Administration Unveils Draft Legislation Authorizing Federal Takeover of Systemically Risky Securities and Commodities Firms

Presaged by testimony before the House Financial Services Committee in which Treasury Secretary Tim Geithner and Fed Chair Ben Bernanke asked Congress to pass legislation allowing the government to take control and unwind non-bank financial institutions such as securities and commodities firms, the Obama Administration unveiled draft legislation empowering a federal regulator to manage the resolution of such firms efficiently and effectively in a manner that limits systemic risk with the least cost to the taxpayer, in conjunction with the primary regulator of the affected institution.

According to Treasury, the lack of a federal regulatory regime and resolution authority for large systemic non-bank financial institutions contributed to the financial crisis and, unless addressed with legislation, will constrain a federal response to future crises. As demonstrated by AIG, severe distress at large global non-depository financial institutions can pose systemic risks to the financial markets just as distress at banks can. The Administration asks for legislation authorizing federal regulators to use the same set of tools for addressing distress at non-bank financial institutions as they currently posses to deal with distressed banks. Institutions covered by the proposed legislation would include holding companies that control broker-dealers, insurance companies, and futures commission merchants.

Before any of the emergency measures specified in the proposed legislation may be taken, Treasury, upon the positive recommendations of both the Fed and the appropriate primary federal regulator of the firm, and in consultation with the President, must make a triggering determination that the financial institution is in danger of becoming insolvent and that such insolvency would have serious adverse effects on financial stability.

Instead of subjecting a firm to bankruptcy or simply injecting taxpayers' funds, the draft legislation would allow for a federal conservatorship or receivership leading to orderly reorganization or wind-down. As part of this process, the draft would enable the federal conservator or receiver to sell or transfer the assets or liabilities of the firm, renegotiate or repudiate contracts, and address the firm’s derivatives portfolio.

The proposed legislation permits many forms of federal assistance in order to stabilize the institution in question, including making loans, purchasing obligations or assets, assuming or guaranteeing liabilities, and purchasing an equity interest in the institution. The federal conservator would also have the power to fundamentally restructure the institution by, for example, replacing its directors and senior officers without seeking the approval of the institution's creditors or other stakeholders.

The draft proposes a funding mechanism that could take the form of a mandatory appropriation out of the general fund of the Treasury or through a scheme of assessments on the financial institutions covered by the legislation. The government would also receive repayment from the redemption of any loans made to the financial institution in question, and from the ultimate sale of any equity interest taken by the government in the institution.