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A year ago FT Alphaville wrote about the Financial Stability Board’s Credit Suisse postmortem, and its almost-casual observation that the SEC believed the entire post-GFC global bank bail-in bonds regime might fall foul of US securities law.
In the US the conversion of debt into equity counts as a new sale of securities, and therefore requires full registration — with new disclosures etc — or a regulatory exemption. Astonishingly, it appears the SEC feels that even bonds expressly designed to fit regulatory requirements by being convertible into equity are not exempt.
The rigmarole of re-registering can be difficult-to-impossible in a shitshow fast-moving banking crisis, but failure to do so might be a breach of federal securities law, according to the SEC. Which is, even in this day and age, broadly considered A Very Bad Thing.
Compounding the issue is the extraordinary extraterritorial reach of US law. In theory you don’t even need to issue a bond in the US to fall foul of it — just a few US investors among the holders might be enough.
Here’s what we wrote, while gently rocking backwards and forwards:
The occasionally conflicting regulatory approaches of the US and Europe is a fun/frustrating fact of life in finance — viz Mifid II. But this looks like next-level headbanger stuff.
Having easily ‘bail-in-able’ bonds to bolster the total loss absorbing capital of a struggling bank is a cornerstone of the entire global post-financial crisis regulatory edifice! This stuff has been debated ad nauseam for over a decade! The FSB even mandates that at least 33 per cent of a global systemically important bank’s TLAC should be in debt!
We gather that quite a few people were as alarmed as we were, but the wheels of cross-border bank resolution regulation grind slowly. As far as we know, nothing concrete has happened with the awkward issue of how loss-absorbing bonds collide with the US legal system.
However, an FTAV reader directed us to the most recent meeting of the FDIC’s System Resolution Advisory Committee, where our primal scream appears to have come up.
We’re not sure who the questioner is, but we think we’ve correctly identified the next speakers despite the grainy video of the open meeting held on Oct 15.
Questioner: There was also some interesting discussion, and it was reported in the FT, about the legal certainty around if you had to go into the TLAC stack — the bail-in bonds. Obviously, you impose losses on the CoCos, which I think was very helpful in solving any risk of a capital problem. But if you were to go into full . . . bail-in and, in effect, convert the bond structure into equity, there might be some US securities law issues.
Have you been able to kind of work through that now that we’ve got, hopefully a chance to catch your breath, to make sure that all been sorted through? Or is that still a process under way?
FINMA* CEO Stefan Walter: You’re right. The cross-border certainty of bail-in is one of the key topics, and one of the key elements of that is when you convert debt to equity, then you have registration and disclosure requirements, and how those could be met over a weekend . . .
You need to go through orderly process, and whether there can be an exemption or not — or other workarounds — is something which is still, you know, being worked on.
Rodgin Cohen: And I’ve got to say on this one, I actually think the commission should be able to reach without exemptions, without ad hoc decisions, a clear decision — which I think is the right legal conclusion — that no further registration or disclosure is required, that it just happens.
Every holder of these bonds were told at the time what the possibility was, there are a number of law firms that gave opinions on this, and I don’t think any that did not. So this really requires the Commission to step up to what I think is the correct legal as well as practical analysis.
“Rodge” Cohen is senior chair of Sullivan and Cromwell, and the granddaddy of US banking lawyers.
His first gig cleaning up a bank came 40 years ago, when he advised Continental Illinois in its FDIC takeover. In 2008 he represented the buyer or seller of almost every single troubled bank. As Treasury Secretary Hank Paulson later remarked: “Every time I looked up, it seemed like Rodge was in the room.”
That Cohen is basically saying the SEC are being muppets is therefore a pretty big deal.
After Cohen there are some more discussions about how important clarity is, that every relevant regulatory institution is brought into the process as quickly as possible, etc etc. Then Margaret Tahyar, a partner at Davis Polk, piles in to give the SEC another solid kick.
Just to be clear, to emphasise the point that Rodge made . . . Every single US experienced capital markets lawyer was surprised by the SEC interpretation.
So I think it’s important that this group — and certainly last year the international representatives — don’t think that we’re dealing with a binding law or a regulation. We are dealing with a position, that was suddenly taken, that was a surprise. So it should be able to be solved.
If that wasn’t enough, Jay Clayton — the former SEC chair — then also delivers a final stamp in the nether regions for the agency he used to lead.
I agree with what Meg said, and I agree with what Rodge said . . . This is a pretty easy one to provide guidance by the Commission . . . We’re in a new era, and whether it’s CoCos or something else, the capital markets are going to be part of any resolution. And we should resolve these issues of securities distribution now, not in the heat of the moment.
As FDIC chair Martin Gruenberg deadpanned at the end of the session:
If there was not a keen awareness before last year’s events of the critical role of securities regulation in these kinds of resolution situations, I think there’s a keen awareness now.
Errr yeah. Indeed.
You can watch the full thing here, but unless you’re REALLY into bank resolution it might put you to sleep (and give you nightmares about wipeout bonds). This discussions comes up around the 1h 50m mark.
*Sorry, obvious Stefan Walter is the CEO of Swiss regulator Finma, not the FDIC. The author just had the FDIC at the top of his mind when writing the post, but will now be punished by being forced to watch all the FDIC open meetings 2013-23.
Further reading:
– Credit Suisse CoCo Pops (Redbubble)
