Shadows and Mirrors: The Role of Debt in the Developing Resolution Strategies in the U.S., U.K., and European Union

Abstract

In response to the 2008-10 financial crisis, international standard setters and national authorities have sought to create a more resilient financial system while fashioning statutory frameworks and strategies to make the resolution of so-called systemically important financial institutions (“SIFIs”) possible. The effort to create more resilient SIFIs has included significantly higher capital and liquidity requirements as well as restrictions in some countries on the activities in which banks can engage. The initiatives designed to make SIFIs resolvable have focused on adopting common resolution tools - such as the authority to place companies into insolvency proceedings, impose losses on equity and debt-holders, restructure their operations, and maintain critical functions - and on identifying viable strategies to resolve globally active SIFIs. Those strategies have begun to coalesce around approaches that focus on restructuring and recapitalizing the failing SIFI through the bail-in or conversion of debt into a new capital base. This approach places a particularly emphasis on the role of debt as a source for new, bailinable equity to recapitalize the SIFI. This paper examines some of the differences in the approaches taken in the US, UK, and European Union and the possible implications for the industry and the financial system.