The Dodd Frank Act - Title II: Orderly Liquidation (Part 2 of 2)
In Part 1 of Title 1 - Orderly Liquidation, we provided an overview of the Title I. In this article, we will discuss in detail the important provisions of this title.
Mandatory terms and conditions for all orderly Liquidation actions
In taking action under this title, the Corporation shall—
- determine that such action is necessary for purposes of the financial stability of the United States, and not for the purpose of preserving the covered financial company;
- ensure that the shareholders of a covered financial company do not receive payment until after all other claims and the Fund are fully paid;
- ensure that unsecured creditors bear losses
- ensure that management responsible for the failed condition of the covered financial company is removed (if such management has not already been removed at the time at which the Corporation is appointed receiver);
- ensure that the members of the board of directors (or body performing similar functions) responsible for the failed condition of the covered financial company are removed the Corporation is appointed as receiver; and does not take an equity interest in or become a shareholder of any covered financial company or any covered subsidiary.
The Liquidation process involves determining if the financial entity is cause for systemic failure. If yes, the Corporation takes over. A fund is instituted for liquidation. An interim board is constituted to settle all claims in a specific order. The company can go for appeal against liquidation if it so desires, citing reasons.
The orderly liquidation plan will take into account actions to avoid or mitigate potential adverse effects on low income ,minority, or underserved communities affected by the failure of the covered financial company, and ll provide for coordination with the primary financial regulatory agencies, as appropriate, to ensure that such actions are taken.
A Three-Tiered Funding Mechanism
Allows the FDIC to borrow from Treasury (up to the Maximum Obligation Limitation, which is generally 90 percent of covered financial company assets) to fund the operations of a receivership or bridge financial company.
If receivership assets are not sufficient to repay Treasury borrowings, requires the FDIC to "clawback" funds from creditors who received higher payments than other similarly situated creditors (except when payment was for operations essential to the receivership or bridge financial company).
If the "clawback" is not sufficient to repay Treasury, requires the FDIC to charge risk-based assessments on "eligible financial companies" (BHCs with consolidated assets of $50 billion or more and any nonbank financial company supervised by the FRB) and any nonbank financial company with assets of $50 billion or more.
Mandatory repayment plan
No amount authorized under may be provided by the Secretary to the Corporation unless an agreement is in effect between the Secretary and the Corporation that—
- provides a specific plan and schedule to achieve the repayment of the outstanding amount of any borrowing
- demonstrates that income to the Corporation from the liquidated assets of the covered financial company and assessments under subsection will be sufficient to amortize the outstanding balance within the period established in the repayment schedule and pay the interest accruing on such balance within the time provided in subsection.
The Title aims at preventing conflict of interest. In the event that the Corporation is appointed receiver for more than 1 covered financial company or is appointed receiver for a covered financial company and receiver for any insured depository institution that is an affiliate of such covered financial company, the Corporation shall take appropriate action, as necessary to avoid any conflicts of interest that may arise in connection with multiple receiverships.
Prohibition on taxpayer funding
- Liquidation required.—All financial companies put into receivership under this title shall be liquidated. No taxpayer funds shall be used to prevent the liquidation of any financial company under this title.
- Recovery of funds.—All funds expended in the liquidation of a financial company under this title shall be recovered from the disposition of assets of such financial company, or shall be the responsibility of the financial sector, through assessments.
- No losses to taxpayers.—Taxpayers shall bear no losses from the exercise of any authority under this title.
Study on secured creditor haircuts
The Council will conduct a study evaluating the importance of maximizing United States taxpayer protections and promoting market discipline with respect to the treatment of fully secured creditors in the utilization of the orderly liquidation authority authorized by this Act.
- The study will aim not to be prejudicial to current or past laws or regulations with respect to secured creditor treatment in a resolution process;
- study the similarities and differences between the resolution mechanisms authorized by the Bankruptcy Code, the Federal Deposit Insurance Corporation Improvement Act of 1991, and the orderly liquidation authority authorized by this Act;
- determine how various secured creditors are treated in such resolution mechanisms and examine how a haircut (of various degrees) on secured creditors could improve market discipline and protect taxpayers;
- compare the benefits and dynamics of prudent lending practices by depository institutions in secured loans for consumers and small businesses to the lending practices of secured creditors to large, interconnected financial firms;
- consider whether credit differs according to different types of collateral and different terms and timing of the extension of credit;
- include an examination of stakeholders who were unsecured or under-collateralized and seek collateral when a firm is failing, and the impact that such behavior has on financial stability and an orderly resolution that protects taxpayers if the firm fails.
The Council will present the findings of the study to Congress within a year.
The Title also aims to study non-banking financial institutions. The study will try to understand the level of current international co-ordination .It will also attempt to understand the barriers to such co-operation and methods to improve current mechanisims. This report is to be presented to Congress no later than a year of enactment of this Act.