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Bank Resolution and Bail-ins inthe context of Bank Groups

Sea of ChangeRegulatory reforms to 2012 and beyond

What do we mean by “bail-in”? ..................................1

Bank groups considered as layer cakes......................2

Resolution at the group level.......................................3

Bank bail-in – Group issues ........................................5

The “Big bank” model.................................................6

The “Bank/nonbank” model ........................................7

The “global multi-bank” model. ...................................8

The “financial conglomerate”.......................................9

contents

Chris BatesPartnerT : +44 20 7006 1041E : [email protected]

London

Simon GleesonPartnerT : +44 20 7006 4979 E : [email protected]

1Bank Resolution and Bail-ins in the context of Bank Groups December 2011

© Clifford Chance LLP, December 2011

Bank Resolution and Bail-ins in thecontext of Bank GroupsMuch of the discussion about bank resolution is predicated on the basis of thesimplifying assumption that a bank is a single entity. In economic terms this isbroadly correct, but in legal terms it is clearly not. Most banks, and all systemicallyimportant banks, are groups of legal entities. In legal terms groups do not exist – itis only the companies which comprise the group which can enter into contracts,incur liabilities or fail. This is not, however the way that economists (or peoplegenerally) see the world. Businesses are generally thought of as single undertakings.Thus for a lawyer it makes perfect sense to talk of a group being partially insolvent,in that some of its components are insolvent whilst others are not. For non-lawyers,however, the concept is almost meaningless – it is like speaking of a human beingas being partly dead.

However, in the same way that it ispossible in emergencies to preserve thelife of a living organism by removing deadparts, it is possible in emergencies tosave parts of bank groups by allowingother parts to become insolvent. To pressthe analogy slightly further, the questionof whether this is possible or not ratherdepends on the functions of the partsbeing amputated. There are some partsof a group whose removal can beaccomplished without damaging thebusiness of the group as a whole; butthere are others whose removal entailsthe immediate and automatic extinctionof the entire organism. It is by no meansalways crystal clear which is which.

There is therefore no automatic answerto the question “what are we trying toresolve – the group or the bank?” - theonly meaningful answer is “it depends”.Consequently it is necessary to thinkabout bank resolution tools not only inthe context of individual undertakings,but also in the context of how thosetools could be applied to banksubsidiaries within a group, to parentcompanies of banks, and potentially tonon-bank subsidiaries of banks. This is adifficult piece of analysis. To complicate

matters further, bank groups are by nomeans uniform, and different bankmanagements have different strategiesas to how the economic activity of thebank should be reflected in the legalstructure of the group. This paper seeksto explore these issues.

What do we mean by “bail-in”?Much of the discussion concerning bail-in has been conducted on the basisthat bail-in is a separate legal processfrom resolution, and can be created by


Bank Resolution and Bail-ins in the context of Bank GroupsDecember 2011

2

different legal mechanisms. However,from the perspective of a seniorcreditor, it is immaterial to him whetherhis claim is reduced by the operation ofa write-down mechanism embedded inthe terms of the instrument creating thedebt, or is reduced by his being left in a“bad bank” out of which assets havebeen transferred. This note focuses onbail-in within resolution, and for thepurposes discussed herein, the legalmechanism which is used to producethis reduction in claims is immaterial.The issue which is addressed here iswhich creditors of which group entitiesshould have their claims reduced in thisway in what circumstances. For thesepurposes legal mechanism isimmaterial.

Bank groups considered aslayer cakesSlightly paradoxically, in order for alawyer to understand the practicalitiesof bank structure, the easiest mentalmodel is the Marxist model. Marxregarded society as composed of the“base” – the forces and relations ofproduction which constitute economicreality – and the “superstructure” -culture, institutions and social norms.Base determines superstructure, and afailure to perceive the realities of thebase constitutes false consciousness.Banks can usefully be considered usingthis paradigm. The “base” is the IT andmanagement systems and processeswhich conduct the banks day to daybusiness, whereas the “superstructure”is the legal construct which sits on topof the base. In analysing the bank itself,a focus on legal structures is a form offalse consciousness. In determiningwhether an entity can continue tofunction, what matters is not whetherthe legal entities are solvent on anaccounting basis, but whether the

underlying systems are continuing tooperate. The failure of Lehman BrothersInternational Europe provides a dramaticdemonstration of this proposition –when the systems stop working, theinstitution is finished, and the notionalsolvency or otherwise of the legalentities is a detail for historians ratherthan a material fact.

A simplified model of a conventionalbank group might be as follows

The key point here is that each of theselayers will be subdivided. Legalstructure will be subdivided intoindividual legal entities. IT Infrastructurewill be subdivided into different systems.Management structure will besubdivided into business areas. Thesesubdivisions are not necessarilycongruent with the subdivisions at otherlayers.

Sometimes one or more of these willconjoin. None of these processes aregenerally related to the others – banksdo not generally prioritise legalstructures when designing managementprocesses or IT systems, or ITfunctionality when designing tradebooking structures.

The effect of all this, however, is toexpose as an illusion the idea that

because business is conducted within aparticular legal subsidiary, it is thereforesegregated – or capable of being easilydivided from – the other activities of thegroup. A subsidiary is, in legal realistterms, simply a few lines in a companyregistry – the question of whether aparticular business can be separatedfrom and easily sold from a group ismuch more likely to be determined byits management and control structuresthan by the legal substructure of itscontracts.

The reason that this is important in theinternational context is that in mostsituations where banks operate throughdifferent national subsidiaries, it is highlylikely that their operational, paymentand functional activities will beconducted through a single bank-widesystem. Even in contexts where bankregulators have required nationalsubsidiarisation they have generally notgone so far as to require themaintenance of separate free-standingnational operational systems – generallybecause such a requirement would addsubstantially to the service costsincurred by national customersHowever, in the absence of such arequirement, the question of thepossible survivability of the nationalsubsidiary is a function of the continuingexistence of the underlying systems.This has a number of consequences.One is that if the architecture of thebank is such that the system concernedis effectively operated by the troubledinstitution, then the failure of thatinstitution will necessarily causecessation of operations throughout thegroup. In order to address this issuewithout fragmenting operationalsystems in a way which would createmassively increased costs, it is clearlynecessary to create some degree ofindependence for the function

IT Infrastructure

Management & Business Structure

Legal Structure



concerned. However, any significantreconstruction of bank systems wouldimpose costs which are very significanton banks, and such costs (payable asthey are out of profits) would directlyimpact capital levels and further inhibitbank’s ability to create credit.

Resolution at the grouplevelConsideration of the complexities ofdealing with group structures helps tomake clear why resolution throughdisposal of the entire undertaking of thefailed institution is always the preferredresolution option - private sale andtransfer to public ownership both havethe immense advantage of not requiringa detailed analysis of which liabilitiesand assets are in which subsidiary inwhich jurisdiction. It is therefore worthconsidering how bail-in fits in to thisstrong policy preference.

There is a reasonably clear decisionpath which faces a supervisorconfronting a troubled bank. The stepsare set out schematically below, but thelogic is perhaps easier to follow than theschema. In a perfect world an institutioncan be resolved by internal restructuring– liquidating some assets, withdrawingfrom certain lines of business, raisingcash and paying down debts. Howeverthe practicability of this course of actionis largely determined by the state of therest of the financial system – for aninstitution which has suffered anidiosyncratic shock in an otherwisebuoyant market sale or floatation maybe a practical proposition, but in adepressed or non-existent market this isunlikely to be an option.

The first recourse for an institutionwhich cannot resolve itself is to go tothe market to raise more capital – this

can be achieved either by placing newequity with market investors, or byengineering a purchase by a solventpurchaser. Again, this will be possiblefor some institutions in some contexts,but not for all in all.

At this point public intervention will berequired. This intervention can take anumber of forms. At its simplest, thisintervention is a reorganization process.This will involve the exercise of statutorypowers to divide up the institutionconcerned, generally into a “good”bank, which can be sold or floated anda “bad” bank. The proceeds of sale ofthe “good” bank will be used to reducethe losses of those creditors left in the“bad” bank. In extreme cases the

institution as a whole may be pastsaving and may have to be closed in itsentirety. However in any sufficiently largebank there should be sufficient assetsto enable the construction of a “good”bank of some size. Those creditors

whose claims are transferred to the“good” bank are effectively preferred toother creditors of the institution – ingeneral, retail deposits are protected inthis way. Once this has been done, the“bad” bank is run off.

This is the architecture which has beenused successfully in a number ofjurisdictions, and has been applied toinstitutions as large as Indymac andBradford & Bingley. It is robust, and (in

Institution restructuring

Market recapitalisation or market purchase

Privately fundedresolution through bail-in

Publicly funded recapitalisationthrough government bail-out

Break-up into good/bad bank structure

Sale of good bank Liquidation of bad bank

Public intervention



4

the US at least) has a long track recordof successful use with smallerinstitutions. The problem is that it is nota technique which has yet been usedfor the largest globally systemicallyimportant financial institutions (SIFIs).Opinions vary between those whobelieve that this technique could beapplied to the largest banks easily, andthose who fear that those banks are toocomplex to be resolvable in this waywithin the time available. The basis ofthe latter view is that global SIFIs are,by definition, massively multinational.Their activities, and their obligations, willbe governed by a number of differentlaws, and no one resolution authoritycan be given control of the entire group.Since global SIFIs generally take theform of complex groups, it is alsodoubtful that resolution techniqueswhich are effective when applied to asingle national entity would be equallyeffective when applied to a complexglobal group. In order to make suchresolution techniques fully effective on across-border basis, it will be necessaryfor jurisdictions to make progresstowards international agreement – andquite possible an internationalconvention – co-ordinating thejurisdiction of relevant resolutionauthorities. The IMF, the FSB and manycommentators have spoken in favour ofthis approach, but progress towards itis slow. In the absence of such anagreement, these conflicts of lawproblems provide another strongincentive for resolution to be addressedat the group level.

It is clear from the schematic diagramabove that the problem which is facedby public authorities is that once a bank

is in need of resolution, if conventionalresolution is not an effective solution,the only remaining alternative is publiclyfunded recapitalization – taxpayer-funded bail-out. It is clearly true that thisis by no means a bad thing. As LordTurner said in his Clare College speechin February 20111:

“…, the International Monetary Fund’s(IMF) estimates of the total direct cost ofpublic support during the crisis,published in June last year2, suggestthat on average it might amount to lessthan 3% of GDP. And latest estimatesfor the US suggest that it could still beless, indeed it could be negative, withthe public authorities making a profit,certainly in relation to the commercialbanks, if not in relation to Fannie Mae,Freddie Mac and AIG.”

This prediction seems even moreaccurate now than when it wasdelivered.

However, no matter how well thetaxpayer may end up doing out of bankbail-outs, it is important to understandthat the taxpayer at the moment has noappetite for them. At least somepoliticians are determined to ensure thatthey can never again be placed in theposition where they are obliged to dopolitically toxic bank bail-outs in order toavoid significant economic damage. Ifthis means breaking up the globalbanks into national ring-fenced localentities, that will be regarded by themas a price well worth paying – not leastbecause the political costs of foregoingfuture economic growth may be minimal– lost potential growth is, after all,invisible. Consequently, the challenge

which the industry faces is to create athird policy option which is credible andpracticable in a public interventioncontext, alongside efforts todemonstrate that conventionalresolution is possible through living wills.

Privately funded recapitalization is atechnique which has a surprisingly longhistory. Central banks have hadconsiderable experience over the yearswith a technique which involvesidentifying the largest creditors of thetroubled institution concerned, lockingthem in a room together, and explainingthat their mutual self-interest clearlyindicates their assembling a resolutionfund out of their own resources. Forexample, in the 1970s the Bank ofEngland dealt with the secondarybanking crisis by organizing a “lifeboat”amongst the major clearing bankswhich at its peak amounted to 40% oftheir capital, and in 1998 the Federalreserve facilitated the rescue of LTCMby a group of the largest UScommercial and investment banks.

The primary problem with this model ofprivately funded recapitalization is that itis more or less impossible to identifyevery significant creditor of a SIFI in anyreasonable timescale, and even harder topersuade them to agree amongstthemselves in the short period availableto those charged with resolving a bank.These issues are more acute where abank is significantly dependent on capitalmarkets funding with a dispersedbondholder group. Even within a small“lifeboat” group under great time pressurethe prisoners dilemma will arise, and, asthe Lehman experience shows,orchestrating all the parties towards a

1 http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2011/0218_at.shtml2 http://www.imf.org/external/np/g20/pdf/062710b.pdf



consensual solution in a weekendtimetable may just prove too challenging.

The obvious solution to this problem isto require at least some creditors of aninstitution to commit to contribute toprivately funded recapitalisation. Thiscould be accomplished by providing inthe terms of the agreement by whichthe creditor becomes a creditor that, inthe event of a recapitalization beingrequired, the amount due to him will bereduced by the amount of hiscontribution to the recapitalization inexchange for shares in the bank or bygiving the authorities statutory powersto achieve this result (or a “hybrid”combination of the two methods). Thisis the basis of the technique known as“bail-in”. It is by no means the onlymethod of approaching this problem,and it is entirely possible that othermechanisms may prove to be equally oreven more effective. However, for thereasons set out in our previous paper 3,we believe that the bail-in techniquerepresents the most legally efficaciousmechanism for ensuring private sectorparticipation in the refinancing of atroubled institution currently available toa multi-jurisdictional entity operatingwithin multiple legal regimes.

There is, however, one final point whichshould be made as regards the use ofthis technique. For any firm in anybusiness, a financial crisis can bedefined as the moment when it runs outof cash. Extinguishing liabilities, whilst

restoring balance sheet solvency, doesnot produce a penny of new cash. Abalance-sheet restructuring, therefore, isonly useful if it is sufficient to restorecredibility – and therefore access toliquidity - to the institution concerned. Aprivate recapitalization done using bail-in techniques will therefore involve asignificantly greater write-down ofcreditor assets than the amount whichwould be required if those creditorswere to agree to advance new moneyto the troubled institution. It may,therefore, be the case that the principaleffect of the possibility of a bail-in mightbe to resolve the prisoner’s dilemma4

and make it easier for central banks tocreate lifeboats. This would not be abad or an undesirable outcome.

Bank bail-in – Groupissues.Bank groups are protean – not only arethey very different one from another, butalso they may change significantly asthe business of the bank changes.Inconveniently for our purposes there isno such thing as a typical bank group.However, we begin by suggesting ataxonomy of bank groups which mayenable some progress to be made inanswering these questions.

We begin by dividing bank groups intofour broad classes. This is not ascientific classification, but is an attemptto create a basis for considering theissues.

3 Legal Aspects of Bank Bail-ins Clifford Chance 2011 ,at http://www.cliffordchance.com/publicationviews/publications/2011/05/legal_aspects_ofbankbail-ins.html4 Or, in technical terms, to restore Pareto optimality to the class of outcomes of individual choices

For the purposes of the examplesthat follow, we have divided creditorsinto three broad types:-

Banking creditors; meaning retailand wholesale depositors andcreditors arising out of the provisionby the bank of payment and custodyservices;

Investment Business creditors;meaning swap counterparties,trading counterparties, exchanges,clearing systems and otherinvestment business counterparties(including repo counterparties).

Financial creditors; meaning long-term creditors of the bank, includingbondholders and other long-termunsecured finance providers



6

1. The “Big bank” model

Here we see a more or less “empty”holding company holding a bank with alarge balance sheet. Assets not heldwithin the bank itself will generally beheld by subsidiaries of the bank. Fundingis likely to be raised primarily at the banklevel, since any funding raised at theholding company level is structurallysubordinated to funding raised at thebank level. In general the “big bank” islikely to do its derivatives, markets andtrading business out of the main legalentity, since this will be the mostcreditworthy member of the group andwill ensure that counterparties have thelowest risk exposure (and therefore thelowest costs of dealing with it). Acommon variant of this structure is wherethe bank itself is the holding company forthe group.

In the context of this institution twoissues arise. One is that it is very unlikely

that investment business creditors will be(or can be) included in the bail-inmechanism, and retail bank depositorscertainly will not be for policy reasons.The bail-in mechanism will therefore beapplied to non-retail banking creditors,and a question may be raised as towhether these form a sufficiently largepart of the exposures of the bank toenable an appropriately sizedrecapitalization. The answer to this is thatit is broadly up to the supervisors of thebank concerned to satisfy themselvesthat the bank does have sufficientliabilities of this kind – if the institutionseeks to reduce its quantum of bail-inable debts by migrating creditors to thestatus of investment business creditors,it should be free to do so, but theregulator should be expected to respondthat if the bank has insufficient bail-incapacity, its capital requirement will beincreased to cover the shortfall.

Mechanically, bailing in the big bankmodel is in some respects the easiestchallenge. If creditors are at the level ofthe bank, it is a relatively simple matterto extinguish their claims on the bankand issue them with new shares in thebank itself. This will have the effect of“crowding out” the holding by theexisting parent company, so the transferof the equity in the bailed-in bank to thebailed-in creditors should occur more orless automatically. Where the bank isitself the holding company (or wherethere are assets in the holding companywhich are valuable to the survival of thegroup), it will be necessary to “crowdout” the old shareholders at the top ofthe group.

Nonetheless this scenario is not entirelyfree from difficulty. First of all, thenumbers needed to “crowd out” the oldshareholders are eyewatering – if a bankhas 100m shares in issue, in order tocram down those shareholders to 1% ofthe new equity 9.9 billion new shareswould have to be issued (which raisestechnical issues in those jurisdictionswhich prohibit shares being issued at adiscount to par value). More importantly,it is generally regarded as important inany resolution that the interests of the“old” shareholders should be completelysubordinated to the interests of theproviders of the resolution funding – ifthe “old” shareholders are permitted tocontinue to maintain a substantialinterest in the future of the entity thiscreates the risk of perverse incentivesfor them in the period running up tocrisis5.

It seems likely that the easiest solutionto this problem would be that the

5 In particular, if the “old” shareholders can expect to participate in post-intervention gains they may obstruct new capital-raising by the institution concerned.

Bank Holding Company

Bank Group

Financial andBanking Creditors

Investment Business Creditors

Investment business

Bank

resolution authority for the bankconcerned should be given rights underthe applicable resolution regime tocancel the outstanding shares andextinguish the claims of theshareholders in the holding company (inconjunction with the issue of the newshares to the bailed-in creditors).Alternatively, the resolution authoritycould be given powers to acquire theshares of the existing shareholders andeither to cancel them (as a prelude tothe issue of new shares to the bailed-increidtors) or to transfer them to thebailed-in creditors.

If there are creditors of the holdingcompany, this poses several furtherdifficulties. Creditors of the holdingcompany have voluntarily accepted aposition where they are structurallysubordinated to creditors of the bank. Itis therefore highly arguable that suchcreditors should be bailed–in firstbefore direct creditors of the bank areaffected. However, if there areinsufficient of these creditors, the bail-inmay have to be extended to thecreditors of the bank. In thesecircumstances it is arguably clear thatcreditors of the holding companyshould be extinguished before creditorsof the bank are bailed-in at all, sincethis outcome best reflects thesubordination positions which theparties have voluntarily assumed.Where the bank creditors are beingcompensated with shares in the holdingcompany, then, if the counterfactual isthat (absent the bail-in) both the bankand the holding company would havegone into liquidation, it would benecessary to determine what (ifanything) the holding company and thebank creditors would have received inthat liquidation in order to determinehow to compensate them with equity inthe holding company while preserving

their relative liquidation priorities. This isstraightforward, if the claims of thebailed-in creditors of the holdingcompany would be worthless in aliquidation. It is more complex if there isvalue at the holding company level thatneeds to be reflected in the allocationof equity compensation for thecancellation or reduction of their claims.

2. The “Bank/nonbank”model.

Here we see a holding company whichowns a bank and a non-bankinvestment firm. These activities arelikely to be ring-fenced by locallegislation into a “bank chain” and a“non-bank chain”, with little interactionbetween the two sides of the groupbelow the level of the holding company.In this case it is more likely thatsignificant funds may have been raisedat the parent company level, sincelenders at that level will have access to alarger asset pool than lenders to thebank. It is also very likely that significantexternal debt will have been raised atthe bank level. Indeed, it is possible thatall three components – the bank, theinvestment firm and the holdingcompany – may have raised senior debt.

We need to begin with a hypothesis asto where in the group the loss has beenincurred. For the purposes of this paperwe will assume that the loss has beenincurred in the banking part of thegroup.

At the level of the bank itself, the issueshere are no different from the “big bank”model. Considering the position of theinvestment firm immediately raises the“dead in parts” problem. It should be

remembered that in this context it ishighly likely that the bank and theinvestment firm will share the samebranding, the same advertisingcampaign and the same IT, processingand payment systems. As a result, itmay well be the case that the survival ofthe brokerage will be entirely dependenton the survival of the bank. Clearly, ifthe bail-in can be conducted entirely atthe group level that is likely to be theoptimal solution. However, if that is notthe case, then there may well be scopefor the creditors of the bank to arguethat they are incurring a cost in respectof which the creditors of the investmentfirm are beneficiaries, even thoughthose creditors are not paying for thatbenefit. This point becomes moredifficult still if there are insufficient



Investment Group

Financial Creditors

InvestmentBusinessCreditors

FinancialandBankingCreditors

Bank Group

Holding Company

Investment firmBank


8

creditors of the bank capable of beingbailed-in, since in that case it willbecome necessary to consider whethercreditors of the investment firm shouldbe bailed-in in order to resolve the bankif that is in fact the only way ofpreserving the investment firm.

3. The “global multi-bank”model.

Here a more or less empty holdingcompany owns a number of banks –generally incorporated in differentjurisdictions and subject to somedegree of restrictions on theirinterconnection. In this case it is likelythat at least some debt has been raisedat the holding company level, althoughit is likely that some (but perhaps not all)of the subsidiary banks will also haveraised external financial debt.

Bailing in the global multi-bank is moreinteresting that the previous cases. The

architecture of the global multi-bank isgenerally in response to pressures fromnational regulators who require nationalbusiness to be undertaken byseparately capitalized local subsidiaries.Since we have hypothesized that theholding company is “empty” (i.e. has noeconomic activity of its own) , it mustfollow that the loss causing the crisismust have been experienced in one or

other of the bank subsidiaries. At theholding company level, the effect of abail-in is therefore to raise new equitywhich can be employed to create newequity into the bank which has sufferedthe loss by forgiving intra-group debtsowed by the subsidiary to the holdingcompany in respect of fundingpreviously received. However, if there isinsufficient debt at the holding companyand in the troubled subsidiary bank (orinsufficient intra-group debts to beforgiven), there could in extremis arisethe possibility of bailing-in creditors of

solvent bank group members in order toresolution the troubled bank.

The permutations in this regard arecomplex and difficult. Considering thegroup above; if Bank A gets into troubleand its own bail-in capital is insufficientto get it out again, should the bail-in-able creditors of Bank B be called on? Ifthey are, how does the capital gettransferred from Bank B to Bank A?What if Bank C (which has no bail-in-able debt) gets into difficulties - shouldbail-in creditors of Banks A or B bebailed-in to resolve it? To complicatematters further, if the bail-in of bank Aresults in majority control of bank Abeing transferred to the bailed-increditors of Bank A, those creditors maytake advantage of their status ascontroller of the bank to restrain thenew capital thus created from beingtransferred elsewhere within the group.

This will require a good deal of goodwillbetween the resolution authorities in thevarious jurisdictions – a commoditywhich tends to be in short supply inthese situations.



Banking Creditors

Bank (Country B)

Bank (Country C)

Bank (Country A)

Banking Creditors

Financial Creditors

Bank Holding Company

Bank (Country D)


4. The “financialconglomerate”.

Here an insurance company owns thebank parent.

In the context of the financialconglomerate, analysis tends to run intothe sands. If the parent of the bank is aregulated entity it is highly unlikely thatthe creditors of that regulated entity willbe permitted to be bailed in in order toresolve the bank. This may be felt to bereasonable, in that even if the parenthas provided equity to acquire the bank,it is most unlikely that it will have raisedand downstreamed funding. Thus insuch cases we might hope to find thatthe senior funding of the bank had beenraised primarily within the bank itself,and if this does indeed turn out to bethe case then the outcome will besimilar to the “big bank” situation.

It is clear that these are no more thanillustrations of broad classes of groupstructures, and it should also be clearthat in each case the theoreticaldeployment of exposures would bedependent primarily on the type and

volume of funding raised at each stagewithin the group.

Transmission of capitalwithin groupsA further problem potentially ariseswithin groups as regards thetransmission of capital. In general,where a member of a group has surpluscapital, if another member of the groupis in need of capital, a number ofmechanisms exist for transferring thatcapital within the group.

At its simplest, the transferring entitycan subscribe for new shares in thetransferee entity. However, this isgenerally not permitted where capital isto be transmitted upwards, sincesubsidiaries generally cannot buy sharesin their own parent. Alternativemechanisms exist - the entity which isin surplus can pay its extra capital upthe chain in the form of dividends until itreaches the group holding company, atwhich point it can be downstreamed


Investment BusinessCreditors


Financial andInsuranceCreditors

Investment firm Bank

Insurance Company


again to the entity which is short ofcapital. Between subsidiariessubscription is possible but can createcomplexities where subsidiaries of acommon holding company havecrossholdings in each other.

An alternative is the indirect creation ofcapital by the forgiveness of intra-groupdebt. This is an effective mechanism(cancellation of debt results in anautomatic increase in shareholdersfunds), but relies on there beingforgivable debt in place, and on thedirectors of the company which is toforgive the debt being confident that the“giving away” of a company asset iswithin their powers and duties.

Another alternative is the capitalcontribution – a straightforward gift ofmoney between one company andanother – although there are sometimesaccounting difficulties with havingcapital contributions recognized ascapital.

In practice there are a host of tax,accounting and regulatory rules whichan inhibit the use of any of thesemechanisms. These rules are difficultenough in one jurisdiction, but rapidlybecome a major obstacle whentransfers between a number of differentjurisdictions are involved.

Plan “B” for “Balkanisation”?At the outset of this note we ventured thehypothesis that the industry fails todevelop a plausible mechanism forensuring that private funding is availableto finance bank resolution, a likelygovernmental response may be to movetowards breaking up the global banksinto national ring-fenced local entities,and that the loss of economic growthresulting from that development would beregarded as – politically - as a price wellworth paying to avoid the risk of beingforced into further taxpayer-funded bail-outs. Although we are optimistic that thiscan be achieved, we must contemplatethe possibility that it may not be.



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Clifford Chance LLP is a limited liability partnership registered in England andWales under number OC323571.

Registered office: 10 Upper Bank Street, London, E14 5JJ.

We use the word ‘partner’ to refer to a member of Clifford Chance LLP, or anemployee or consultant with equivalent standing and qualifications.

This publication does not necessarily deal with every important topic nor coverevery aspect of the topics with which it deals. It is not designed to provide legal orother advice.

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