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Fundamental Changes Ahead

II. Dissolution Authority

The bill provides for orderly dissolution of failing firms with the intent of putting an end to the concept that an entity might be “too big to fail.” The legislation provides for authority that would enable regulators to dissolve large, highly complex financial companies in an orderly and controlled manner, ensuring that shareholders and unsecured creditors bear the losses.

When a firm enters the dissolution process, management responsible for the failure would be dismissed, shareholders and unsecured creditors would be the principal bearers of losses, and the firm would cease as a going concern.

The FDIC would be able to unwind a failing firm so that existing contracts could be dealt with and the claims of secured creditors could be addressed. However, unlike traditional bankruptcy, which does not account for complex interrelationships of such large firms and could endanger financial stability, the intention of this process is to help prevent contagion and disruption to the entire system and the overall economy.

Dissolution costs would be repaid first from the assets of the failed firm at the expense of shareholders and creditors, and any shortfall would be repaid by assessments on all large financial firms. As a result, the financial industry would pay for any problem arising from the financial sector for which financial assistance is necessary for an orderly dissolution.

A financial company with $50 billion or more of assets would be subject to risk-based assessments to fund a “Systemic Dissolution Fund” that would be available to ensure that any losses incurred in connection with the resolution of a systemically significant institution would be borne by the financial industry. The Systemic Dissolution Fund could be used to help wind down failing financial institutions, but not to preserve them. The Fund would also be pre-funded by assessments on hedge funds with more than $10 billion in assets. This authority would sunset on December 31, 2013, unless extended by Congress.

III. Other Actions Affecting Banking Organizations

Risk Retention for Securitizations. Lenders would be required to retain a portion of the risk they generate in order to provide market discipline for underwriting decisions. New rules from the banking regulators and the SEC would require creditors to retain at least five percent of the credit risk associated with any loans that are transferred, sold, or securitized.

Countercyclical Capital Requirements and Deposit Insurance Assessments. The bill would amend the International Lending Supervision Act of 1983 to require the agencies “to seek to make such requirements countercyclical” to allow for capital requirements to decrease during times of economic contraction but subject institutions to increased capital requirements during times of expansion. In addition, the FDIC would have flexibility to maintain the size of the Deposit Insurance Fund in a countercyclical manner.

Changes to Section 23A. The bill contains several changes to the restrictions on bank transactions with affiliates under section 23A of the FR Act. The definition of “affiliate” would be expanded to cover any investment fund to which a bank or an affiliate is an investment adviser. Currently, the definition applies to companies that are “sponsored and advised” by the bank or an affiliate (or is otherwise controlled or defined as an affiliate).

H.R. 4173 would also (i) expand the definition of “covered transaction” to include expressly a loan by a bank secured by “other debt obligations” of an affiliate rather than only covering transactions secured by “securities” of an affiliate; (ii) clarify that repos are extensions of credit rather than asset purchases; (iii) treat a securities borrowing and lending transaction with an affiliate as a covered transaction to the extent that the transaction creates credit exposure; (iv) treat current and future credit exposure on derivative transactions with an affiliate as covered transactions; and (v) remove the exemption for financial subsidiaries from the 10 percent limit on transactions with an affiliate.

The FRB would be required to obtain the concurrence of the Chairman of the FDIC in order to grant an exemption by regulation or order and, in the case of a transaction or relationship involving a federally chartered or licensed institution, the concurrence of the OCC.

An amendment to section 18 of the Federal Deposit Insurance Act (“FDI Act”) would subject asset purchase and sale transactions between bank insiders and their related interests to a market terms requirement and, if the transaction is in an amount exceeding 10 percent of the bank’s capital, approval of the bank’s board of directors. The FDIC would have authority to issue regulations to implement this provision and comparable authority of the FRB under section 22 of the FR Act would be removed.

Scope of Transactions Subject to Lending Limits. Under the legislation, the scope of transactions subject to the national bank lending limits under section 84 of the National Bank Act would expand to include any liability of a bank to advance funds under a contractual commitment; and credit exposure arising from derivatives, repos, reverse repos, and securities lending and borrowing transactions. A similar amendment would be made to section 22 of the FR Act to subject these transactions to Regulation O when they involve insiders.

Charges for Holding Company Examinations. The FRB would be required to asses fees for any examination of a bank holding company with consolidated assets of $10 billion or more. The FRB currently avoids imposing charges for holding company supervision by conducting “inspections” rather than examinations.

GAO Audits of the FRB. The legislation also substantially enhances the authority of the Government Accountability Office (“GAO”) to examine the FRB and the Federal Reserve Banks to provide greater transparency to Federal Reserve facilities and actions.

Consumer Financial Protection Agency. The agency, which will be headed by a single director for the first two years, would be authorized to restrict bank overdraft protection programs and impact bank interchange. A manager’s amendment that the House adopted restores some preemption for national banks that the original Consumer Financial Protection Agency proposal took away. Specifically, the language provides that state laws that “prevent, significantly interfere with, or materially impair” the ability of national banks (or state banks in states with wild-card statutes) to engage in the business of banking may be preempted. This is closer to the preemption standards set forth in the Barnett Bank case.

Nationwide Deposit Cap. The bill would expand the scope of the restriction against agency approval of an interstate merger or acquisition that resulted in an acquirer controlling more than 10 percent of “bank” deposits to include thrift deposits.

Nationwide De Novo Branching. The bill would authorize state and national banks to establish de novo branches in any state.

About the author: Paul S. Pilecki, a partner in Winston & Strawn’s Washington, D.C., office, is the firm’s bank regulatory practice head. He represents foreign and domestic financial institutions on regulatory and corporate matters, and has extensive experience in helping banking organizations plan new activities and corporate structures for their U.S. activities.

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