Banks Should Make Living Wills to Plan for Failure, FSA Says

Banks should prepare so-called living wills setting out how they may be broken up with the least possible disruption to the economy if they collapse, the U.K. Financial Services Authority said today.

Lenders should be able to be shut down without roiling markets or requiring public support, according to the FSA. Failed lenders’ bondholders should also bear part of the costs of closure, the regulator said, as part of plans to shield taxpayers published on its website.

Banks are warning that rules considered by global regulators to limit the need for bailouts may harm the economic recovery. Michel Barnier, the European Union’s financial services chief, published draft proposals in January to impose losses on failing lenders’ bondholders -- a step that firms including Citigroup Inc. and Goldman Sachs Group Inc. have said may make it more expensive for banks to raise funds.

Living wills “are largely untested,” because the U.K. hasn’t had a major bank collapse since they have come under consideration by regulators, Darren Fox, a financial services lawyer at Simmons & Simmons LLP, said in a telephone interview. “They require quite a bit of work and possibly restructuring to design and implement and consequently can be intensive in terms of the level of financial and human resources that they absorb.”

Bank ‘Funerals’

Living wills should allow decisions on what to do about a bank’s assets, depositors and creditors “to be taken and executed in a short space of time,” the FSA said.

The wind-down plans may lead to “fundamental changes to firms’ structures, business operations or systems,” the London- based regulator said. All lenders with assets greater than 15 billion pounds ($24.4 billion) will be expected to draw up living wills.

The measures “will result in a monumental amount of work for firms in order to document and arrange what are, in effect, their own funerals,” Jake Green, a lawyer at Ashurst LLP in London, said in an e-mailed statement. “The FSA’s relatively prescriptive guidance will most likely be welcomed although there will clearly be a considerable amount of further consultation.”

The FSA said that it would seek comments on the proposals, with the intention of issuing binding rules “around the end of the year.” It said “some banks” will have plans in place by the middle of 2012.

‘Financial Stability’

“The financial crisis highlighted that firms failed to consider what they would need to do when faced with a potential failure of their business models,” said Thomas Huertas, a member of the FSA’s executive committee. “The result meant that billions of pounds of public money was required to support financial institutions around the globe and that financial stability was put at risk.”

The Financial Stability Board, which brings together watchdogs from the Group of 20 nations, has called for national authorities to require banks to make plans that would ensure their orderly winding down.

Lobby groups representing some of the world’s biggest financial companies have called on U.S. regulators to clarify what constitutes a “credible” plan for unwinding a complex firm before requiring companies to file living wills.

Losses from failing banks should be “borne by firms and their shareholders, capital providers, and unsecured creditors, rather than the taxpayer,” the FSA said.

One option would be to empower authorities to write down the amount owed to holders of a banks’ subordinated debt and senior unsecured debt, or to convert the securities into ordinary shares, the regulator said.

“In order to ensure continued proper functioning of markets it might be necessary to exclude certain liabilities, such as secured debt, from the list of those that could be subject to conversion or write down,” the FSA said.

To contact the reporters on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net;

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net.

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