University of Hong Kong

Department of Law
Corporate Conflicts 20102011
Research Paper

Name: Brandon Tee Zhi Yi University Number: 2010982505 Number of Words: 5429

Introduction

The globalization-driven demise of national frontiers has led to a rapid expansion of cross-border banking activities and international markets over the past decade. Many contemporary banks are constituted by an extensive network of branches and subsidiaries that span across several jurisdictions. While cost efficiencies and economies of scale and scope derive from such integration, the failure of a bank with cross-border operations can generate spillovers that threaten financial stability in countries which it has operations in. Thus, the advent of cross-border banking activities presents a host of challenges which are particularly salient in the field of cross-border insolvency. The present approach to cross-border insolvency is a fragmented one, comprising a mlange of locally based and entity-centric legislations, and based necessarily on the voluntary cooperation between different national authorities. The stakeholders involved in a cross-border bank insolvency, however, are multifarious, with potentially conflicting interests1. The objectives and interests of different domestic laws are also often at variance, and in the absence of an ex ante resolution framework, this cooperation is often an uneasy one. These various factors render the present regime limited and inadequate for the support of cross-border resolution of banks, which must be decided by national authorities under the severe time pressure and uncertainty of acute crisis, as was thoroughly exposed by the Fortis
1

Lastra, Rosa M. and Wihlborg, Clas. Resolving Cross-Border Banking Crises. Paper presented at Financial Markets Group (FMG), Conference on Prompt Corrective Action & Cross Border Supervisory Issues in Europe, London School of Economics, London, United Kingdom, 2006 at 6.

experience2 of the 2007-2009 financial crisis. In the interests of financial stability, a clear, certain and credible legal framework is necessary, particularly during a financial crisis, to govern how a bank in financial distress would be reorganized to salvage its going concern value or liquidated where reorganization is not a realistic prospect in an orderly and coordinated fashion that minimizes systemic repercussions and therefore fiscal costs. A practical solution in the wake of the financial crisis is one that steers a path between universalism and territorialism and which emphasizes an ex ante framework for effective inter-jurisdiction cooperation. For the purposes of the following discussion, insolvency in the context of banks is a two-pronged regime incorporating reorganization and liquidation, with the latter only occurring upon the determination of the futility of the former. While liquidation may by the simplest resolution procedure, it is not necessarily the least costly, particularly in the context of banks that operate internationally. Therefore, an effective cross-border bank insolvency regime necessitates timely intervention to try and salvage a distressed banks going concern value, with liquidation constituting the measure of last resort. This need for a robust earlyintervention structure was highlighted by the Northern Rock crisis, which culminated in the introduction of a special resolution regime in England under the auspices of the U.K. Banking Act 20093.
2

For an account on Fortis resolution, see Kudrna, Zdenek. Cross-Border Resolution of Failed Banks in the EU: A Search for the Second-best Policies. Institute for European Integration Research Working Paper No. 08/2010 (November 2010), available at: http://www.eif.oeaw.ac.at/downloads/workingpapers/wp2010-08.pdf at 1217. 3 Lastra, Rosa M. et al. Bankruptcy and Reorganization Procedures for CrossBorder Banks in the EU: Towards an Integrated Approach to the Reform of the

Lex Generalis Versus Lex Specialis

As alluded to earlier, insolvency legislations vary widely across jurisdictions, with some being pro-creditor and others pro-debtor. There are, in general, two different approaches to bank insolvency laws. Some jurisdictions like Germany adopt the lex generalis approach to bank insolvency4, viz, banks are treated like any other corporation and therefore subject to general insolvency laws, while others like the U.S. and New Zealand adopt the lex specialis approach5, viz, banks are subject to a separate insolvency regime. Bank insolvency, it is suggested, requires a lex specialis which empowers a relevant authority such as the supervisor or the deposit insurance agency to intervene. Whereas general corporate insolvency laws are designed around the utilitarian objectives of maximising the collective return to creditors6 and the fair and predictable treatment of creditors7, banks perform a systemically significant function in todays integrated financial market, such that the laws that govern their insolvency merit additional idiosyncratic considerations. The role of banks EU Safety Net. J. of Fin. Reg. and Comp., 17(3):240276, 2009 at 246. 4 Mayes, David G. Financial Stability in a World of Cross-Border Banking: Nordic and Antipodean Solutions to the Problem of Responsibility Without Power. Presented at the Annual Meetings of the Allied Social Science Associations, Boston, MA, January 6, 2006, available at: http://www.wlu.ca/viessmann/Capri/Mayes.pdf at 19. 5 Ibid. 6 Fince, Vanessa. Corporate Insolvency Law: Perspectives and Principles. Cambridge: Cambridge University Press, 2002, at 28; Mevorach, Irit. Insolvency Within Multinational Enterprise Groups. Oxford: Oxford University Press, 2009 4.2.2.1. 7 Hpkes, Eva. A New Architecture for Regulating Global Financial Institutions. European Business Organization Law Review 10(3): 369-385, 2009 at 373.

has expanded beyond the mere supplying of liquidity and taking of deposit to functioning as a payment and settlement intermediary. As such, the global financial market is highly interdependent and interconnected by a complex network of exposures. In addition, as the financial crisis has demonstrated, a substantial part of a banks primary liabilities are short-term and international money markets are relied upon for constant refinancing. Consequently, a sudden shock to market confidence can precipitate a liquidity crisis with systemic implications8. The systemic repercussions of a bank failure, if not appropriately and adequately contained, can spillover to the rest of the financial market and wider economy, resulting in a domino effect reminiscent of the 2007-2009 financial crisis. Thus, there is a public interest in ensuring sound banking and the smooth functioning of the payment systems9. Accordingly, the primary objectives of bank insolvency laws are to serve the broader public interests of preserving the integrity of the payment systems and maintaining the stability of financial system at large by containing systemic spillovers10. Against this backdrop, preserving going concern value and increasing the chances of continuing viability take priority in bank insolvency laws. Thus, a lex
8

Krimminger, Michael. Deposit Insurance and Bank Insolvency in a Changing World: Synergies and Challenges. International Monetary Fund Conference, May 28, 2004. Available at: http://www.imf.org/external/np/leg/sem/2004/cdmfl/eng/mk.pdf at 3. 9 Lastra, Rosa M. Cross-Border Resolution of Banking Crises in International Financial Instability: Global Banking and National Regulation. Evanoff, Douglas D. et al. (eds.). Singapore: World Scientific Publishing, 311330, 2007 at 313. 10 Lastra, Rosa M. Northern Rock, UK Bank Insolvency and Cross-border Bank Insolvency. Journal of Banking Regulation, 9(3):165186, 2008 at 171; Leckow, Ross B. The IMF/World Bank Global Bank Insolvency Initiative Its Purposes and Principle Features in Banking Restructuring and Resolution. Hoelscher, David S. (ed.). New York: Palgrave MacMillan, 2006 7.

specialis is required for banks to empower the authorities to facilitate the timely intervention and taking control of the distressed bank from existing shareholders, since a lex generalis means that the process has to be handed over to the courts and that quick resolution is less likely. With a lex specialis, the loss of public funds are minimized, the reputation of the regulator is safeguarded, the risks of bank run-type events and the resulting systemic repercussions are better contained, and political pressure to keep failing banks (particularly banks classified as too-big-to-fail) afloat are eased11. In addition, the prospect of early intervention also acts as a restraining mechanism over excessive risk-taking behaviour, thereby encouraging the exercise of management prudence12.

When is a Bank Insolvent?

The foregoing discussion on the importance of the ability to institute insolvency proceedings at a relatively early stage of a banks difficulties necessitates a definition of insolvency, i.e. a trigger for insolvency. Two tests are usually applied in the context of general corporate insolvency. First, the liquidity test postulates that a corporation is insolvent when it fails to pay its obligations as they fall due. While the test is fairly straightforward, there is, in the context of banking, no bright-line between illiquidity and insolvency. Indeed, a bank can
11

Marin, Matej and Vlahu, Razvan. The Economic Perspective of Bank Bankruptcy Law. Paper Presented at the Conference on Resolving Insolvent Large and Complex Financial Institutions held in Cleveland, OH (2011, April 1415), available at: http://www.clevelandfed.org/research/conferences/2011/4-142011/Marinc_Vlahu.pdf, at 1112. 12 Ibid at 13.

experience temporary liquidity difficulties without being fundamentally insolvent, as for example an inability to honour the convertibility guarantee of deposits is not a proof of insolvency per se, but merely evidence of illiquidity. Secondly, the balance-sheet test posits that a corporation is insolvent when its liabilities exceed its assets. While the balance-sheet test is clearly more commensurate with the realities of the financial state of a bank, it is nonetheless inappropriate in the context of bank insolvency. As averred previously, an important aspect of bank insolvency laws is the facilitation of early and prompt intervention by the authorities so as to, if possible, restore the banks viability. Thus if insolvency proceedings can only be commenced when the banks liabilities already exceed its assets, it may be too late to take any action other than to liquidate the bank. Furthermore, the sheer magnitude and complexity of banking activities afford banks considerable scope to gamble for resurrection by employing discretionary accounting to distort or conceal true losses from the authorities, as was widely practised during the 2007-2009 financial crisis13, which undermines the efficacy of the balance-sheet test as a barometer of financial distress. In light of the shortcomings of the traditional tests applied in the context of ordinary corporate insolvencies, an appropriate trigger for bank insolvency should be based on a combination of a concrete quantitative threshold as well as discretionary intervention by the relevant authority based on a qualitative assessment of relevant circumstances. It is suggested that the criteria for the quantitative threshold should be modeled after the Basel III capital rules with
13

Huizinga, Harry and Laeven, Luc. Accounting Discretion of Banks during a Financial Crisis. International Monetary Fund Working Paper, WP 09/207 (2009).

slight modifications, buffered by a grace period afforded to the bank to recapitalise itself before official administration is imposed. Accordingly14, insolvency will be triggered once common equity held by a bank falls below a threshold of 7%. In addition, a countercyclical buffer of 2.5% should be included to empower regulators to require banks to increase capital levels to a higher ceiling of 9.5% during periods of excessive aggregate credit growth. However, instead of the risk-weighting approach to calculating capital ratio endorsed by the Basel Committee, the backstop leverage ratio of common equity to total assets, it is suggested, should be the primary capital control. In this authors opinion, retaining the risk-weighting approach is the principle failure of Basel III. One of the key components of Basel II was to increase the amount of capital that banks had to hold against riskier assets, and extremely low-risk assets, meanwhile, could be held with very little or even no capital. Risk, moreover, was calculated primarily by reference to the rating assigned by one of the recognized ratings agencies, which, as the subsequent crisis proved, is an unreliable indicator of an assets riskiness. An unfortunate consequence of the Basel II reform was therefore to disincentivize lending to lowly rated enterprises, and to encourage the concentration of apparently risk-free assets. This was one of the primary contributors to the financial meltdown, as securitization was a way to "manufacture" apparently risk-free assets out of in fact risky clusters. Since banks will need to hold more common equity against their risk-weighted assets under Basel III, the incentive to find low-risk-weight assets with some return is
14

Under Basel III, banks are required to hold a common equity floor of 4.5% of risk-weighted assets and an additional capital conservation buffer of 2.5%, bringing the total common equity to 7%.

greater, since these assets can be leveraged much more than risky assets. To illustrate, if a bank lends to a start-up, it would require 7% in capital; on the contrary, if it lent that money instead to an AAA or AA-rated sovereign like Greece, the bank would only require 1.6% in capital, thereby allowing it to leverage its capital 62.5:1. Thus, in order to restrain this method of regulatory arbitrage, the leverage ratio should function as the primary capital control. Finally, the leverage ratio under Basel III is pitched at 3%, which translates into an uncomfortably high maximum leverage of 33:1. To put things into perspective, Lehman Brothers leverage was 30.7:1 just before it went into liquidation15. Accordingly, a more appropriate figure would be somewhere between 4-5%16, which would produce a leverage of 25:1 and 20:1 respectively. As propounded in the preceding paragraph, a second subjective trigger should be in place to empower an authority to institute insolvency proceedings against a distressed bank even if it has not (yet) breached the formal threshold. This second trigger affords some degree of flexibility to facilitate a more calibrated response, as the first trigger does not purport to cover all scenarios and may therefore be under-inclusive. The circumstances warranting the exercise of discretion should take into account a number of factors, including but not limited to: (1) whether there are any indicators of a significant risk that the
15

Lehman Brothers Holdings Inc Annual Report at or for the year ended November 30, 2007, available at: http://fclass.vaniercollege.qc.ca/~laroccag/FOV1-00043009/FOV100051364/Lehman%20Brothers%20yr%202007%20Annual%20Report.pdf? FCItemID=S002288FE&Plugin=Loft. 16 Pursuant to Section 38 of the U.S. Federal Deposit Insurance Act of the 1950, a financial institution is considered undercapitalized for the purposes of Prompt Corrective Action once its leverage ratio falls below 4%.

bank would fail the threshold conditions explicated above in the near future17, such as management failures and growing financial losses; (2) liquidity and transformative risks18 that the bank is exposed to; (3) the necessity of such intervention for maintaining the stability of the financial system; and (4) whether the bank is exposed to any macroeconomic shocks19. In the interests of transparency and certainty, a standardized set of considerations should be articulated at the international level.

A Cross-Border Bank Insolvency Regime?

The experience of the 2007-2009 financial crisis has revealed the pressing need for a clear, certain and credible cross-border bank resolution regime so as to minimize the systemic repercussions and fiscal costs of a distressed international bank and in turn enhance financial stability. Broadly speaking, jurisdictions around the world either adopt universal principles consistent with a single court applying a single procedure to the resolution of an international bank and its branches abroad, wherever they are located, or territorial principles, consistent with separate procedures for each of a banks entities in different jurisdictions. The universalism-territorialism debate has been the subject of much academic discourse in recent years20, and in the following sections, the author
17

Dewatripont, Mathias and Rochet, Jean-Charles. The Treatment of Distressed Banks in Macroeconomic Stability and Financial Regulation: Key Issues for the G20. Dewatripont, Mathias et al. (eds.). London: Centre for Economic Policy Research, 2009 at 154. 18 Ibid. 19 Ibid. 20 See, e.g., Perkins, Liza. Note, A Defense of Pure Universalism in Cross-

attempts a non-discursive analysis of their respective merits and flaws and proposes a balanced solution to the dichotomy.

A.

Universalism

In its purest manifestation, the theory of universalism propounds that cross-border bankruptcy proceedings should be unitary and universal21, treating the various branches of a bank as a single entity. Accordingly, a unitary bankruptcy proceeding will be heard in the court of the bankrupts domicile22 or by a supranational entity23, and either the lex concursus24 or a harmonized set of insolvency laws will govern the effects and conditions of the proceedings, including the ranking of creditors, erga omnes in the other jurisdictions in which the parent bank may have assets or branches. Thus, ideal universalism envisages the administration of cross-border bank insolvencies by a single court applying a single insolvency law. The universalism ideal, as Westbrook25 Border Corporate Insolvencies. N.Y.U. J. Intl L. & Pol., 32(3):787828, 2000; Guzman, Andrew T. International Bankruptcy: In Defense of Universalism Colloquy: International Bankruptcy. Mich. L. Rev., 98:21772215, 2000; Westbrook, Jay L. Universalism and Choice of Law. Penn St. Int'l L. Rev.. 23(3):625638, 2004; Baxter, Thomas C. et al. Two Cheers for Territorality: An Essay on International Bank Insolvency Law. Am. Bankr. L.J., 78(1):5791, 2004; LoPucki, Lynn M. Universalism Unravels. Am. Bankr. L.J., 79(1):143 168, 2005. 21 In re HIH Casualty and General Insurance Ltd [2008] 1 W.L.R. 852 6. 22 Ibid; Guzman, Andrew T., International Bankruptcy: In Defense of Universalism, (2000) 98 Mich. L. Rev. 2177 at 2179. 23 Basel Committee on Banking Supervision. Consultative Document: Report and Recommendations of the Cross-Border Bank Resolution Group (2009), available at: http://www.bis.org/publ/bcbs162.pdf?noframes=1 70. 24 Goode, Royston, Principles of Corporate Insolvency Law, 3rd ed., (Durham: Sweet & Maxwell, 2005) 14-07; Guzman, ibid. 25 Westbrook, Jay L. A Global Solution to Multinational Default. Mich. L. Rev.,

contends, conforms to the notion that bankruptcy, being a collective legal device that operates in each case to protect and adjudicate the interests of many stakeholders, requires a regime that is symmetrical with the market, such that it covers all or nearly all transactions and stakeholders in that market with respect to the legal rights and duties embraced by those systems26. Proponents of universalism argue that such an approach to bankruptcy will yield a variety of benefits, including a more efficient ex ante allocation of capital27; reduced administrative costs due to a reduction in the number of proceedings28; avoidance of forum shopping and the race to file29; facilitating reorganizations30, which is a critical advantage in the context of banks31; increased liquidation value32; and the provision of clarity and certainty to all parties33. Indeed, a cursory survey of existing literature reveals that universalism is deemed by scholars to be the ideal approach to cross-border insolvency34. 98:22762328, 2000. 26 Ibid at 2283. 27 Bebchuk, Lucian A. & Guzman, Andrew T., An Economic Analysis of Transnational Bankruptcies. J.L. & Econ., 42:775808, 1999. 28 Bebchuk, ibid at 778. 29 Rasmussen, Robert K., A New Approach to Transnational Insolvencies, (1997) 19 Mich. J. Intl. L. 1 at 610. 30 Westbrook, Jay L. Theory and Pragmatism in Global Insolvencies: Choice of Law and Choice of Forum. Am. Bankr. L.J,, 65(4):457490, 1991 at 465. 31 Hadjiemmanuil, Christos. Europes Universalist Approach to Cross-Border Bank Resolution Issues in Systemic Financial Crisis : Resolving Large Bank Insolvencies. Evanoff, Douglas et al. (eds.). Singapore: World Scientific Publishing, 2005 at 223. 32 Supra Note 29 18. 33 Westbrook, Jay L. Universal Participation in Transnational Bankruptcies in Making Commercial Law: Essays in Honour of Roy Goode. Cranston, Ross (ed.). Oxford: Clarendon Press, 419437, 199s7 at 421. 34 See e.g., Westbrook, Jay L. A Global Solution to Multinational Default. Mich. L. Rev., 98:22762328, 2000; Silverman, Ronald J. Advances in Cross-Border Insolvency Cooperation: The UNCITRAL Model Law on Cross-Border Insolvency. Ilsa J. Intl & Comp. L., 6(2):265272, 2000; Perkins, Liza. Note, A

While a universal regime, along with its associated advantages, is an attractive proposition, several practical constraints render it, at least in the foreseeable future, a mere chimera. The primary hurdle is, in this authors opinion, a political one. Global financial centres such as New York and London tend to have large concentrations of funds invested in their jurisdictions by banks around the world. Thus, for example, Deutsche Bank is likely to have a substantial amount of funds invested in government securities in New York, which translates into a larger pool of assets which may be ring-fenced for the benefit of local creditors. As such, there is little incentive for such jurisdictions to lobby for a global solution which would require them to relinquish their sovereignties. Moreover, a universal regime requires a major overhaul of existing national legal frameworks, which is a daunting task considering that national legislations are founded on different principles, conflicting policies and deep seated cultural differences. Thus, at present, the practical hurdles to a universal solution appear to be quite insurmountable.

B.

Territorialism

In contrast, the theory of territorialism, or pejoratively referred to as the grab rule35, contemplates the confinement of the effects of insolvency Defense of Pure Universalism in Cross-Border Corporate Insolvencies. N.Y.U. J. Intl L. & Pol., 32(3):787828, 2000; Bufford, Samuel L. Global Venue Controls Are Coming: A Reply to Professor LoPucki. Am. Bankr. L.J,, 79(1):105142, 2005. 35 Westbrook, Jay L. Universalism and Choice of Law. Penn St. Int'l L. Rev.. 23(3):625638, 2004 at 625.

proceedings to such property as is located within the territorial jurisdiction of the country in which the proceedings are instituted. It is firmly entrenched in the concepts of national sovereignty and vested rights, which imposes the law of the sovereign on all that is within its territorial reach, and that law grants vested rights in assets so situated at the time an insolvency proceeding is instituted36. Thus, it entails the notion of plurality of proceedings37, which envisages that courts in different jurisdictions act independently, applying their respective local laws to the administration and distribution of assets located in their jurisdiction38, without regard to the fact that the bank operates globally and that there may be parallel bankruptcy proceedings taking place concurrently elsewhere. One would surmise that jurisdictions that adopt a territorial approach are motivated by considerations of national interests39, with local assets being ring-fenced for the purposes of minimizing losses that accrue to local stakeholders to whom they are accountable40. The contrasting approaches taken by the U.S. in respect of U.S. branches of a foreign bank and a U.S. bank with foreign branches highlight how national interests are the paramount consideration in the context of cross-border
36

Westbrook, Jay L. Multinational Enterprises in General Default: Chapter 15, The ALI Principles, and The EU Insolvency Regulation. Am. Bankr. L.J,, 76:1 42, 2002 at 5. () 37 Goode, Supra Note 24 at 621. 38 LoPucki, Lynn M. Cooperation in International Bankruptcy: A Post-Universalist Approach. Cornell L. Rev., 84(3):696762, 1999 at 701. 39 Supra Note 23 53; International Monetary Fund. Resolution of Cross-Border BanksA Proposed Framework for Enhanced Coordination. Prepared by the Legal and Monetary and Capital Markets Departments (2010, June 11), available at: http://www.imf.org/external/np/pp/eng/2010/061110.pdf 20. 40 Ibid 5354; Campbell, Andrew. Issues in Cross-Border Bank Insolvency: The European Community Directive on the Reorganization and Winding-Up of Credit Institutions in Current Developments in Monetary and Financial Law, vol. 3. Washington: International Monetary Fund, 2005 at 5.

bank insolvencies. In particularly, the U.S. adopts a ring-fencing approach to the liquidation of U.S. branches of a foreign bank, as was the case in the BCCI liquidation where the New York court refused to make assets available to the U.K. liquidator, whereas a unitary approach is purportedly applicable where the bank concerned is a U.S. bank with foreign branches, where the Federal Deposit Insurance Corporation (FDIC) will act as receiver for the failed bank, collecting and realizing all assets, as well as responding to all claims against the bank regardless of situs41. The primary difficulty with the territorial approach is that the restrictions on capital flows imposed as a result of ring-fencing produce allocative inefficiencies in respect of capital and liquidity42. This can have the counterproductive effect of exacerbating the financial woes of the distressed bank and consequently hastening its failure in a manner that erodes value43. In addition, a fragmented approach excludes the possibility of a recovery effort that seeks to preserve the continuity of critical functions the failure of which could have dire systemic ramifications44. As was clearly demonstrated by the financial crisis of 2007-200945, most nations adopt a moderated territorialist approach which invokes a system entrenched in territorialism principles but which includes an element of international cooperation a cooperative territorialism46. Under this approach,
41 42

Pursuant to statutory powers conferred by the U.S. Banking Act of 1933. Claessens, Stijn et al. A Safer World Financial System: Improving the Resolution of Systemic Institutions. London: Centre for Economic Policy Research, 2010 at 88 43 IMF, Supra Note 39 22. 44 Ibid. 45 Supra Note 23 53. 46 Supra Note 38 at 702; LoPucki, Lynn M. Case for Cooperative Territoriality in International Bankruptcy, The Colloquy: International Bankruptcy. Mich. L. Rev.,

the starting point would be that each jurisdiction involved would separately administer the assets located within their respective borders while voluntarily cooperating with the other jurisdictions in a variety of matters. Given the voluntary basis upon which cooperation is extended, the amenability to cooperation is conceivably dependant on the utility or mutual benefits that it yields47. Hence, in the absence of a robust ex ante legal framework, coorperation is uncertain, especially when there are no incentives for relevant authorities to consider the broader cross-border spillovers that could ensure from a narrowly focused national resolution apart from the risk that a deteriorating international financial environment may end up affecting the national economy48. One might, for example, doubt the prospect of Mexico coorperating with the FDIC in a resolution of Citigroup, given that the 100% owned subsidiary of Citigroup in Mexico, Banamex, is Mexicos second largest bank49. Hence, the present regime of ex post and ad hoc cooperation, if it takes place at all, stands as a significant impediment to coordinated and effective action being taken under circumstances where time is of the essence to minimize disruptions, contain contagion and preserve value. In the absence of a framework conducive to inter-state cooperation, a plausible solution would be to de-globalise cross-border banks into a network of independent national entities that are structured separately for capital, liquidity, 98(7):22162251, 2000; LoPucki, Lynn M. Courting Failure: How Competition for Big Cases Is Corrupting the Bankruptcy Courts. Ann Arbor: University of Michigan Press, 2005, chapters 78; LoPucki, Lynn M. Universalism Unravels. Am. Bankr. L.J,, 79(1):143168, 2005. 47 Supra Note 38 at 750. 48 Supra Note 42 at 96. 49 http://www.relbanks.com/north-america/mexico/banamex.

assets and operations within each jurisdiction50, such that their operations, regulation, supervision and resolution would be conducted strictly on a national basis without any extensive cross-border cooperation and burden sharing. By promoting the functionality of banks through stand-alone subsidiaries subsidiarization51 the mismatch between cross-border banks and national regulations is substantially reduced. The resolution of an international banking group organized as a network of subsidiaries is likely to be less costly and destabilizing since healthy subsidiaries that operate independently of the parent should, in principle, be better able to survive the failure of the parent52. As such, subsidiarization is said to enhance the resilience of host country operations53. Indeed, this approach has its merits, especially for countries like the U.K., which bore the brunt of the fiscal strains from bailing out foreign banks like the Icelandic banks54, whose home country did not possess the capacity and fiscal resources to finance even the mandatory deposit insurance, much less rescue the failing banks. Notwithstanding the obvious benefits, subsidiarization has its difficulties. Compartmentalising an international bank into subsidiaries that straddle various legal structures increases the cost of providing cross-border financial services by preventing synergy gains arising from economies of scale and scope55. This may
50 51

Supra Note 23 9. Supra Note 2 at 24. 52 Fiechter, Jonathan et al. Subsidiaries or Branches: Does One Size Fit All?. International Monetary Fund Staff Discussion Note, SDN/11/04 (2011, March 7), available at: http://www.imf.org/external/pubs/ft/sdn/2011/sdn1104.pdf at 4. 53 IMF, Supra Note 39 27. 54 Edmonds, Timothy. Icelandic Bank Default. House of Commons Briefing Paper, SN/BT/4864 (2009, July 21), available at: http://www.parliament.uk/briefingpapers/commons/lib/research/briefings/snbt04864.pdf. 55 Supra Note 42 at 91.

in fact have the perverse effect of increasing systemic risk, since the restrictions in capital and liquidity flow prevent resources make it harder for international banks to respond to localized crises as they emerge56. Additionally, internationalization of banks can in fact, in some cases, strengthen the resilience of the financial markets in which they operate. The experience of Central and Eastern Europe clearly demonstrates that the financial support provided by parent banks to subsidiaries operating in member countries experiencing a financial crisis played a crucial role in crisis resolution57. Thus, without such parental support, the host country subsidiary would probably be more likely to require a costly taxpayer rescue.

C.

Modified Universalism The Middle Ground Approach

In light of the shortfalls of attempting a cross-border bank resolution regime based on either the principle of universalism or territorialism in their strictest sense, a more practical approach would be to adopt a solution that balances the merits and flaws of both principles, i.e. a middle ground approach. Under this model, host countries are empowered with the right, but not the obligation, to bring local resolutions against local components of an international bank, while the home jurisdiction addresses the overall resolution of the

56

Sheeren, David. U.S. Policy Toward Foreign Banks During the Financial Crisis: Lessons for Cross-Border Banking Regulation. Paper Submitted for the Seminar in International Finance (2010, April 23), available at: http://www.law.harvard.edu/programs/about/pifs/education/select-papers-fromthe-seminar-in-international-finance/llm-papers-2009-2010/sheeren.pdf at 57. 57 IMF, Supra Note 39 28.

international bank. As the idiosyncratic characteristics of banks necessitate a coordinated in the resolution phase, a high emphasis should be placed on developing an effective ex ante legal framework for the facilitation of cooperation between jurisdictions. There are two elements to developing such a framework. First, some aspects of national laws pertaining to bank resolution need to be amended to create a more complementary legal framework that facilitates financial stability and continuity of key financial functions across borders58. Critical areas where legal convergence is necessary include the trigger for the commencement of insolvency proceedings59 as suggested previously, the powers available to the supervisors to deal with an insolvent bank and the treatment of local and foreign creditors. More aligned resolution laws makes it more likely that authorities will take consistent actions, with fewer conflicts ex post and therefore less delay and destruction of value. Second, efficient and equitable burden-sharing mechanisms between home and host countries need to be determined ex ante. Each countrys respective burden, it is suggested, could be determined on the basis of the assets held by the international bank in each of the participating countries, as assets are a good proxy for the real and contagious effects of a bank failure60 in each other participating countries. Another possible measure is the participating
58 59

Supra Note 23 67. IMF, Supra Note 39 17. 60 Avgouleas, Emilios et al. Living Wills as a Catalyst for Action. Paper Presented at the International Financial and Monetary Law Conference held at Benjamin Cardozo School of Law, New York City, 3-4 June 2010, available at: http://fic.wharton.upenn.edu/fic/papers/10/10-09.pdf at 6.

countries respective gross national product (GDP). The difficulty with GDPbased burden sharing, however, is that countries with small economies but large banking sectors such as the UK may refuse to participate.

Conclusion

The veritable financial meltdown highlighted the frailties of the current cross-border bank insolvency regime, or the lack thereof. The Basel III rules designed to prevent another financial crisis of similar scale will not fully be adopted until 2019, and if history, which suggests that the financial industry faces a crisis typically every 7-10 years, is anything to go by, then there is certainly real risk of an interim crisis. Thus, there is a compelling need to establish a robust cross-border bank insolvency framework so as to contain systemic risk and minimise financial loss. While full universalism is perhaps the ideal solution to the conundrum, the political dimension renders it unfeasible at least in the foreseeable future. At the other end, while territorialism delineates loss apportionment clearly during a crisis, it comes at significant costs to global economic growth and perhaps with the perverse consequence of increasing systemic risk in the global banking system. Thus, it has been suggested that a middle ground approach which emphasizes on enhanced inter-jurisdictional cooperation by achieving some degree of legal convergence necessary to facilitate a coordinated response, particularly in areas like the trigger for the commencement of insolvency proceedings. The second fundamental aspect to

enhanced cooperation is putting in place ex ante burden-sharing mechanisms. In this connection, the author has suggested the measure for apportioning burden to be the assets held by the international bank in each of the participating countries.

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