial institutions (G-SIFIs), firms’ Recovery Plans will assist discussions across the globe among international regulators that participate in the FSB-established Crisis Management Groups (CMGs). Armed with the reassurance that firms can deal with testing situations, regulators should, opines the FSA, be discouraged from taking pre-emptive action which could negatively affect the wider global market.
— Resolution Plans
Resolution Plans provide a strategy for how a firm will wind-down should it fail for any reason. They are designed to minimise the impact on financial stability without resorting to public sector funds.
Since these Plans will be prepared by the relevant regulatory authorities, they will need up-to-date information on each firm’s business operation, structure and critical economic functions4 as well as comprehensive resolution analysis from each firm. To perform this role effectively, the authorities will be asking firms to prepare a “separability or wind-down analysis” for each of its critical economic functions. The FSA refers to this information and analysis as the “Resolution Pack.”
According to the FSA, the information and analysis set out in the Resolution Pack will help the authorities prepare a Resolution Plan for each firm which will aim to:
- Ensure the continuity, or the orderly wind-down, of the firm’s important functions at the lowest possible cost without recourse to public funds and at the same time minimise the impact on financial stability as well as the effect on UK depositors and consumers.
- Allow for action to be taken within a short timeframe, for example over a single weekend. This will require identifying any barriers to resolution during the preparation stage and, where possible, eliminating them before resolution looms.
- Identify those economic functions which must be continued because their availability is considered critical to the UK economy or financial system, or which must be wound-up in an orderly manner in order to avoid financial instability (together, the Critical Economic Functions).5
- Separate identified Critical Economic Functions from non-critical activities which could be allowed to fail (e.g., term lending to small and medium-sized enterprises or households, albeit only temporarily). In many cases, Critical Economic Functions are performed by multiple entities within a group and often co-mingle with non-critical activities (where a sudden withdrawal from the market will probably not cause a significant risk to financial stability or long-term material loss).
- Enhance co-operation and crisis management planning for G-SIFIs with international regulators to help develop group-wide compatible Resolution Plans.6
Firms will be required to review their Resolution Plans at least annually and keep them undated in light of any material developments in the firm’s business.
UK-incorporated deposit-takers, subsidiaries and significant investment firms with assets exceeding £15 billion will be required to implement RRPs. UK branches of overseas entities will not be subject to this requirement for the immediate future. Resolution arrangements will need to be resolved bilaterally with the home state regulator and via the relevant CMGs.
Client Money and Assets
The FSA’s latest paper also sets out a number of proposed requirements concerning CMA, known as the CASS7 Resolution Pack (CASS RP). The FSA’s proposals aim to reduce the wider economic cost of firm failure by promoting the speedier return of CMA to clients in the event of a failure. The FSA seeks to deliver this by ensuring that the key CMA information is readily accessible to the appointed insolvency practitioner. These proposals will apply only to firms already within the remit of CASS 6 or 7, owing to their holding of investment-only CMA.
Alongside the consultation paper, the FSA has published a discussion paper designed to promote market debate on different approaches to removing barriers to resolution and enhancing resolvability. It discusses the resolution of trading books, enhancing the resolution toolkit, and bail-ins. Feedback on these issues will help refine the FSA’s policy in this area which will, in turn, help shape the European and international agenda.
The FSA is inviting comments on its proposals until Wednesday 9 November. The final rules will be published during the first quarter of 2012. While certain provisions will come into effect that same quarter, the FSA will implement transitional provisions in order that firms have until June 2012 to prepare their initial PPRs.
The FSA anticipates that most of the rules for the preparation of RRPs will be implemented by the FSA before the Prudential Regulation Authority (PRA) takes over responsibility for supervising the relevant firms.8 To this end, the FSA has sought to ensure as far as possible that the proposals outlined above will be compatible with the PRA’s likely objectives.
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