The Federal Deposit Insurance Corporation has released its intended strategy for responding to the failure of Systemically Important Financial Institutions, banks and other financial firms deemed to pose a risk to financial stability if they fail. The plan will undergo a 60-day public comment process once published in the Federal Register.

The FDIC has been developing a “Single Point of Entry” strategy to achieve policy goals outlined in the Dodd-Frank Act. The FDIC is required to resolve a SIFI in a manner that holds owners and management responsible and accountable for the failure of the company, Creditors and shareholders will bear losses without imposing a cost on taxpayers.

Title I of the Dodd-Frank Act requires banks to prepare resolution plans, or “living wills,” to demonstrate how they would be unwound in the event of material financial distress or failure. Title II, creating the Orderly Liquidation Authority, provides, essentially, a back-up plan if no viable private-sector alternative is available to prevent the default, or if resolution through the bankruptcy process would have adverse effects on U.S. financial stability.

If a SIFI encounters severe financial distress, bankruptcy is the first option. A Title II resolution would only occur if bankruptcy proceedings could not be implemented or pose adverse effects on financial stability.

Before a SIFI can be resolved under Title II, two-thirds of the Federal Reserve Board and the Board of Directors of the FDIC must make recommendations to the Secretary of the Treasury and President, followed by a 24-hour judicial review process. If approved, a bridge financial company will be chartered with a new board of directors. At its initial meeting, directors will appoint a new chief executive officer.

U.S. SIFIs are typically organized under a holding company structure with a top-tier parent and operating subsidiaries that comprise hundreds of interconnected entities. The top-tier company typically raises the equity capital of the institution and down-streams equity and debt funding to its subsidiaries.

The FDIC will be appointed receiver only of the top-tier U.S. holding company; subsidiaries would remain open and continue operations. It will organize the bridge financial company, into which assets from the receivership estate will be transferred. Through a securities-for-claims exchange, claims of creditors would be satisfied by the issuance of securities representing debt and equity of the new holding company/companies.

The bridge financial company will continue to provide the holding company functions and subsidiaries would remain in operation. Any obligations supporting subsidiaries' contracts will be transferred to the bridge financial company. Counterparties to most derivative contracts would have no legal right to terminate and net out their contracts, preventing a “fire sale of assets.”

The FDIC intends to maximize the use of private funding in resolutions. If funding cannot be immediately obtained, an Orderly Liquidation Fund (OLF) will serve as a back-up source of liquidity. Funding may be secured directly from the OLF by issuing obligations backed by the assets of the bridge financial company. These obligations would only be issued in limited amounts for a brief transitional period in the initial phase of the resolution process and repaid once access to private funding resumes.

The FDIC will require a review of pre-failure management practices to determine why the financial company failed and develop a plan to mitigate future risks. Also required is a plan for restructuring the bridge financial company, including divestiture of certain assets, businesses, or subsidiaries that allow it to be resolvable under the Bankruptcy Code.

Day-to-day management of the company will be supervised by the officers and directors of the bridge financial company. The FDIC retains control over high-level governance matters, including: approval of stock issuance; amendments or modifications to bylaws; capital transactions or asset transfers or sales in excess of established thresholds; merger, consolidation, or reorganization of the bridge financial company; changes in directors; distribution of dividends; equity-based compensation plans; designation of valuation experts; and termination and replacement of the independent accounting firm.

Funding the bridge financial company will be the top priority for management. If customary sources of funding are not immediately available, the FDIC can secure advances from the OLF. Once private market funding can be accessed, these funds will be repaid.

Once a valuation of assets is completed, creditors' claims will be prioritized and paid through a securities-for-claims exchange. Obligations of vendors providing essential services would be assumed by the bridge financial company in order to keep day-to-day operations running smoothly.

Before terminating the bridge financial company and turning operations over to the private sector, the FDIC will require the board of directors and management to formulate a plan and timeline for restructuring that make it resolvable under the Bankruptcy Code.

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