What Living Wills Can Do (Part 2 of 2)

Instead of providing a plan for the financial institution's own resolution, we should instead use living wills as a way to force financial institutions to provide regulators with all of the information they'd need to actually carry out a rapid and orderly resolution. This may not seem like much, but it would actually be critically important.



The most important piece of information that financial institutions should be required to periodically submit would be a detailed description of cross-border and intra-company funding arrangements. This would allow regulators to see the direct cross-border consequences of seizing the holding company and placing it in receivership. For example, had Lehman been required to submit this kind of detailed description, regulators would have seen that Lehman centralized its funding/liquidity in the holdco, and would have known that the moment the holdco filed for bankruptcy, Lehman's European broker-dealer subsidiary (LBIE) would have been insolvent too. At the very least, this would have focused regulators' attention on the direct consequences of LBIE's insolvency. It's possible that had the Bank of England known in advance that LBIE's insolvency would have immediately frozen tens of billions in prime brokerage assets, it would have provided LIBIE with the day-to-day financing necessary to stay out of bankruptcy until the Nomura deal closed (like the Fed did with Lehman's US broker-dealer, which was sold to Barclays).



Living wills should also include an updated list of the financial institution's counterparties, including exposures (on both a gross and net basis). If a financial institution can't provide that kind of comprehensive and up-to-date information, then, well, they're just going to have to invest in the necessarily operational infrastructure — that'll simpy be part of the cost of being a large, complex financial institution.



Another requirement, which is closely related to the description of the institution's funding arrangements, would be a list/map of where all of the institution's assets are held, and a description of the insolvency regime in each jurisdiction. For regulators to effectively coordinate with their international counterparts, they first need to know what issues they need to coordinate, and with whom. Knowing where all a financial institution's assets are held, and how they'll be treated in an involvency proceeding, is a necessary precondition to an orderly resolution of the financial institution.



The financial institution should also be required to submit a list of IT/compliance/general back office personnel that the regulators would need to retain to help them navigate the institution's data management systems. These employees wouldn't know how to make it rain even if they tried, so retaining them wouldn't entail paying ludicrously large bonuses that would tend to stir public anger. But their retention would be necessary, because it would allow regulators to focus on the task of actually carrying out the resolution, instead of fumbling around trying to learn the institution's data management systems.



Ideally, living wills would be folded into the prompt corrective action (PCA) regime. This way, if an institution's capital/liquidity started to deteriorate, regulators could force it to start augmenting its cross-border and intra-company funding arrangements in a way that would make it easier to resolve the financial institution. Or, just as importantly, regulators could start to restrict the financial institution's ability to engage in certain intra-company transfers that would make an orderly resolution more difficult. But for regulators to be able to use PCA to start softening the ground for an orderly resolution, they need to first have all the necessary information in hand. That's something that living wills can realistically do.



This is obviously not an exhaustive list, but I think it's illustrative. I realize that financial institutions would scream and yell about how much it would cost to gather all the information required in a living will on a regular basis ("that's not how our internal systems work!"). And for some financial institutions, I'm sure it would be quite costly to develop the operational capacity to comply with the ongoing requirements of living wills. But you know what? That's just the cost of doing business as a large, complex financial institution.