Category Archives: Bankruptcy & Financial Distress

Resolution Preparedness: Do You Know Where Your QFCs Are?

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication by Mr. Ryan, Frank Serravalli, Dan Weiss, John Simonson, and Daniel Sullivan. The complete publication, including appendix, is available here.

In January, the US Secretary of Treasury issued a notice of proposed rulemaking (“NPR”) that would establish new recordkeeping requirements for Qualified Financial Contracts (“QFCs”). [1] US systemically important financial institutions (“SIFIs”) and certain of their affiliates [2] will be required under the NPR to maintain specific information electronically on end-of-day QFC positions, and to be able to provide this information to regulators within 24 hours if requested. This is a significant expansion in both scope and detail from current QFC recordkeeping requirements, which now apply only to certain insured depository institutions (“IDIs”) designated by the FDIC. [3]

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Enhancing Prudential Standards in Financial Regulations

The following post comes to us from Franklin Allen, Professor of Economics at the University of Pennsylvania and Imperial College London; Itay Goldstein, Professor of Finance at the University of Pennsylvania;
 and Julapa Jagtiani and William Lang, both of the Federal Reserve Bank of Philadelphia.

The recent financial crisis has generated fundamental reforms in the financial regulatory system in the U.S. and internationally. In our paper, Enhancing Prudential Standards in Financial Regulations, which was recently made publicly available on SSRN, we discuss academic research and expert opinions on this vital subject of financial stability and regulatory reforms.

Despite the extensive regulation and supervision of U.S. banking organizations, the U.S. and the world financial systems were shaken by the largest financial crisis since the Great Depression, largely precipitated by events within the U.S. financial system. The new “macroprudential” approach to financial regulations focuses on both the risks arising in financial markets broadly and those risks arising from financial distress at individual financial institutions.

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Financial Market Utilities: Is the System Safer?

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication.

It has been two and a half years since the Financial Stability Oversight Council (FSOC) designated select financial market utilities (FMUs) as “systemically important.” These entities’ respective primary supervisory agencies have since increased scrutiny of these organizations’ operations and issued rules to enhance their resilience.

As a result, systemically important FMUs (SIFMUs) have been challenged by a significant increase in regulatory on-site presence, data requests, and overall supervisory expectations. Further, they are now subject to heightened and often entirely new regulatory requirements. Given the breadth and evolving nature of these requirements, regulators have prioritized compliance with requirements deemed most critical to the safety and soundness of financial markets. These include certain areas within corporate governance and risk management such as liquidity risk management, participant default management, and recovery and wind-down planning.

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Ten Key Points from the FSB’s TLAC Ratio

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication by Mr. Ryan, Kevin Clarke, Roozbeh Alavi, and Dan Weiss. The complete publication, including appendix, is available here.

On November 10th, the Financial Stability Board (FSB) issued a long-awaited consultative document that defined a global standard for minimum amounts of Total Loss Absorbency Capacity (TLAC) to be held by Global Systemically Important Banks (G-SIBs). TLAC is meant to ensure that G-SIBs have the loss absorbing and recapitalization capacity so that, in and immediately following resolution, critical functions can continue without requiring taxpayer support or threatening financial stability.

The FSB’s document requires a G-SIB to hold a minimum amount of regulatory capital (Tier 1 and Tier 2) plus long term unsecured debt that together are at least 16-20% [1] of its risk weighted assets (RWA), i.e., at least twice the minimum Basel III total regulatory capital ratio of 8%. In addition, the amount of a firm’s regulatory capital and unsecured long term debt cannot be less than 6% of its leverage exposure, i.e., at least twice the Basel III leverage ratio. In addition to this “Pillar 1” requirement, TLAC would also include a subjective component (called “Pillar 2”) to be assessed for each firm individually, based on qualitative firm-specific risks that take into account the firm’s recovery and resolution plans, systemic footprint, risk profile, and other factors.

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ABI Commission to Study the Reform of Chapter 11 Report

The following post comes to us from Donald S. Bernstein, Partner and head of the Insolvency and Restructuring Practice at Davis Polk & Wardwell LLP, and is based on a Davis Polk memorandum authored by Mr. Bernstein, Marshall S. Huebner, Damian S. Schaible, and Kevin J. Coco. The complete publication is available here.

On December 8, the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 released its Final Report and Recommendations. The American Bankruptcy Institute organized the 23-member Commission in 2011 to study and address how financial markets, products and participants have evolved and, in some respects, outgrown the current chapter 11 framework, enacted in 1978. Since the 19th century, Congress has overhauled the corporate reorganization provisions of the federal bankruptcy law approximately every 40 years, and the 40th anniversary of the enactment of the 1978 Bankruptcy Code is just four years away. The Commission Report, which spans nearly 400 pages, recommends significant changes that seek to reconfigure our corporate insolvency system.

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New ISDA Protocol Limits Buy-Side Remedies in Financial Institution Failure

The following post comes to us from Stephen D. Adams, associate in the investment management and hedge funds practice groups at Ropes & Gray LLP, and is based on a Ropes & Gray publication by Mr. Adams, Leigh R. Fraser, Anna Lawry, and Molly Moore.

The ISDA 2014 Resolution Stay Protocol, published on November 12, 2014, by the International Swaps and Derivatives Association, Inc. (ISDA), [1] represents a significant shift in the terms of the over-the-counter derivatives market. It will require adhering parties to relinquish termination rights that have long been part of bankruptcy “safe harbors” for derivatives contracts under bankruptcy and insolvency regimes in many jurisdictions. While buy-side market participants are not required to adhere to the Protocol at this time, future regulations will likely have the effect of compelling market participants to agree to its terms. This change will impact institutional investors, hedge funds, mutual funds, sovereign wealth funds, and other buy-side market participants who enter into over-the-counter derivatives transactions with financial institutions.

Among the key features of the Protocol are the following:

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Towards a “Rule of Law” Approach to Restructuring Sovereign Debt

Steven L. Schwarcz is the Stanley A. Star Professor of Law & Business at Duke University School of Law.

In a landmark vote, the United Nations General Assembly overwhelmingly decided on September 9 to begin work on a multilateral legal framework—effectively a treaty or convention—for sovereign debt restructuring, in order to improve the global financial system. The resolution was introduced by Bolivia on behalf of the “Group of 77” developing nations and China. In part, it was sparked by recent litigation in which the U.S. Supreme Court held that, to comply with a pari passu clause (imposing an equal-and-ratable repayment obligation), Argentina could not pay holders of exchanged bonds without also paying holdouts who retained the original bonds. That decision was all the more dramatic because the holdouts included hedge funds—sometimes characterized as “vulture funds”—that purchased the original bonds at a deep discount, yet sued for full payment.

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Cross-Border Recognition of Resolution Actions

The following post comes to us from Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication authored by Mitchell S. Eitel, Andrew R. Gladin, Rebecca J. Simmons, and Jennifer L. Sutton. The complete publication, including footnotes, is available here.

On September 29, 2014, the Financial Stability Board (the “FSB”) published a consultative document concerning cross-border recognition of resolution actions and the removal of impediments to the resolution of globally active, systemically important financial institutions (the “Consultative Document”). The Consultative Document encourages jurisdictions to include in their statutory frameworks seven elements that would enable prompt effect to be given to foreign resolution actions. In addition, due to a recognized gap between the various national legal resolution regimes that are currently in place and those recommended by the FSB, the Consultative Document sets forth two “contractual solutions”—that is, resolution-related arrangements to be implemented as a matter of contract among the private parties involved—to address two underlying substantive issues that the FSB considers critical for orderly cross-border resolution, namely:

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The Duty to Maximize Value of an Insolvent Enterprise

The following post comes to us from Brad Eric Scheler, senior partner and chairman of the Bankruptcy and Restructuring Practice at Fried, Frank, Harris, Shriver & Jacobson LLP, and is based on a Fried Frank M&A Briefing authored by Mr. Scheler, Steven Epstein, Robert C. Schwenkel, and Gail Weinstein. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In Quadrant Structured Products Company, Ltd. v. Vertin (October 1, 2014), Vice Chancellor Laster clarified the Delaware Chancery Court’s approach to breach of fiduciary duty derivative actions brought by creditors against the directors of an insolvent corporation. Importantly, the Vice Chancellor applied business judgment rule deference to the non-independent directors’ decision to try to increase the value of the insolvent corporation by adopting a highly risky investment strategy—even though the creditors bore the full risk of the strategy’s failing, while the corporation’s sole stockholder would benefit if the strategy succeeded. By contrast, the court viewed the directors’ decisions not to exercise their right to defer interest on the notes held by the controller and to pay above-market fees to an affiliate of the controller as having been “transfers of value” from the insolvent corporation to the controller, which were subject to entire fairness review.

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Update on Directors’ and Officers’ Insurance in Bankruptcy

The following post comes to us from Douglas K. Mayer, Of Counsel in the Restructuring and Finance Department at Wachtell, Lipton, Rosen & Katz, and is based on a Wachtell Lipton memorandum by Mr. Mayer, Martin J.E. Arms, and Emil A. Kleinhaus.

Directors’ and officers’ (“D&O”) insurance coverage continues to represent a key element of corporate risk management. See memo of July 28 2009. A decision in the bankruptcy of commodities brokerage MF Global, In re MF Global Holdings Ltd., No. 11-15059 (S.D.N.Y. Sept. 4, 2014), provides a recent illustration of how D&O insurance may be treated upon the bankruptcy of the insured company, depending on the specific structure and terms of the insurance at issue.

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