Recovery & Resolution:
Never too early to write a Living Will

“It is increasingly certain that the UK regulatory authorities will require financial services institutions to prepare more formal recovery plans to avoid fatalities. Institutions will also need highly detailed analysis to assist the authorities in developing resolution plans should the worst actually occur.”

The UK banking industry clearly faces uncertain times – about the general state of the economy and whether a recovery can be sustained, about whether retail and investment banking operations will be required to be separated and about the UK regulatory framework, following the abolition of the Financial Services Authority (FSA).

In this state of uncertainty, what can banks be sure of? Late in the 18th century, Benjamin Franklin said ‘nothing is certain but death and taxes’. Taxes are particularly poignant at the moment, given the need to reduce the UK’s fiscal deficit, the announcements in the June Emergency Budget and, in particular, the introduction of a bank levy from 2011.

Those of us working in financial services and banking certainly hope that, despite its challenges, the UK industry isn’t facing certain death. However, it is increasingly certain that the UK regulatory authorities will require financial services institutions to prepare more formal recovery plans to avoid fatalities. Institutions will also need highly detailed analysis to assist the authorities in developing resolution plans to facilitate what would happen should the worst actually occur.

These Recovery and Resolution Plans (RRPs) are commonly referred to as “living wills”. They are receiving increasingly widespread support from UK and international regulators, and the Financial Stability Board (FSB) is due to make further recommendations in preparation for the next G20 Summit of Global Leaders in Seoul in November when living wills are again on the agenda.

There are essentially two components to an RRP:
• a recovery plan to prolong the ability of a firm to continue in business; and
• a resolution plan to ensure an orderly workout should the recovery plan fail and to minimise systemic risk.

RECOVERY PLANS should cover both capital and liquidity and are likely to build on existing contingency capital and funding plans and scenarios identified in stress tests already formulated. The focus is to identify clear actions that a firm could take under severe strains (be they market-wide or idiosyncratic) but these actions are likely to have to be more radical than those previously identified in stress tests.

It is essential that firms not only identify potential actions but also analyse them in detail to prove, amongst other things, that the actions are credible and capable of execution within a reasonably short timeframe.

RESOLUTION PLANS will be prepared and owned by the regulatory authorities but firms will be required to provide significant amounts of data and perform detailed analysis to assist the authorities in producing these plans.

The complexity of many institutions and the fact that some of the necessary information and analysis is not produced in a normal “going concern” situation means that firms may not currently have this information readily available and collating it into a useful form, for a “going concern” scenario, is likely to be a highly onerous exercise. There are also no guarantees that, even with large amounts of planning, executing a resolution plan will be easy or without significant cost.

The FSA has said that it expects the requirement to produce RRPs to apply initially to all UK deposit takers (this is reinforced by the requirements of the Financial Services Act) and other systemically important firms. However, given the current popularity of the concept of RRPs and the fact they are a further tool available to help the regulatory authorities maintain financial stability, there is every likelihood that the concept may be extended to other regulated institutions.

There is no confirmed timeline for final implementation of the rules in the UK, but it is currently expected that the FSA will release detailed rules for consultation towards the end of this year.

Producing an RRP is obviously a big task. Some larger organisations have already commenced pilot projects and are working with the authorities to develop the draft regulatory rules. Some smaller organisations, or those who have not yet come into the focus of the regulators in this area, may be inclined to defer work, believing that there are more urgent regulatory demands and that it may be sensible to wait until the FSA has produced some more detailed proposed rules in a Consultation Paper.

However, it is likely to be advantageous to at least do some initial planning and it may pay to take certain initiatives in advance of the regulators. The authorities have stated that if living wills that are produced by institutions make apparent obstacles to resolution, steps will be taken to either restructure firms or require them to hold additional capital or liquidity buffers.

Firms will no doubt find that it is far better to be able to answer the questions when they are asked about how “recoverable” or “resolvable” their firm is and potentially mitigate the impact of additional capital or liquidity buffers, which can be very costly and quickly erode the profitability of certain business lines.

In summary, there will be real economic benefits of having an effective RRP and preparing early.

Nick Jacques is a director in Deloitte’s financial services team.

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