The Case Against the Dodd-Frank Act’s Living Wills

The following post comes to us from Nizan Geslevich Packin of the University of Pennsylvania Law School.

In the paper, The Case Against the Dodd-Frank Act’s Living Wills: Contingency Planning Following the Financial Crisis, forthcoming in the Berkeley Business Law Journal, I focus on the Dodd-Frank Act’s “living will” requirement that mandates that systemically important financial institutions (SIFIs) develop business strategic analyses, and submit plans for reorganization or resolution of their operations to regulators. The goal of this regulation is to mitigate risks to the financial stability of the US and encourage last-resort planning – in order to enable a rapid and efficient response in the event of an emergency – for multinational financial institutions that are so large that their insolvency could shake the entire financial system and the economy. Nearly everyone believes that living wills are just about the perfect solution to the problems highlighted in the recent financial crisis; regulators from all over the world strongly support the concept and have been advocating for its implementation. Nevertheless, I argue that this solution is ill-designed to address the too-big-to-fail problem, and that living wills are not the silver bullet that regulators seem to think they are. My paper shows that there are a lot of open issues concerning living wills, and that there are real questions as to how effective they can be.

Since very little is known about living wills beyond the general framework set forth in the Dodd-Frank Act, my paper focuses on two issues: (i) the implementation and operation of living wills for systemically important financial institutions; and (ii) the problematic aspects of living wills, and how those aspects can lead to the failure of even the most ideally planned living wills.

The paper commences by presenting the concept of a living will, and outlines the process a SIFI should use in order to prepare one. First, a SIFI needs to create a comprehensive real-time database that houses all essential information to the SIFI’s financial, organizational and legal operations, as well as all client-related and cross-industry financial information. Second, using that database, a SIFI must create guidelines for business and financial recovery plans (including preventive measures) and tailor options for different resolution plans. Third, a SIFI must invest in better risk management procedures, better deal with risk resulting from unknown factors, and use game simulations as a method to improve risk monitoring. But the success of this process depends on regulators as well as on the SIFIs. Thus, the paper also reviews the significant role that regulator supervision plays in the success of living wills and the measures that should be taken by regulators to improve the effectiveness of the monitoring process.

The paper then introduces the significant problems and difficulties associated with the implementation of the living wills concept, which have not been properly addressed by the concept’s many supporters, including: (i) the difficulty in identifying and predicting risk; (ii) the failure to solve the too-big-to-fail problem; (iii) the failure to solve the cross-border insolvency problem; (iv) the costs associated with living wills; (v) the confidentially problem; (vi) the potential failure of the living wills solution in a market-wide crisis; (vii) the problem of creating a false sense of security; (viii) the problem of contingency planning in a vacuum; (ix) the problems resulting from regulator intervention; and (x) the issue of liability and the difficulty in getting SIFI board approvals.

The paper concludes that given the many difficulties and associated dilemmas, a living wills solution is not likely to be generally effective, and other suggested solutions should be considered instead. Indeed, despite its popularity and the high expectations of living wills, the living wills requirement is not a substantive regulation, but a limited-power disclosure requirement that simply bypasses the too-big-to-fail problem rather than solves it. Therefore, not only do the threats posed by the too-complex-to-succeed, international SIFIs, whose collapse can threaten the stability of the financial system, remain unresolved, but the costly-to-implement living wills solution might also have the perverse effect of increasing systemic risk and instability.

The full paper is available for download here.

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