Existing derivative contracts need to be amended and future contracts need to provide that the parent’s entry into the Title II proceeding does not trigger the close-out option, or legal changes need to be implemented abroad so that the “one-day stay” that applies to qualified financial contracts governed by U.S. law is enforceable against those contracts governed by foreign law. Only by making these changes can we avoid the potential for disruptive closeouts. I strongly encourage the ongoing efforts to address this critical issue. A second issue with respect to Title II resolution is that we cannot be certain how foreign authorities will react when the parent is put into the Title II proceeding. While the U.S. authorities have been in discussion with our colleagues abroad to enable the coordination needed for a smooth cross-border resolution process, we cannot always be certain of the circumstances under which host authorities may choose to take or be required to take actions such as unilateral “ring-fencing” that might disrupt the implementation of the single point of entry approach. Thus, we need to continue to work with foreign regulators to iron out any issues ahead of time so that the resolution regime will work well for global, systemically important firms. The smooth operation of a resolution proceeding also depends on the existence of adequate liquidity in the early days of the process.
These plans should identify actionable options that the firm can take in response to financial weakness that will restore the confidence of the firm’s counterparties in the firm without the need for extraordinary official sector support. Firms must also have disciplined processes that analyze the root causes of their problems and identify longer-term strategies that will need to be employed as other recovery options to restore capital and liquidity are being executed. And firms must support the viability of their contingency and recovery plans by implementing the internal governance necessary to develop, test, update and implement them credibly. There is also more work that we, as supervisors, can do to reduce the probability of failure and to incent firm managers to act well before resolution becomes necessary. We need to do more to create incentives to force banks to act sooner to steer away from impending icebergs – cut capital distributions earlier, raise new capital faster, restructure businesses sooner, and restructure senior management and boards of directors more radically when the firm is not performing well. For example, one approach might be to implement a long-term debt requirement in a way that enhances market discipline. Another reform would be to reduce the incentives of large, complex firms to rely on shortterm wholesale funding to finance longer-term, illiquid assets. Among other benefits, reducing a firm’s susceptibility to sudden runs associated with short-term wholesale funding will lengthen the “runway” for management to implement the strategic actions that would restore the firm to health.