Although the U.S. and global resolution framework remains at best uncertain, the strategic impact of the newly-aggressive U.S. approach is not in our view in doubt. We have thus issued an in-depth report that details what U.S. GSIBs now must do to pass muster and how this affects both their franchise value and that of the next waves of U.S. resolution-plan filers. Our key conclusions include:

  • Policy: The overall approach taken in these orders is a demand that BHCs manage all material operating entities – including but not limited to insured depositories – for resolvability, not profitability. Combined with the interaction of this requirement and others such as the CCAR mandate that lending continue unabated even under acute stress, GSIBs are essentially being transformed into new-style GSEs or de facto public utilities. The agencies may intend this to create a strong incentive short of statutory break-up mandates that nonetheless achieves the FRB’s goal of reducing GSIB systemic footprints, the FDIC’s demand that insured depositories be as resilient as possible, and that any lapses in the statutory resolution framework in the U.S. or key cross-border regimes are solved now by BHCs regardless of the prospects for remedies to come (if they do). Although GSIBs are the prime target of these mandates, we expect regional BHCs and large FBOs doing business in the U.S. to come under comparable scrutiny.
  • M&A: A major problem is that GSIBs were found not to have targeted feasible divestitures under stress conditions and not to have put in place operational steps (e.g., contractual rights to transfer assets, to redesign critical-services providers, to obtain regulatory approvals) to ensure that desired deals could in fact be executed. We believe much of what is needed to satisfy regulators will destroy value at affected activities and lead not only to ring-fencing, but also to pre-resolution divestitures that create significant M&A opportunities outside the sphere of entities subject to top-tier U.S. resolution standards. Targeted M&A by GSIBs and smaller BHCs is also possible where M&A targets are found with operational capability that can be leveraged by mergers with existing capacity or integrated with remaining BHC entities to add value.
  • Broker-Dealers: Several BHCs were sanctioned for the way broker-dealer activities are integrated with U.S. and offshore-branch banking. This synergy is critical to the GSIBs and, for Goldman Sachs and Morgan Stanley, essential to retain reasonable return at BHCs given that a return to their prior broker-dealer status is barred by the “Hotel California” provisions of Dodd-Frank. Charles Schwab will come under challenging scrutiny here as it enters the resolution-planning process and this could prove excruciating if FSOC turns to Nomura as a U.S. G-SIFI.
  • Asset Management: Inter-connectedness was also found wanting with regard to the integration of banking and asset management, with the regulators ordering restructuring actions that also undercut strategic assumptions on which many BHCs have based expanded operations in this capital-favored sector. Asset-transfer and other resolution issues are particularly thorny ones as well, with most BHCs sanctioned for failing to have put in place not only systems to ensure this, but also the agreements that make it possible. Several of these could create significant client-relationship problems unless or until the SEC adopts comparable standards across the sector.
  • Cross-Border: Most BHCs are sanctioned for failing to anticipate host-country demands for capital and liquidity ring-fencing under stress scenarios. Numerous other issues not yet resolved by global regulators are also cited throughout the orders, with U.S. GSIBs told essentially to plan for the worst and assume that global regulators will not cooperate to facilitate a home-country resolution, especially under bankruptcy.
  • Franchise Value: The policy issues above of course have far-reaching and largely adverse implications for GSIB and BHC franchise value. However, several details in the living-will determinations pose immediate challenges, especially in the context of CCAR and the TLAC proposal. This is particularly true for any BHC ordered to ensure that its lead bank remains well-capitalized throughout the resolution scenario that will combine with CCAR to pose a serious challenge to capital distributions. The cost of all the changes to shared services and inter-affiliate relationships is likely also to pose near-term problems for ongoing efforts to reduce operating costs to enhance earnings in compensation for the cost of higher regulatory requirements. BHCs are told in these orders to maximize resolvability, not efficiency, suggesting that many will need either to erect costly internal barriers or to divest those activities for which ready buyers (most likely non-banks) can be found. Formation of intermediate holding companies also poses various franchise-value challenges.    

Karen Petrou’s memo last week contrasted these orders with FDIC Chairman Gruenberg’s startling statement that U.S. BHCs now can be resolved either via bankruptcy or OLA. One wouldn’t have thought so from reading the orders and we doubt anything substantively will change as the agencies demand the remedies we described above despite Mr. Gruenberg’s optimism.