The adequacy of the GLAC buffer mitigates the negative externalities from a default, while the possible use of managementheld long-term debt as an element of GLAC could bolster incentives to reduce the risk of a default in the first place. There are implementation details of the FDIC’s SPE resolution framework that still need to be worked out. These arise from the challenge involved in operationalizing the framework with financial firms that conduct business across several jurisdictions and geographic borders. In this international arena, one specific issue needs to be promptly addressed. Due to parent guarantees or other cross-default provisions, the placement by the FDIC of the parent company into receivership may be treated by some counterparties as an event of default. This could trigger the close-out of qualified financial contracts (QFCs) such as interest rate swap contracts at international subsidiaries, which could potentially be destabilizing. To deal with this issue, the Dodd-Frank Act’s Title II one-day stay on the close-out of qualified financial contracts needs to be extended to cover contracts governed by non-U.S. law and involving non-U.S. counterparties. Resolving this issue is important to ensuring a smooth transition to the new bridge company. Addressing the contract close-out issue can be accomplished in two ways that are not mutually exclusive. First, existing derivative contracts could be amended and future contracts written to stipulate that the parent’s placement into a Title II resolution does not trigger the close-out option.
Second, legal provisions in other countries could be modified so that the one-day stay that applies to qualified financial contracts governed by U.S. law is also enforceable for those contracts governed by foreign law. Either or both of these actions would help ensure that the FDIC’s SPE mechanism could be successfully executed without unduly disrupting financial markets and counterparty risk positions. Given the cross-border activities of the G-SIFIs, the effectiveness of resolution mechanisms also will depend on the degree of coordination across national authorities. For example, we do not know for certain how foreign authorities would react if the parent of a U.S.-based GSIFI were placed into a Title II resolution proceeding. Uncertainties exist regarding whether foreign authorities either might choose, or be required, to take defensive actions such as ring-fencing that could disrupt the smooth implementation of the resolution process. An important task going forward is for authorities to work cooperatively and expeditiously to resolve these uncertainties. A well-crafted and well-executed resolution process for G-SIFIs can still be expected to create some strains in financial markets, especially considering the likely unsettled state of these markets at the time a resolution is being implemented. This suggests that it is also important to work on improving the resiliency in financial markets so that any shocks associated with a G-SIFI resolution are dampened rather than amplified. Two areas of work that show promise along these lines are new funding requirements and the move to central clearing for many OTC derivatives.