A hearing of the House Subcommittee on Regulatory Reform revealed a strong bi-partisan consensus for amending the Bankruptcy Code to provide a first alternative to putting failed and failing financial firms into the orderly liquidation authority of Title II of the Dodd-Frank Act. Subcommittee Chair Spencer Bachus (R-AL) noted that two points of consensus emerged after careful expert consideration of why the Bankruptcy Code was not used to resolve failing firms during the financial crisis. The first point is that a single point of entry is the best way to resolve a failing firm; and the second point is that the current Bankruptcy Code cannot accommodate single point of entry. Hence, the need for the legislation.
Amplifying the deep bi-partisan support for the bill, the Ranking Member of the full Committee, John Conyers (D-MI), noted that the goal of the legislation is to position the Bankruptcy Code so that it can better facilitate the resolution of failing financial firms. Dodd-Frank posits the Bankruptcy Code as the first alternative for resolving a failed financial firm.
Professor Thomas Jackson of University of Rochester business school, and a member of the Federal Deposit Insurance Corporation’s (FDIC) Systemic Resolution Advisory Committee, testified that in two key places, the Dodd-Frank Act envisions bankruptcy as the preferred mechanism for the resolution of SIFIs. The effectiveness of bankruptcy law in being able to resolve SIFIs in ways that do not unnecessarily destroy value (such as by liquidating a viable going concern) is critically important to the development of approvable resolution plans under Title I of Dodd-Frank. In his view, the important question for bankruptcy law is the effectiveness of the current Bankruptcy Code as a credible resolution mechanism for a SIFI in financial difficulty, measured today against the FDIC’s single point of entry proposal for how it would use Title II of the Dodd-Frank Act.
Donald S. Bernstein, co-chair of the Insolvency and Restructuring Group at Davis Polk & Wardwell LLP, testified that the single-point-of-entry approach to resolution involves commencing resolution proceedings only with respect to the financial firm’s top-level parent holding company, with all losses of the distressed financial firm being borne by shareholders and creditors of that entity and not the taxpayers. Operating entities like the firm’s brokerage subsidiary would not be placed into resolution but would be recapitalized using assets of the holding company. Fortunately, he continued, in the United States (unlike some other countries), large financial firms already utilize a holding company structure, and significant amounts of equity and long-term unsecured debt are issued by these holding companies and are structurally subordinated to deposits and other operating liabilities of financial subsidiaries.
In addition, he noted that, because of initiatives by regulators at the multinational level, including those of the Financial Stability Board and crisis management groups organized among key regulators of individual firms, there is increasing alignment among national regulatory authorities regarding the benefits of the recapitalization and bail-in approaches to dealing with distressed financial firms. A single-point-of-entry recapitalization, for example, protects host-country interests by making resolution proceedings for host country operations unnecessary.