Are the U.S. Securities Laws Really an Impediment to a Bank Bail-In?
The FDIC's Systemic Resolution Advisory Committee discusses
In October 2023 the Financial Stability Board released a report intended to identify preliminary lessons learnt from the bank failures of 2023 as relevant to the framework for resolving systemically important banks.
One portion of the report discusses how, as things continued to look dire for Credit Suisse in the months leading up to its failure, Swiss regulators and their counterparts in other jurisdictions began to prepare for a bail-in resolution of the firm.
Oversimplifying a little, this would have been a resolution in which the bank’s senior debt and other “bail-inable” liabilities were written down to zero, with holders receiving in exchange new equity shares in the bank. Various aspects of the post-financial crisis regulatory framework have been designed to enable such a resolution.
Ultimately Swiss authorities settled on a different strategy for Credit Suisse, but the FSB report observes that, if an open-bank bail-in resolution had been pursued, it may have given rise to legal challenges. Not because of banking law, necessarily, but rather because of the U.S. securities laws.
According to the SEC staff, there would have been legal challenges relating to US securities laws in executing a bail-in; they noted that banks need to prepare sufficiently to comply with US securities laws after an open bank bail-in. US investors held bail-in bonds issued by Credit Suisse representing a significant portion of the firm’s TLAC. US securities laws apply to any TLAC instruments held by US investors, irrespective of the currency or governing law of that TLAC instrument.
Under US law, all offers and sales of securities need to be either registered or exempt from registration. The conversion of Credit Suisse’s bail-in-bonds to equity would have constituted a sale, thus requiring registration or an exemption.
In the view of the SEC staff, among the challenges involved in executing open-bank bail-in in compliance with US federal securities laws is that it would require detailed preparation, including possibly adapting the bank’s systems to enable prompt provision to the market of current and accurate (pro-forma) financial statements. In an open-bank bail-in, the SEC staff considered that it would be difficult for an issuer to compile the disclosures required by securities regulations and anti-fraud laws over a resolution weekend and that ex ante preparations would be necessary to mitigate these challenges.
It is not clear when the SEC staff first came to see this as a concern,1 but in any case the FSB in its report commits to further work with the SEC to understand these issues and “enhance the legal certainty of bail-in.”
How Concerned Should We Be?
Also unclear is exactly how significant an obstacle the concerns articulated by the SEC staff would be in reality. After the FSB report came out, Robin Wigglesworth at FT Alphaville highlighted the issue as a potential “regulatory nightmare.” The law firm Cleary Gottlieb (quoted in a Matt Levine article), however, suggested that this may be an overreading of the SEC staff views as summarized in the FSB report.
For example, even if it is true, as the SEC staff believes, that an exemption from registration may be required, in Cleary’s view “there are exemptions from the registration requirements that would likely apply in the event of a bail-in, and these exemptions have been considered by and discussed among regulators, banks and their advisors.” Further, even though, as the FSB report observes, “the SEC cannot confirm or grant exemptions on an ex ante basis,” Cleary believes this should not be read to “necessarily mean that the SEC staff has cast doubt on the availability of a particular exemption in the context of a bail-in.” Instead, this is better read as just a general statement of how things work under the U.S. securities laws: “it is incumbent on the issuer of the securities, with the assistance of its counsel, to determine whether an exemption is available.”
This is just a silly free internet blog, so this post does not attempt to take a position on the issue. Instead, it will just highlight comments made yesterday on this question by a handful of individuals considerably more qualified that the author of this post.
Yesterday’s SRAC Meeting
Yesterday the FDIC’s Systemic Resolution Advisory Committee (SRAC) met in Washington, DC.2
Established by the FDIC in 2011, the SRAC is meant to “provide advice and guidance on a wide range of issues regarding the resolution of large, systemically important institutions.” Like other FDIC advisory committees, the SRAC has no rule- or other decision-making authority, but its membership list includes many prominent figures, including former U.S. and international regulators, judges, academics, finance executives, and lawyers.
The committee has developed a pattern of meeting only infrequently (once every 1-2 years), and this week’s gathering was the group’s first meeting since the U.S. banking turmoil of early this year.
It makes sense, then, that the failures of Silicon Valley Bank and other U.S. banks, and the decisions the FDIC and other U.S. regulators made in relation to those failures, were at the top of the agenda,3 but a session of the meeting a little later in the day invited Eva Hüpkes4 and Sebastiano Laviola5 to also discuss the resolution of Credit Suisse.6
During that presentation, Laviola discussed a few of the key findings of the FSB’s report and in the course of his remarks mentioned specifically the potential interactions between bail-in resolution strategies and the U.S. securities laws.7
The other aspect that came out [of the FSB report], and again linked to the experience with Credit Suisse, is the one of working on resolution preparedness for cross-border recognition and execution of the cross-border bail-in, because clearly there are securities laws that have to be respected.
Normally if there is a subscription in — issuances in foreign countries, or subscription by foreign investors — according to the securities laws, this situation may be different in the case of the US and the SEC. Any conversion of bail-in bonds into shares is assimilated to a sale and therefore requires either registration, meaning a prospectus, essentially, or an exemption. There are conditions for the exemptions. In other legislation there are not even conditions for the exemptions, but associated to that there may be also disclosure requirements that have to be followed.
This means that we want to work more on the resolution preparedness for these cases in case of cross-border banks — how one can qualify for the exemption in these cases, and also on pro-forma disclosures of some statements, because this is also required by the securities laws.
There is work ongoing in the FSB to this regard, even today. . . . [and] in Basel there is a workshop to this regard.
After the presentation by Hüpkes and Laviola, committee members had the opportunity to share their own perspectives, some of which also addressed this U.S. securities law question, starting with Richard Herring of The Wharton School:8
… A final point if I may make it, the role of the SEC was rumored in the newspapers, you actually explained it very well I think. But it does call into question the huge reliance we are placing on TLAC if in fact it hasn’t been pre-cleared with regulators — securities regulators around the world.
If every time we use TLAC we have to renegotiate exemptions or prospectuses with securities regulators, it raises questions about how useful the TLAC tool actually is.
Laviola responded:9
… We believe that more work has to be done in terms of increasing the awareness — both of the banks and of the resolution authorities — to be able to be sure that you qualify for the exemptions or in any case that you decrease the legal risk to an extent tolerable.
I have to say that any legal action that would be started by any claimants that would feel discriminated [against] or not properly informed would not stop the legality of the situation.
So it’s not that you have to wind back the operation. However, if there is a big uncertainty, this has an impact on the credibility of the situation.
I am not totally sure about that second paragraph,10 but in any case soon thereafter it was Rodge Cohen’s turn to speak and he brought the discussion back around to the U.S. securities law question.11
Just a word on this securities law issue which seems to be so pervasive.
I think it is close to, if not the unanimous view, of the securities law bar that bail-in is not a second sale or issuance of a security. But if the Commission is not prepared to go there because of precedent or whatever, there are two quite simple solutions.
One, they can issue an exemption. Or second they can do a no-action letter. And what you do is attach to the exemption or no-action letter a form of disclosure which would be the typical disclosure and say if the disclosure is consistent with this then you’re entitled to the exemption.
And if there is any further worry about secondary market trading in the future, you could simply say, look, the security can be delisted unless there is a filing within X months of pro forma financial statements.
So I don’t think this — I realize this was a very serious issue, but I don’t think it’s a very serious issue to resolve.
After brief comments from a few other speakers, Laviola responded12 by again recapping what the FSB learned from the SEC staff, going on to say that he agrees the issue is solvable, but that at the same time “I am not sure that everybody across the world was [previously] aware” of the potential issue.
Laviola further observed that based on prior work he was “relatively sure” there was no problem, but that “now, of course, we are doubling the efforts to be double sure that it will work.”
At this stage, former FDIC Chair Sheila Bair chimed in to say that if in fact it does not work the instruments should not count as TLAC, and that this should incentivize the “banks themselves to get engaged with the SEC and get this problem solved.”13
On that helpful note, the discussion moved on to other issues.
One other thing from the SRAC meeting…
Moving away from the securities law issue (non-issue?), something that I missed yesterday but took note of when going back over the video today was this from Chair Gruenberg’s opening remarks:14
Let me note that our agenda, not surprisingly, places a lot of attention on regional bank resolution because of the events of this spring. I want to let you know we have not forgotten about GSIB resolution. At the FDIC it obviously remains a key priority for us.
And I wanted to let you know that the FDIC is close to releasing a new paper that will provide the most detailed explanation that we’ve yet given as to how we are thinking about and planning to use the FDIC’s Orderly Liquidation Authority under Title II of Dodd-Frank to resolve a GSIB. That paper and GSIB resolution will be a significant area of discussion at the next meeting of this committee.
Thanks for reading! Thoughts on this post are always welcome at bankregblog@gmail.com, but honestly if they are about the U.S. securities laws they are probably better directed elsewhere.
Earlier the report notes that the SEC was invited in to Credit Suisse-specific discussions in November 2022, but it “took some time” for the SEC to be able to join.
The Securities and Exchange Commission (SEC) and the New York State Department of Financial Services (NYDFS) were invited to join the Credit Suisse CMG in November 2022. The SEC joined the CMG in light of the likely applicability of the US securities laws to any eventual transaction involving investors (e.g., merger, bail-in, etc.) that would be undertaken in relation to Credit Suisse, as well as the materiality of the firm’s two US broker-dealers to the firm’s US operations. The NYDFS joined the CMG in connection with Credit Suisse’s New York branch. The SEC’s accession to the CMG took some time, as it required agreement by the Commission itself to the terms of existing Cooperation Agreements governing the CMG.
Even aside from Credit Suisse specifically, though, the SEC has consistently been represented on the FSB and in other international and domestic financial regulatory bodies, so the idea of a bail-in resolution would not (or at least should not) have come as a surprise to the SEC’s staff.
A video of the meeting is currently available via the FDIC’s website here.
See articles from Risk.net and Capitol Account.
Hüpkes currently serves as the Secretary General of the International Association of Deposit Insurers and prior to that served in various roles at the FSB, FINMA and the IMF.
Laviola is a member of the Single Resolution Board and previously worked at Italy’s central bank.
The portion of the meeting discussed in this post begins around the 2 hour 25 minute mark in the video linked in footnote 2. References in the below footnotes to timestamps are also based off the link in footnote 2.
Roughly at 2:51:00.
Roughly at 3:02:35.
Roughly at 3:09:30.
With respect to the U.S. at least, and acknowledging I am far beyond my area of expertise here, I had thought that a key concern wasn’t necessarily about what the bondholders could do, but about what the SEC itself could do in the event it determines that an exemption doesn’t apply and that registration is required. Even if you assume that the holders of these instruments could bring claims only after the fact, wouldn’t the Commission itself have the power to ask the courts to enjoin what it sees as an illegal unregistered securities offering?
Obviously as practical matter you might say this would never actually happen, and I think agree, but anyways.
Roughly at 3:17:45.
Roughly at 3:25:00.
Roughly at 3:26:35.
Roughly at 14:50.